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Price Spike Redux: A Market Emerged, Remarkably Rational

Fortnightly Magazine - February 1 1999

transactions to rise along with prices. In reality, during the weeks of the price spikes, power flows fell relative to surrounding periods. The week of June 22 had more hours with TLR curtailments in effect than any other of the summer, but the week of July 20 had fewer such hours than the summer's average. We cannot with certainty conclude that TLR rules caused the spikes, but even if not, they may have contributed to inefficient use of resources over a wide area.

An administrative decision in PJM also contributed to the Midwestern price spikes. In June 1998, the pool announced that 2,500 to 4,000 MW of power exports could be subject to curtailment. This meant the power had to stay in PJM, instead of being exported to the Midwest, even if users in the Midwest valued the power more highly than users in PJM. The system operator's action kept more low-cost power in PJM, but it also reduced the amount of power exported to the Midwest. As with most non-price rationing schemes, the costs imposed on those who could not bid for the power in all likelihood exceeded the benefits conferred on the lucky buyers who got it.

Energy Resources:

Distorted By Regulation

We agree with the FERC staff report that the spikes were odd phenomena in a relatively undeveloped market and, like FERC staff, we found no evidence that they resulted from the exercise of market power by owners of generation or transmission. Prices accurately reflected underlying supply and demand conditions. However, those conditions had been distorted by regulation and industry practices that rendered the Midwest and South more likely candidates for extreme price movements than other regions.

As discussed, utilities in both regions generate most of their electricity in large plants and rely less on the market for power supplies than utilities in the Northeast and Southwest. The default of a Northwestern marketer in late June had a smaller, shorter-lived impact than the one in the Midwest, in part because the Western market was more extensive, with more sources of power and transmission for those caught short.

Michigan is the Midwest's leader in independent power, ranking tenth among the states but with only 21 percent of California's capacity. Excluding recent utility divestitures, Ohio, Indiana and Illinois combined contain less than 1,000 MW of independent capacity, a total that is 20 percent of Michigan's. California, on the other hand, recently gave non-utility producers under contract to utilities expanded rights to market their surplus power. This move was intended to ease some bottlenecks that have raised the prices of ancillary services. A small number of outages in the Midwest will thus have a greater impact, particularly if imports are constrained.

On the demand side, Midwestern utilities typically serve at rates that insulate a high proportion of their customers from market price movements, and utilities have fewer opportunities to curtail loads or call on industrial generation to meet capacity shortfalls. California's flexibility exceeds the Midwest's on all these dimensions. All California customers with demands of more than 1 MW must take time-of-use