Public Utilities Reports

PUR Guide 2012 Fully Updated Version

Available NOW!
PUR Guide

This comprehensive self-study certification course is designed to teach the novice or pro everything they need to understand and succeed in every phase of the public utilities business.

Order Now

The Role of Power Exchanges in Restructured Electric Markets

Fortnightly Magazine - October 1 1999

of electricity is far more volatile than that of other commodities. Since reliability of the grid is paramount and because electric power cannot be economically stored, demand and supply are balanced on a knife-edge. Relatively small changes in load or generation can cause large changes in price in a matter of hours, if not minutes. In this respect, there is no other industry like electricity.So far end-users have been insulated from wholesale volatility. Will that continue?As was the experience in the Midwestern and Eastern U.S. markets in June 1998, the possibility of extreme price movements increases the risk of trading in electricity markets. Since hundreds of millions of dollars were won and lost on a single day of trading in late June 1998, counterparty risk has been a prominent concern of regulators, politicians, traders and executives in the electricity industry.California's experience at that time showed how a deep and liquid exchange like the CalPX could stabilize potentially runaway bilateral markets.[fn.8] For that to occur, a large number of buyers and sellers in the market must trade a significant level of volumes through the exchange. The depth of CalPX's market, combined with its transparency and auction process, reduces the risk of price spikes that occur in bilateral markets susceptible to chain reactions to isolated market events.[fn.9] Furthermore, the credit management and clearing function of an exchange sets and manages the security or margin requirements for its trading members. The CalPX has stringent credit requirements and vigorously monitors its participants' collateral daily. In the case of default, a participant's collateral is used to offset financial losses. Ultimately, however, a large advantage of an exchange is that it pools default risk. The counterparty for both buyers and sellers in an exchange is the well-funded pool itself.California's Model: A Hybrid DesignCalifornia was the first U.S. state to seriously debate and implement electricity market restructuring. Over the years, California's system of regulation and franchised monopoly resulted in one of the highest-cost electricity systems on the continent. If California's industries and commerce were to be competitive, power costs had to be reduced. It was perceived that competition would reduce energy costs. Therefore, opening the market to competition was the obvious answer; but the precise institutional arrangements best suited to meet this objective were unknown at the time of restructuring.Bilateral or Pooled Trading? Soon after California regulators announced their intention to open retail markets to competition, debate began as to how the new market should be structured. Should the market be centralized around a mandatory hourly spot market similar to the United Kingdom's restructured market (poolco) or should it be opened to individually negotiated bilateral trades, with no central exchange or spot market? In the case of a poolco, another issue was whether it should be a separate entity or a function of an independent system operator (ISO).[fn.10] Critics of the poolco were adamant that a centralized, mandatory pool administered by the ISO simply would result in a new monopoly, defeating real competition that already existed in wholesale markets. One objective of restructuring in California was to maximize the