If you pay for your electricity, why should you also have to pay for the cost of running the power plant that generates it?
This may be the question on the minds of many household consumers who typically are concerned with uninterrupted power supply with minimum monthly electricity bills. However, the efficiency and productivity of a power plant is a critical determinant in the performance of electricity markets and are often the subject of active policy debates amongst experts.
Advocates of market intervention believe that competitive markets for power should include compensation for ‘reserve generating capacity’, meaning they will ensure that there is uninterrupted power supply for consumers.
Most of the regional transmission operators (RTOs) in the U.S., including PJM Interconnection and New York (NYISO), operate capacity markets. Capacity markets are essentially the mechanism to compensate for reserve capacity. Both hedgers as well as speculators build their energy trading strategies around these capacity markets.
About a decade ago Enron Corp. was the single biggest player supplying necessary liquidity to the market. However its subsequent collapse and the mass exodus of its army of traders left a void in the market. To fill this void, the U.S. government permitted Wall Street firms to expand into the energy markets. However the results they yielded were not what they had anticipated and hoped.
So to boost investment, California Independent System Operators (CAISO) was the first ISO to bring in the concept of ‘Ex Post Price Correction’ – a mechanism to compensate market participants in the event that cleared bids becoming uneconomical when evaluated against the corrected price. In 2010, the ISO decided to compensate all market participants, including power plants, for times when they experienced adverse financial impacts. Through this initiative, the ISO developed a make-whole payment mechanism to compensate market participants for adverse financial impacts – such as in the case when prices are adjusted in a way that is not consistent with their accepted bids. The make-whole adjustment applies to cleared Demand Bids including export and load in the event of an upward price correction.
In recent weeks, we have seen a barrage of news articles on how big banks have been using ‘ex post price correction mechanism’ for their own benefits.
In fact, Federal Energy Regulatory Commission (FERC) had to investigate the matter and resulted on big penalties and almost a billion dollars settlement with those involved in benefiting from the market manipulation. Now, there is serious anticipation that big banks will quit the physical commodity and electricity market and focus on their core business. This move could have severe implications on the available liquidity in the electricity markets and could further dampen the electricity sector investment prospects.
This series of events is causing a sense to revisit the regulations controlling the power markets. A large section of U.S. senators are questioning the settlement deal between FERC and the violating banks. “We are concerned about whether the settlement includes adequate refunds to defrauded ratepayers and also concerned that the individual executives who sought to impede the commission’s investigation will not be punished,” Senators Elizabeth Warren and Ed Markey stated in a letter.
Right now, the fate of the power markets is unknown. The exiting of Wall Street banks could lead to a liquidity crunch in the energy markets at the same time the senators’ anguish over the markets exploitation doesn’t seem like it’s going to cool down anytime soon.
To get the regular updates and the data for commodities, power and financial markets stay tuned with ZEMA. ZEMA provides access to required data as well as the ability to analyze, manage risk and automate the trading process.