Electricity Markets—Recent Issues in Market Structure and Energy Trading

Summary

Electricity today is widely viewed as a commodity. As a commodity, electricity is bought and sold as power (measured in kiloWatts or MegaWatts) and energy (measured in kiloWatt-hours), with various attributes being traded in electricity markets. The importance of transparency in wholesale electricity markets was underscored by the Energy Policy Act of 2005 (P.L. 109-58), which aimed to facilitate price transparency in interstate markets for the sale and transmission of electric energy, and to prohibit energy market manipulation.

Regional Transmission Organizations (RTOs) are regional entities authorized by the Federal Energy Regulatory Commission (FERC) to administer the electricity transmission grid. RTOs use various types of markets to serve end-use customer needs, and to make operational decisions. Over time, each RTO market has developed its own regulations or variations thereof, all under FERC’s regulatory jurisdiction. However, these regulations and rules appear to be increasing in complexity, as the markets are revised to adjust for operational issues and regional differences. Electricity market issues can be usually separated into two categories—manipulation by market participants or RTO market structural issues.

Capacity markets and Forward Capacity markets are two RTO topics often debated. Capacity markets have come under fire in some areas where they are used, as brownouts or blackouts have still occurred in unusually high demand periods. In other RTOs without formal capacity markets, the question has been whether the additional cost is justified by the perceived benefits. Several RTOs use Forward Capacity markets to provide some degree of certainty that there will be adequate capacity to serve future load demand and meet system reserve needs. However, there has been considerable debate on whether Forward Capacity markets work since high load pockets continue to persist in some RTO regions.

RTO markets have enabled a variety of products and services including derivatives and hedges for market participants, ostensibly to reduce risks from volatile prices. Financial instruments were added to RTO markets essentially to increase liquidity. It could be reasonably argued that a drive to increase liquidity has also led to the addition of financial instruments, which ostensibly act to encourage speculation in the electricity markets. With the California (or Western) energy crisis of 2000 to 2001, the susceptibility of electricity markets to manipulation became evident. Enron and its affiliates were principally found liable for “engaging in various gaming and market manipulation schemes.” FERC continues to investigate allegations of energy market manipulation, with several recent cases ending in prominent settlements.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (DFA or Dodd-Frank, P.L. 111-203) was passed largely as a response to the recent U.S. financial crisis. DFA initiated a number of reforms intended to strengthen oversight of the U.S. financial sector. Dodd-Frank addresses issues related to market manipulation from fraud, stating that “specific intent” or “recklessness” would trigger a rules violation. FERC for its part states that its focus is on anti-competitive “conduct that threatens market transparency.” Some might argue that the recent spate of settlements at FERC leads to a lack of clarity about what constitutes market manipulation, and what does not.

The electricity industry is entering a time of change, and electricity markets are evolving with the industry. The expected retirement of many coal-fired power plants can affect RTO markets as generator portfolios change to include more natural gas-fired plants, and the prices that this new generation is expected to command. With load growth stagnant in many regions, the pull towards a greater use of hedging and more liquid markets may increase as the need to decrease costs and stabilize revenues increases. Congress may choose to consider whether to change how RTO electricity markets are regulated and operated (i.e., through some standardization of these markets or elements in these markets), with an eye towards improving efficiency, and increasing regulatory clarity and transparency, lowering costs, and thus potentially reducing opportunities for fraud or market manipulation.