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Money, Power and Trade: What You Never Knew About the Western Energy Crisis

Fortnightly Magazine - May 1 2001

times, however, over-generation means that they will have to rely on spot market purchases of fuel, pipeline deliveries, storage, and emissions credits. These constraints may combine to create an economic limit on the energy that can be produced. The limit can be exceeded only at high prices. Thus, off-peak prices do not decline (em the cost of generating stays high because it reflects the opportunity foregone to sell into peak market conditions.

Environmental regulations often impose outright restrictions on generation by limiting annual emissions. Other local ordinances may constrain activity to particular times of the day or season. For example, the city of Pasadena limited the use of combustion turbines under its jurisdiction to 300 hours per year in 2000. (The city recently has increased the limit to 1,300 hours per year. It has 226 MW of oil and gas fired capacity, but these generating units are old, heavily polluting, and not suitable for prolonged use.) %n16%n

The problem of obtaining emission credits also contributes to the rising marginal cost. During the summer, emission credits in the South Basin environmental district increased more than forty-fold, from a monthly average of $.85 in January to $36.93 per pound of NOx emissions in September. %n17%n

The rise in demand and contraction in supply that has gripped the western power market presented an unexpected and serious problem. Yet it need not have turned into a tragedy. It was the failure by politicians and regulators to heed or understand market signals that compounded the problem and created a crisis. Because a variety of federal and state decision-makers did not understand the nature of trade in the WSCC, their decisions have greatly inhibited the normal flow of electricity.

False Signals. When prices first rose in May 2000, the California ISO maintained a real-time price cap of $750 per megawatt-hour, high enough to have little or no practical impact on the market. However, as higher wholesale prices worked their way through SDG&E's retail rates, politicians applied pressure on the ISO board to lower the cap to $250 per megawatt-hour. The board compromised. On July 1 it lowered the cap to $500, followed on Aug. 7 by a drop to $250. The lower caps did have serious impacts, although not those intended by its architects.

Because the ISO maintained price caps, the PX did not have to. Those purchasing power in the exchange would never bid more than the ISO cap, instead they would shift demand to the real-time market. In a normal market that would never have posed a problem (em just one or two days of dislocation. But problems in the western power market compounded as shortages continued through most of June and into July and August. More and more of the load was served through the real-time market, which remained highly prone to panic buying. On July 28 the phenomenon peaked, when as much as 28 percent of load had to be met by real-time purchases. %n18%n

The ISO compounded the migration to the real-time market through its own actions. Initially, the ISO procured reserve capacity