Let's Get Physical

Deck: 

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
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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.

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