Letters to the Editor / Corrections & Clarifications
To the Editor:
In a letter to the Oct. 1, 2003, , a letter from Lewis Evans and Kevin Counsell claims that a "pay-as-bid" day-ahead market would produce prices comparable to real-time prices even if loads understated their demand day-ahead, eliminating the incentive to underschedule (as allegedly happened in California).
In fact, a uniform-price day-ahead auction should produce the same effect. Evans and Counsell state that in a day-ahead market bidders will attempt to "guess the market-clearing price" and bid close to it. On the other hand, auction theory predicts that in a second-price auction suppliers will bid their costs. The important point is the correct definition of cost.
Suppose that a generator has an operating cost of $20/MWh, and anticipates the real-time price will be $40/MWh. In a second-price real-time market that generator will bid $20/MWh. But for the purposes of bidding into the day-ahead market, which will reliably be followed by an opportunity to sell into the real-time market, that generator's cost is the $40/MWh in real-time revenue it forgos by placing power into the day-ahead auction instead-its opportunity cost. (In reality, the bid would be modified to account for the uncertainty in the prediction of real-time prices.)
This means that bidding behavior in a day-ahead second-price auction should be the same as in a pay-as-bid day-ahead auction, as long as it is not the last opportunity to transact. So why then should purchasers still be able to play a demand understatement game, as they allegedly did in the California ISO markets?
1) Absent all considerations of costs and bids, an ISO that operates a real-time market may consider that it has a responsibility to keep real-time prices low by, for example, requiring that bids reflect only variable costs with no fixed cost recovery. In that case the opportunity cost seen by day-ahead bidders will be below their operating costs, so they bid operating costs. The real-time price will be reliably below the day-ahead price, and load-serving entities will seek to shift load into real time.
2) Purchasers may feel some political or regulatory constraint against bidding opportunity costs. We have seen occasions where regulators or case participants imply that any bidding above operating costs is market manipulation.
Political and regulatory constraints can create the opportunity for multiple gaming behaviors that aren't always labeled as such. Labels, and their connotations, are key. "Virtual bidding," for example, is nothing other than a short sale, but "short selling" has acquired an odor of illegitimacy. But physical storage will not bring electricity forward and physical markets into balance. That role must be played by short sales, opportunity-cost bidding, and similar trading arbitrages. The designers of the California markets relied heavily on the anticipated use of these tactics, which were later categorized as games and market manipulation, and which constituted most of the smoke in the famous Enron "smoking gun" memos.
To the Editor:
John Sillin's commentary ("The Blackout of 2003: Why We Fell Into the Heart of Darkness," Sept. 15, 2003) on "the management and social causes of the [August] blackout, [and on what] needs to be done about them" is both important and interesting. I am in full agreement on the urgency of maintaining bulk power system reliability. I disagree with his history, and I agree with his argument that reliability has seriously been neglected in recent years.
1. I believe that he overemphasizes .
(A) Con Ed's passing its dividend in 1974 did send shock waves. But the article does not recognize the intellectually serious effort of state commissioners to overcome the Con Ed 1974 effect. I was a Wisconsin commissioner at the time, and we had every intention of trying to sustain the financial credibility of the utilities under our jurisdiction. The lesson I learned was that the utility should always pay its dividend. That has its own harsh problems.
(B) I do not think transmission deficiencies in 2002 come out of prudency reviews in the 1970s. However, prudency reviews were often essential. Capital investment, the basis on which returns are authorized, could not be approved simply because utilities said so. On the other hand, regulators made every effort to approve construction proposals that seemed reasonable. To get down to earth, Wisconsin Electric built a plant named Pleasant Prairie. I am the guy who was responsible, in a split vote, for the finding of emergency that allowed Wisconsin Electric to go ahead. State commissioners did not just stand arbitrarily in the way of plant construction and transmission construction. FERC (and before it FPC) had practically no jurisdiction on power plant construction. When I arrived at the FERC (1977), I found on the commission docket, or in staff work, relatively little attention to the National Power Survey. We were too busy with natural gas, and with wholesale electric rate cases.
(C) Even California does not provide a good case. I went into the California experience in some detail in an article in Public Works Management and Policy in 2002 ("The Artificial Earthquake"). I can find no systematized record of efforts by firms to put a construction program in front of California utilities. In 2001, one of California Gov. Pete Wilson's former cabinet members gave a talk on the California experience, and I asked what "reserve requirements" were considered at the time the legislation was being developed. The remarkable answer was that he simply did not know. If this had been a big issue, a member of the governor's cabinet would have known. If the companies had thought it a big issue, they would have said so.
2. Though I can only mention it here, we should also remember the competitive business pressures on utilities, with the demand from industrial customers. This depresses investment, exactly when it is needed.
3. Sillin is right that reliability has been seriously neglected. It has been hostage to differences of interest and opinion on "competition," "restructuring," and "deregulation." Competition took over as the goal, even at FERC, though Chairman James Hoecker, especially, spoke also of reliability. People who favored deregulation did not want to hear "reliability." In 1997, I testified on this issue before both the Virginia legislative committee and a Maryland legislative committee. The Maryland committee chairman just shut me up. The advocates of deregulation basically treated "reliability" as a scare word. In moving forward, let us get the history right and get at the real conflicts of interests that obstruct reliability.
We can have system failure, but we cannot stand it.
In the "Commission Watch" column in the Oct. 1, 2003, issue ("Restructure or Bust?" p. 17), the editor-in-chief let a sentence slip onto the page that should have been deleted.
The offending sentence was the penultimate sentence at the lower right-hand column on p. 17, which implied that the U.S. Federal Energy Regulatory Commission might seek to protect the position of a jurisdictional electric utility in case its wholesale power supplier declared bankruptcy.
The authors of the article, Kenneth Irvin and Robert Loeffler, advise readers that they do not subscribe to such an implication.
The regrets the error.
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