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ISOs as Market Regulators The Emerging Debate

Fortnightly Magazine - April 15 1998

monitoring and mitigation by ISOs is "critical to¼ the Commission's efforts to address market power." %n4%n Indeed, FERC granted market-based rate authority in the WEPEX proceedings based on "effective monitoring programs being in place." %n5%n

THE WEPEX PLAN. Through its reliance on monitoring and mitigation, the FERC appears to acknowledge the practical limits of structural reform. Thus, with FERC's blessing, the WEPEX ISO will focus instead on day-to-day behavior of market participants, including strategic withholding of capacity, mischaracterization of generation as must-run and creation or manipulation of transmission constraints. The ISO will collect and analyze data, including market-clearing prices, bids, unit availability over time, market share data and generating costs. In this way, the ISO will seek to monitor bidding strategies and predatory pricing. If market abuses are identified, the ISO may impose sanctions subject to approval by the FERC, including fines and suspension of trading rights. The ISO is encouraged to "consider the appropriateness of price caps." %n6%n The ISO also will file annual reports with the FERC that will analyze power problems, general market operation and effectiveness of mitigation measures.

THE ISO-NE PLAN. In its proceeding to restructure itself from a power pool to an ISO, the ISO-New England also had filed a plan designed to detect and mitigate the exercise of market power in transmission-constrained settings. ISO-NE had proposed to identify anomalous bid patterns (indicative of economic withholding) and instances of unjustifiable physical withholding before applying corrective measures.

As initially filed, the proposal drew sharp criticism from state regulators for doing too little to thwart horizontal market power. The New England Conference of Public Utilities Commissioners found the market power analysis "clearly inadequate" since, according to a separately commissioned study, market power was found to pose a serious threat to competition in affected markets even in the absence of transmission constraints. %n7%n

Under a revised proposal filed December 1997, ISO-NE can reduce the bidding flexibility enjoyed by a particular supply resource, or increase a participant's reserve requirements and substitute a "default bid" for a participant's bid. During transmission constraints, the ISO will apply a market structure screen to detect if competition exists and a price screen to evaluate whether a resource has raised its bid substantially. If the former reveals a lack of competition in the constrained area or the latter detects that necessary resources are bid higher than average, the ISO will restate the resource's bid to a default level equal to the applicable screen price. These procedures for constrained periods are intended to be applied with mitigation for general withholding in unconstrained periods.

Even as revised, however, this new proposal from ISO-NE has not escaped criticism. The Maine attorney general has asserted that "effective mitigation of market power in affected markets requires a structural remedy." %n8%n

Similarly, the staff of the Bureau of Economics of the Federal Trade Commission sees potential difficulties in detecting and preventing market power. According to the staff, "Monitoring and mitigation through behavioral regulations could require virtually transaction-by-transaction oversight and likely would be particularly difficult when transactions are highly time-sensitive, as they are