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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

each fuel was on the margin. When there is congestion, there can be more than one marginal unit during a particular five-minute interval. As PJM describes on its Web site, the share of each fuel in each hour is calculated based on the number of five-minute intervals that a unit burning each fuel type is marginal or jointly marginal.

Although data for 2004 had been available for several months, questions arising from the 2005 LMP price run-up inspired Virginia commission staff to request that data for 2005 be posted to the Web site or otherwise provided. Quickly responding to that request, PJM posted year-2005 marginal fuel-type data on Jan. 31, 2006. The data contains information indicating when coal, natural gas, light oil, heavy oil, landfill gas (LFG), wind, and interface power are running on the margin. “Miscellaneous” also is reported as a fuel-type category. The vast majority of hours had some combination of coal, natural gas, or petroleum as the marginal unit. LFG, wind, and interface appeared extremely infrequently and were dropped from the analysis.

Because heat rates are not reported, “miscellaneous” also was dropped. Heavy and light oil were combined into a single category. Table 1 summarizes the frequency of coal, natural gas, and oil as the marginal fuel. Changes in the PJM footprint significantly affected the percentage that each fuel was marginal during the two-year study period. Commonwealth Edison (Com Ed), AEP, Duquesne Light (DLCO), and Dominion Virginia Power (DVP) integrated their generation and transmission systems on May 1, 2004, Oct. 1, 2004, Jan. 1, 2005, and May 1, 2005, respectively.

The first analytical task is to merge spot-fuel price data with marginal fuel-type information so that hourly LMP may be estimated. The calculation is based on which fuel is running on the margin, the portion of the hour that the fuel was marginal, spot-fuel prices, 4 and heat-rate assumptions. Monthly results as plotted in Figure 2 are set forth in Table 2. 5 The hourly estimation procedure calculates weighted average LMP by adding across each marginal fuel type’s contribution to that hour’s total. Each fuel type’s component is calculated as appears below:

In Table 2, only the fuel type of the marginal unit is known; the heat rate of that marginal unit remains a mystery. 6 This problem most seriously manifests itself in the assignment of the proper heat rate when natural gas is indicated as the marginal fuel. Is a combined-cycle combustion turbine (CT) with a relatively low heat rate dispatched as the marginal unit or is a relatively inefficient simple-cycle CT setting the price? The analysis crucially depends on which gas technology is assumed to be marginal when natural gas is indicated as the marginal fuel.

First, we asked PJM to provide the heat rates of the marginal units and waited for a response. Next, we pressed ahead by assigning heat rates as best we could. For example, when we encountered a relatively high load hour (relative to that month’s peak load) during winter or summer, a simple-cycle CT (12,000 Btu/kWh) was assumed to be on the