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The Role of Power Exchanges in Restructured Electric Markets

Fortnightly Magazine - October 1 1999

over time.[fn.4] The extension of an exchange's services to other regional markets can enhance the trading efficiency of its participants and narrow spreads between markets, thus enhancing overall market efficiency. In fact, regional commodity exchanges have, over time, become worldwide institutions trading different types of futures, options and other derivative products.

Today there are 16 power exchanges operating in the world. Of these, CalPX and Nordpool were created similarly as commercial functions separate from transmission operations. They were formed to provide a solid underlying spot market to facilitate retail competition. Nordpool and CalPX model their businesses after other commodity exchanges and primarily are concerned with creating a commercially efficient market. While transmission operators are charged with ensuring a reliable electricity delivery system and process, the role of an exchange is to operate and develop a reliable market.

Is the California model right for the rest of the country?

As the FERC gathers comments and formulates policy in its RTO docket, the national debate over power exchange structure likely will come to mirror the one that took place in California early on - and for which some vestige still remains - about whether to integrate the market trading function with grid management.

Yet, as the FERC asks for comment on whether an integrated power exchange might compromise the independence of an RTO, it is important also to ask whether an RTO operating an exchange compromises the commercial viability of the market.

The Generic Exchange:

Institutional and Commercial Roles

Like other commodity exchanges, the commercial role of a power exchange is to provide the market mechanism that facilitates competitive trading of time-differentiated energy products. Its business is focused on meeting its participants' trading needs cost-effectively. To be successful, it must reduce the costs and risks of trading otherwise done bilaterally or through other means (e.g., brokers, over-the-counter markets, bulletin boards, etc.). This focus is quite distinct from that of a regional or local transmission operator.

Just like commodity exchanges formed in the late 1840s, a power exchange provides a forum for buyers and sellers to come together, thus avoiding "search" costs. Similarly, an exchange provides reliable price information using standardized trading contracts (e.g., day-ahead hour 22 at NP15). Because the power exchange is an institution established to be a neutral trading forum, and to the extent its volumes represent a large share of the market, the quality of its price discovery can not be matched by surveys and other means.[fn.5] Price information serves to narrow bid and ask "spreads," enhancing market efficiency while also reducing costs to participants and levelizing information. It also provides valuable information to assist in the financing of new generation. By providing standardized trading contracts, clearing and settlement functions, an exchange essentially allows buyers and sellers to trade independently of one another while effectively pooling risk and reducing any participant's exposure to a counterparty default.

Aiding Competition. The CalPX was created under state law to provide a non-discriminatory, efficient and open trading forum to facilitate the opening of retail markets to competition.

Explicitly, it was created to (1) provide a