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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

basic spikes occur where natural gas prices climbed precipitously, but the response in Texas seems to exceed the response in Louisiana. Given ERCOT’s large position in coal, Texas might be expected to have lower marginal costs — especially for off-peak periods.

Again, the lack of a consistent benchmark is frustrating. FERC allowed the utilities in ERCOT to cease providing system lambdas when the administered markets went into operation. Given the insignificant interconnections between Louisiana and Texas, the California example is more compelling.

The national experience mirrors the situation in Texas (see Figure 3) . Since 2003 the differential between prices charged in RTO states and non-RTO states has continued to increase. In January 2003, RTO states averaged $74.43/MWh versus $64.01/MWh for non-RTO states — a differential of $10.42/MWh. In the most recent data the differential has climbed to $23.90/MWh, doubling in about four years. As in Texas, removing fossil fuels from retail prices indicates an increasing differential. RTO states showed a differential of $11.26/MWh at the beginning of 2003 that has risen to a differential of $27.55/MWh in July 2007 (see Figure 4) .

Natural gas prices are the most common explanation for the poor showing of the RTO states. The facts show, however, the actual delivered cost of natural gas is comparable across the United States and natural gas is a common fuel in both RTO and non-RTO states (see Figure 5) .

The simplest and most pertinent explanation is the shift in producers’ surplus away from consumers. Under traditional regulation, consumers were able to capture the values above the supply curve. The ill-fated Illinois wholesale electricity auction in fall 2006 clearly demonstrates this effect. Under traditional regulation, the triangle between price and the supply curve ( i.e., producers’ surplus) is captured by customers. In a competitive market, low-cost producers receive a windfall when increasing demand raises prices above their marginal costs. In most restructuring efforts, the cost of returning the producers’ surplus to producers has been overlooked. The impact of the transfer is not necessarily small, nor likely to be ignored by consumers.

While there is no assurance that setting rates at levels that reflect marginal cost will be higher than average total cost, it is a very likely outcome during periods when marginal costs are quite high. The absence of marginal cost information for the nation’s administered markets is a significant problem.

Lack of Transparency

The relative lack of transparency in an RTO ( i.e., substantial lags in revealing bidders’ identity, if indeed the bidders’ identities are revealed) means there are relatively few checks and balances against strategic bidding. In ERCOT, one market participant repeatedly has bid $990.01/MWh for a small block of energy. In many cases, this unrealistic bid actually sets the market price. 4 This form of strategic bidding does not even require market manipulation, although it appears similar to Enron’s “Project Stanley,” a market manipulation scheme in Alberta, Canada, in which Enron would set a high price and then share the proceeds with its suppliers.

By contrast, open-outcry markets like the WSPP provide more