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The High Cost of Restructuring

RTO markets aren’t living up to the promise of cheaper power.

Fortnightly Magazine - February 2008

information to market participants. Since all bids and asks are public, irrational market behavior is easily recognized. Even simple applications of market power is more easily identified in open-outcry markets, since the exercise must be in plain view.

A frequent counter-argument involves the theory that potential conspirators will use the information available in open markets to coordinate their transactions. Little or no evidence suggests a desire to conspire is stymied by the necessity of exchanging data outside the RTO’s web site. To the contrary, Enron coordinated bids in Project Stanley by simply calling up their fellow conspirator. Any rules designed to make its communications difficult were simply sidestepped by the use of a telephone.

For example, Illinois experienced a massive transfer of producers’ surplus from consumers to producers beginning in January 2007. A single auction in 2006 operating under conditions of extreme secrecy produced prices for the majority of the state’s customers 40 percent above contemporaneous open markets at the time. The auction then became the basis of a complaint to FERC that was later settled by a $1 billion rollback. The auction mechanism has now been abandoned.

Neighboring states did not enjoy the benefits of the Illinois electric auction and fared far better in 2007 although their fuel mix was comparable. A central problem in Illinois was the lack of transparency. Bid behavior was unusual, but could not be observed due to the stringent secrecy. Today, even after the results of the auction have been rolled back and the auction process abandoned, the bids are still secret from non-participants. The end result of such mechanisms is to reward strategic bidding.

RTO Irony

Many RTO advocates argue the efficiency of administered markets has been proven. Unfortunately, no formal benchmark exists to test their conjectures, and the only easily available reference point, retail rates, appears to be moving in the wrong direction. Increasingly, these advocates now are agitating for government intervention to encourage additional investment by raising prices. There is substantial irony in this, for RTOs may well be incapable of meeting the competition from traditionally regulated utility organizations that can and do afford to provide new generation without intervention to raise prices to consumers.

Will additional fixes to these cumbersome, artificial markets make them as efficient as open outcry markets? Obviously, a good first step is to require RTOs to file system lambdas. This will allow a better understanding of whether the administered markets truly are competitive. Eventually, transparency must be restored to these markets so market participants cannot pursue pricing that does not reflect economic realities.

In the alternative, America stands a real risk of losing the objective in pursuit of the dream.

 

Endnotes:

1. “Acting in Time: Regulating Wholesale Electricity Markets,” William Hogan, May 8, 2007.

2. “ Looking for the ‘Voom’: A Rebuttal to Dr. Hogan’s ‘Acting in Time: Regulating Wholesale Electricity Markets ’,” Robert McCullough, June 26, 2007 .

3. “Many Texas consumers feel competition in the state’s energy markets has been a costly failure,” Tom Fowler and Janet Elliott, Houston Chronicle , October 7, 2007.

4.