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Paper Electrons and Power Pools: Complementary Markets for a Deregulated Environment

Fortnightly Magazine - July 1 1995

market will determine its success. Generators, traders, and DSM sources will bid a price to supply the system on a day-ahead, spot, hour-by-hour basis. The ISO will provide detailed market information to support market efficiency. The bidding results will determine the dispatch sequence. Actual demand requirements will determine the market clearing price. Prices should approach marginal cost. The pool and its CfD market will operate in coordination with a bilateral contract market. Structured appropriately to ensure broad participation among market participants with diverse risk preferences and market positions, the pool should become a deep, liquid spot market.

The ISOs will create a bidding market for reliability. Today, most regions carry expensive and excessive spinning, load following, and planning reserves due to inadequate coordination among control areas and inefficient price signals. The ISO would provide excellent reliability at a lower cost. Longer term, the ISO may facilitate the development of forward pricing mechanisms to provide appropriate market signals when new capacity is needed. The shape of the intersection between the supply and demand curves should provide an appropriate signal about the type of new capacity the market requires (see Exhibit 1).

Futures Can Swim

in Power Pools

Once a competitive pool spot market is well established, a strong electricity futures market could emerge. An efficient network of electricity pools, much like the network of natural gas hubs, could provide deep market liquidity, with prices highly correlated to a central futures market delivery point. The pool would provide cash-market price transparency, futures deliverability, and contract homogeneity. Futures could swim quite well in power pools.

Competition will reshape the electricity industry structure. Electricity futures could provide important market efficiency and risk management roles, but first the industry must address unique market structure and technological challenges. A well-structured power pool can provide the foundation for an effective cash market, while addressing these challenges. Power pools could provide a fertile ground for the development of electricity futures.

SDG&E has designed a power pool which allows for a competitive generation market and open access to transmission on a comparable basis for all generators. With this solid foundation in place, the market should have a key tool from which it can shape and structure an electricity futures market. t

Stephen Baum is an executive vice president with San Diego Gas & Electric Co. He has led SDG&E's efforts to design a new regulatory model. John Treat is a vice president with Booz-Allen & Hamilton's global energy practice in San Francisco. Mr. Treat was formerly president of the New York Mercantile Exchange. He introduced the crude oil futures contract and wrote the natural gas futures contract. The authors gratefully acknowledge the input of Bill Reed, director of strategic planning, and Ed Lucero, financial analyst, both of SDG&E; as well as that of Matt Rogers, principal, and Dana MacLaurin, consultant, from Booz-Allen's San Francisco energy practice.

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