Message-ID: <22337723.1075846344692.JavaMail.evans@thyme> Date: Thu, 3 Aug 2000 20:46:00 -0700 (PDT) From: dsgeorge@firstworld.net To: dsgeorge@firstworld.net Subject: WSP: Market Ripe for Manipulation... Mime-Version: 1.0 Content-Type: text/plain; charset=us-ascii Content-Transfer-Encoding: 7bit X-From: X-To: "Dick George" X-cc: X-bcc: X-Folder: \Steven_Kean_Dec2000_1\Notes Folders\Ferc X-Origin: KEAN-S X-FileName: skean.nsf Cc list suppressed... Public opinion is the pendulum that swings law...dsg August 4, 2000 Deregulation Leaves Electricity Market Ripe for Manipulation by Power Firms By REBECCA SMITH and JOHN J. FIALKA Staff Reporters of THE WALL STREET JOURNAL It's a market ripe for manipulation: surging demand for an indispensable commodity, weak oversight and a chaotic new set of rules amid a transition from heavy regulation to open competition. This is the state of the U.S. electricity business in the summer of 2000. And sure enough, there's growing evidence that some power companies are finding lucrative ways to exploit the system -- at consumers' expense. The tactics include manipulating wholesale electricity auctions, taking juice from transmission systems when suppliers aren't supposed to and denying weaker competitors access to transmission lines. None of this is illegal, and much of it might be considered basic competition. But as an electricity shortage plunges sweltering California into an energy crisis and fears of even worse shortages rattle the Northeast, the practices of power suppliers face more scrutiny than ever. (See related article.) Steamy Conditions A hot summer day last year shows one kind of manipulation. On July 28, 1999, wholesale electricity prices in the Middle Atlantic states hit $935 per megawatt hour. That was seven times what it costs to generate power at the most expensive plant in the region. An analysis of trading data from that day shows that PECO Energy Corp. and PPL Corp., the old Philadelphia Electric Co. and Pennsylvania Power & Light, made the most of steamy conditions. In the region's power market, deregulated in 1997, a new corporation called PJM Interconnection LLC runs the transmission system once operated piecemeal by eight utilities. It also operates a daily electricity auction that sorts the hourly bids of 540 generating plants. The cheapest plants are called on first, but when the weather is hot and demand is acute, higher offers are taken as well. To attract as many bidders as possible, the highest bid, each hour, sets the price for the entire market for that hour. Grid and Bear It Rise in average wholesale electricity prices at key transmission-interconnection points for the month of May from 1997 to 2000. TRANSMISSION-INTERCONNECTION POINT % CHANGE 1997-2000 Texas +293% Louisiana-Mississippi-Arkansas +216 Tennessee Valley Authority +165 California-Oregon border +162 New York-West +138 Chicago area +130 New England +117 New York-East +101 Upper Midwest +99 Florida +89 Mid-Atlantic region +80* *Includes only years 1999-2000 Source: Federal Energy Regulatory Commission, RDI Power What PECO and PPL did was offer much of their output at low prices so that the majority of their plants would be called into service. But knowing demand was so high, they offered power from their tiniest plants at vastly higher bids, in a way that often set the peak price for a number of hours. Consumers that day ended up paying millions of extra dollars for power. Cases like this show that during the transition to deregulation, "there's a good argument the system has broken down," says William Massey, a commissioner at the Federal Energy Regulatory Agency. FERC, which polices the nation's bulk power markets, began the deregulation movement in 1996. It wasn't supposed to be this way. In the old days, utilities generated electricity and delivered it to customers in exclusive territories. To protect consumers from gouging, rates were regulated. But while supply had to be able to meet peak demand at all times, demand varied widely within regions, between regions and from one season to another. The result was tremendous reliability but also inefficiency and waste. Deregulation, now under way in half the country and functioning nationally at the wholesale level, allows new players -- some affiliated with utilities, some not -- to build power plants and sell electricity. Prices are supposed to be set by competitive markets. Risks are borne by investors, not ratepayers. At the same time, utilities are surrendering control of long-haul transmission lines to new nonprofit operators, like the one in the Middle Atlantic region, which are supposed to ensure fair access to the grid -- the multistate system of high voltage lines. Under this new regime, energy prices should have dropped as companies raced to compete with one another. But the massive U.S. energy infrastructure wasn't designed to serve as the backbone of a free market. On hot summer days, when there's little or no surplus electricity in the nation's most populous regions, generators can charge prices far in excess of their production costs and be confident they'll get tapped for service by grid operators who must keep the lights on at any cost. Utility holding companies that still control transmission lines have an added advantage: They can effectively lock out cheaper competitors. California Cuts Price Cap for Electricity Once Again (Aug. 2)Price Cap Is Set for Electricity That Is Sold in New England (July 27)PPL, KeySpan Say Earnings Surpassed Wall Street Targets (July 27)Energy Trading, Internet Operations Help Enron's Net Income Jump 30% (July 25)PG&E Posts 36% Rise in Net to $248 Million (July 21) The new regional grid operators, called independent system operators, or ISOs, eventually will be in charge of preventing manipulation. But as nongovernmental organizations, they won't have basic investigative tools, like subpoena powers or the ability to impose significant penalties. FERC, which does have those powers, rarely uses them, preferring to let the market discipline itself. A Strange Drop Sometimes it's difficult to know what constitutes an abuse of the market. In July 1999, engineers noticed that a substantial amount of power was being taken from the grid for which there was no explanation. They contacted the North American Electric Reliability Council, the industry group charged by Congress with overseeing the grid since the late 1960s. After a lengthy investigation, NERC determined that Cinergy Corp., a utility holding company, had surreptitiously taken enough power over a three-day period, about 9,600 megawatt hours, to light a small city for a month. Cincinnati-based Cinergy had underestimated power demands. Rather than buy electricity on the open market at ferociously high prices or cut power to Cincinnati, it quietly borrowed power from the system when demand was peaking and later replaced it in the cool of the night when demand wasn't so high. James E. Rogers, Cinergy's chief executive, received a letter from A.R. Garfield, the chairman of NERC's regional power-coordination center, accusing his company of showing "blatant disregard" for the rules and of using the grid "as a supplemental resource without regard to the reliability or integrity of the system." But Cinergy paid no fine. That's because it runs its own transmission "control area" and is trusted to enforce NERC's voluntary rules, even when it is the violator. Smaller utilities in Cinergy's area, by contrast, face contractual penalties of as much as $35,000 per megawatt for unilaterally borrowing from the grid, a practice known as "leaning on the ties." Dancing on the Edge? Mr. Garfield is still steamed about Cinergy's actions, which he said removed part of the system's essential reserve needed to avoid cascading blackouts, or a chain of uncontrollable outages that could darken whole sectors of the country. "How fair is it that someone can dance on the edge like that and get away with it?" he asks. Mr. Rogers points to old rules that permit utilities to temporarily borrow small amounts of power during emergencies. "We were very careful to make sure, when we leaned on the ties ... we didn't bring the whole system down," he says. Nevertheless, he concedes, "in a competitive world, those rules need to be changed." The region's regulators have since gone to FERC for authority to charge "borrowers" for the market value of the electricity they take off the grid. Leaning on the ties is only one way fair competition is being frustrated on the country's transmission system, a vast web of connections that resembles the nation's highway system before the construction of the interstates. While there are plenty of routes to get electricity from outlying power plants directly to big cities, there are relatively few routes connecting regions. That makes it possible for some big companies to shut out competitors. A Snag in Transmission St. Louis-based Aquila Energy hit that snag when it tried to use a transmission corridor owned by New Orleans-based Entergy Corp. to move electricity to a buyer in East Texas. Entergy granted the request, initially, but then it canceled, saying it didn't have sufficient space on its lines. Aquila didn't buy it. After analyzing transmission-capacity data, the company argued to FERC that Entergy did have enough space on its lines and so was in effect breaking a rule that required it to provide transmission-line access when possible. Without access to Entergy's lines, Aquila was forced to compensate the buyer and lost nearly $300,000 on the deal. From whom did the Texas customer end up buying the power? A unit of Entergy -- and for a higher price than it would have paid Aquila. FERC said Entergy had been within its rights to restrict access in this case, because it had transmission problems. But FERC found that Entergy, on other occasions, had hoarded transmission capacity that should have been made available to the market. Entergy declines to comment. Such scenarios are costly for consumers, and they are among the reasons the electricity industry is enjoying flush times. In the second quarter just ended, companies ranging from AES Corp. in Arlington, Va., to Enron Corp. in Houston reported huge profit increases, some as much as 50%. To be sure, a lot of those profits are coming from extraordinary demand growth and a pickup in energy trading. But Sean Murphy, president of Southern Energy New England, a unit of Southern Cos., Atlanta, Ga., worries that the industry has gotten too greedy and risks retribution. "Pigs get fat, but hogs get slaughtered," he says. Tremendous Volatility New federal data show that average wholesale power prices have more than doubled at 14 of 17 key pricing points across the country in the past three years. By May of this year, prices had risen across a broad range -- by 89% in Florida, for example, and by 294% in Texas. But even these increases mask the tremendous volatility that has struck all the major wholesale markets during the past year. In the case of the Midwest, where prices in July 1999 hit $9,000 per megawatt hour, it was as if a $1.89 gallon of gas suddenly sold for $567. Prices like these have prompted growing calls for investigations into whether electric companies are gouging their customers. Some consumer groups, lukewarm to deregulation in the first place, now are agitating for re-regulation. Residential electricity bills have doubled in San Diego, which is notable because it's the first city in the nation to be served by a utility that's buying all of its energy on the competitive market. Politicians are sounding the alarm in the Pacific Northwest. There, wholesale prices peaked at a record $1,300 per megawatt hour during the last week in June. Energy-intensive industries like mines and aluminum smelters are cutting back on production and temporarily laying off workers. "We may be seeing too much opportunism in the market," says Montana Gov. Marc Racicot. Demands by Mr. Racicot and his counterpart in Washington, Gary Locke, were instrumental in prompting FERC to open a national investigation in late July into possible market abuses. A Six-Month Lag One big premise on which deregulation rests is that a free flow of information will let markets police themselves and operate efficiently. But a key tool for market monitoring, the data on utility Web sites used to book transmission orders, is often unreliable. There's a six-month lag on the release of bidding data, which are coded to mask the identities of bidders. What's more, the four FERC-controlled ISOs operating in California, the Middle Atlantic states, New England and New York don't have the authority to compel market participants to give them internal documents, like bilateral contracts, and other information they don't want to hand over. Without such documents, "there's a lot more looking than finding," says Bill Museler, chief executive of the New York ISO. Even if the ISOs do find something problematic, there isn't much they can do about it. The tariffs, contracts and bylaws under which they operate generally prohibit them from releasing company-specific data and so exposing wrongdoers. And with the exception of California, the ISOs' own board meetings are closed to the public. "The reality is, confidentiality rules protect the guilty," says Frank Wolak, a professor of economics at Stanford University and chairman of the California ISO's Market Surveillance Committee. "And there are no codes of conduct to instill a sense of fair play." That can be a huge problem on hot days. In California, an independent exchange runs a daily forward auction in which it tries to match the next day's anticipated demand to bids by generators. But this summer, generators often have offered less power than they know will be needed, so that they can submit higher bids later when the ISO is forced to pay stiffer prices for emergency power. On occasion, ISO engineers have had just 40 minutes to frantically phone around and nail down suppliers, knowing that if they fail they could be forced to begin rolling blackouts. The bidding strategy, while legal, "undermines reliability and forces the ISO to do some real gymnastics," says Kellan Fluckiger, chief operations officer for the California ISO. Generators say they aren't to blame for the mad scramble. Utilities, buying power for their customers, often order less power than they really need for fear that a big order will drive up the overall market price to prohibitive levels. The only real recourse available to the ISOs is to rewrite the rules governing their local markets. But FERC is reluctant to let them meddle too often because generators are investing billions of dollars based on existing market rules. There's another reason, too, says Ron Rattey, a veteran FERC economist who in June wrote a 10-page internal memo criticizing the agency for not doing more to ferret out unfair conduct. "Every single ISO has identified strategic abuses," he says. "And every time the ISOs make adjustments to the rules, the market participants find new ways around them." Write to Rebecca Smith at rebecca.smith@wsj.com and John J. Fialka at john.fialka@wsj.com