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Price Spike Tsunami: How Market Power Soaked California

Last year saw no shift in fundamentals. Then why was the ISO so willing to be deceived?
Fortnightly Magazine - January 1 2001

The California PX and ISO represent a strictly mechanical system that is easy for suppliers to reverse-engineer. Specific actions initiate automatic actions from the ISO and PX computer programs. The PX process has now been dismantled by the FERC, but it represented a simple target for market power.

The PX does not check for the reasonableness of the supply curves submitted by the market participants. PX and ISO market surveillance groups have been restricted to their own operations. ISO and PX data is not even routinely exchanged between the two agencies. The complexity of the process makes effective auditing virtually impossible. The sale of thermal generating projects to a small number of owners makes market power easy to procure and easy to apply. During high load periods, the major players in California dominate the ISO's calculations.

The methodology of collusion is uncomplicated. Market players can experiment with their filings at the PX and ISO. The results in the market are available for inspection the following day. When the ISO forecasts a system peak, it is easy for bidders to adjust their behavior to decrease supply. If competitors do not join in the process, their decisions are evident in the EHV real-time data.

Motive. This speaks for itself. The ability to sell into the PX and the ISO during high-priced periods is massively more profitable than business as usual. Traditional industry practice would assume that a margin of 10 mills over generation cost (1 cent per kilowatt-hour) would be more than sufficient to creative incentives for new generation projects. Since May 22, the margin has averaged five times that level.

Opportunity. The traditional problem in the exercise of market power is not the means nor the motive. The California ISO and PX may have made the means easier, but any sufficiently concentrated market can find the means to exercise market power. The major hurdle is the enforcement of non-competitive outcomes.

For 30 years the Organization of Petroleum Exporting Countries has attempted to exercise market power. Its track record is very poor. The problem is not the willingness of OPEC members to abide by production limits. The problem is the enforcement.

Most cartels cannot measure the degree to which the different market players are observing the output restrictions. The ISO's decision to collect and distribute the hourly operating data for its suppliers eliminated this challenge. Suppliers in the ISO service territory knew exactly the production levels of their competitors at any time.

The ISO's decision was all the more puzzling because the distribution of this data explicitly violated its own restrictive policies on the dissemination of market information.

Measuring the Damage

The increase in bulk power prices caused by the exercise of market power is the change not explainable by changes in natural gas prices, hydroelectric generation, and the load/resource balance. To isolate and identify that change, we have assembled a statistical model that includes these components. We have also included a "dummy" variable to represent market power, starting in the last week of May. The results of our model indicate a very high