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What Can We Learn from the Collapse of California Wholesale Electricity Market In-Koo Cho1 Hyunsook Kim2 Sean P. Meyn3 1 Department of Economics University of Illinois 2 KIPF 3 Department of Electric and Computer Engineering University of Illinois October 27, 2009 Origin Indispensable Not storable Reliability of service is extremely important. Northeast black out on August 14, 2003 cost more than $6B. According to Richardson, [U.S. is] ”a superpower with a third-world electricity grid”. Affected Area of Black out on August 14, 2003 Figure: Area affected by the black out. [Source: Wikipedia] Before Figure: Area before the black out. [Source: Wikipedia] After Figure: Area after the black out. [Source: Wikipedia] Origin, continued Large market PJM, serving 51M people in 13 states with annual billing exceeding $20B. CAISO, serving 27M Californians (excluding LA and some other metropolitan area). 2nd largest in U.S. and 5th largest in the world. CAISO control area Figure: PG&E, SCE and SDG&E serve 75% of the state. LA is controlled by LADWP. Major California Grid System 1 Figure 2.1: Map of Major California Transmission Lines Schematic Drawing NW2........ 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. . . . . . . . . . . . . . . . .. . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . .. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . NW3 SR2 HUMB SF SR3 NP15 PATH15 ZP26 PATH26 SP15 LA1 LA2 II1 LA3 II2 NV3 LA4 NV4 MX LC3 AZ2 LC2 AZ3 LC1 AZ5 Origin, continued Large capital investment Generators Transmission network Large capital cost High entry barrier Origin, continued Used to be Vertically integrated monopolist Tightly regulated Rate is set to recover the cost Close relationship between regulators and utilities Wholesale Power Market A bold attempt to reform a traditionally regulated industry Competition among generators and utilities to achieve Low price Reliable service Time Line California Public Utility Commission (CPUC) Blue Book [1994] spell out the key components of restructuring: Retail competition Transition cost recovery Generation divestiture CAISO and CalPX CAISO and CalPX were founded in 1997 and 1998, respectively. CalPX administers market transactions. CAISO ensures reliable management of transmission network. Implementation Traditional utilities were forced to sell off the generation capacities to generators. The utilities purchase the power, while generators supply power competitively in the wholesale market CalPX. Transmission lines are managed by Independent System Operators (ISO) to ensure fair and reliable way of allocating the capacity. Implementation Traditional utilities were forced to sell off the generation capacities to generators. The utilities purchase the power, while generators supply power competitively in the wholesale market CalPX. Transmission lines are managed by Independent System Operators (ISO) to ensure fair and reliable way of allocating the capacity. Emulate a market where the utilities and the generators compete each other. Stack up the marginal production cost of different generators to build a supply curve (nuclear, coal, gas turbine, and so on). Find an intersection of the demand and the supply to clear the market. Supply and Demand Price Supply Curve Trash ($30+) Gas Turbine ($20-30) Coal ($10-15) Nuclear ($6) O Quantity Supply and Demand Price High Priority Customers Customers with interruptible services Demand Curve O Quantity Supply and Demand Price High Priority Customers Customers with interruptible services Supply Curve Consumer Surplus Equilibrium Price ($20-30) Gas Turbine ($20-30) Producer Surplus Coal ($10-15) Nuclear ($6) O Demand Curve Quantity Equilibrium Quantity (< 45,000MW) Important Details Meeting the demand continuously is extremely important, because the cost of black-out is large. Although one can predict the demand for power fairly accurately, there will be a forecasting error. Maintain reserve capacity to meet the unexpected surge. Real Example Figure: Forecast and actual demand on Feb 18, 2007 posted at CAISO Web page Important Details, continued The main constraint is that the generators need time to ramp up (and down) to meet the demand. Nuclear. Practically fixed. Coal. 1 hour. Gas turbine. 15-30 minutes. Hydro. Shorter. A schematic scheduling is Nuclear provides the base load, under “must run” contract. Coal provides the shoulder load. Gas turbine and hydro provide the peak load. Important Details, continued Multiple rounds of markets to help generators set the dispatch schedule. Day ahead Hour ahead Real time (10-20 minutes) Adjustment bids and rebate Important Details, continued Primary Services Bulk energy State-wide service Ancillary Services Needed for reliability Localized service Rules differ, as the composition of generating technologies differ across the regions. Different Phases April 1998-May 2000. Stable and low prices ($20-$37/MW) Price ceiling ($100-$150/MW) for retail price was not binding. June 2000-January 2001. High price ($147-$265), occasionally hitting $750 Low reserve capacity (Below 1.5%) triggers rolling black-outs PG&E declared bankruptcy, as it cannot pay for the wholesale power. January 2001. Collapse of CalPX Signs of Market Dysfunction(?) Extreme price volatility in the ancillary service market as early as 1998 Shortage of power at key junctures Large profit accrued by generators and fuel suppliers Extremely high retail price Price Volatility Illinois, July 1998 APX Power NL, July 2006 Previous Week Price (Euro/MWh) Volume MWh Current Week (7/27) Purchase Price $/MWh 5000 Previous week 4000 3000 2000 1000 0 Mon Tues Weds Thurs Fri 4000 3000 2000 1000 800 600 400 200 0 Sat Sun 70 250 60 200 50 150 30 20 50 10 0 Thurs Fri Sat Sun Mon Tues Weds Forecast Prices 40 100 Weds Tues Wed Thus Fri Ontario, November 2005 PX prices $/MWh Forecast Demand California, July 2000 Spinning reserve prices Mon Demand in MW Last Updated 11:00 AM Predispatch 1975.11 Dispatch 19683.5 21000 18000 15000 2000 1500 1000 500 0 Last Updated 11:00 AM Predispatch 72.79 Dispatch 90.82 Hourly Ontario Energy Price $/MWh 3 6 9 12 15 18 21 Tues 3 6 9 12 15 18 21 Weds Figure: Price dynamics in four different markets 3 6 9 12 15 18 21 Time Thurs Cause Supply Drought in the winter of 2000 reduced the supply of hydro power in Pacific Northwest No significant generation capacity was built in the preceding 10 years in California Transmission capacity was not improved. Demand The economy of California has expanded throughout 90’s. Especially, the demand from the area around Silicon Valley increased, causing congestion from south to north. Cause, continued... Manipulation Generators could have manipulated the dispatch schedule. Natural gas price may have been manipulated. Enron traders openly discussed manipulating California’s power market during profanity-laced telephone conversations in which they merrily gloated about ripping off “those poor grandmothers” during the state’s energy crunch in 2000-01, according to transcripts of the calls. The calls were obtained from the government and transcribed by a public utility district near Seattle that wants Enron to forfeit millions of dollars in ill-gotten gains over the energy trading scandal. [AP by Kristen Hays (06/03/04)] Cause, continued... Design Compared to PJM, California design is more decentralized. The market could be fragile against the exogenous shock and manipulation (such as capacity withdrawal). Price cap at the retail level, but no such cap at the wholesale level, caused the utilities and CalPX to declare bankruptcy. Economic theory predicts... 1 If the demand and the supply are stable, so is the market price. 2 Without market power, the market price must be close to the marginal production cost of power, which is around $30-50. 3 If the market is competitive,then both consumers and generators gain something out of the market. Supply and Demand, again Price Supply Curve Consumer Surplus Equilibrium Price Producer Surplus Demand Curve O Equilibrium Quantity Quantity Therefore,... If the market price is bouncing between 0 and the price cap, then something is wrong with the market. In particular, the gap between the market price and the production cost is an evidence of the market power. Consumer rip-off strengthens the evidence of the market power. If we design the market properly, then the market price should be hovering around the marginal production cost. Economic theory predicts...? The prediction is valid if the energy market is static, or the energy market is not subject to any friction. Economic theory predicts...? The prediction is valid if the energy market is static, or the energy market is not subject to any friction. The power market is operating 24/7, and is subject to the ramping constraint. Economic theory predicts...? The prediction is valid if the energy market is static, or the energy market is not subject to any friction. The power market is operating 24/7, and is subject to the ramping constraint. But, if the supply side friction is not too severe, then it should be valid? Economic theory predicts...? The prediction is valid if the energy market is static, or the energy market is not subject to any friction. The power market is operating 24/7, and is subject to the ramping constraint. But, if the supply side friction is not too severe, then it should be valid? No. Economic theory says... Even if the supply side friction is small, the market outcome is very different from what we expect. In particular, the price is extremely volatile, fluctuating between 0 and the ceiling, without any tendency to converge to the marginal production cost, and the supplier can accrue all the gains from trading, leaving nothing to the consumers. All these bad things can happen even if the market is free from any strategic manipulation, and even if the market is efficient. Price Sample Path Prices 250 200 Normalized demand Reserve 150 100 50 0 Mon Tue Wed Thu Fri Sat Sun I am not saying I am not saying There was no market manipulation by suppliers of power and fuel. I am not saying There was no market manipulation by suppliers of power and fuel. There is an ample empirical evidence, not to mention the phone and e-mail records of Enron traders. I am not saying There was no market manipulation by suppliers of power and fuel. There is an ample empirical evidence, not to mention the phone and e-mail records of Enron traders. Volatility is an acceptable outcome as long as the market outcome is efficient. I am not saying There was no market manipulation by suppliers of power and fuel. There is an ample empirical evidence, not to mention the phone and e-mail records of Enron traders. Volatility is an acceptable outcome as long as the market outcome is efficient. No risk averse consumer wants to have volatile utility bills, not to mention a large bill. I am not saying There was no market manipulation by suppliers of power and fuel. There is an ample empirical evidence, not to mention the phone and e-mail records of Enron traders. Volatility is an acceptable outcome as long as the market outcome is efficient. No risk averse consumer wants to have volatile utility bills, not to mention a large bill. Distribution of welfare is something we can ignore in designing a market, as long as the market outcome is efficient. I am not saying There was no market manipulation by suppliers of power and fuel. There is an ample empirical evidence, not to mention the phone and e-mail records of Enron traders. Volatility is an acceptable outcome as long as the market outcome is efficient. No risk averse consumer wants to have volatile utility bills, not to mention a large bill. Distribution of welfare is something we can ignore in designing a market, as long as the market outcome is efficient. Electricity is a necessity, that is quite insensitive to the price changes. High retail price has a large impact to overall economy. I am saying It might be impossible to design an efficient market that achieves efficiency of allocation and stability of market price. Extreme volatility of price is not an evidence of market dysfunction. An attempt to fix it by imposing price cap may result in more harm than benefit. Even if the consumers are being ripped off, we need other evidences to prove the presence of non-competitive behavior such as e-mail exchange among traders of natural gas. If a stable price of power is a policy goal, we should look for an alternative trading mechanism to the wholesale market such as a bilateral long term contract. I am saying, continued Because the demand for power is very insensitive to price changes, the long run stability of price can be achieved only by providing ample reserve capacity rather than generation capacity per se. Increasing reserve capacity can be achieved through increasing generating capacity, increasing transmission capacity but also through conserving energy use. For example, we need to re-evaluate the cost and the benefit of installing smart meters. A Bit of Theory Imagine a market where the demand is increasing and decreasing rapidly. The demand and the supply curves are overlaid, and the intersections are moving around. Graphs Price Supply Curve Consumer Surplus Equilibrium Price Producer Surplus Demand Curve O Equilibrium Quantity Quantity Graphs Price Consumer Surplus Supply Curve Producer Surplus Demand Curve O Quantity Graphs Price Supply Curve Consumer Surplus Equilibrium Price Producer Surplus Demand Curve O Equilibrium Quantity Quantity Graphs Price Supply Curve Consumer Surplus Producer Surplus Demand Curve O Quantity What is wrong with this picture? Price Supply Curve Consumer Surplus Equilibrium Price Producer Surplus Demand Curve O Equilibrium Quantity Quantity What is wrong with this picture? Price Consumer Surplus Supply Curve Producer Surplus Demand Curve O Quantity Answer The supply cannot catch up with the demand, because of the ramping constraint. The excess demand forces the price increase all the way to the ceiling. We will see extremely high price and no consumer surplus. Yet, there is no market power. Correct Figures Should Be ... Price Supply Curve Consumer Surplus Equilibrium Price Producer Surplus Demand Curve O Equilibrium Quantity Quantity Correct Figures Should Be ... Price Supply Curve Producer Surplus Demand Curve O Quantity Less Obvious Price Supply Curve Consumer Surplus Producer Surplus Demand Curve O Quantity Less Obvious, continued Even with excess supply, the generator would not dump the boiling water, because the demand will increase with a positive probability. The price go down to the floor, as a result. Even less obvious is that in the end, the generator will extract all the gain from trading. Friction, not the market power, is the basis for the large profit. Epilogue Long term contract vs. spot market Market uncertainty may lead to policy uncertainty. Policy uncertainty may discourage investment to infrastructure. New way of diagnosing the market power.