COMMENTS ON RTO MARKET DESIGN AND PRICING

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					    COMMENTS ON RTO MARKET
       DESIGN AND PRICING

              THREE
              PERSPECTIVES




1
    SPONSORED BY THE COMPETE
    COALITION

    l   MARCH 3, 2009
    l   WEBEX SEMINAR
    l   PARTICIPANTS
        –   ROSS BALDICK
        –   ROY SHANKER
        –   ROBERT STODDARD



2
    RTO MARKET DESIGNS UNDER FIRE

    l   CONTINUING CRITICISMS OF RTO “DAY
        2” MARKET DESIGNS
    l   COMPLAINTS THAT SINGLE CLEARING
        PRICE MARKETS ARE RAISING PRICES
        AND INEFFICIENT
    l   COMPLAINTS THAT SUCH MARKETS
        DON’T SUPPORT LONG TERM
        CONTRACTS, AND SUCH CONTRACTS
        ARE NECESSARY FOR NEW ENTRY
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    THREE PERSPECTIVES ON THESE
    CRITICISMS

    l   CRITICISMS ARE SIMPLY NOT VALID
    l   NEW STUDY BY DR. BALDICK
        EXPLAINING THE VALIDITY AND
        IMPORTANCE OF SINGLE CLEARING
        PRICE MARKET DESIGN FOR ELECTRIC
        MARKETS



4
    THREE PERSPECTIVES ON THESE
    CRITICISMS

    l   CRITICISMS ARE INVALID
    l   RECENT COMMENTS BY DR. SHANKER
        THAT THESE CRITICISMS ARE MORE
        ABOUT REGRETS REGARDING HISTORIC
        BUSINESS DECISIONS THAN MARKET
        DESIGN



5
    THREE PERSPECTIVES ON THESE
    CRITICISMS

    l   CRITICISMS ARE INVALID
    l   NEW STUDY BY DR. STODDARD AND
        CHARLES RIVER ASSOCIATES (CRA)
        EXPLAINING THAT IN SIMILARLY
        SITUATED INDUSTRIES THE LACK OF
        LONG-TERM CONTRACTS IS COMMON,
        AND NOT A BARRIER TO NEW ENTRY


6
    PRESENTERS

    l   Ross Baldick - Department of Electrical and
        Computer Engineering, The University of
        Texas at Austin
    l   Roy Shanker - Independent Consultant
    l   Robert Stoddard -Vice President CRA
        International, Head of the Regulation &
        Litigation


7
    Single Clearing Price
    in Electricity Markets


              Ross Baldick




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    Electricity market auctions.

    l   Single clearing price rule:
        –   All energy is sold at one single price, the market-
            clearing price.
        –   The offer price of the highest accepted offer in the
            market (ignoring demand bids and transmission
            constraints).
    l   Maximizes the gains of trade between sellers
        and buyers:
        –   Given that offers and bids reflect valuations.

9
     Coordination of electricity.

     l   Electricity needs central coordination to
         match supply to demand:
         –   Due to lack of stock-piles of electricity,
         –   Central coordination is necessary in any market
             design.
     l   By design, the single clearing price auction
         coordinates so as to maximize gains of trade.
     l   Alternative market designs:
         –   Would still need coordination of supply and
             demand, but
10       –   Might not maximize gains of trade.
     The law of one price.

     l   In any market, natural forces of supply and
         demand encourage the formation of a single
         price.
     l   In electricity, this price formation is done
         explicitly in the auction.
     l   But for any commodity (aluminum, oil, etc):
         –   The “law of one price” dictates that in the same
             market at any time, there is only one price for that
             commodity,
11       –   True whether or not there is central coordination.
     Other markets with
     an explicit single price rule.

     l   Opening and closing prices on stock
         exchanges,
     l   U.S. Treasury securities,
     l   Regional Greenhouse Gas Initiative.




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     “Pay-as-bid” as an alternative rule.

     l   Sellers receive their offer price, instead of the
         single market-clearing price.
     l   Proponents suggest that prices would
         decrease:
         –   Rests on naïve, false expectation that sellers
             would keep their offers the same!
     l   Theoretical, experimental economics, and
         empirical evidence does not support a
         change to pay-as-bid from perspective of
13       prices.
     “Pay-as-bid” as an alternative rule.

     l   Pay-as-bid would not significantly reduce
         prices and might increase prices.
     l   Pay-as-bid has significant disadvantages:
         –   Gains from trade may not be maximized,
         –   Bias against small market entrants,
         –   Difficulties with market monitoring.




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     Summary

     l   Electricity supply must be coordinated with demand.
     l   The single market-clearing price has substantial
         benefits in electricity markets.
     l   Alternatives, such as pay-as-bid, will not improve
         performance of electricity markets and can worsen
         performance of the market.
     l   Single clearing price auction is the efficient
         coordination mechanism.


15
     MARKET MISPERCEPTIONS
              AND
      REGRETS ABOUT PAST
       BUSINESS DECISIONS

               Roy J. Shanker Ph.D.




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     Criticisms of RTO Markets

     l   Most confuse two basic issues:
         –   Misconceptions about market mechanisms
         –   Historic business decisions which parties now
             regret
     l   When the two are separated, it is clear that
         RTO pricing is working in efficient manner for
         energy and capacity
     l   When the two are separated it is clear that
         prices are not “wrong” or “too high”
17
     Market Mechanisms

     l   Advantages of single clearing price
         mechanisms for energy and capacity
         –   See Baldick discussion and my paper
     l   Misconceptions about alternatives
         –   Pay as bid-typically ignores adaptive behavior
         –   Result is inefficient guess at clearing price and
             increase in price
         –   Need to guess makes it impossible to distinguish
             between “bad guess” and economic withholding

18
     Historic “Bad” Decisions-1

     l   In restructuring basic “deal” was settlement
         of stranded costs and exchange of
         generation assets in return for price freezes.
     l   Key element in valuation of assets and
         stranded costs was forecast of future energy
         and capacity markets
     l   The higher the forecast, the higher the value,
         the lower the stranded costs, the higher the
         value received by consumers for assets
19
     Historic “Bad” Decisions-2

     l   Complaints about high prices typically are really complaints
         about this historic business deal
          –   Price freezes weren’t long enough or too high
          –   Parties failed hedge their costs after the expiration of the freezes
               l   Typically because “right prices” for hedges were higher than artificially
                   low frozen rates
     l   Complaints really reflect the end of the freezes and these bad
         decisions
          –   Many of the complaints come from parties that
               l   Didn’t even pay stranded costs
               l   Got the benefits of the freezes
               l   Chose not to hedge



20
     Historic “Bad” Decisions-3

     l   Empirical evidence by PJM Market Monitor
         shows legitimate long term hedge prices
         were much higher than market prices (energy
         and capacity)
     l   Obviously higher than even lower frozen
         rates
     l   Lack of hedging is conscious decision in face
         of these rates
21
     Historic “Bad” Decisions-4

     l   Actual review of restructuring data confirms
         this picture-particularly for capacity pricing
         where criticism has been most pronounced
     l   Industrial customers forecast significantly
         higher prices for capacity than have actually
         occurred over last decade in PJM
     l   Latest results show these consumer
         forecasts were over 80% higher than last
         PJM auction. (See paper for tables)
22
     Historic “Bad” Decisions-5

     Basic Story
        –   Generation assets sold in exchange for frozen rates
        –   Consumers forecast high future rates to increase the sales
            price, but then failed to hedge based on their own
            information
        –   Spot prices and frozen prices both have been below
            legitimate long term contract rates
        –   As freezes disappear, complaints about market design
            really are about these business decisions



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