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Letter to the Editor

Fortnightly Magazine - August 2006

between cost and price during the latter half of 2005 is the direct result of the flawed assumptions. The fact that gas prices increased significantly in the latter half of 2005 made the results for that period more sensitive to the unit type assumption.

The spot-market price of natural gas in the second half of 2005 was 69 percent higher than over the prior 18 months, the spot market price of light oil in the second half of 2005 was 41 percent higher than over the prior 18 months, while the spot market price of coal increased less than 1 percent over the same period. The result of the increase in gas prices was an increase of 69 percent in the difference between the costs of a gas-fired CC and a gas-fired CT.

The interaction of heat-rate assumptions in the article and fuel price increases explains why Spinner underestimates marginal costs and overestimates the difference between prices and marginal costs for the latter half of 2005. There was, in fact, no increase in the markup and no increase in market power in the latter half of 2005.

Prices increased in PJM in 2005 as the result of increased fuel prices and increased demand rather than from an increase in market power. In a competitive market, it is expected that increased input prices will result in increased marginal costs and increased prices. The 2005 State of the Market Report concluded that, on a fuel-cost adjusted basis, prices in PJM increased by 1.5 percent.

Net revenue is an indicator of generation investment profitability and thus is a measure of the overall market performance as well as a measure of the incentive to invest in new generation to serve PJM markets. While higher PJM prices resulted in higher net revenues for all unit types in 2005, the increase was significant only for coal units. This is consistent with the underlying reasons for the price increases. The increase in net revenues for baseload coal units was the result of higher PJM prices which were in turn the result of higher gas prices and higher demand. Higher gas prices resulted in higher prices when gas-fired units were marginal but did not result in higher net revenues for marginal gas-fired units. Spinner had all the information available to him to directly test his claim that units of all types experienced higher net revenues in the latter half of 2005, but he failed to do so.

The MMU found that PJM energy market results were competitive in 2005 based on detailed analyses of market structure, participant behavior, and market results. There is no evidence of increased market power in the latter half of 2005.

Joseph Bowring, PJM Market Monito r