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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

random. Further analysis that considers the effects of weather and outages might clarify the pattern. The overview results presented here simply suggest that congestion impacts in the two systems are similar.

Commodity Price Certainty: The Unsolved Riddle

It has often been pointed out that, as a commodity, electricity is highly complex. It has three characteristics that combine to make it particularly difficult to manage in a market structure—instant decay, the necessity to balance the grid in real-time, and the externalities of transmitting through a common grid.

Electricity only has value for an instant. In order to define electricity in a form in which it can be bought and sold, it must be scheduled as a rate of flow over a block of time. Thus, a variety of "products" are offered in the market—day-ahead hourly blocks, on-peak and off-peak blocks, weeklong contracts during on-peak or off-peak periods, month-long contracts, balance-of-the-month contracts, and various combinations. This solution may be complicated, but it is not unique—the economy has many commodities that are tied to delivery schedules.

The Engineering Problem. Balancing the grid presents a difficult, but not impossible task for a market to resolve. In practice, there is a very small tolerance between the balance of load and generation. In nearly every jurisdiction the electricity market resolves the problem in two steps. First, generators and buyers contract for forward deliveries and schedule the power—typically one day ahead, but procedures vary. Plans often go awry, however, and on the day of delivery, actual dispatch and control passes to a central authority and the "real-time" market. Usually the ISO or system operator must buy and/or sell a small amount of power to bring the grid into balance. The process can be almost completely administrative. It involves adjusting generators based on their marginal costs, or in a market-based system through the advance purchase of ancillary services and real-time bidding. The various pools and ISOs have a variety of means to solve this problem. Some work better than others. However, because grid management ordinarily involves a very small percentage of total generation or load, the process usually need not impose a great impact on the market as a whole.

By contrast, however, transmission pricing is by far the most difficult task for a market to solve. The problem boils down to a lack of information for market participants.

The Information Problem . In most commodity markets, participants can assume that transportation costs are fixed (at least for the short term). That is, suppliers in a variety of locations know exactly how much it will cost to ship their product to various consumers. As a consequence, they can make bids based on a predictable set of production and transportation costs. Nevertheless, that is not the case for an electrical grid in the presence of congestion. The cost of delivering power from one location to another can change radically with weather and outages. Furthermore, transmission costs for any given market participant depend on the behavior of all other market participants.

Economic modelers often assume there are no information or contracting costs