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Scarce Resources, Real Business or Threat to Profitability?

Fortnightly Magazine - October 1 1997

use postagestamp or contract-path pricing, or both. But what defines equal access when the ISO has to ration system use? Does the ISO have sufficient information to ration transactions on an economic basis, or perhaps by physical criteria, such as the impact of each individual transaction on line loading and constraints? Without defining these criteria, the term "equal access" will have no meaning.

Proposals: Bidding, Rationing, Hedging

At least three proposals now on the table would suggest how to run the transmission system and ration its use, including financial instruments to hedge price swings. The proposals come from three academic institutions: Harvard University (William Hogan), the University of California at Berkeley (Felix Wu, et. al.), and the Massachusetts Institute of Technology (Marija Ilic, et. al.). While all three are technical, and all will keep the lights on, the plans could produce different monetary results for individual market participants.

Harvard Plan. In the Harvard plan, the ISO plays an active role in determining transmission prices under constrained circumstances. The ISO economically and functionally bundles energy and transmission. The competitive market participant learns the price of transmission (the difference in bulk power prices between generation node and the consumption node) after the fact. The marketer, however, can hedge prices through transmission-congestion contracts. The plan gives the ISO the power to make decisions (including allocation of charges and of financial rights) that affect the profits of market participants.

As a hedging tool, the Harvard plan calls for the use of transmission-congestion contracts (which gain value as congestion increases) to average the costs of congestion over time. This approach would cause users of transmission to value the service, because they have to decide, each time, whether they garner greater profit from using the transmission system or selling their contract to use it. As a drawback, however, these contracts may not give any incentive to the owner of the transmission system to expand the capacity of the network.

Berkeley Plan. The Berkeley plan proposes a three-step system. First, buyers and sellers negotiate in an open energy market. Then, the ISO examines the proposed transactions and either allows all transactions to take place at agreed prices (no constraints) or allows only some of the transactions to go through (system constraints). Finally, the ISO tells disappointed parties how to make trades without exceeding system limits. With that information in hand, they can buy power from certain generators, with the understanding that they will resell some of that power to other generators to stay within system constraints.

In effect, the ISO's curtailment procedure determines how much power is priced in the uncongested (first) market, and in the congested (second) market. Obviously, the purchaser wants to obtain power from the former market. Studies conducted at MIT indicate that the market of choice significantly affects the profit of individual players. %n3%n As a financial instrument for hedging, the Berkeley plan calls for a joint forward market covering rights to energy and transmission, thereby incorporating the price of transmission congestion into the trading decision. A sub-market for transmission access could develop, though, which