[BETA] Fortnightly

 

While neither is perfect, the former has done better than its critics would admit.

In France, analysts admit that markets work in practice , but question if they work in theory. ¹ Now this Gallic flavor has taken hold in the New World, but with a different twist. Today, as electricity restructuring proceeds in North America, the regulators and analysts there seem enraptured with theories of ideal market structures, but they largely ignore the practical results.

In the real world, commodities with immediate spoilage, such as transportation, sports, and theater—and yes, electricity—require a transparent and robust forward market. Yet in power markets, this reality often has been sidestepped—lost in the debate of the structure of independent system operators (ISOs) and regional transmission organizations (RTOs). The idea is not such a mystery in other industries. It is obvious to any business traveler that a reserved seat on a scheduled airline flight is preferable to relying on the uncertainties of a spot market. Travelers (and airlines) need to plan ahead if supply and demand functions are to be matched.

In fact, when it has been allowed to do so, the wholesale power market has acknowledged the importance of forward markets by dividing itself into three segments.

The first segment is the real-time market for balancing the grid and managing congestion. The second is the prescheduled market, which occurs in advance of day-ahead scheduling. The third segment includes forward and futures markets where deals may be struck months or even years in advance of delivery. Prices from the prescheduled market allow participants to plan daily generation and load. Forward and futures markets allow participants to perform seasonal planning and make rational investment decisions. While these market segments remain separate (having distinctly different prices), they are interrelated. Under a well-designed system, all three will function efficiently.

In this paper, I compare the power prices emerging from two restructured markets, each having a different approach. One market is PJM, the Pennsylvania-New Jersey-Maryland Interconnection. The other is California. The results show similarities on the surface, but reveal distinct differences when one digs deeper. These differences may well turn on the philosophical debate illustrated by these two markets. Which is more valuable in designing a power market with efficient prices: a focus on grid congestion, or on price transparency and certainty?

The first market, PJM, operated as a "tight" power pool for many years but reconstituted itself as an independent system operator in January 1998. Later, in April 1998, it shifted its congestion management to a system of Locational Marginal Pricing (LMP). This market structure has been distinctly short term, with pricing in the forward market left to bilateral negotiations. ² The restructured California market, on the other hand, began operations in April 1998, with two new institutions: an ISO that combined the transmission systems of the state's three largest utilities; and a power exchange operated and managed separately from the ISO. In California, the ISO operates a real-time market and the Power Exchange operates a series of forward markets. In addition, in each of the two markets—California