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Pondering PJM's Energy Price Run-Up

Does inappropriate market power explain the increase during late 2005?

Fortnightly Magazine - June 2006

by a combination of high levels of supply, moderate demand and competitive participant behavior.” 9

Market structure generally refers to measures of generation ownership concentration quantified by calculations of Herfindahl-Hirschman Indices (HHI). The 2004 report notes some concerns about high levels of market concentration in general as well as in particular geographic areas. Apparently, the MMU was concerned with the high degree of market concentration in PJM energy markets, but noted that because of high levels of supply, moderate demand in 2004 and “competitive participant behavior” prices remained competitive. The 2004 report goes on to state:

“No evidence exists, however, that market power was exercised in these areas during 2004, both because of generator obligations to serve load and because of PJM’s rules limiting the exercise of local market power.” 10

Interestingly, after stating similar concerns, the 2005 report identically states:

“No evidence exists, however, that market power was exercised in these areas during 2005, both because of generator obligations to serve load and because of PJM’s rules limiting the exercise of local market power.” 11

The above comment about market power being constrained by “generator obligations to serve load” is crucial if it is indeed correct. It may help explain the results of the study set forth in this paper. Since about 80 percent of the energy generated in PJM in 2004 was produced by entities that must also supply customers at prices that are constrained by some form of regulation, the financial benefit to generators that would otherwise accrue from high energy prices might have been limited in the past. This would have depended on specific circumstances in particular jurisdictions. Nevertheless, generator obligations to serve load at capped rates was thought to have had a calming effect on prices in the past.

Such calming influence may wane as the obligation to serve retail load at regulated prices and the generation needed to serve that load are financially divorced. Generation that no longer must, in some way, share margins with regulated customers would be able to unilaterally reap the benefits of high market prices. In the many jurisdictions where auction results directly translate into increased prices for customers—and profits for generators—the divorce is fast becoming effective. Although the 2005 report finds to the contrary, could near-term diminution in generators’ obligation to serve load at capped prices be a factor in the 2005 PJM price run-up?

State regulatory commissions must try to participate in these matters as best they can. This is even more true in states where rate caps are coming off and retail customers face the “sticker shock” of market rates even as they recall the promises that changes in this industry were supposed to reduce electric bills.

It also is troubling that the result obtained by this analysis shows that energy market margins expanded greatly in the latter half of 2005—at odds with the PJM MMU’s finding that the price-cost markup index did not vary greatly over 2005. 12 In fact, the MMU found that relatively small margins tended to get smaller as year 2005 progressed. It would be