Dissecting California s Electricity Industry Restructuring Process James Bushnell University of California Energy Institute www.ucei.org Outline The origins of restructuring unrealistic goals realistic goals the trouble with electricity markets The California market What happened? Where do we go from here? The options 1
Source Materials www.ucei.org Severin Borenstein, James Bushnell, Christopher Knittel, and Catherine Wolfram. Learning and Market Efficiency: Evidence from the Opening of California s Electricity Markets. Mimeo. UCEI Borenstein, Severin and James B. Bushnell. "Electricity Restructuring: Deregulation or Reregulation? Regulation 23(2), 2000. Also PWP-074. Severin Borenstein, James Bushnell, and Frank Wolak. "Diagnosing Market Power in California's Wholesale Electricity Industry." PWP-064, June 1999. James Bushnell and Frank Wolak. "Regulation and the Leverage of Local Market Power in the California Electricity Market." PWP-070, September 1999. Severin Borenstein, James Bushnell, and Christopher Knittel. "Market Power in Electricity Markets, Beyond Concentration Measures." The Energy Journal, Vol. 20, No. 4, October, 1999. Why Restructure? Wrong answer: to get cheap power from Oregon. Why rates were high in California in 1996 investment decisions and sunk costs these costs don t go away with restructuring operations were reasonable efficient How might we save money from restructuring? make better investment decisions rate-payers not on the hook for bad decisions these benefits accrue very slowly Customer choice and retail innovation 2
The California Restructuring Plan Deregulate power production except for a few assets retained by IOUs California ISO responsible for operating grid and maintaining system balance runs ancillary services and imbalance energy markets California Power Exchange (PX) runs a day-ahead market for energy along with other schedule coordinators IOUs mandated to purchase from PX during transition Customers can choose their retailers but most of the retailers buy power from the same place default rates frozen for transition period 10% reduction funded by bond issue Difference between wholesale price and frozen rate is applied to recover stranded costs Why not restructure? The trouble with electricity markets Electricity markets are really complicated California s is probably the most complicated this means it may be operated less efficiently than under regulation Electricity markets are particularly vulnerable to the exercise of market power can t store electricity producers have binding capacity limits transmission is limited consumers don t see, let alone respond to prices In the short run, there will likely be efficiency losses from restructuring will they be offset by long-term gains? 3
Market Power in Electricity Markets Market power is the ability to raise prices above marginal costs It is not necessary to induce investment It exists in a lot of industries although a lot of commodity markets are perfectly competitive Generally we want to intervene in markets to mitigate market power when the benefits of doing so (efficiency and equity) outweigh the costs (increased regulation and lawsuits). $140.00 PX Average Price PX Average Price $120.00 $100.00 $80.00 $60.00 $40.00 $20.00 $- july august september october november december january february march april may june july august september october november december january february march april may june 4
Market Power in California s Electricity Markets Estimate perfectly competitive price levels and compare to observed price levels. Accounts for fuel costs, shortages, outages, reserves, imports, hydro and must-take production calculate the total cost of power purchases compared to hypothetical cost under perfect competition Market power has always existed in this market and is worst during summer months and high demand hours reason for the wholesale price-cap California Electricity Market Price-Cost Margins by Month Acutal Price Cap $250 Price Cap 1 0.5 Margin 0 July August September October November December January February March April May June July August September October November December January February March April May June 1998 1999 2000-0.5 Month 5
Other Interesting Stories Underscheduling and arbitrage between the PX and ISO markets Inefficiencies in the ISO real-time market when engineers set prices MW laundering The ancillary services markets Local market power and reliability must-run plants Congestion management problems the dec game Where do we go from here? Return to 1996? The animals have left the barn Trading off the costs of market power with the costs of mitigating it are wholesale price-caps enough? How should they be set? Increase price-responsiveness of demand and transmission capacity into less competitive regions a comment on punishment and firm specific measures a comment on uniform price auctions and regulation Contracts: what they can and cannot do can t eliminate monopoly power (unless price is set by regulators) can increase competition between multiple firms can reduce volatility (not always a good thing) can be used to bridge transition periods The stalemate between wholesale buyers and sellers and regulators prudence and retail competition 6
Lessons from California We re still learning them market rules? transmission pricing? market power mitigation? Don t oversell restructuring Take market power seriously mitigation is a poor substitute for a competitive structure Can we capture the benefits of a market process for investment without incurring the short-run losses experienced under radical restructuring? 7