A motley assortment of naysayers and recalcitrants continue to oppose competitive electricity markets around the world. But the alternative to markets is centralized command economics—a...
Pondering PJM's Energy Price Run-Up
Does inappropriate market power explain the increase during late 2005?
Beginning around June 2005, prices in the PJM day-ahead locational market pricing (DA LMP) energy markets and real-time pricing (RT LMP) markets rose precipitously. During most of 2004 and the first five months of 2005, the PJM monthly average unweighted energy prices generally did not stray too far from $40/MWh. However, prices finished 2005 in the $60/MWh to $80/MWh range. Nevertheless, in its recently released 450-page State of the Market Report for 2005, the PJM Market Monitoring Unit (MMU) found that “Energy market results were competitive.” 1 The MMU found that fuel-price increases almost completely explain the increase in LMP.
Parsing the Standard Explanations
What explains the PJM 2004/ 2005 price patterns and the run-up in the latter part of 2005? Was the run-up caused by market forces consistent with a well functioning competitive process, or is there evidence that market power inappropriately influenced market results? Does the PJM energy market, working in conjunction with other PJM markets, result in prices that are just and reasonable to both consumers and producers?
Based on publicly available information, our study concludes that price increases in PJM energy markets are not fully explained by higher loads and higher commodity fuel prices. Something else appears to be going on. Could higher energy prices be the result of the inappropriate exercise of market power rather than the appropriate result of market dynamics operating in the presence of scarcity?
Our basic finding is that, beginning in July 2005—one month after the price run-up began—actual DA LMP begins to exceed systematically its estimated value. Interestingly, load-serving entities in several state jurisdictions were conducting default service auctions during this period, including Delmarva Power on behalf of its approximately 20,000 Virginia ratepayers. 2
Actual PJM energy prices observed in the latter half of 2005 no doubt influenced suppliers’ offers to sell electricity in those auctions. Since the results of these auctions directly translate into much higher retail prices for electricity, it is important to determine why actual prices exceed estimates in what appears to be a systematic way during the last six months of 2005.
But there is a crucial flaw in the analysis. While PJM has provided the fuel type of the marginal unit, the information that is needed to increase the precision of the analysis and corresponding faith in any set of results is the heat rate of the marginal unit(s). This data is not yet publicly available. 3 Nevertheless, by keeping heat-rate assignment rules constant throughout the 24-month period, it is posited that study of the available data results in increased understanding of PJM energy market results during this especially important time period.
The results are very interesting. For many sets of heat-rate assignments tested, actual DA LMP begins