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Spot-Market Clearing

Solving the electricity credit malaise.

Fortnightly Magazine - May 2005

is an essential clearinghouse function, performed to ensure the integrity of its members, customers, and markets. Financial surveillance ensures the financial integrity of the clearinghouse, through monitoring of customers and clearing members. Market surveillance ensures that the markets are operating in an orderly fashion, and free from distortion or manipulation.

The Guarantee Pyramid

As discussed previously, a guarantee is only as good as the organization providing it. Clearinghouses use an escalating series of trade guarantees to protect market participants from the default of any individual participant. Figure 4 provides an example of the guarantee structure for NYMEX.

Importantly, this structure does not rely upon variables outside its control, such as the availability of credit default swaps, or the performance of the third parties providing such products. Additionally, despite the existence of many levels of guarantee, the upper levels are rarely called upon. NYMEX, for example, has never needed to call upon its guarantee fund or any higher levels of protection.

A Call to Action

As stated recently by Bob Ludlow, the CFO of ISO New England, "ISO New England views clearing as the logical next step in materially reducing the credit risk of the markets." The time has come for electricity spot markets to institute comprehensive reform in the way they manage credit risk.


  1. Quoted from ERCOT, "Market Notification re TCE Payment Default (2005-01-17)."
  2. For the purpose of this paper, the term "spot market" is used in the broad sense, and refers to near-term cash markets in electric energy (real-time, day-ahead, hourly), as well as markets in related products (ancillary services, unforced capacity, etc.).
  3. This can include independent system operators (ISOs), regional transmission organizations (RTOs), power exchanges (PXs), or any other entity responsible for operation of the electricity spot market.
  4. Source: Moody's Investors Service, Special Comment on PJM Interconnection, December 2004.
  5. Around $1 million was later recovered in bankruptcy proceedings.
  6. Estimate by the Reorganized California Power Exchange, in L.A. Superior Court, Docket # CR308007.
  7. This is a feature common to all proper clearinghouses, and helps ensure that the rapid collapse of a participant, even one previously rated highly ( e.g., Enron), does not compromise the integrity of the market as a whole.
  8. Because of the "obligation to serve," it may not be possible for a default to be resolved until some days after it is detected.
  9. Monthly billing would represent a substantial risk to the clearinghouse if a default exceeding the defined statistical boundaries for collateral ( e.g., 99th percentile) were to occur i.e., a 1-in-1,000 event given five days of exposure is less problematic than such an event given 60+ days of exposure.
  10. Additional collateral must be collected on a Friday to cover this extended period.
  11. Supervisory Control and Data Acquisition (SCADA) and State Estimator are related systems commonly used by system operators as part of their overall energy management system (EMS).



Defining the Numerical Benefits

Detailed cost-benefit analyses of spot-market clearing were performed by Accenture and NYMEX, in conjunction with a number of North American spot-market operators. Summary results from one such analysis are