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California pays the bill, but who gets the blame- the feds or the fundamentals?
Fortnightly Magazine - September 1 2000


Kyle Rudden, vice-president and head of global utilities equity research at J.P. Morgan, sees some companies getting hurt by the market.

"It would likely shoot first and ask questions later," he says.

"It would likely focus on companies that made significant investments in California such as Reliant, Duke, Calpine, Dynegy, and AES-those that right now are making money there and do have capacity there and bought or built capacity there in anticipation of a competitive market. Those would certainly get hit first."

Edward Tirello Jr., managing director at Deutsche Bank, sees the price cap policy as "a pure-and-simple case of regulators and politicians gone crazy."

He adds, "It is delusional to think you can take a rate-of-return industry in which they were losing money on two of the three services they were offering É break it up into three separate business, transmission, distribution and generation, two of which are federally regulated and one regulated by the state, and expect the prices to go down.

"Let's say you put [in] a $500 price cap you know what happens? Everybody bids $499. You put in $250, everybody bids $249. Instead of the price coming down, it stays artificially high. "Price caps cause higher prices. They can't stop what is happening because they caused it."

Meanwhile, the PX says it has a formula that shows that its prices reflect economic reality. Of course, the PX apologizes that it developed its model by taking market observations only through March of this year, but so much the better. That should make the model even more unbiased in testing whether the summer's prices behaved as expected, or whether someone was gaming the market. The PX described its model in its second annual report to the Federal Energy Regulatory Commission, filed on July 31. It relies on six input variables, reflecting demand, supply, and prior market experience:

  • The unconstrained market-clearing price (UMCP) for the previous day.
  • The prior day's UMCQ.
  • The ISO's load forecast.
  • . Temperatures in San Francisco, Sacramento, Los Angeles, and San Diego,
  • The natural gas city gate price for the three major investor-owned utilities, SoCal Edison, PG&E, and San Diego Gas & Electric,
  • Coal plant availability for the three IOUs, and
  • Nuclear plant availability for the three IOUs.

The PX notes that of all the variables in the model, yesterday's price and volume seem to be the least relevant. In fact, the closer the hour to mid-afternoon (hours 14-17), the more important are load, temperature, and unit availability, and the less important still is yesterday's price. All these factors taken together explain all but 12 percent of price movements, says the PX. But its report adds a disturbing observation: During the 12-month study period from April 1, 1999 to March 31, 2000, the off-peak prices fit the model the best. By contrast, the model explained only about 60 percent of price trends seen during the peak hours.

Nevertheless, the PX still refuses to acknowledge any untoward market behavior to account for unexplained price behavior. It suggests instead that other "fundamental factors" might be at work,