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East vs. West: Comparing Electric Markets in California and PJM

While neither is perfect, the former has done better than its critics would admit.
Fortnightly Magazine - July 15 2000

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NYMEX offers month-long on-peak power futures contracts for both the PJM and California regions. So far, however, these contracts have not proven successful. As Figure 1 illustrates, the volume of trading in the electricity contracts has remained significantly below comparable levels in the natural gas contract since the power contracts were launched.

Many factors explain why trading in electricity futures is so thin. Consider two of the more important reasons. First, NYMEX entered the market very early, just as deregulation got underway; without well-developed trading in "physicals" it is unrealistic to expect a high volume in "futures." 10 Second, so far there has been high basis risk due to the volatility in transmission charges related to congestion; this factor limits the market for a futures product. All the same, it is a good bet that the run-up in prices in the Western market in early summer will change perspectives on the NYMEX contract (and the CalPX block forward market). A Southern California buyer could have locked in a price between $33.15 and $36.80 per megawatt-hour for May 2000, by purchasing the NYMEX futures contracts in March for delivery in May.

Survey Findings: Price Differentials and Correlations

Figures 2 and 3 illustrate pricing in PJM and the CalPX. Each graphic compares four separate series: (1) exchange or pool prices in the largest zone, (2) bilateral prices (determined by survey) for the same region, and estimated marginal costs of operating a (3) gas turbine and a (4) diesel oil generator in that region of the grid. 11 Prices represent the average of a 16-hour on-peak block for each day of operation.

A closer look at the data (see Table 1) reveals the differences in price trends between the two systems.

Average Prices . Over the 26-month period covering this comparison, the results are almost identical...average prices for SP15 resulting from the day-ahead CalPX auction and congestion adjustment from the California ISO were $32.54 per megawatt-hour. The average for the Western Hub in PJM was $31.14.

Volatility. The removal of bidding restrictions in April 1999 also has been accompanied by increased volatility in PJM's prices. From April 1998 through March 1999, the standard deviation of on-peak average prices in PJM was $21.94, compared to $15.48 in Southern California. In the 12 months beginning April 1, 1999, the standard deviation of prices in PJM rose sharply to $60.17, while the standard deviation of California's prices fell to $10.33. Overall, across the entire 26-month period, the standard deviation of the California market was $18.54, as compared to $44.53 for PJM.

Bilateral Contracts . Prices in PJM and California are comparable to prices in bilateral contracts, as determined from market surveys. Prices in the PJM Pool have been slightly higher than bilateral prices in the Western hub of PJM, with an average difference of $0.22 per megawatt-hour. CalPX prices for Southern California have averaged $1.73 per megawatt-hour greater than in bilateral deals. In fact, much of that difference has occurred in the most recent two months. During the period from April 1, 1999 through March 31,