Do ISO Bidding Processes Result in Just and Reasonable Rates?

8/14/2019 Do ISO Bidding Processes Result in Just and Reasonable Rates?

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Robert McCullough, Managing Partner

McCullough Research

October 14, 2009

[email protected]


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If you look long enough into the void, the voidlooks back.


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FERCs Office of Market Oversight and Investigations


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Price Theory As An Evangelical Force The U.S. left the Cold War with an inflated senseof the power of competition

Successful competitive bulk power markets inthe Pacific Northwest (and with a nod towards PhilChabot) and the Southwest created an appetite forchange

The resulting legislation, AB-1890, was anamazingly bad cartoon of wholesale competition

While the failure of AB-1890 was a Titanic-leveldisaster, the image of computers setting prices basedon arcane formulas beyond the ken of humans has aterrible attraction for middle-aged people brought upon Lost In Space


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Danger, Will Robinson! California spent half a billion dollars on its firstfaltering computer programs, and hundreds ofmillions more on upgrades, repairs, and patches

The outcome was so impossibly complex thatfew outsiders understood the concepts, let alone theimplementation

One group of consultants even travelled theWest Coast, conducting a Crime School for hacks of

the software The complexity and computational requirementsof the solution have greatly exceeded most the graspof most participants

Even Enron viewed the California computationsas a black box

MISO and ERCOT frequently havecomputational errors overruled quietly in thebackroom by the operators


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Whats the Problem? Pure trading is a zero sum game with little profitfor honest traders

After a few years, it was clear that only illegalmethods would assure significant trading profits inCalifornia

Tim Belden (dressed as a devil on the left)characterized the result as prone to gaming

Although Enron had a pivotal role in the

disaster, various schemes were adopted widely inboth California and the remainder of the WECC

These schemes now show up across the U.S. andCanada

No prohibitions have been placed on Enron (and

other) traders who violated federal law. They cannow be found throughout the U.S.


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Against All Probability the CaliforniaModel Has Been Copied Across the U.S. Each of the states that has adopted the model has

had similar problems As far as we have been able to determine, notone of the implementations has managed to create amarket remotely similar to competitive markets

Odd bidding patterns are the rule, rather thanthe exception

Although frequent press releases note howcompetitive the markets are, prices have continued todiverge from those outside of the California modelstates


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Whose Theories Are At Fault? The basic supply and demand model wasdeveloped by Alfred Marshall early in the 19th

century

Bill Hogan has successfully popularized theBritish administered-market concept in the U.S.

The problems with the concept have proved awindfall for Hogan who now has a successfulpractice explaining away the systems failures

He is a frequent purveyor of questionableapologies still arguing that the California fiasco wasthe fault of an imaginary drought in the PacificNorthwest

The theories are just fine; the fault lies with thefacts


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Samuelsons Conditionsfor Perfect Competition

1. Many Buyers

2. Many Sellers

3. Open Entry4. Open Exit

5. Freedom of Information


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Reasons Why Artificial MarketsGenerally Work Poorly

High levels of concentration

Profound informationasymmetries

Mechanisms designed to dampencompetition among suppliers

Complex rules and entryrequirements to frustrate new entrants

Very limited market surveillance Frequent rule changes

Malfunctioning computerprograms


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Marginal Cost Theory

In theory, bidders in anadministered market will lose money iftheir bids do not reflect marginal cost.The logic is straightforward:

A higher bid will mean lowerrates of dispatch, but since themarket is competitive, the bidwill not change prices

A lower bid would lead todispatch at a loss since theresulting price might be less thanmarginal cost


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The Flaw

All this depends on whether bids individually or collusively affect prices

While FERC (and the ISOs) view this asthe default set of facts, the reality is verydifferent

Each of the ISOs receives implausiblebids every day sometimes thousands of them

The correct default fact is that bids individually and collusively are changingprices continuously

The proof of the matter isstraightforward: the thousands of bids provethat bidders in each ISO ( 55 in New York alone)are acting on the basis of the correct facts


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Facts at NYISO

11% of all bids submitted to theNew York ISO in March included bid pricesabove $900/MWh

The second most-common highprice in the March bids was $999/MWh

Many bids are at arbitrary levelsthat do not reflect generation levels or fuelprices

Approximately 9% of New Yorkgeneration was bid at implausible prices insummer 2008


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What is MarginalCost?

Only the most prejudicedobserver believes that $999/MWhrepresents anyones marginal cost

For most high-priced plants

marginal cost is equal to natural gas xheat rate x variable O&M and a smallemissions charge

Real-world heat rates rangefrom the high 6,000s to 15,000 with few very few out of that range

Hence, $900/MWh actuallymeans $60/mmbtu gas

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In the absence of bids that matchmarginal cost, there is little relevance tothe ISO bidding process if the objective

is fairness (Just) or efficiency(Reasonable)

FERC has shown little interest inthe efficiency issues

Explaining efficiency has provedfar more difficult than explainingtraditional cost-based methods

Absent discovery, figuring out the

reason and method behind these bids isa challenge


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1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010

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New York and US Residential Electricity Price Difference(Data compiled from the Energy Information Administration, US Department of Energy)

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Do ISO Bidding Processes Result in Just and Reasonable Rates?