Commission Watch

Price controls turn upside-down in New England.
Fortnightly Magazine - July 15 2003

Price controls turn upside-down in New England.

Several months have now passed since grid operators in New England introduced the region to a PJM-style standard market design (SMD), complete with a day-ahead market (DAM) and nodal-based locational marginal pricing (LMP) to manage congestion on transmission lines (a major problem in southwest Connecticut). Yet the SMD has not taken all the excitement out of electricity price discovery. Instead, the New England independent system operator (ISO-NE) has found it necessary to augment the new SMD regime with three new ad hoc price control schemes-three schemes so convoluted that they appear to run at cross-purposes, each undoing the other in turn.

Of course, the bid cap of $1,000 per megawatt-hour (MWh) still remains in place as a last-ditch safety net. Yet many observers, including the Federal Energy Regulatory Commission (FERC), still wonder why the $1,000 price ceiling should not be sufficient to guard against gaming or a price blowout. But the physics and politics of bulk power operation and regulation still confound the experts. Even with the new SMD, things don't turn out as simply as they first appear.

For example, in a bizarre twist, one of ISO-NE's three new price control schemes would actually allow some generators to collect an energy price greater than the $1,000 limit on bids. In other words, the safety net will now serve not so much as a cap on prices, but as a floor. The ISO now says that in certain hours of high demand and scarcity of supply, when bulk power markets are most fragile and vulnerable to manipulation, it wants energy prices to rise to the highest permissible level, and perhaps even higher than $1,000, depending on line losses and congestion uplift.

So how did price controls get turned upside-down in New England? The story reveals how ISO-NE has sought to deal with a trio of distinct problems.

One, how should regulators deal with power producers who control a dominant share of available generation and thus might hold or exert market power? Two, how should the market compensate peaking plants (gas fired, simple-cycle combustion turbines) that cost so much that they don't get a chance very often to run and make money, but yet are still essential to maintain reliability in areas with lots of grid congestion? Three, how should ISO's compensate for shortcomings in price-setting software algorithms, so that the SMD will treat all generators fairly and equally, whether they furnish energy for consumption or supply nothing but reserve capacity-not strictly a product, but needed all the same, to keep the system solvent?

In New England, at least, the answers have come in the form of three proposals: Pivotal, Push, and Scarcity.

1. PIVOTAL. To control market power, ISO-NE proposes a two-step price mitigation procedure to govern power producers that control an amount of capacity that exceeds the supply margin (supply minus load) for the New England system during the hour in question. These "pivotal" suppliers (the rule would apply in noncongested areas only), the ISO would flag and evaluate any energy bid that equals 300 percent of the prior reference level or exceeds it by $100. It would then mitigate the derived SMD price if the bid produces an upward move of $100 or a price doubling, whichever is lower, or a downward move of $25 or 200 percent, whichever is lower, above or below the LMP in any other market serving NEPOOL (New England Power Pool).

2. PUSH. To compensate high-cost gas turbines, and to carry out FERC's directive in its landmark Devon Power decision (103 FERC 61,082, Apr. 25, 2003), where FERC rejected the idea of signing piecemeal RMR ("reliability-must-run") contracts with individual suppliers, ISO-NE now in effect will guarantee fixed cost recovery by proposing a safe harbor bid level exempt from price mitigation for any peaking plant with a capacity factor of 10 percent or lower that operates in a designated congestion area (DCA). The bid level ("peaking unit safe harbor," or PUSH), will reflect the prior year's fixed and variable costs, averaged over actual hours of operation-not just hours of congestion, as under a previous but now terminated cost recovery scheme known as the CT Proxy. FERC says that all PUSH bids must be allowed to set the hourly LMP, so that the rising price tide will lift all generator boats and furnish incentives for new plant construction. But so far the ISO refuses, saying that its software can allow LMP price-setting for only about 75 percent of PUSH plants, and it describes this as-yet unsanctioned compromise as "rough justice" for turbines.

3. SCARCITY. Lastly, to encourage new plant construction in the absence of a resource adequacy model (expected next year) that reflects locational capacity needs, ISO-NE proposes to set the LMP price in the real-time market at $1,000 during scarcity conditions if the ISO cannot otherwise restore operating reserves to required levels under NEPOOL Operating Procedure 8, or if the ISO is able to maintain the required level of reserves only by purchasing power from outside the system in external transactions ineligible to set LMP prices, while it redispatches and constrains successful supply bidders from inside the system by instructing them to supply only reserves, rather than product energy. This idea has come partly from ISO market advisor David B. Patton, who argues that the reserve obligation marks an unequivocal obligation for the ISO, and thus an ISO decision to look out-of-merit for reserve supplies should be seen as the true marginal price driver. Thus, Patton claims that the energy bid cap of $1,000 (the highest merit price) identifies the applicable opportunity cost for shortage hours. But note that the ISO predicts that its scarcity pricing proposal would likely kick for as few as two to four hours during an entire year.

In a key development for New England, FERC has now granted conditional approval of a similar scarcity pricing proposal for the New York ISO, saying it will "benefit customers" by sending "better economic signals." However, the New York scheme differs in that it adds a locational parameter. New York will boost the energy price to the $1,000 cap depending on whether the shortage exists only in the eastern part of the ISO's control area, or statewide.

Thus, some say that the New York scheme should do a better job of distinguishing between honest economic scarcity rents in areas of true supply deficit, versus high prices in other areas that might well stem from withholding, gaming, or market manipulation.

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