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Let's Get Physical

To manage congestion on the power grid, most traders would rather book a firm path than risk a loss on a financial hedge.

Fortnightly Magazine - January 15 2001

The utility regulators in Washington, D.C. want utilities to build complicated computer algorithms to manage congestion in electric transmission.

"My own view," says commissioner William Massey, "is that the California ISO's market rules should look more like those of PJM."

So in its final order issued Dec. 15, the Federal Energy Regulatory Commission told the California Independent System Operator to replace its system of adjustment bids and price zones with a new PJM-style model, complete with locational marginal pricing (LMP) for each bus or node on the grid.

But many don't want it. They want to trade energy, not congestion.

Under the practice followed in PJM and New York (and under development in New England), congestion rights are financial. Buyers and sellers hedge their deals by purchasing financial rights between any two points on the system. After the deals close, the ISO resolves congestion by setting a theoretical marginal price of energy (locational marginal price, or LMP) at every point on the system. The customer earns (or loses) congestion revenues, depending on the size and direction (positive or negative) of each paired price differential. The settlement comes after the fact, however.

By contrast, many traders see congestion as a physical impediment to be overcome—not a market in its own right. They grow suspicious of economists building Byzantine markets to integrate transmission costs with the locational value of generating plants in a single pricing protocol—like physicists in search of the unified field theory.

Enron argues that physical, path-based FTRs are "homogenous" and "stable" and more easily adapted to trading in secondary markets. It complains that LMP models in PJM and New York keep traders in the dark. "Many congestion management systems [CMS's] rely exclusively on after-the-fact LMP. ... Because those CMS's offer no advance price certainty and cannot trade in secondary markets, transmission grids operated on this basis deny market participants the stability of forward markets and expose them to volatile, short-term price swings."

Moreover, no one has proved that PJM's relatively stable power prices stem from its LMP model, or that congestion caused California's "apocalypse" (Massey's word). The FERC's Nov. 1 staff report on western power markets found that "transmission was not a major issue in 2000 in most discussions with market participants."

But now come the new regional transmission organizations (RTOs), proposing all manner of methods to manage congestion. And none of them wants to "be like PJM."

Most of the new RTOs that issued startup plans late last year opted for a physical flowgate or flowpath model. Two good examples are GridFlorida and RTO West. Under this "physical" view of the world, the RTO determines the total transfer capability of each flowpath or flowgate likely to be constrained. The RTO will issue only a limited and finite quantity of firm transmission rights (FTRs). FTRs trade in secondary markets, but transmission customers that schedule energy across flowpaths or flowgates must have FTRs. (GridFlorida calls them

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