Recent years have seen fundamental changes in the supply and competitive landscape of the North American natural gas market. In response to high natural gas prices that prevailed during most of...
Industry Structures and Market Mechanisms
By Seabron AdamsonSeabron Adamson is senior consultant with London Economics Ltd., a consulting firm for the private sector. A native of Georgia, Mr. Adamson joined London Economics in 1992 and currently resides in the United Kingdom.
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The debate over "PoolCo" vs. bilateral contract markets is a question of market mechanism, or how transactions can be made while recognizing the realities of power systems. The big picture, the structure of the industry, is not yet clear, but the debate continues to focus on how things should work, instead of addressing what is meant to be working. We risk arguing about the relative merits of carburetors and fuel injection, and forgetting our destination. I submit that we need less mechanics and more navigation, at least at this point.
When it is time to choose a market mechanism, the following criteria will help in our selection:
s The market mechanism should support, not hinder, the proposed structure for the industry. If we believe a system that unbundles generation, distribution, and transmission of electricity is best, a PoolCo mechanism may be most appropriate. If we wish to keep any vertically integrated utilities, contract markets are a more natural evolution.
s Under both proposals, most electricity will be sold under bilateral contracts. The main practical difference between the proposals is how these contracts will be structured. Which type of contract is most transparent? Contracts for differences (for the PoolCo mechanism) are complex, but can be compared to a "headline" pool price.
Proper evaluation of bilateral contracts is also not simple, especially where a utility's own generation is affected. This issue has been neglected in the United States, but will become increasingly important as the transfer prices between and within utilities become clear. If competition is not available to all consumers, regulators must decide whether a utility is purchasing a portfolio of contracts (or generating electricity) that meets customer needs at lowest cost. Transparent contract structures and markets would make this decision a lot easier.
s Limited bilateral contract markets already exist in the United States in a number of regions. These should, in theory, approach a least-cost dispatch of the system. Anecdotal evidence from two U.S. power pools suggests that this occurs in practice as well. Solid empirical work is needed to determine how efficient the existing bilateral markets have proved themselves.
s Power markets will require some regulation over the short term. We need to recognize that some generators will have market power for considerable amounts of time, due to location, transmission constraints, and so on. The entire infrastructure of the U.S. power industry has been developed for noncompeting utilities; it is unrealistic to expect that market forces can immediately erase years of history. The market mechanism should make regulation as limited as possible.
s Low liquidity will reduce benefits to consumers. If all generators bid into one pool, short-term liquidity will increase. Liquidity in longer-term forward markets may be affected.
s The market mechanism should be as simple as possible, while getting the basic incentives right.
With some additional homework,