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PennFuture's E-cubed is a commentary biweekly email publication concerning=
=20 the current themes and trends in the energy market.=20 July 16, 2001 Vol. 3, No. 13 Market Lessons from 2000 =20 School's still out for summer, but just as the new and improved Federal=20 Energy Regulatory Commission (FERC) issued a watershed RTO decision last = =20 week which could lead to substantial expansion of PJM into the Northeast, P= JM=01, s State of the Market Report 2000 contains some interesting information an= d =20 lessons for us.=20 After the California experience demonized spot electricity markets, it wou= ld=20 surprise many that PJM=01,s 2000 spot energy market was a bargain. Spot pr= ices=20 in 2000 were below $30.00 per megawatt-hour (MWh), or three cents per=20 kilowatt-hour (kWh), 70.88 percent of the hours in the year. The single=20 highest hourly price was $810 per MWh or 81 cents per kWh, but prices =20 reached or exceeded $200 per MWh during only 13 hours in the entire year = =20 (download charts on our website by typing=20 www.pennfuture.org/items/hourlypricecharts_71601.pdf in your browser). By= =20 contrast, California experienced spot prices that often exceeded $200 per= =20 MWh for most of the last 12 months. Authored by the PJM Market Monitoring Unit =01* but likely reviewed and ed= ited=20 by top PJM management =01* the Report delivered to FERC concludes that all= of=20 the markets operated by PJM were "reasonably competitive." It cautions, =20 however, that, "there are potential threats to competition in the energy, capacity and=20 regulation markets that require ongoing scrutiny and in some cases may=20 require action in order to maintain competition. Market participants do =20 possess some ability to exercise market power under certain conditions in= =20 PJM markets."=20 In order to maintain and improve the functioning of the PJM markets, the= =20 Report recommends: Retention of the $1000/MWh bid cap in the PJM energy market and=20 investigation of other rule changes to reduce incentives to exercise marke= t=20 power. Retention of the $100/mw bid cap in the PJM regulation market. =20 Evaluation of additional actions to increase demand-side responsiveness to= =20 price in both energy and capacity markets. Modification of incentives in the capacity market to require all Load=20 Serving Entities (LSEs) to meet their obligations to serve load on a =20 longer-term basis, and require all capacity resources to be offered on a = =20 comparable longer-term basis. The Report uses several analytical methods to reach these recommendations= =20 and conclusions, including looking at the net revenue for generation from= =20 all sources, the increase in bid amount over marginal cost, market=20 concentration (as measured using the HHI index), and lastly an analysis of= =20 the resulting prices. =20 See Spot go to market Perhaps the Report=01,s most intriguing information on price trends concer= ns=20 the spot energy market, where average prices declined by 9.81 percent from= =20 1999 levels. Driven by lower peak prices in the most expensive 100 hours o= f=20 the year, the average locational marginal price (LMP) in 2000 was $30.72 p= er=20 MWh (3.072 cents per kWh), falling from the 1999 average of $34.06 per MWh= =20 (3.406 cents per kWh). This average price decline in the spot market was= =20 more significant because it occurred even though fuel costs were sharply= =20 higher in 2000. Indeed, the average fuel-adjusted LMP in 2000 declined to= =20 $24.78 per MWh, or 27.25 percent from the 1999 price of $34.06 per MWh.=20 And when one compares 2000 spot market prices to competitive future prices= =20 for the year 2000 and to 1996 regulated rates for generation, it becomes= =20 clear that spot market prices in 2000 were significantly lower than 2000 = =20 future contracts. Even with appropriate price adjustments to facilitate =20 comparison, they were also much lower than 1996 regulated residential=20 generation rates for all hours charged by Pennsylvania=01,s six major elec= tric=20 utilities, which ranged from about $51 dollars to $85 dollars per MWh, or= =20 5.1 to 8.5 cents per kWh.=20 The lesson Spot market prices, which received so much bad publicity as a result of th= e=20 California fiasco, can be a bargain and customers who are able to manage= =20 their demand to reduce or avoid the hours of high spot prices can reap maj= or=20 savings by purchasing electricity from the spot market. In fact, spot market prices in 2000 were below most of Pennsylvania=01,s= =20 shopping credits or "prices to compare." That's saying something, since th= e=20 shopping credits in turn are as much as 4.0 cents per kWh less than the 19= 96=20 regulated rate for just generation paid by customers to the monopoly =20 utilities.=20 But=01( Since spot market prices in 2000 were well below both the 1996 generation= =20 rate paid to monopolies and the much lower shopping credits, why were ener= gy=20 suppliers increasingly unable to offer electricity at prices below the=20 shopping credits?=20 ICAP pricing and reliance by electricity suppliers on higher priced future= =20 or forward market contracts supply most of the answer.=20 The spot market gives a good indication of what the forward markets should= =20 be under typical circumstances. As the data below indicate, the average sp= ot=20 market price for all market locations in 2000 was $30.72/MWh, almost 10=20 percent less than during 1999, and more than 27 percent lower upon adjusti= ng=20 for higher year 2000 fuel prices.=20 =09=09=09 =09=09=09 =09=09=09PJM Load-Weighted Average LMP ($/MWh) =09=09=09 =09 =09 =091999 =09=09 =09=09 =09=092000 =09=09=09 =09=09=09 =09=09=09Change =09=09=09 Average LMP =09 =09 =0934.06 =09=09 =09=09 =09=0930.72 =09=09=09 =09=09=09 =09=09=09-9.81% =09=09=09 Median LMP =09 =09 =0919.02 =09=09 =09=09 =09=0920.51 =09=09=09 =09=09=09 =09=09=097.83% =09=09=09 Standard Deviation =09 =09 =0991.49 =09=09 =09=09 =09=0928.38 =09=09=09 =09=09=09 =09=09=09-68.98% =09=09=09 ? =09 =09 =09? =09=09 =09=09 =09=09? =09=09=09 =09=09=09 =09=09=09? =09=09=09 Average Fuel Adjusted LMP =09 =09 =0934.06 =09=09 =09=09 =09=0924.78 =09=09=09 =09=09=09 =09=09=09-27.25% =09=09=09 Median Fuel Adjusted LMP =09 =09 =0919.02 =09=09 =09=09 =09=0916.80 =09=09=09 =09=09=09 =09=09=09-11.67% =09=09=09 Standard Deviation =09 =09 =0991.49 =09=09 =09=09 =09=0922.04 =09=09=09 =09=09=09 =09=09=09-75.91% =09=09=09 =20 While the dramatically lower standard deviation in 2000 indicates that=20 prices were much less volatile than in 1999, there remained a substantial = =20 gap between average and median prices, indicating that extreme prices durin= g=20 a small number of hours continued to substantially skew overall average=20 prices. =20 Grading on a curve The PJM 2000 price duration curves, measuring the percent of time prices= =20 were at or below a particular level, tell an interesting story. As one wou= ld=20 expect with higher fuel prices, especially for natural gas, the general=20 trend was for prices to be slightly higher during periods where natural ga= s=20 was the marginal fuel. For approximately 99 percent of all hours, 2000=20 energy prices were more expensive than in 1999. Yet, with relatively low= =20 peak demand, the price for the most expensive 1 percent of demand during= =20 2000 was considerably lower in 2000 than in 1999, accounting for the entir= e=20 9.81 percent average reduction in 2000 prices from 1999. If not for the=20 reduced prices for the most expensive 1 percent of demand, overall prices= =20 for 2000 likely would have risen approximately 18 percent over 1999, due = =20 largely to higher fuel costs.=20 For these reasons, the Report recommendation to "evaluate" additional=20 actions to increase demand-side responsiveness is SEVERELY understated. PJ= M=20 and all consumers have an essential interest in implementing demand-side= =20 response programs to the maximum economic level, with dramatic implication= s=20 for saving individual consumers money, improving system reliability, keepi= ng=20 market prices lower for everyone, and improving market competitiveness.=20 Can everyone say I-C-A-P? So with the lower wholesale energy prices and plenty of supply, why did th= e=20 retail market sputter?=20 Installed capacity (ICAP) price increases are a partial explanation. In=20 addition to energy, the controversial charge for ICAP is the other=20 significant cost born by electricity consumers within PJM. ICAP represents = a=20 call option on physical generation resources by PJM during system=20 emergencies. All LSEs are required to purchase an amount of installed=20 capacity equivalent to their customer=01,s peak load contribution plus an= =20 adequate reserve margin, currently 19 percent. But although it exists for= =20 reliability purposes, PJM curtailed the export of energy outside PJM from= =20 PJM-committed installed capacity on only one day during 2000.=20 Logically, the price for installed capacity, like the price of energy, mig= ht=20 have been expected to decrease during 2000. Yet that didn't occur. As ener= gy=20 prices decreased within PJM, they remained high or continued to increase i= n=20 surrounding control areas. Higher prices in the surrounding markets led so= me=20 generation owners to de-list their generation committed to PJM in order to= =20 sell out to other control areas without the risk of being curtailed by PJM.= =20 The result was an increase in ICAP prices from an average of $52.86 in 1999= =20 to $60.55 in 2000. The increase was concentrated over the summer with pric= es=20 in the daily markets rising to $177 or more for most of June, July and=20 August. The increase in ICAP prices raised the cost of supplying many reta= il=20 customers by about 1 cent per kWh. The Market Monitoring Unit concluded th= at=20 the price spikes over the summer months were a direct result of the=20 opportunity cost associated with the prices in neighboring control areas. But the Report=01,s finding that the ICAP market was "reasonably competiti= ve"=20 seems inconsistent with PJM=01,s conclusion last year that the 2000 ICAP m= arket=20 performed so poorly that it needed a major overhaul. This inconsistency=20 raises questions about the reasonableness of that portion of the 2000 Repo= rt=20 or giving the 2000 ICAP market the PJM seal of approval.=20 PJM has invested substantial time and resources since last summer in an=20 extensive stakeholder process to revise its ICAP rules, especially =20 concerning the allocation of deficiency revenues and the interval over whic= h =20 ICAP is purchased. But since the "reformed" ICAP market began operating onl= y =20 recently on July 1, 2001, it's too soon to know whether it is functioning= =20 well or competitively. We remain skeptical that the PJM prescription cures= =20 the disease, or is merely life support for a dying program. =20 See Spot offer lower prices Apart from the ICAP market, the differing prices in forward and spot marke= ts=20 provide substantial explanations for why electricity suppliers have found = it=20 easy to beat the 1996 regulated generation rate for most utilities but=20 difficult or even impossible to beat the lower shopping credits. (Shopping= =20 credit =3D 1996 regulated generation rate =01) stranded generation cost). = Prior=20 to the 2000 summer season, prices in the forward markets, before anyone kn= ew=20 how mild the weather was going to be, substantially reflected the=20 high-priced experience of 1999. Because of the high prices in 1999, energy= =20 that was purchased through forward markets =01* about 82 percent of all en= ergy=20 =01* was considerably more expensive than the spot prices turned out to be= .=20 Since customers often prefer to lock in a price in advance, competitive=20 suppliers generally didn't want to provide fixed prices below the retail= =20 shopping credits. If suppliers had relied on the spot market, they could = =20 have offered lower prices. Also, customers who can reduce or shift demand= =20 may well benefit from purchasing more power from the spot market. =20 Recent developments Both in the East and West coast markets this week, electricity in daily=20 trading has been near its low for the 52-week period. Several developments= =20 are pushing down the price of wholesale electricity. Mild weather, falling= =20 gas prices, new generation coming online, increasing demand response and= =20 conservation as well as a FERC which understands that competition must exi= st=20 prior to price deregulation, are all pushing prices lower. Moreover, forwa= rd=20 market prices for 2002 within PJM are beginning to fall and are under=20 downward price pressure.=20 The new downward trend in forward markets partially results from moderate= =20 prices this summer, even during high demand periods, with prices generally= =20 staying under $150 MWh/$0.15 kWh. A good example of this was July 10, a=20 relatively hot day with significant demand, which saw prices reach $150 per= =20 MWh for one hour but average $62.78 per MWh for all on-peak hours.=20 What's driving forward prices lower? More efficient generation being installed (below 8000 btu/kWh as opposed t= o=20 11000 btu/kWh). More ICAP in the market (new capacity estimated at over 4000 MW with load= =20 growth at only 1.5 percent or 1000 MW). More demand-responsive load in the form of 300 additional MW of Active Loa= d=20 Management. The addition of PJM West slated for 2002, with lower prices generally.=20 Lower natural gas prices =01* falling from $4.0561 /mmBtu in July 2000 to= =20 $3.29/mmBtu as of July 12, 2001. This good news, which suggests that retail customers in late 2001 or 2002= =20 may again see retail competitive offers below the Pennsylvania shopping =20 credits, must be weighed against the troubled ICAP market. ICAP remains an = =20 anachronism. ICAP prices have not returned to competitive levels and remain= =20 one of the significant obstacles to serving retail customers. The forward= =20 prices for ICAP alone have remained above 10 percent of the typical shoppi= ng=20 credit.=20 Yet even in the world of ICAP there is hope. ICAP prices may be beginning = to=20 soften in the face of a substantial amount of new generation that is comin= g=20 online and increased demand response from customers. PJM has instituted bo= th=20 an emergency and an economic demand-response program, through which more= =20 customers can respond to prices and reduce the price that all customers pa= y=20 for electricity.=20 Tomorrow's homework The State of the Market Report contains plenty of data which confirms that= =20 PJM is the country=01,s best-run independent system operator and best (tho= ugh=20 still flawed) wholesale market. Prices in the spot energy market were well= =20 below 1996 regulated generation rates, even with appropriate adjustments.= =20 But none of this warrants complacency. Only when PJM becomes the first=20 market to give consumers the tools they need to change their demand for=20 electricity, will the wholesale and retail markets within PJM be FULLY, as= =20 opposed to "reasonably," competitive. A link to download (in .pdf) the PJM MMU Report can be found on the Intern= et=20 at: http://www.pjm.com/market_monitoring/reports.html.=20 E-cubed is available for reprint in newspapers and other publications.=20 Authors are available for print or broadcast. PennFuture (www.pennfuture.org), with offices in Harrisburg, Philadelphia= =20 and Pittsburgh, is a statewide public interest membership organization,=20 which advances policies to protect and improve the state's environment and= =20 economy. PennFuture's activities include litigating cases before regulator= y=20 bodies and in local, state and federal courts, advocating and advancing legislative action on a state and federal level, public education and=20 assisting citizens in public advocacy. To unsubscribe, simply reply to this email with "unsubscribe" in the =20 subject. - vol3no13_71601.doc
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