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COMMENTS ON RTO MARKET DESIGN AND PRICING

COMMENTS ON RTO MARKET DESIGN AND PRICING. THREE PERSPECTIVES. SPONSORED BY THE COMPETE COALITION. MARCH 3, 2009 WEBEX SEMINAR PARTICIPANTS ROSS BALDICK ROY SHANKER ROBERT STODDARD. RTO MARKET DESIGNS UNDER FIRE. CONTINUING CRITICISMS OF RTO “DAY 2” MARKET DESIGNS

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COMMENTS ON RTO MARKET DESIGN AND PRICING

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  1. COMMENTS ON RTO MARKET DESIGN AND PRICING THREE PERSPECTIVES

  2. SPONSORED BY THE COMPETE COALITION • MARCH 3, 2009 • WEBEX SEMINAR • PARTICIPANTS • ROSS BALDICK • ROY SHANKER • ROBERT STODDARD

  3. 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

  4. 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

  5. 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

  6. 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

  7. 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

  8. Single Clearing Price in Electricity Markets Ross Baldick

  9. 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.

  10. 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.

  11. 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.

  12. Other markets with an explicit single price rule. • Opening and closing prices on stock exchanges, • U.S. Treasury securities, • Regional Greenhouse Gas Initiative.

  13. “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.

  14. “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.

  15. 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.

  16. MARKET MISPERCEPTIONSANDREGRETS ABOUT PAST BUSINESS DECISIONS Roy J. Shanker Ph.D.

  17. 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”

  18. 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

  19. 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

  20. 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

  21. 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

  22. 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)

  23. 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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