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The Economists: On the Future of Energy Markets

The Power of Price Responsiveness
Fortnightly Magazine - April 1 2002

time," Stalon says. "There were no real signs of market manipulation by any significant player."

Stalon, described by former FERC commissioner Oliver "Rick" Richard as the most intellectual of the members to serve on the commission, says the monitoring committee did notice some strange bidding behavior. "When we would challenge the industry on the bidding behavior, we would get explanations that would send cringes up and down the back of anybody who had been through sophomore economics," he remembers.

In theory, Stalon says, all competitive generators bidding into such a spot market as California would bid their short-run marginal cost curve. "But we would go into meetings with the industrial groups and somebody in the group would stand up and make the argument, 'you can't possibly make any money just bidding your short-run marginal cost curve.' And many of them were not."

They would bid into the market, he says, as if they were trying to game the system. "And yet it didn't make any sense to be gaming. It wasn't in their interest to be gaming. They were not raising the price by gaming," he explains. "But we would see them bidding higher than their short-run marginal cost curve. It was a puzzle. I never really figured out why they were doing it. We couldn't deduce any pattern of price increases because of this behavior."


"The question is, what happens when these standard offers come to end?" Joskow asks. "Do we just throw the customers out in the spot market? What's going to happen? As of now, the answer is, there is no answer. That seems to be an agenda item that states like my own, Massachusetts, and Rhode Island, New York, New Jersey and Pennsylvania really need to focus some attention on."

The Power of Price Responsiveness

Bruce Humphrey, an economist and vice president of Xenergy Inc., suggests all parties involved with retail restructuring need to look for ways to obtain price-responsiveness on the consumption side. "Without price responsiveness, and if it's only quantity and not price adjusting, you get the behavior you got first in the Midwest and then out in the West," Humphrey says. "The big hurdle to overcome is creating mechanisms and technologies that allow consumers of whatever size to react to short-run prices in the marketplace. As long as consumers are facing some version of average cost, then the benefits of competition will be difficult to achieve."

Behind the California and Enron events, though, Humphrey sees a big story in the background where as many as 50 million customers accounts "are now nominally free to choose their supplier. "As we come out the end of this transition process, which is not that many years away, that is quite a large number of customers and more are coming," he says. "I think the transition pricing issue will resolve itself over time, both through market forces and regulatory decisions. I think new entrants will be attracted to the market once the customers begin to move."

Economists agree that San Diego's foray into retail electric power choice during