EPSA analysis: FERC's standard market design must allow for short-term price volatility

Washington, D.C., May 15, 2002 - Short-term price volatility is a natural characteristic of all well-functioning wholesale power markets and should be allowed to play its economic role in any standard market design (SMD) devised by the Federal Energy Regulatory Commission (FERC), according to principles and a supporting analysis released Tuesday by the Electric Power Supply Association (EPSA).

"While market mitigation is an important feature of FERC's SMD efforts, it is a poor substitute for the downward price pressure that's achievable through well-designed, well-functioning and truly competitive markets," said Julie Simon, EPSA's vice president of policy. "This is the essence and the guiding light of the principles we're filing today with the commission."

The accompanying research, performed independently by the Boston Pacific Co., covered public data from nine diverse electricity markets across the United States, and found that short-term price volatility was "pervasive" in all of them.

"Price volatility occurs in peak and off-peak periods, in all seasons, and in markets that have restructured for competition as well as in those that remain mostly regulated," according to the analysis. "In short, significant price volatility should be expected."

As part of its study, Boston Pacific also reviewed these markets from the perspective of a variety of hypothetical "price screens" and determined that such screens all have drawbacks.

"Because we fully accept the goal of retaining consumer confidence, we hoped for an approach that was less intrusive and arbitrary, and one that did not simply degenerate into another price cap," the study said. "Despite the significant research effort reported herein, we could not design such a price screen given the actual price history in the nine markets we analyzed."

Among other scenarios, the study conceded that the possibility of a SMD incorporating a $1,000/MWh bid cap could limit short-term volatility, but stipulated that this too could have adverse consequences.

"In the four Midwest markets that we researched, in which that cap does not already exist, the imposition of the demand-side proxy bid cap would lower price volatility and average market prices in these markets in almost all periods of time," the report said. "We must caution, however, that had the price spikes of 1998-1999 been quashed, the Midwest probably would not have seen the significant investment in new power plants that the region has enjoyed since that time."

According to the analysis, the answer to short-term volatility in wholesale spot markets is greater and more efficient access to multiple markets.

"Real-time markets are more volatile than day-ahead markets, and block forward markets are less volatile than day-ahead markets," according to the study. "Because of this, the commission already has a structural remedy available to address concerns with price volatility. That is, it can assure access to multiple markets.

"This, along with access to long-term contracts and risk-mitigation products, offers consumers and suppliers alike the opportunity to build a portfolio of purchases or sales to match their appetite for price volatility."

"We all agree that most consumers should be protected from the volatility of a real-time spot market," said Boston Pacific's Craig Roach, the author of the study. "One way to do that is to intervene in the real-time market and attempt to make it something it's not, a market without volatility. This has unintended consequences. The other is to enable consumers to stay out of the real-time spot market in the first place by assuring they have access to other markets and products. Based on our research, we support the latter."

For more information, visit www.epsa.org.


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