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Sunday, August 5, 2012

Wholesale Electricity Markets

Once generated, electricity must be able to instantaneously find an end use. The precise balancing act between creating electricity and getting it to the end user requires the ultimate just-in-time market.

Regulatory market to create competition can also hamper smart grid development. The rules force separation of supply, wholesale transmission, and retail distribution functions. But all those areas need to coordinate to optimize smart grid planning and data usage.

Markets Domain - The National Institute of Standards and Technology released a common semantic model for the Smart Grid in June 2009 - NIST worked with the appropriate standards development organizations to form a common representation of information models for the smart grid

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Back to Markets & Pricing Index
1. Grid Background
2. Market Background
3. Acronyms/Definitions
4. Business Case
5. Benefits
6. Risks/Issues
7. Case Studies
8. Success Criteria
9. Companies
10. Next Steps
11. Links

1.Grid Background
  • Electricity is by its nature difficult to store and has to be available on demand. Consequently, unlike other products, it normally isn’t possible to keep it in stock, ration it or have customers queue for it. Complicating matters even more, demand and supply vary continuously.
  • There is a physical requirement for the transmission system operator, to coordinate the dispatch of generating units to meet the expected demand of the system across the transmission grid. If there is a mismatch between supply and demand, the generators speed up or slow down causing the system frequency to increase or decrease. If the frequency falls outside a predetermined range the system operator will act to add or remove either generation or load.
  • Supply is becoming less schedulable, less dispatchable, less firm and more distributed due to increasing penetration of variable resources.
  • Loads are becoming less predictable, more dispatchable due to demand response and storage, more price-sensitive due to usage and price data becoming more available and dynamic tariffs and more temperature sensitive due to population moving to hotter areas and the increase in home size.

2. Market Background
  • Electricity market restructuring emphasizes the potential for competition in generation and retail services, with operation of transmission and distribution wires as a monopoly. Network interactions complicate the design of the institutions and pricing arrangements for open access to the wires. The design of the institutions for the wholesale market can accommodate access for both wholesale and retail competition while recognizing the special requirements of reliability in the transmission grid.
  • Wholesale electricity market exists when competing generators offer their electricity output to retailers. The retailers then re-price the electricity and take it to market, in a classic example of the middle man scenario. While wholesale pricing use to be the exclusive domain of the large retail suppliers, more and more markets like New England are beginning to open up to the end users.

Normal Electric Transfers between NERC Regions

3. Acronyms/Definitions
  1. Aggregator - A company joining two or more customers, other than municipalities and political subdivision corporations, into a single purchasing unit to negotiate the purchase of electricity from retail electric providers. Aggregators may not sell or take title to electricity. Retail electric providers are not aggregators.

  2. ATC - Available Transfer Capability calculation - The transfer capability remaining on a transmission provider’s transmission system that is available for further commercial activity over and above already committed uses.

  3. Bundled Transaction/Unbundled Electricity Service - In a bundled transaction, retail consumers pay one price that includes transmission, distribution, and generation. In unbundled electricity service, states have restructured, and consumers are billed for separate transmission, distribution, and generation charges. On March 4, 2002, the U.S. Supreme Court ruled in favor of FERC and held that FERC has jurisdiction over transmission, including unbundled retail transactions.

  4. Congestion Rental – The difference between the higher and lower cost of generation net of marginal losses when congestion causes a higher cost generator to be sourced. Limitations in the transmission grid in the short run may constrain long-distance movement of power and thereby impose a higher marginal cost in certain locations. In the simplest case, power will flow over the transmission line from the low cost to the high cost location. If this line has a limit, then in periods of high demand not all the power that could be generated in the low cost region could be used, and some of the cheap plants would be "constrained off." In this case, the demand would be met by higher cost plants that, absent the constraint, would not run, but due to transmission congestion would be then "constrained off".

  5. Economic Dispatch – Takes account of transmission losses to adjust market prices. The laws of physics determine how electricity flows through an electricity network. The extent of electricity lost in transmission and the level of congestion on any particular branch of the network will influence the economic dispatch of generation units. Incorporating these losses yields different marginal costs and different prices, depending on location, but the basic market model and its operation in the short-run is preserved.

  6. EWG's - Exempt Wholesale Generators - Created by EPACT92, EWG's are not considered utilities. EWG's, also referred to as merchant generators, were intended to create a competitive wholesale electric generation sector. In addition, EPACT92 provided a means for these non-utility generators to have access to the transmission system.

  7. Dispatability - The ability of a given power source to increase and/or decrease output quickly on demand. The concept is distinct from intermittency; and is one of several ways grid operators match output (supply) to system demand.

  8. Electricity Derivatives - Most major grids have markets for electricity futures and options, which are actively traded.

  9. EPACT - Energy Policy Act of 1992 - 14 years after PURPA, again in an era of concern about the nation’s dependence on imported fuels, Congress passed the EPACT. It required that competitive generators or any utility be given access to the utilities’ transmission grid on rates and terms that were comparable to those that the utility would charge itself for access to the grid. This access to the transmission grid became indispensable to the growth of wholesale power markets, whereby power generators can use the transmission system to send power to one another at fair and predictable rates and terms.

    EPACT92 effectively deregulated wholesale generation by creating a class of generators that were able to locate beyond a typical service territory with open access to the existing transmission system. The resulting competitive market encouraged wholesale, interstate power transfers across a system that was designed to protect local reliability, not bulk power transfers.

  10. EPACT05 - Energy Policy Act of 2005 (P.L. 109-58) set in place government activities intended to relieve congestion on the transmission system. The law creates an electric reliability organization that is to enforce mandatory reliability standards for the bulk-power system. In addition, processes are established to streamline the sitingof transmission facilities.

  11. ERO - Electric Reliability Organization - Created by Title XII of EPACT05 to enforce mandatory reliability standards for the bulkpower system. These standards are necessary for reliable operation of the grid. The Federal Energy Regulatory Commission (FERC) approved the North American Electric Reliability Corporation, a wholly owned subsidiary of the North American Electric Reliability Council (NERC), as the ERO. NERC is a nonprofit corporation whose membership is composed of the eight regional reliability councils. FERC will be reviewing the ERO’s proposed reliability standards before granting its approval. Under this title, the ERO could impose penalties on a user, owner, or operator of the bulk-power system that violates any FERC-approved reliability standard.

  12. Federal Energy Regulatory Commission Orders - Since the mid-1990s, the Federal Energy Regulatory Commission (FERC) has issued several orders to carry out the goals of EPACT.

    1. FERC Order 719 - October 2008. In order to further eliminate barriers to demand response and encourage the use of market prices to elicit demand response, FERC requires that ISOs and RTOs comply with the following requirements:
      • Accept bids from demand response resources in their competitively bid markets for certain ancillary services, comparable to any other resource.
      • Eliminate, during a system emergency, a charge to a buyer in the energy market for taking less electric energy in the real-time market than purchased in the day-ahead market.
      • Unless prohibited by the relevant regulatory authority, permit an aggregator of retail customers, as long as it meets the same requirements as other demand response bidders, to bid demand response on behalf of retail customers directly into the organized energy market, which would allow small retail loads that otherwise could not participate on an individual basis to participate in the markets by pooling their loads together
      • Modify their market rules, as necessary, to allow the market-clearing price, during periods of operating reserve shortage, to reach a level that rebalances supply and demand so as to maintain reliability while providing sufficient provisions for mitigating market power; and
      • Study and report whether further reforms are necessary to eliminate barriers to demand response in organized markets.

    2. FERC Order 888 detailed how transmission owners should charge for use of their lines and the terms under which they should give others access to their lines. Order 888 also required utilities to functionally unbundle their transmission and generation businesses and to follow a corporate code of conduct. FERC hoped that this separation would make it impossible for the transmission business to give its own power plants preferential access to the company’s transmission lines.

      In practice, this means that a utility’s generation and transmission operations must be conducted separately, without the sharing of resources, books, and records. Some states that have opened their retail markets to competition, including California, have required utilities to divest of either transmission and distribution or of generation.

    3. FERC Order 889 created an on-line system through which transmission owners could post the available capacity on their lines and the companies that wanted to use the system to ship power could observe the available capacity.

    4. FERC Order 890 - Preventing Undue Discrimination Preference in Transmission Service - Issued in February 2007. The final Order reflected much of what was addressed in the 2006 NOPR (Notice of Proposed Rulemaking), including calculations of available transfer capability, coordination of the transmission planning process, establishing requirement for conditional firm long-term point-point service contracts, reforming nergy and generator imbalance charges, and increasing the transparency of the existing pro forma OATT (Open-Access Transmission Tariff).

    5. FERC Order 679 - Issued in July 2006 to encourage investment in transmission by promoting Transmission Investment through Pricing Reform. The order identifies specific incentives that FERC will allow, but the burden remains on an applicant to justify the incentives.

    6. FERC Order 2000 encouraged transmission-owning utilities to form regional transmission organizations (RTOs). FERC did not require utilities to join RTOs; instead, it asked that the RTOs meet minimum conditions, such as an independent board of directors. FERC gave these regional organizations the task of developing regional transmission plans and pricing structures that would promote competition in wholesale power markets, using the transmission system as a highway for that wholesale commerce.

    7. FERC Order 2003-A - Issued in 2004 which requires transmission owners to interconnect new generators of larger than 20 megawatts to their grid. Order 2003-A required the transmission owners to connect these large generators under a standard set of terms and conditions and to follow a standard process and timeline for interconnecting them. Sometimes new power plants add new stresses to the power grid. Transmission owners need to upgrade the transmission grid when this happens. Order 2003-A defines who pays for these upgrades.

  13. Forward Markets - Electricity retailers, market and generators, can protect themselves from price and volume volatility, by entering into "hedge contracts" with each other. The structure of these contracts varies by regional market due to different conventions and market structures. Many hedging arrangements, such as swing contracts, Virtual Bidding, Financial Transmission Rights, call options and put options are traded in sophisticated electricity markets. In general they are designed to transfer financial risks between participants.

  14. IPP – Independent Power Producer –Produce and sell electricity on the wholesale market at market-based rates, and do not have franchised service territories. Most are designated as exempt wholesale generators, which relieves them of many of the regulatory requirements applicable to traditional utilities subject to FERC regulation. Allowed fair access to transmission system by FERC Orders 888 and 889.

  15. ISO - Independent System Operator - In a deregulated marked, although utilities retain the ownership of transmission lines, they no longer control access to them. This responsibility has been transferred to a non-profit organization called an "Independent System Operator" which controls transmission of all electricity in the region.

    An RTO or ISO is defined as an electric utility regulated by FERC, and most are non-profit. It is
    funded by a grid management charge approved by FERC and paid by generators and load serving entities within the RTO/ISO’s balancing authority. It operates the electric transmission acilities under its authority in compliance with NERC approved mandatory reliability standards. In so doing, it provides nondiscriminatory access to transmission services for all qualified market participants.

    Historically, some RTO/ISOs evolved from power pools, for example PJM, while others were created by state legislation which also mandated electric industry restructuring, for example CAISO, or through other voluntary associations, such as the Midwest ISO.

    An RTO/ISO designs and administers within its balancing authority several types of auction markets, including day-ahead and real-time wholesale spot markets (including five minute dispatch) for electric energy and ancillary services, and forward markets for financial transmission rights; several also operate forward markets for capacity. These markets are characterized by transparent prices and have both ex ante and ex post rules that support workably competitive market outcomes.

    Source: EPRI

    Importantly, both the RTO/ISO market operators and its market monitors (which may be internal
    or external or both) evaluate performance of its wholesale power markets, reporting evidence of
    possible manipulative behavior to its management and/or directly to FERC. In collaboration with its market participants and other transmission project developers, an RTO/ISO also proactively plans for transmission expansion and improvement projects to increase reliability of transmission service, reduce grid operating costs by relieving transmission congestion, and to facilitate achievement of state and (potentially) federal energy/climate policy goals.

    Texas has ERCOT, which while not officially an ISO for the most part performs the same functions.

    As of 21 December 2010, there are thirteen regional power markets North America:
    1. California ISO (CAISO)
    2. Midwest (MISO) Carmel, Indiana - MISO operates one of the world’s largest real-time energy markets and has 93,600 miles of transmission lines under its direction.
    3. New England (ISO-NE) -  Responsible for reliably operating New England's 32,000-megawatt bulk electric power generation and transmission system.
    4. New York Independent System Operator (NYISO) - Operates New York's bulk electricity grid, administers the state's wholesale electricity markets, and provides comprehensive reliability planning for the state's bulk electricity system. A not-for-profit corporation, the NYISO began operating in 1999.
    5. Northwest RTO (Proposed) - 
      1. ColumbiaGrid - Provides single-utility based transmission planning for the combined network of its participating utilities/.  A nonprofit corporation, is not a regional transmission organization (RTO) and has no plans to become one, but instead seeks to achieve many of the benefits of an RTO through incremental additions to its functions. ColumbiaGrid was formed after some of its members chose not to continue in efforts to form Grid West, a Northwest evolutionary structure with the ability to add functions and to move toward independent grid management. The ColumbiaGrid members, including the Bonneville Power Administration, several Washington State public utilities and two investor-owned utilities, wanted an organization with more limited functions and no independent ability to change.
      2. Northern Tier Transmission Group - The former Grid West participants who had argued for an eventual RTO, mainly investor-owned utilities and state representatives from Oregon, Idaho, Montana, Wyoming and Utah, formed the Northern Tier Transmission Group (NTTG), a nascent effort open to evolution but initially focused on inexpensive and relatively easy improvements to grid management.
    6. PJM Interconnection - Serving all or parts of Delaware, Illinois, Indiana, Kentucky, Maryland, Michigan, New Jersey,North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia. PJM, headquartered in Valley Forge, Pennsylvania, is currently the world's largest competitive wholesale electricity market.  More than 650 companies are members of PJM, which serves 51 million customers and has 167 gigawatts of generating capacity. With 1,325 generation sources, 56,000 miles of transmission lines and 6,038 transmission substations, PJM delivered 682 terawatt-hours of electricity in 2009.
    7. Southeast (No ISO)
      Southeast Electric Region
    8. Southwest (No ISO)
      2007 Southwest Electric Regions
    9. SPP (No ISO)
      2007 Southwest Power Pool (SPP) Regions
    10.  Texas Electric Reliability Council of Texas (ERCOT)
    11. Alberta Electric System Operator (AESO)
    12. Independent Electricity System Operator (IESO), operates the Hydro One transmission grid for Ontario, Canada
    13. New Brunswick System Operator
  16. Loop Flow – Event though some buyers and sellers sign bilateral contracts for a certain amount of transmission capacity to deliver specific quantities of power at specific times, the power at any given moment will actually travel over the network’s path of least resistance, perhaps onto lines that belong to a company that receives no compensation for moving the power.

  17. Market Participant – An entity participating in the energy marketplace by buying and selling transmission rights, energy or ancillary services into, out of, or through an ISO controlled grid.

  18. OASIS - Open Access Same-Time Information System - An Internet-based system for obtaining services related to electric power transmission in North America. It is the primary means by which high-voltage transmission lines are reserved for moving wholesale quantities of electricity. The OASIS concept was originally conceived with the Energy Policy Act of 1992, and formalized in1996 through Federal Energy Regulatory Commission (FERC) Orders 888 and 889

  19. PUHCA – Public Utility Holding Company Act. This first major federal regulation of the electric power industry signed in 1935 by President Roosevelt. PUHCA limits the geographical scope of utility holding companies and the corporate structure of the holding companies. The act of created vertically integrated utilities (owning both power plants and power lines) in monopoly service areas. The Federal Power Act gave the Federal Power Commission jurisdiction over wholesale power sales and over transmission of electric power. States retain jurisdiction over siting of generation and transmission and over distribution rates. This combination of federal and state regulation of the industry remained in much the same form for close to a half century.

  20. PURPA - 1978 Public Utility Regulatory Policies Act - Passed at a time when the nation was focused on what appeared to be a steady stream of oil price increases and a great deal of concern about energy imports from politically unstable countries. PURPA was ground-breaking because, for the first time, it required that utilities buy power from companies that were not utilities. PURPA created a new industry of nonutility power generators. It was important to transmission policy because it required that the nonutility generators be given access to the transmission system in order to deliver their power onto the grid.

  21. Regulation - Generation that is already up and running (synchronized with the power grid) and can be increased or decreased instantly to keep energy supply and energy use in balance.

  22. Reserves - The amount of those reserves is set through industry standards, which are reviewed and approved by regulators. Typical reserve margins are in the 15% to 20% range, usually based upon the need to have power available if two of the utilities’ largest plants are out of service at the same time during the system’s peak.
    • Spinning Reserve - Generation that is running, with additional capacity that can be dispatched within minutes.
    • Non-Spinning Reserves - Generation that is not running, but can be brought up to speed, within ten minutes.
    • Replacement Reserves - Generation that can begin contributing to the Grid within an hour.

  23. REMC -Rural Electric Membership Cooperative/Corporation - A term commonly used in the name of an electric co-op such as the South Central Indiana REMC.

  24. RTO – Regional Transmission Organization - Similar to an ISO though controls the operation of electric power transmission system over wider areas. Where RTOs exist, the RTO and the transmission owners in the area decide which one (or both) prepares and submits transmission rates to FERC for approval. Although utilities retain the ownership of transmission lines, they no longer control access to them. This responsibility has been transferred to a non-profit organization called an "Independent System Operator" which controls transmission of all electricity in the region. Currently five such "ISOs" are in operation throughout the country. As of 21 December 2010, there are three RTO's operating in North America
    1. ISO-NE (ISO - New England Inc.), an RTO despite the ISO in its name
    2. MISO - (Midwest Independent Transmission System Operator), an RTO despite the ISO in its name
    3. PJM - (PJM Interconnection LLC)

  25. Schedule –An agreed upon transaction size in megawatts, start and end time, beginning and ending ramp times and rate, and type required for delivery and receipt of power and energy between the contracting parties and the control areas involved in the transaction.

  26. Scheduling Coordinator – An entity certified by an ISO or RTO for the purpose of undertaking scheduling functions.

  27. Spot Markets - In California, a nonprofit "Power Exchange" or "PX" was created as an auction market for the buying and selling of electricity. This feature was discontinued when it was realized that a reliance on "spot market" pricing was contributing to the high cost. Now utilities contract with power suppliers directly and are able to structure contracts which provide more price stability

    • Ancillary Services Market - This market helps adjust the flow of electricity when the unexpected happens, such as a power plant failure or a sharp rise in demand for power. The capacity that is bought and sold can be dispatched within seconds, minutes or hours.

    • Real-Time Imbalance Market - This market is where supplemental energy is quickly bought or sold every 10 minutes to accommodate energy use just moments before it occurs. Scheduling Coordinators receive payment for extra generation they supply or are billed for extra energy they need to meet the demand of their customers. Market Participants can submit incremental (“inc”) bids to supply more power, or decremental (dec) bids to reduce power output because of oversupply or congestion on transmission lines.

    • Transmission Market - This market allocates space on the transmission lines and is conducted the day-ahead and the hour-ahead of when electricity is delivered. When there’s not enough room for all the electrons on a line, congestion zones are established and Scheduling Coordinators operating in these zones can participate in the congestion management market, curtailing their power deliveries or generating more.

    • Hour Ahead Market - Forward markets where electricity quantities and market clearing prices are calculated individually for each hour of the day on the basis of participant bids for energy sales and purchases.

    • Day Ahead Market - The market for energy for the following day, or more specifically, the market for energy 24 hours in advance of a given time in any day. A day in this context may be more or less than 24 hours. For example, a utility may purchase the next morning's energy in the afternoon (less than 24 hours ahead) or purchase the next afternoon's energy the previous morning (more than 24 hours ahead). Energy producers offer energy on this market based on their ability to produce energy for a specific period on the following day.

  28. Transmission Pricing Schemes
    • License Plate Pricing - Companies that use the transmission grid pay different prices based on the costs at the point at which the power is delivered to their area. The license plate metaphor applies because each company pays a fee to obtain access to the transmission system and can use any part of the system after paying that fee. Companies based in the low-cost areas tend to favor this approach.

    • LMP - Locational Marginal Pricing (aka Nodal Pricing) The LMP is set by the highest accepted bid by any power plant at the node. The hypothetical production cost of the hypothetical kilowatt-hour of electricity at each node on the network is a calculated based on a "shadow price", in which it is assumed that one additional kilowatt-hour is demanded at the node in question, and the hypothetical incremental cost to the system that would result. LMP is used in some deregulated markets, most notably in the PJM Interconnection New York and New England markets in the US and in New Zealand.

      The new market structure is a nodal market. ERCOT says the new structure will be able to directly assign the costs of congestion on the transmission system to the power plants that cause the congestion.  This is expected to result in clearer price signals to the market and improved dispatch of power plants.

    • Distance-Sensitive Transmission Pricing bases the price for using the transmission system on the number of miles of the system for which users contract. Users that contract to use the transmission system for 10 miles would pay less than those that use it for 100 miles. Distance-sensitive rates may discourage investments in long-distance transmission and as a result may, in some markets, be a barrier to fully free-flowing wholesale power competition.

    • Pancaked Transmission Rates come into play when power under contract traverses more than one power system, and each system charges its full rate to provide transmission service. This method of pricing for a regional transmission system is expensive and tends to discourage companies from sending power over long distances and through several transmission systems, regardless of the value of the transaction to consumers.

    • Postage Stamp Pricing - The per-unit fee to use the transmission system within a single zone is the same, whether the power is contracted to move 100 feet or 100 miles. It costs 44 cents to send a first class letter from one part of Boston to another part of Boston, and it costs 44 cents to send a first class letter from Boston to Hawaii. Companies located in less densely populated areas and in higher cost areas tend to favor postage stamp pricing.

      The original wholesale market is structured as a zonal market. In this structure, ERCOT is divided into transmission congestion management zones as shown in this map. According to ERCOT, this model has problems with poor price transparency and indirect assignment of congestion costs, resulting in economically non-ideal dispatch of power plants and few tools for ERCOT to relieve congestion on the transmission system.

4. Business Case
  • In different deregulation processes the institutions and market designs are often very different but many of the underlying concepts are the same.
    • Separate the contestable functions of generation and retail from the natural monopoly functions of transmission and distribution
    • Establish a wholesale electricity market and a retail electricity market. The role of the wholesale market is to allow trading between generators, retailers and other financial intermediaries both for short-term delivery of electricity and for future delivery periods.
  • Along with operating the power grid, the California ISO conducts reliability markets matching the supply with demand and fine-tuning the flow of electricity. The ISO is like an escrow company, acting as a clearinghouse for energy transactions, but never buying or selling power itself. The markets allow the ISO to make adjustments in power deliveries in response to changes in energy consumption.
  • The ISO’s three open markets, which make up less than 10 percent of the total wholesale electricity markets, help maintain operational reliability of the transmission grid by providing electrical services such as regulation and voltage support.

5. Benefits
  • Increased Competition – The evolution of the power system from a local to interstate and regional scopes has spawned competition. Now, low-cost power plants in Illinois, Indiana and Ohio can supply power to the East Coast. The new competitive non-utility generators must be able to rely on fair and nondiscriminatory access to the transmission system to deliver their product to any connected market. As a result, low-cost, imported electricity can displace high-cost electricity from nearby power plants, as has happened in recent years as new Arizona power plants have begun to serve customers in California.

  • Reduced Capital Costs - Reduced transmission congestion costs from increased transmission transfer capability without building additional transmission capacity.

  • Cost-of-service rates encourage power plant operators to inflate costs and run power plants inefficiently, which saddles consumers with over-priced electricity.

6. Risks/Issues
  • Barriers to Smart Grid Optimization - Regulatory market rules put in place at state and federal levels over the last 20 years to create competition in electricity are also hampering smart grid development. The rules force separation of supply, wholesale transmission, and retail distribution functions. But all those areas need to coordinate to optimize smart grid planning and data usage.
  • Inefficient Pricing - Users do not have the incentive to respond to the requirements of reliable operation. Without such price incentives, the system operator is required to restrict choice and limit the market. Perverse incentives are created when prices do not reflect the marginal costs of dispatch.

  • Price Volatility – Extremely high price volatility at times of peak demand and supply shortages can be a consequence of the complexity of a wholesale electricity market. The particular characteristics of this price risk are highly dependent on the physical fundamentals of the market such as the mix of types of generation plant and relationship between demand and weather patterns. Price risk can be manifest by price "spikes" which are hard to predict and price "steps" when the underlying fuel or plant position changes for long periods.

  • Volume Risk - Electricity market participants have uncertain volumes or quantities of consumption or production. For example, a retailer is unable to accurately predict consumer demand for any particular hour more than a few days into the future and a producer is unable to predict the precise time that they will have plant outage or shortages of fuel. The introduction of substantial amounts of intermittent power sources such as wind energy may have an impact on market prices.

  • Concentration of Power Generation Industry - One result of deregulation is that many public utilities have formed new holding companies and subsidiaries which only generate power. The top ten companies now generate almost 50% of the nation's power and the top twenty companies generate about 75% of the power. This restructuring has been partly the result of the deregulation legislation in some states which have required utilities to divest their generating capability. This "horizontal" domination of the market can lead to the same type of market manipulation that prompted federal regulation legislation in the 1930's.

  • Transaction Costs - In The Nature of the Firm, Nobel Prize-winning economist Ronald Coase used transaction costs to rationalize the existence of large organizations. In his formulation, a firm will define its size and scope by the extent to which the transaction costs of contracting out for a given task outweigh efficiencies captured through the market. In other words, large companies exist because they complete tasks more efficiently than a collection of independent actors with contractual relationships, all things considered. The benefits of a neutral, market-oriented approach must be balanced against the extra transaction costs.

  • Gaming to Prevent New Generatation Market Entrants - While in theory the LMP concepts are useful and not evidently subject to manipulation, in practice system operators have substantial discretion over LMP results through the ability to classify units as running in "out-of-merit dispatch", which are thereby excluded from the LMP calculation. In most systems, units that are dispatched to provide reactive power to support transmission grids are declared to be "out-of-merit" (even though these are typically the same units that are located in constrained areas and would otherwise result in scarcity signals). System operators also normally bring units online to hold as "spinning-reserve" to protect against sudden outages or unexpectedly rapid ramps in demand, and declare them "out-of-merit". The result is often a substantial reduction in clearing price at a time when increasing demand would otherwise result in escalating prices. The consequence is that prices paid to suppliers in the "market" are substantially below the levels required to stimulate new entry.

  • Imperfect Auction Markets - Auction markets for electricity generation have been designed to operate like competitive markets and thereby bring the benefits of competition to consumers and producers alike. In practice, however, these markets have often deviated from that ideal. A report by John Kwoka, Finnegan Professor of Economics at Northeastern University investigates one such deviation, stemming from the ability of a bidder in an electricity auction market to acquire information about the costs of rival bidders’ generation units. Such cost information reduces the uncertainty associated with rivals’ bids, in particular, alleviating the threat that rivals might bid in their output at a lower price. The effect is to allow the bidder with such information to raise its own bid price and shift market price upwards.

    The Kwoka Report first presents the economic theory of such bidding markets, focusing on the role of information about rivals’ costs. This theory establishes the proposition that information about rivals’ costs can elevate bids and thus the final market price. The Report goes on to examine the New York Independent System Operator (ISO) auction market for electricity for evidence of such an effect. Using a variety of statistical techniques, it finds an extensive amount of disclosure of information about rivals’ costs, and a significant upward effect of that disclosure on bidding and price.

    The mechanism by which a bidder gains information about rivals’ costs in the New York ISO market is simple. Bidders need not be the owners of generation units themselves, and if not, they can have supply contracts with any number of actual generation owners whose output they bid into the auction. Crucially, bidders can alter their portfolio of such contracts as often as they wish. As a result any single bidder will have nearly-current information about other generation units with which it had recent (but expired) contracts. This contractual control convey information about rivals–notably, their costs–that is not available in truly competitive markets and permits bidding into the auction market at levels higher than otherwise would be the case.

    The practical importance of this effect is established by analysis of data from operation of the New York ISO auction market for electricity in 2006-2008. The Report finds that during this
    time period on average any single bidder controlled about twelve different generators in the 6-
    month period preceding any bid that it made. An examination of bidding practices finds that the  level of bid submitted by any one bidder increases with the number of contracts that the bidder  previously held, that is, the number of rival generators whose unit cost data were revealed to it  by recent cross-control. For the average bidder with twelve such recent contracts, that bidder’s  bid price rises by 7 percent relative to a bidder with only a single generating unit under its control.

  • Contract Path Deviation - Traditionally, transmission owners have been compensated for use of their lines based on a contract path for the movement of electricity, generally the shortest path between the generator and its customer. However, electricity rarely follows a contract path and instead follows the path based on least impedance. Transmission lines often carry electricity that has been contracted to move on a different path. As more bulk power transfers are occurring on the transmission system, transmission owners not belonging to RTOs (regional transmission organizations) are not always being compensated for use of their lines, because a contract path rarely follows the actual flow. This creates a disincentive for transmission owners to increase capacity.

7. Case Studies
  1. California - In California and some other states, the utilities were required to divest themselves of power generating assets. In California, utilities were subject to a rate cap until they recovered their "stranded costs" and completed divestment.

    In California, a nonprofit "Power Exchange" or "PX" was created as an auction market for the buying and selling of electricity. This feature was discontinued when it was realized that a reliance on "spot market" pricing was contributing to the high cost. Now utilities contract with power suppliers directly and are able to structure contracts which provide more price stability. Under all plans, the costs and profits associated with the transmission, delivery and sale of electricity to consumers remain regulated.

    Under the legislation, the price of electricity was temporarily fixed at 6.5 cents per killowat hour which was substantially higher than the market price. The utilities were allowed to use the difference to recover "stranded" costs which were costs for equipment which could not be sold to producers.

    The wholesale price for electricity generation precipitously jumped in the summer of 2000 less than a year after one of the three major utilities (San Diego Gas & Electric - SDG&E) was allowed by the legislation to charge consumers an unregulated price after recovering these stranded costs. The rise in price was unrelated to any increased demand when compared to the previous year.

    The causes of such a dramatic rise are not completely clear although it is becoming more clear that power companies took advantage of the absence of regulation to close plants for maintenance to create artificial shortages. Indeed, the pattern of plant closures was abnormal when compared to the previous year.

    Other studies have indicated that increased demands caused by population growth and a decrease of hydroelectric power capacity in the Pacific Northwest substantially contributed to the problem.

    Because they had not recovered stranded costs, the other two major utilities in California, Southern California Edison (SCE) and Pacific Gas and Electric (PG&E) were required to charge consumers no more than 6.5¢ per kilowatt hour until March 2002. Because this rate had become much lower than the market rate, both utilities began to lose vast sums of money because they had to purchase power at the unregulated market rates. Their requests to raise rates above the legislative cap were refused and PG&E declared bankruptcy. Because SDG&E was exempted from the cap, the State government has been purchasing power over 6.5¢ on behalf of San Diego consumers since September 2000.

    For many months in the fall of 2000 and spring of 2001, the Federal Energy Regulatory Commission and the Bush Administration refused to regulate the wholesale prices despite the requests of California Governor Gray Davis and most members of California's Congressional delegation. Finally in April 2001, the FERC did institute a temporary wholesale price cap formula only after the state began purchasing power under long term contracts. The result has been a form of new regulation. In order to pay for purchases of power, the state authorized rate increases and the issuance of a $12.5 billion bond measure. Shortly after the negotiation of these contracts, the cost of electricity substantially decreased but the state is locked into long-term contracts which are substantially higher than the present market rate. The state has only had limited success in obtaining relief from the size of these contractual burdens. One organization which has studied the problem has concluded that the total cost to California consumers and taxpayers is $71 billion, an amount which is very close to the yearly state budge

    Restructuring has not caused the problems that California has experienced, probably because no "spot market" for power was created and long term contracts guarantee a steady electricity supply.

    Some flaws attributed to industry restructuring in California
    • Poor market design making it vulnerable to gaming
    • Inability to affect consumer behavior through price signals
    • Inadequate resources made available at peak times
    • Smart Grid embodies some of the solutions: Dynamic Pricing, Demand Response and Energy Storage
  2. PJM's Reliability Pricing Model - This paper by the  EMRI - The Electric Market Reform Initiative - provides an overview of the results of the seven auctions held to date under PJM's Reliability Pricing Model (RPM) and to highlight several concerns. September 2010

    Since RPM was initiated in the spring of 2007, seven Base Residual Auctions (BRAs) have been conducted to procure capacity for successive 12-month periods beginning June 2007. Each BRA procures capacity for a ―delivery year‖ as far as three years in the future. The most recent BRA,
    held in May 2010, procured capacity for June 2013 through May 2014. Two notable outcomes of these auctions are the steady increase in demand response clearing the auction and the large differential between prices in transmission-constrained areas and the rest of RTO

    This paper provides an overview of the PJM Interconnection LLC’s (PJM) Reliability Pricing Model (RPM), the prices paid to generators and demand response providers and the extent to which new resources were bid into each auction. The purpose of this paper is to provide an overview of the results of RPM to date, and to highlight concerns, rather than to investigate or propose changes to the specific RPM rules.

    The results of the seven auctions held to date provide a portrait of a market that is costing consumers more than needed to ensure reliability and incent demand response, as evidenced by the following outcomes:
    • Prices have steadily increased in the transmission-constrained zones, which account for about half of PJM’s load,even though resources currently exceed reliability requirements. Within the non-constrained ―rest of RTO‖ region, prices have been relatively low.
    •  Over 94 percent of revenue is paid to existing generation resources.
    • Greater prices within constrained zones have not led to relatively more new supply there than in the ―rest of RTO‖ area.
    • PJM has implemented a series of administrative changes to RPM, a number of which are likely to increase prices further, especially in constrained zones.
  3. xxx

8. Success Criteria
  • A competitive market with choice and customer flexibility depends on getting the usage pricing right.

  • Bid Based - The system price in the day-ahead market is, in principle, determined by matching offers from generators to bids from consumers at each node to develop a classic supply and demand equilibrium price, usually on an hourly interval

  • Security Constrained - Transmission systems are operated to allow for continuity of supply even if a contingent event, like the loss of a line, were to occur.

  • Economic Dispatch with Nodal Prices - the LMP algorithm described above is run, incorporating a security-constrained, least-cost dispatch calculation with supply based on the generators that submitted offers in the day-ahead market, and demand based on bids from load-serving entities draining supplies at the nodes in question.

9. Companies
  • Google Energy - Google is interested in procuring more renewable energy as part of their carbon neutrality commitment, and the ability to buy and sell energy on the wholesale market could give them more flexibility in doing so. Google requested to the Federal Energy Regulatory Commission (FERC) to buy and sell electricity on the wholesale market so they can have more flexibility in procuring power for Google’s own operations, including their data centers.

10. Next Steps
  • Independent System Operator Coverage - In legislation Congress should: direct FERC to develop and implement a plan to reduce the number of electric power balancing authorities and to establish independent system operators and organized wholesale power markets covering the northwest and southwest United States, which do not already have such coverage. Legislation should provide a 3-year transition period for this to occur.

11. Links
  1. EPSA: Electricity Primer: What Is a Wholesale Electricity Market?

  2. Energy Information Administration - Status of Electricity Restructuring by State Restructuring means that a monopoly system of electric utilities has been replaced with competing sellers.

  3. PNL - A Primer on Electric Utilities, Deregulation, and Restructuring of U.S. Electricity Markets

  4. EMRI - The Electric Market Reform Initiative - Launched in 2006 in response to growing problems public power utilities were experiencing obtaining power supplies in regions with centralized power supply markets operated by Regional Transmission Organizations (RTOs). The purpose of EMRI has been to investigate the restructured wholesale electricity markets and develop proposals for needed reforms to the markets. EMRI's investigative studies provide strong evidence that the RTO-run centralized wholesale markets have substantial problems, and are not yielding just and reasonable rates, as the Federal Power Act requires. Based on the findings of the studies, APPA developed the Competitive Market Plan, a proposal for reforms for the wholesale electricity markets.

  5. Barriers to New Competition in Electricity Generation, June 2008, by John Kwoka, Northeastern University. - This report examines the belief of supporters of restructuring that competition would emerge in the electricity generation sector among different suppliers and that entry into the market would protect consumers against excess price and profit. But those assumptions have not been borne out. A number of real-world factors have impeded entry, with the result that entry has often been constrained and generation is not adequately competitive.


  1. The structure is the current model of many power grid states in the United States. In this tough economic times, we need innovation for sustainability.