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The Economists: On the Future of Energy Markets

The Power of Price Responsiveness
Fortnightly Magazine - April 1 2002

For most customers, Joskow explains, they're going to want to hedge much of the market volatility. "That's the job of retailers and utilities if they still have retail service obligations to try to come up with a portfolio of contracts that match consumers' risk preferences and balance the costs and benefits of shorter and longer-term commitments at fixed prices," he says.

Joskow predicts that one of the problems that might emerge in the Northeast United States, if a clear plan for retail competition is not developed, is many customers will be moving straight into the spot market. When a large percentage of customers are in the spot market, the industry begins to see bad investments and opportunities to exercise market power.

"I think the natural equilibrium for end-use customers is one where the vast majority of demand-85 percent to 90 percent-is forward contracted out for periods of one to five years," Joskow says. "And the spot market is primarily a balancing market that allows generators to trade with one another when they have lower cost power."

In New England, most utilities agreed to a default service obligation at a fixed price for a number of years during restructuring negotiations with state public utility commissions. But these service commitments end in two or three years, and there's little hope retailers will be able to grab many of these customers if the trouble they've had attracting residential and small commercial customers during the transition phase is any indication.

Veteran Regulator Finds California Behavior Strange, But Clean

Charles Stalon has worn many hats during his long career in the electric and gas industries. Aside from serving as a FERC commissioner in the 1980s and as an Illinois Commerce Commission member prior to that, Stalon has sat on the boards of ISO New England and New Jersey Resources, and has served as a member of the advisory council of the Gas Research Institute and on the Harvard Electric Policy Group.

After retiring in 1993 from his position as director of the Institute of Public Utilities and Professor of Economics at Michigan State University, Stalon moved to Cape Girardeau, Mo.-a scenic riverboat town along the Mississippi River and only 40 miles north of the New Madrid Fault-where he set up his own private consulting practice.

Undeterred by spring flooding of the Mississippi or speculation about an earthquake striking the biggest fault line in the United States east of California, Stalon has spent the last decade in southeastern Missouri examining the best methods for designing and implementing competitive electric power markets. Included among his many tasks was serving on the first market monitoring committee of the California Power Exchange, prior to the eruption of the state's electric restructuring program.

Consistent with statements by generators operating in the state, Stalon says he never saw any evidence of manipulation in the market. "Let's draw a distinction here between raising the price of energy in that market versus raising prices in a forward market temporarily that do not cause any increase in the price of energy. People bet wrong all the