Electricity and Ancillary Services Markets in New York State: Market Power in Theory and Practice

Since electricity, and its reliable provision on command, is a multi-attribute commodity, it should be priced over multiple dimensions if it is to be provided efficiently, and that requires multiple but related markets. So far New York is the only domestic electricity market that has introduced separate segments for ancillary services, together with eleven locationally defined markets for energy. By fragmenting the market over dimensions of space, time, and various contributing factors to reliability, the chances for greater efficiency are available in theory, but by spreading the market out, the possibility also exists of having fewer potential suppliers for each segment, thereby increasing opportunities to exercise market power at particular times and places. In fact several instances of market power have been observed that are not surprising with the benefit of perfect hindsight, and the lessons learned are combined with theoretical principles to establish guidelines for future electricity market design and operation. I. New York State Market Structure The Independent System Operator in New York (ISO) is charged with operating the bulk power system (generation and transmission) reliably, while 0-7695-0981-9/01 $1 developing and maintaining efficient wholesale markets for electricity. As a prelude to deregulation, each of the state’s six utilities sold its generating facilities (except for nuclear plants) to independent companies; although these utilities continue to own both the transmission lines, that however are controlled by the ISO, plus their distribution system. In addition, the New York Power Authority (NYPA) is a public generation and transmission company, and the Long Island Power Authority (LIPA) serves customers on the island through its transmission and distribution system and long term contracts for its former generation. These two authorities collaborate with the ISO and participate in its wholesale markets. Because of the potential for transmission line congestion limiting, at times, the statewide flow of power, New York has been divided into eleven separate geographic markets for electric energy, as illustrated in Figure 1, whose prices can differ when transmission lines crossing zonal borders are congested. Furthermore, each location has three temporal markets: day ahead, hour ahead balancing, and real time. While bi-lateral contracts operate outside the ISO’s wholesale markets, the power flows are scheduled through the ISO and bi-lateral suppliers are afforded the opportunity to furnish “decremental bids”, e.g. prices at which they would substitute purchases from the wholesale market at their supply location for their own supplies. Capacity and/or reliability related markets include 0.00 (c) 2001 IEEE 1 Proceedings of the 34th Hawaii International Conference on System Sciences 2001 transmission congestion contracts (TCCs) which essentially are purchased as hedges against price differences that may emerge across the boundaries of the eleven energy pricing zones, and mandatory purchases of rights to installed capacity (ICAP), which must be secured by load serving entities to meet their area’s estimated peak load plus its required reserve margin, as computed for six month summer and winter periods. Providers of ICAP must offer into the day ahead energy market in order to demonstrate the availability of their units. Voltage support (VARs) are arranged for separately by the ISO and the costs are spread over all use through a separate tariff. In addition, there are four active markets for reserves, both day and hour ahead, regulation, ten minute spinning reserves, ten minute nonsynchronized reserves and thirty minute reserves – each successively less spontaneous in response to calls to action by the ISO. Regulation reserves are provided by units already operating and serving substantial loads, but that can pick up small amounts of additional load at almost a moment’s notice. Typically, units selected for regulation reserves will back-down their energy supplies by an equivalent amount, and so suppliers that have been selected to serve this market will be paid the market-clearing price for regulation plus the lost opportunity cost (determined in the energy market) for the amount of energy withheld. Ten minute spinning reserves are facilities that can meet their obligations within ten minutes of notification, as assured by the fact that the units are running and synchronized with the system. Ten minute non-synchronized reserves are provided by fast-starting units, primarily gas turbines and hydroelectric facilities. Thirty minute reserves require longer ramp-ups, and therefore are in that sense less certain. When suppliers offer into the energy markets, not only do they provide hour by hour energy supply offers, they also specify start-up costs and minimum generation times. Thus, the unit commitment problem is still solved by the ISO’s system-cost-minimizing algorithm, but instead of using cost and capability data reported by the utilities, as under the previous regulated power regime, the ISO bases its optimization computations and calculates market clearing prices using offers form all vendors that can vary widely over time. II. Chronology of Market experience The New York ISO began trial generations on 0-7695-0981-9/01 $1 November 18, 1999 and officially took over the former power pool’s responsibilities on December 1, 1999. A. Regulation Markets Almost immediately, the amount of regulation service offered was inadequate, market-clearing prices soared, and the ISO operators contacted numerous generators calling their attention to the commercial opportunities available to them were they to offer their units into the regulation market. Gradually, their capacity offered increased over the next two or three weeks and prices drifted down to the $20-$30/mW range within a month, (see Figure 2) and to the $15/mW level by spring where they have remained every since. For the first time, experienced power system operators claim, there is some evidence of the true cost of providing regulation. Under regulated power pool operation, particular units were assigned the responsibility of providing regulation on a rotating mandatory basis, with small, pre-determined compensation. Plant operators grumbled when assigned the duty because of the wear and tear imposed on equipment as a result of the rapid rampups in generation. Perhaps this explains the initial reluctance of the operators of generation to offer their units into regulation markets. Lesson # 1: The transition from regulated to marketallocations requires ongoing real-time education, since many of the same people who were trained under one regime will continue to influence decisons in the market environment. By closely monitoring markets in transition periods and offering market participants “hints” on how they may perform better, so long as fairly provided, the costs born by customers may be reduced as the participants learn how to function under the new regime. B. Ten Minute Non-Synchronized Reserves In late January, the prices in the ten minute nonsynchronized reserve markets rose sharply, as shown in Figure 3, from the $2-3/mW, range to spikes of $140/m, in large part because the capacity offered into the market was diminished. Although a single statewide clearing price is established for these reserve markets, because of congestion of transmission lines linking downstate (New York City and Long Island) with the rest of the market, ISO reliability requirements mandate that adequate downstate reserve be available to meet the downstate demands during 0.00 (c) 2001 IEEE 2 Proceedings of the 34th Hawaii International Conference on System Sciences 2001 these congested periods. Because of unusual winter weather, line congestion was experienced in January and February 2000, and downstate supply-demand conditions set the statewide market prices, an unfortunate market design flaw since there were plentiful reserves upstate to meet upstate demand. Compounding factors were the downstate market composition and yet-to-be-resolved problems with the market-clearing software and rules that prohibited large hydro-units located downstate from offering into the ten minute reserve markets. Together these factors limited the number of generation suppliers offering into the ten minute non-synchronized reserves market to four, with two accounting for nearly seventy percent of the supplies (see the NYISO filing before FERC, 2000, [1]). As suggested by experimental results (see Bernard, et.al, 1998 [2]), in markets that are repeated many times with similar supply and demand characteristics, after 40-50 repetitions, four suppliers might be expected to begin to exercise market power without any explicit collusion. By the end of January 2000, New York markets had been in operation for over eight weeks with approximately forty repetitions of each weekday hour, so in this case the practice was consistent with the experimental results. Despite these high prices for reserves, where in many circumstances the higher-valued ten minute spinning reserves had market prices lower than did ten minute nonsynchronous reserves (see Figure 4), many suppliers were slow in reallocating their offers to the higher priced markets. Also, some suppliers who did not have all their offers filled in the energy market failed to shift their offers into the high-priced reserve markets. Once again, the ISO operators engaged in substantial “educational contact” with the generators, but as illustrated in Figure 3, little reallocation of offers took place in this case, and high prices persisted on and off again for almost eight weeks until the ISO announced its intention of filing a request for investigation with the Federal Energy Commision (FERC) and capped the offers into the reserves markets at their levels over the two months prior to the run-up in prices [1]. With the benefit of perfect hindsight, virtually everything that could be done wrong was done wrong in the original structuring of the market for reserves downstate by the market participants: Lesson #2: It takes more than four suppliers to create a workably competitive electric market, particularly where two suppliers account for more than 70 percent of the market share. Here Hirshman-Hirfindah Indices (HHI) may be useful gauges of the potential for exercising market power if the effective market area is properly defined in light of likely congestion 0-7695-0981-9/01 $1 constraints. Lesson # 3: Apparently the designers of the market relied on the fact that public authorities comprise a substantial portion of the potential supplies of reserves to downstate markets, but it appears that any entity with market power might be expected to exercise it, regardless of their corporate structure. One view of the public interest is to keep prices as low as possible to all customers; apparently this was the behavior assumed by the market participants who designed the downstate reserves markets when they saw the potential dominant market shares controlled by public authorities. But another view of the public interest, if defined only over the customers served by the authority, would be to optimize revenues from wholesale markets for sales to both their own and outside customers so that the gains could offset other costs in setting prices to their own customers. Lesson # 4: Congestion possibilities must be recognized in defining market areas where the same clearing price will be applied; otherwise, tremendous incentives are provided to generate profits for suppliers (particularly if commonly-owned) on both sides of the congestion. The cure for New York Reserve markets is to allow separate reserve prices up -and downstate, just as there may be as many as eleven different locationally-based energy prices in New York. Question: might some of California’s high average summer prices be due to gaming for the benefit of units across congested boundaries? Lesson # 5: Some suppliers may be slow to integrate market-clearing prices in multiple markets into their decision-making processes. In this case of downstate reserve markets, even after informational conversations with ISO operators, suppliers who offered into the area’s energy or ten minute spinning reserve markets were extremely slow to redirect their offers into the seemingly more profitable ten minute non-synchronzied reserve markets. Is there a parallel to a previous conceptual analysis where dominant suppliers recognizing lagged customer response to price differences continue to find it profitable to charge high prices(see Schuler, 1998 [3]) ? In this case, the dominant suppliers might behave similarly, recognizing how slowly potential competitors are likely to respond by shifting their market focus. Lesson # 6: It isn’t the market-share of ownership that matters; it is the share of the available supplies whose offer strategies are determined by a single operator that counts. In the case of the downstate reserve markets, the public authority contracted the operation and marketing strategies for its generation to the operator of competing facilities, thereby further concentrating the market. 0.00 (c) 2001 IEEE 3 Proceedings of the 34th Hawaii International Conference on System Sciences 2001 By summer’s end, downstate reserves markets may once again be opened with caps on their offers eliminated. Important corrections to the market structures will have been made allowing for separate downstate and upstate markets and different prices, in congested periods plus market clearing software has been improved both to allow hydro-electric units to offer into reserve markets and to consider gas-turbine offers in smaller increments of supply that are consistent with their control capabilities. All of these factors should enhance the number of suppliers of reserves to the downstate region.