Let's Get Physical


To manage congestion on the power grid, most traders would rather book a firm path than risk a loss on a financial hedge.

Fortnightly Magazine - January 15 2001

The utility regulators in Washington, D.C. want utilities to build complicated computer algorithms to manage congestion in electric transmission.

"My own view," says commissioner William Massey, "is that the California ISO's market rules should look more like those of PJM."

So in its final order issued Dec. 15, the Federal Energy Regulatory Commission told the California Independent System Operator to replace its system of adjustment bids and price zones with a new PJM-style model, complete with locational marginal pricing (LMP) for each bus or node on the grid.

But many don't want it. They want to trade energy, not congestion.

Under the practice followed in PJM and New York (and under development in New England), congestion rights are financial. Buyers and sellers hedge their deals by purchasing financial rights between any two points on the system. After the deals close, the ISO resolves congestion by setting a theoretical marginal price of energy (locational marginal price, or LMP) at every point on the system. The customer earns (or loses) congestion revenues, depending on the size and direction (positive or negative) of each paired price differential. The settlement comes after the fact, however.

By contrast, many traders see congestion as a physical impediment to be overcome—not a market in its own right. They grow suspicious of economists building Byzantine markets to integrate transmission costs with the locational value of generating plants in a single pricing protocol—like physicists in search of the unified field theory.

Enron argues that physical, path-based FTRs are "homogenous" and "stable" and more easily adapted to trading in secondary markets. It complains that LMP models in PJM and New York keep traders in the dark. "Many congestion management systems [CMS's] rely exclusively on after-the-fact LMP. ... Because those CMS's offer no advance price certainty and cannot trade in secondary markets, transmission grids operated on this basis deny market participants the stability of forward markets and expose them to volatile, short-term price swings."

Moreover, no one has proved that PJM's relatively stable power prices stem from its LMP model, or that congestion caused California's "apocalypse" (Massey's word). The FERC's Nov. 1 staff report on western power markets found that "transmission was not a major issue in 2000 in most discussions with market participants."

But now come the new regional transmission organizations (RTOs), proposing all manner of methods to manage congestion. And none of them wants to "be like PJM."

Most of the new RTOs that issued startup plans late last year opted for a physical flowgate or flowpath model. Two good examples are GridFlorida and RTO West. Under this "physical" view of the world, the RTO determines the total transfer capability of each flowpath or flowgate likely to be constrained. The RTO will issue only a limited and finite quantity of firm transmission rights (FTRs). FTRs trade in secondary markets, but transmission customers that schedule energy across flowpaths or flowgates must have FTRs. (GridFlorida calls them PTRs, or "physical transmission rights.")

Some RTOs, such as the Southern Companies (SeTrans Grid) and the Southwest Power Pool (SPP) have proposed a hybrid model that would combine physical, flow-based FTRs with LMP for settling imbalances. Enron likes this form better (SPP's idea avoids a "common trap"), but listen to this critique from the American Public Power Association:

"Southern's proposal ... is almost purely theoretical. ... While evidently the current rage among theoretical economists ... there have only been a few short years of practical experience with such market structures in this country. And that experiences has been at best unpromising-and at worst disastrous."

"WE HELD A PUBLIC SYMPOSIUM," says Ricky Bittle, vice president of planning rates and dispatch for Arkansas Electric Cooperative Corp., in describing how the new RTO Southwest Power Pool would manage congestion, under its "binary" plan with the proposed Entergy transco.

As Bittle adds, "prominent proponents of various congestion management mechanisms participated." He runs down the names: "Larry Ruff of Energy & Economics Consulting, Bill Hogan of Harvard University, Narasimha Rao of Tabors Caramanis & Associates, and Ed Cazalet of Automated Power Exchange.

"After several meetings of the congestion sub-team, two proposals emerged. One group promoted LMP ... the other group promoted physical rights at flowgates. ... This hybrid [nodal LMP to clear imbalances, FTRs traded in a forward market] received the support of parties on both sides of the debate."

Why does PJM still win the loyalty of some traders? Morgan Stanley Capital Group is one that prefers financial over physical: "GridFlorida has not justified why a nodal congestion pricing mechanism, like that used by PJM, was not proposed instead of [this] unproven flowgate-based system." Morgan Stanley complains that a physical model will force GridFlorida "to constantly redefine" which flowgates matter the most. By contrast, it claims that PJM's financial model is much more flexible:

"Such nodal systems allow the market to decide which paths are commercially relevant. As new congestion develops with changing flow patterns, the aggregated LMP values will reflect the changing system conditions ... the market price will evolve with the changing flow patterns."

And liquidity matters, too. At the Northwest Power Planning Council, Wallace Gibson (manager for system analysis) complains that under the physical scheme proposed by RTO West, "those without FTRs will not be able to schedule on congested paths at all unless they can arrange independent bilateral redispatch arrangements."

"In principle," he adds, "given enough market liquidity, either a physical rights scheme or a financial rights scheme ... will work satisfactorily. ... However, in the absence of adequate market liquidity ... a physical rights scheme is much more significantly handicapped than a financial rights scheme and may offer very little in the way of market access."

"WHY DOES LIFE HAVE TO BE SO COMPLICATED?" That's the view from Dynegy, which staunchly opposes PJM's LMP vision.

"Rather than trying to find or to create the perfect market-something that even if found or created would only last for a fleeting instant," Dynegy would prefer just to deal with congestion, without allowing congestion management to drive the transmission sector.

In a white paper issued in November, "Congestion Pricing Issues in RTO Filings," Dynegy's Daniel King, Mary J. Doyle, and Edward A. Ross argue in essence that congestion doesn't really matter, when you compare the costs involved with the billions being won and lost in California's generation market. "To understand this," they say, just compare congestion costs with energy costs.

"The total congestion costs in PJM, in 1999 were $65 million," say King, Doyle, and Ross. "This represents about 1 percent of the total energy market in PJM, and only 0.3 percent of retail electricity sales in PJM (including T&D costs.) Of this, the potential socialized costs would be on the order of 0.12 percent of energy demand value and 0.03 percent of retail electricity sales in PJM.

"Similarly low levels of congestion occur in California. During the past 12 months [ending October 2000] total congestion costs in California were just $211 million in a $26 billion market."

Dynegy concedes that a "market driven" scheme could aid the market. "Or," it adds, "it could mean that a congestion management system is created to be a market. These are two very different paradigms."


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