Message-ID: <5189738.1075851604543.JavaMail.evans@thyme> Date: Mon, 16 Jul 2001 17:14:00 -0700 (PDT) From: pennfuture@pennfuture.org To: pennfuture@pennfuture.org Subject: PennFuture's E-Cubed - Market Lessons from 2000 Mime-Version: 1.0 Content-Type: text/plain; charset=ANSI_X3.4-1968 Content-Transfer-Encoding: quoted-printable X-From: PennFuture X-To: pennfuture@pennfuture.org X-cc: X-bcc: X-Folder: \Dasovich, Jeff (Non-Privileged)\Dasovich, Jeff\Deleted Items X-Origin: DASOVICH-J X-FileName: Dasovich, Jeff (Non-Privileged).pst Please respond to PennFuture=20 PennFuture's E-cubed is a commentary biweekly email publication concerning= the current themes and trends in the energy market.=20 July 16, 2001 Vol. 3, No. 13 Market Lessons from 2000 =20 School's still out for summer, but just as the new and improved Federal En= ergy Regulatory Commission (FERC) issued a watershed RTO decision last wee= k which could lead to substantial expansion of PJM into the Northeast, PJM'= s State of the Market Report 2000 contains some interesting information an= d lessons for us.=20 After the California experience demonized spot electricity markets, it wou= ld surprise many that PJM's 2000 spot energy market was a bargain. Spot pr= ices in 2000 were below $30.00 per megawatt-hour (MWh), or three cents per= kilowatt-hour (kWh), 70.88 percent of the hours in the year. The single h= ighest hourly price was $810 per MWh or 81 cents per kWh, but prices reach= ed or exceeded $200 per MWh during only 13 hours in the entire year (downl= oad charts on our website by typing www.pennfuture.org/items/hourlypricecha= rts_71601.pdf in your browser). By contrast, California experienced spot = prices that often exceeded $200 per MWh for most of the last 12 months. Authored by the PJM Market Monitoring Unit - but likely reviewed and edite= d by top PJM management - the Report delivered to FERC concludes that all = of the markets operated by PJM were "reasonably competitive." It cautions, = however, that, "there are potential threats to competition in the energy, capacity and re= gulation markets that require ongoing scrutiny and in some cases may requi= re action in order to maintain competition. Market participants do possess= some ability to exercise market power under certain conditions in PJM mar= kets."=20 In order to maintain and improve the functioning of the PJM markets, the R= eport recommends: Retention of the $1000/MWh bid cap in the PJM energy market and investigat= ion of other rule changes to reduce incentives to exercise market power. Retention of the $100/mw bid cap in the PJM regulation market. =20 Evaluation of additional actions to increase demand-side responsiveness to= price in both energy and capacity markets. Modification of incentives in the capacity market to require all Load Serv= ing Entities (LSEs) to meet their obligations to serve load on a longer-te= rm basis, and require all capacity resources to be offered on a comparable= longer-term basis. The Report uses several analytical methods to reach these recommendations = and conclusions, including looking at the net revenue for generation from = all sources, the increase in bid amount over marginal cost, market concent= ration (as measured using the HHI index), and lastly an analysis of the re= sulting prices. =20 See Spot go to market Perhaps the Report's most intriguing information on price trends concerns = the spot energy market, where average prices declined by 9.81 percent from= 1999 levels. Driven by lower peak prices in the most expensive 100 hours = of the year, the average locational marginal price (LMP) in 2000 was $30.7= 2 per MWh (3.072 cents per kWh), falling from the 1999 average of $34.06 p= er MWh (3.406 cents per kWh). This average price decline in the spot marke= t was more significant because it occurred even though fuel costs were sha= rply higher in 2000. Indeed, the average fuel-adjusted LMP in 2000 decline= d to $24.78 per MWh, or 27.25 percent from the 1999 price of $34.06 per MW= h.=20 And when one compares 2000 spot market prices to competitive future prices= for the year 2000 and to 1996 regulated rates for generation, it becomes = clear that spot market prices in 2000 were significantly lower than 2000 f= uture contracts. Even with appropriate price adjustments to facilitate com= parison, they were also much lower than 1996 regulated residential generati= on rates for all hours charged by Pennsylvania's six major electric utilit= ies, which ranged from about $51 dollars to $85 dollars per MWh, or 5.1 to= 8.5 cents per kWh.=20 The lesson Spot market prices, which received so much bad publicity as a result of th= e California fiasco, can be a bargain and customers who are able to manage= their demand to reduce or avoid the hours of high spot prices can reap ma= jor savings by purchasing electricity from the spot market. In fact, spot market prices in 2000 were below most of Pennsylvania's shop= ping credits or "prices to compare." That's saying something, since the sh= opping credits in turn are as much as 4.0 cents per kWh less than the 1996= regulated rate for just generation paid by customers to the monopoly util= ities.=20 But? Since spot market prices in 2000 were well below both the 1996 generation = rate paid to monopolies and the much lower shopping credits, why were ener= gy suppliers increasingly unable to offer electricity at prices below the = shopping credits?=20 ICAP pricing and reliance by electricity suppliers on higher priced future= or forward market contracts supply most of the answer.=20 The spot market gives a good indication of what the forward markets should= be under typical circumstances. As the data below indicate, the average s= pot market price for all market locations in 2000 was $30.72/MWh, almost 1= 0 percent less than during 1999, and more than 27 percent lower upon adjus= ting for higher year 2000 fuel prices.=20 =09=09=09 PJM Load-Weighted Average LMP ($/MWh) =09 =09 1999 =09 2000 =09 Change =09 Average LMP =09 34.06 =09 30.72 =09 -9.81% =09 Median LMP =09 19.02 =09 20.51 =09 7.83% =09 Standard Deviation =09 91.49 =09 28.38 =09 -68.98% =09 =09 =09 =09 =09 Average Fuel Adjusted LMP =09 34.06 =09 24.78 =09 -27.25% =09 Median Fuel Adjusted LMP =09 19.02 =09 16.80 =09 -11.67% =09 Standard Deviation =09 91.49 =09 22.04 =09 -75.91% =09 =20 While the dramatically lower standard deviation in 2000 indicates that pri= ces were much less volatile than in 1999, there remained a substantial gap= between average and median prices, indicating that extreme prices during a= small number of hours continued to substantially skew overall average pri= ces. =20 Grading on a curve The PJM 2000 price duration curves, measuring the percent of time prices w= ere at or below a particular level, tell an interesting story. As one woul= d expect with higher fuel prices, especially for natural gas, the general = trend was for prices to be slightly higher during periods where natural ga= s was the marginal fuel. For approximately 99 percent of all hours, 2000 e= nergy prices were more expensive than in 1999. Yet, with relatively low pe= ak demand, the price for the most expensive 1 percent of demand during 200= 0 was considerably lower in 2000 than in 1999, accounting for the entire 9= .81 percent average reduction in 2000 prices from 1999. If not for the red= uced prices for the most expensive 1 percent of demand, overall prices for= 2000 likely would have risen approximately 18 percent over 1999, due larg= ely to higher fuel costs.=20 For these reasons, the Report recommendation to "evaluate" additional acti= ons to increase demand-side responsiveness is SEVERELY understated. PJM an= d all consumers have an essential interest in implementing demand-side res= ponse programs to the maximum economic level, with dramatic implications f= or saving individual consumers money, improving system reliability, keepin= g market prices lower for everyone, and improving market competitiveness.= =20 Can everyone say I-C-A-P? So with the lower wholesale energy prices and plenty of supply, why did th= e retail market sputter?=20 Installed capacity (ICAP) price increases are a partial explanation. In ad= dition to energy, the controversial charge for ICAP is the other significa= nt cost born by electricity consumers within PJM. ICAP represents a call o= ption on physical generation resources by PJM during system emergencies. A= ll LSEs are required to purchase an amount of installed capacity equivalent= to their customer's peak load contribution plus an adequate reserve margi= n, currently 19 percent. But although it exists for reliability purposes, = PJM curtailed the export of energy outside PJM from PJM-committed installe= d capacity on only one day during 2000.=20 Logically, the price for installed capacity, like the price of energy, mig= ht have been expected to decrease during 2000. Yet that didn't occur. As e= nergy prices decreased within PJM, they remained high or continued to incr= ease in surrounding control areas. Higher prices in the surrounding markets= led some generation owners to de-list their generation committed to PJM i= n order to sell out to other control areas without the risk of being curta= iled by PJM. The result was an increase in ICAP prices from an average of = $52.86 in 1999 to $60.55 in 2000. The increase was concentrated over the s= ummer with prices in the daily markets rising to $177 or more for most of = June, July and August. The increase in ICAP prices raised the cost of supp= lying many retail customers by about 1 cent per kWh. The Market Monitoring= Unit concluded that the price spikes over the summer months were a direct= result of the opportunity cost associated with the prices in neighboring = control areas. But the Report's finding that the ICAP market was "reasonably competitive"= seems inconsistent with PJM's conclusion last year that the 2000 ICAP mar= ket performed so poorly that it needed a major overhaul. This inconsistenc= y raises questions about the reasonableness of that portion of the 2000 Re= port or giving the 2000 ICAP market the PJM seal of approval.=20 PJM has invested substantial time and resources since last summer in an ex= tensive stakeholder process to revise its ICAP rules, especially concernin= g the allocation of deficiency revenues and the interval over which ICAP i= s purchased. But since the "reformed" ICAP market began operating only rec= ently on July 1, 2001, it's too soon to know whether it is functioning well= or competitively. We remain skeptical that the PJM prescription cures the= disease, or is merely life support for a dying program. =20 See Spot offer lower prices Apart from the ICAP market, the differing prices in forward and spot marke= ts provide substantial explanations for why electricity suppliers have fou= nd it easy to beat the 1996 regulated generation rate for most utilities b= ut difficult or even impossible to beat the lower shopping credits. (Shopp= ing credit =3D 1996 regulated generation rate - stranded generation cost).= Prior to the 2000 summer season, prices in the forward markets, before an= yone knew how mild the weather was going to be, substantially reflected th= e high-priced experience of 1999. Because of the high prices in 1999, ener= gy that was purchased through forward markets - about 82 percent of all en= ergy - was considerably more expensive than the spot prices turned out to = be. Since customers often prefer to lock in a price in advance, competitiv= e suppliers generally didn't want to provide fixed prices below the retail= shopping credits. If suppliers had relied on the spot market, they could = have offered lower prices. Also, customers who can reduce or shift demand m= ay well benefit from purchasing more power from the spot market. =20 Recent developments Both in the East and West coast markets this week, electricity in daily tr= ading has been near its low for the 52-week period. Several developments a= re pushing down the price of wholesale electricity. Mild weather, falling = gas prices, new generation coming online, increasing demand response and c= onservation as well as a FERC which understands that competition must exis= t prior to price deregulation, are all pushing prices lower. Moreover, for= ward market prices for 2002 within PJM are beginning to fall and are under= downward price pressure.=20 The new downward trend in forward markets partially results from moderate = prices this summer, even during high demand periods, with prices generally= staying under $150 MWh/$0.15 kWh. A good example of this was July 10, a r= elatively hot day with significant demand, which saw prices reach $150 per = MWh for one hour but average $62.78 per MWh for all on-peak hours.=20 What's driving forward prices lower? More efficient generation being installed (below 8000 btu/kWh as opposed t= o 11000 btu/kWh). More ICAP in the market (new capacity estimated at over 4000 MW with load = growth at only 1.5 percent or 1000 MW). More demand-responsive load in the form of 300 additional MW of Active Loa= d Management. The addition of PJM West slated for 2002, with lower prices generally.=20 Lower natural gas prices - falling from $4.0561 /mmBtu in July 2000 to $3.= 29/mmBtu as of July 12, 2001. This good news, which suggests that retail customers in late 2001 or 2002 = may again see retail competitive offers below the Pennsylvania shopping cr= edits, must be weighed against the troubled ICAP market. ICAP remains an a= nachronism. ICAP prices have not returned to competitive levels and remain = one of the significant obstacles to serving retail customers. The forward = prices for ICAP alone have remained above 10 percent of the typical shoppi= ng credit.=20 Yet even in the world of ICAP there is hope. ICAP prices may be beginning = to soften in the face of a substantial amount of new generation that is co= ming online and increased demand response from customers. PJM has institut= ed both an emergency and an economic demand-response program, through whic= h more customers can respond to prices and reduce the price that all custo= mers pay for electricity.=20 Tomorrow's homework The State of the Market Report contains plenty of data which confirms that= PJM is the country's best-run independent system operator and best (thoug= h still flawed) wholesale market. Prices in the spot energy market were we= ll below 1996 regulated generation rates, even with appropriate adjustment= s. But none of this warrants complacency. Only when PJM becomes the first = market to give consumers the tools they need to change their demand for el= ectricity, will the wholesale and retail markets within PJM be FULLY, as o= pposed to "reasonably," competitive. A link to download (in .pdf) the PJM MMU Report can be found on the Intern= et at: http://www.pjm.com/market_monitoring/reports.html .=20 E-cubed is available for reprint in newspapers and other publications. Aut= hors are available for print or broadcast. PennFuture (www.pennfuture.org ), with offices in Harrisburg, Philadelphia= and Pittsburgh, is a statewide public interest membership organization, w= hich advances policies to protect and improve the state's environment and = economy. PennFuture's activities include litigating cases before regulator= y bodies and in local, state and federal courts, advocating and advancing legislative action on a state and federal level, public education and assi= sting citizens in public advocacy. To unsubscribe, simply reply to this email with "unsubscribe" in the subj= ect. - vol3no13_71601.doc