THREE PERSPECTIVES

COMMENTS ON RTO MARKET DESIGN AND PRICING

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SPONSORED BY THE COMPETE COALITION

MARCH 3, 2009 WEBEX SEMINAR PARTICIPANTS

– ROSS BALDICK – ROY SHANKER– ROBERT STODDARD

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RTO MARKET DESIGNS UNDER FIRE

CONTINUING CRITICISMS OF RTO “DAY 2” MARKET DESIGNS

COMPLAINTS THAT SINGLE CLEARING PRICE MARKETS ARE RAISING PRICES AND INEFFICIENT

COMPLAINTS THAT SUCH MARKETS DON’T SUPPORT LONG TERM CONTRACTS, AND SUCH CONTRACTS ARE NECESSARY FOR NEW ENTRY

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THREE PERSPECTIVES ON THESE CRITICISMS

CRITICISMS ARE SIMPLY NOT VALID NEW STUDY BY DR. BALDICK

EXPLAINING THE VALIDITY AND IMPORTANCE OF SINGLE CLEARING PRICE MARKET DESIGN FOR ELECTRIC MARKETS

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THREE PERSPECTIVES ON THESE CRITICISMS

CRITICISMS ARE INVALID RECENT COMMENTS BY DR. SHANKER

THAT THESE CRITICISMS ARE MORE ABOUT REGRETS REGARDING HISTORIC BUSINESS DECISIONS THAN MARKET DESIGN

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THREE PERSPECTIVES ON THESE CRITICISMS

CRITICISMS ARE INVALID NEW STUDY BY DR. STODDARD AND

CHARLES RIVER ASSOCIATES (CRA) EXPLAINING THAT IN SIMILARLY SITUATED INDUSTRIES THE LACK OF LONG-TERM CONTRACTS IS COMMON, AND NOT A BARRIER TO NEW ENTRY

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PRESENTERS

Ross Baldick - Department of Electrical and Computer Engineering, The University of Texas at Austin

Roy Shanker - Independent Consultant Robert Stoddard -Vice President CRA

International, Head of the Regulation & Litigation

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Ross Baldick

Single Clearing Price in Electricity Markets

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Electricity market auctions.

Single clearing price rule:– All energy is sold at one single price, the market-

clearing price.– The offer price of the highest accepted offer in the

market (ignoring demand bids and transmission constraints).

Maximizes the gains of trade between sellers and buyers:– Given that offers and bids reflect valuations.

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Coordination of electricity.

Electricity needs central coordination to match supply to demand:– Due to lack of stock-piles of electricity,– Central coordination is necessary in any market design.

By design, the single clearing price auction coordinates so as to maximize gains of trade.

Alternative market designs:– Would still need coordination of supply and demand,

but– Might not maximize gains of trade.

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The law of one price.

In any market, natural forces of supply and demand encourage the formation of a single price.

In electricity, this price formation is done explicitly in the auction.

But for any commodity (aluminum, oil, etc):– The “law of one price” dictates that in the same market

at any time, there is only one price for that commodity,– True whether or not there is central coordination.

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Other markets with an explicit single price rule.

Opening and closing prices on stock exchanges,

U.S. Treasury securities, Regional Greenhouse Gas Initiative.

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“Pay-as-bid” as an alternative rule.

Sellers receive their offer price, instead of the single market-clearing price.

Proponents suggest that prices would decrease:– Rests on naïve, false expectation that sellers would

keep their offers the same!

Theoretical, experimental economics, and empirical evidence does not support a change to pay-as-bid from perspective of prices.

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“Pay-as-bid” as an alternative rule.

Pay-as-bid would not significantly reduce prices and might increase prices.

Pay-as-bid has significant disadvantages:– Gains from trade may not be maximized,– Bias against small market entrants,– Difficulties with market monitoring.

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Summary

Electricity supply must be coordinated with demand. The single market-clearing price has substantial

benefits in electricity markets. Alternatives, such as pay-as-bid, will not improve

performance of electricity markets and can worsen performance of the market.

Single clearing price auction is the efficient coordination mechanism.

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Roy J. Shanker Ph.D.

MARKET MISPERCEPTIONSAND

REGRETS ABOUT PAST BUSINESS DECISIONS

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Criticisms of RTO Markets

Most confuse two basic issues:– Misconceptions about market mechanisms– Historic business decisions which parties now

regret When the two are separated, it is clear that

RTO pricing is working in efficient manner for energy and capacity

When the two are separated it is clear that prices are not “wrong” or “too high”

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Market Mechanisms

Advantages of single clearing price mechanisms for energy and capacity– See Baldick discussion and my paper

Misconceptions about alternatives– Pay as bid-typically ignores adaptive behavior– Result is inefficient guess at clearing price and

increase in price– Need to guess makes it impossible to distinguish

between “bad guess” and economic withholding

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Historic “Bad” Decisions-1

In restructuring basic “deal” was settlement of stranded costs and exchange of generation assets in return for price freezes.

Key element in valuation of assets and stranded costs was forecast of future energy and capacity markets

The higher the forecast, the higher the value, the lower the stranded costs, the higher the value received by consumers for assets

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Historic “Bad” Decisions-2

Complaints about high prices typically are really complaints about this historic business deal

– Price freezes weren’t long enough or too high– Parties failed hedge their costs after the expiration of the freezes

Typically because “right prices” for hedges were higher than artificially low frozen rates

Complaints really reflect the end of the freezes and these bad decisions

– Many of the complaints come from parties that Didn’t even pay stranded costs Got the benefits of the freezes Chose not to hedge

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Historic “Bad” Decisions-3

Empirical evidence by PJM Market Monitor shows legitimate long term hedge prices were much higher than market prices (energy and capacity)

Obviously higher than even lower frozen rates

Lack of hedging is conscious decision in face of these rates

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Historic “Bad” Decisions-4

Actual review of restructuring data confirms this picture-particularly for capacity pricing where criticism has been most pronounced

Industrial customers forecast significantly higher prices for capacity than have actually occurred over last decade in PJM

Latest results show these consumer forecasts were over 80% higher than last PJM auction. (See paper for tables)

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Historic “Bad” Decisions-5

Basic Story– Generation assets sold in exchange for frozen rates– Consumers forecast high future rates to increase the sales

price, but then failed to hedge based on their own information

– Spot prices and frozen prices both have been below legitimate long term contract rates

– As freezes disappear, complaints about market design really are about these business decisions

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