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Fingerprinting the Invisible Hands

Opaque markets inflate power prices.

Fortnightly Magazine - July 2009

F x Price Cap.

• Mean Bid = A + B x Gas Price + C x Load + D x Shame Cap + E x Reporting Delay + F x Price Cap.

The data used are the most recent 22,280 hourly observations available on ERCOT’s web site. Since the error terms are highly correlated, the analysis uses STATA’s “Robust” regression algorithm to avoid any bias in the statistical coefficients. 11 All pricing data is deflated to eliminate the impact of inflation on the data set. No other adjustments or alternative specifications are modeled.

The maximum bid model is significant at the 99.9 percent level. The maximum bid in each hour is reduced by $0.95 for each day of delay in reporting the bidding data. This result confirms that additional transparency will lead to competing bids at the high end of the market (see Figure 3A) .

The regression results for average bids also are significant at 99.9 percent. The impact of a one-day reduction in reporting delay of bids is $0.053/MWh (see Figure 3B) . The confidence interval around this value is 7/10ths of one cent.

The conclusion is straightforward. When the Texas PUC reduced the bid delay from 180 days to 60 days, it reduced the average bid submitted to ERCOT by $6.32/MWh. Interestingly, the impact of a single day change in bid reporting is relatively large compared to changes in the price cap or in the “shame cap,” an indication that competitive dynamics may well be a better enforcer of market efficiency than arbitrary bidding rules. Certainly, this reprises Adam Smith’s belief that true market discipline comes from competition, not the rules of the trade association.

Hockey Stick Bids

It’s interesting to test the alternative hypothesis. In May 2008, a paper the author presented at the American Public Power Association caught the interest of the Wall Street Journal . Energy reporter Rebecca Smith, whose reporting is well known and respected in the industry, conducted her own investigation. 12 As part of her story, she commented on the “hockey stick” bids filed by one of the market participants. Hockey stick bids are those that have normal economic prices at lower levels and then a massive “stick” where the last few megawatts are priced from ten to hundred times the going price.

FERC prohibits hockey stick bidding:

First, bids that vary with unit output in a way that is unrelated to the known performance characteristics of the unit are prohibited. An example of this bidding practice is the so-called “hockey stick” bid where the last megawatts bid from a unit are bid at an excessively high price relative to the bid(s) on the other capacity from the unit. A variant of this pattern could be a single unit in a portfolio that is bid at an excessively high level compared to the remainder of the portfolio, without any apparent performance or input cost basis.

A second category of prohibited bids are those that vary over time in a manner that appears unrelated to change in the unit’s performance or to changes