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Energy Trading: Down But Not Out

The speculative electricity trading industry has a bad case of rigor mortis, but current efforts might breathe new life into the practice.

Fortnightly Magazine - January 15 2003

regarding standard-market design and gathering comments from interested parties, the current state of limbo does not help electricity markets.

In the long term, the standard market design should bring new opportunities for trading activities. Ironically, however, a key component of FERC’s proposal—LMP—might represent the last nail in the coffin for speculative trading.

“LMP is designed to take the mystery out of price discovery,” Janardhan says. “You’ve got published prices for every node in every region. So what is the role for speculative trading? You don’t need brokers speculating on bid-ask price spreads if LMP is spoon-feeding price spreads for every nodal generation point on the system.”

Some role might exist for speculative trading in the future—namely in making longer-term deals and identifying intertemporal arbitrage opportunities. But for the most part it is rendered obsolete by FERC’s LMP-based market design. Hourly and day-ahead markets will continue to exist, of course, but LMP will limit the degree to which traders can capitalize on supply-demand imbalances in the next-hour time horizon. Instead, these markets will come to resemble the cooperative in the next-hour time horizon trading activity that was carried out among neighboring utilities in the old NERC regions.

Thus the industry seems to be coming full circle in its evolution, returning to a tighter regulatory framework as it heads into the future. Not all players will agree that this is a good thing, but it represents a logical and realistic solution to the industry’s problems.

As FERC Commissioner William Massey said in a recent speech, “What is the appropriate mix of regulation and free market ideology? There are good arguments on virtually every side. Yet, despite the ambiguity, someone has to decide.”

The electricity trading business might never recover its former vitality. But FERC’s decisions—and ultimately the actions of the industry itself—promise to keep electricity markets alive for a long time to come.