IT TAKES LABOR, FUEL, OPERATING CASH AND INVESTMENT capital to produce and deliver electric power. Which utilities have managed to use these resources optimally to produce and sell kilowatt-hours...
Price Spike Redux: A Market Emerged, Remarkably Rational
The post-mortems on last summer's price spikes in the Midwest are in. At least three studies of the event diverge in their conclusions:
First, on Sept. 24 of last year, the staff of the Federal Energy Regulatory Commission found the root cause of the spikes in extreme weather and unexpected outages. It observed no direct evidence of market manipulation and concluded that the events were unlikely to recur.
Reacting to those findings, Judah Rose of ICF Kaiser International saw deficiencies in the FERC report and predicted more spikes as a shortage of generating capacity worsens in the near future. (See "Missed Opportunity: What's Right and Wrong in the FERC Staff Report on the Midwest Price Spikes," Public Utilities Fortnightly, Nov. 15, 1998, p. 46.) To cope with it, he recommends operational changes and quick deregulation, the latter to end uncertainty that discourages new investments.
Four days later, on November 19, the Public Utilities Commission of Ohio reported to the legislature that last summer's weather and outages might well recur. Policy interventions to improve market coordination were needed, said the PUC, since today's "immature" market could "evolve rapidly only under optimal conditions."
Today, several months later, is there anything left to say?
Certainly it is true that bulk power markets in the Midwest are relatively underdeveloped. However, our data show that they functioned quite effectively under extreme conditions. A relatively undeveloped market adapted quickly and efficiently to events never before seen. Buyers and sellers reacted rationally to those events in the face of great uncertainty and unfamiliar limits on their abilities to transact. Market forces were at work over much of the Eastern Interconnection, both at a macro level and hour by hour over the critical days. Observed prices offer evidence of a unifying market that joined many regions within the Eastern Interconnection - before, during and after the spikes. Transaction data shows that the choices of market participants were surprisingly rational, despite unprecedented restrictions on transmission availability.
Yet, these restrictions on transmission deserve a second look. Here we attempt to isolate their causative role.
The transmission restrictions flowed from new protocols introduced to relieve line overloading. They arose last year in mid-June, a few weeks ahead of the price spikes, when the FERC took notice of a request by the North American Electric Reliability Council to impose procedures for transmission loading relief. These new TLR rules would relieve the impact of parallel flows on grid systems not located directly on the contract path of the curtailed transaction. Though it took the matter under advisement, the FERC encouraged utilities to apply the TLR rules within the Eastern Interconnection pending a final decision.fn1
Did market turmoil in the Midwest flow directly from transmission restrictions? With the data presented here we cannot conclude with certainty that TLR procedures caused the price spikes. However, even if they did not, we find that these restrictions may have contributed to inefficient use of resources over a wide area. These new TLR rules curtailed substantial amounts of power and foreclosed valuable market transactions. Major utilities declared emergencies just short