# Presentation: 365499

## What We Do and Do Not Know About How Electricity Markets Work:  implications for energy modeling and policy

**James Bushnell**
**University of California  Energy Institute**
**www.ucei.org**

## Outline

**Energy Policy and Modeling**
**traditional goals of modeling**
**deregulation and the new paradigm**
**A generic blueprint of electricity restructuring**
**Measuring market efficiency**
**What we do and do not know**

## Energy Policy in the 21st Century

**Deregulation of supply is a reality**
**Utilities aren’t investing in new production**
**Regulators don’t get to firms what kind of production to invest in any more**
**policies setting goals for nuclear, coal, and renewable technologies need to recognize this reality**
**Policy-makers have two main levers through which to influence energy markets**
**Competition policy**
**anti-trust policy, RTOs as regulators**
**Environmental policy/ regulation**
**straighten out the ends and the means**

## Modeling Energy Markets

**Traditional models rely upon cost-based approaches**
**Deregulated firms act differently than regulated ones**
**example on transmission planning**
**example on ethanol in California**
**Deregulation of energy markets creates a need for two new modeling approaches**
**modeling imperfect competition**
**equal emphasis on strategic behavior and costs**
**Competitive benchmarking models**
**‘****backcasting’ market performance to measure market efficiency**

## Competitive Benchmark Analysis in Electricity Markets 

**Nature vs. Nurture argument in electricity**
**is it market structure or market design??**
**Estimate perfectly competitive price levels and compare to observed price levels.  Accounts for**
**fuel costs, shortages, outages, reserves, imports, hydro and must-take production**
**Produces estimates of margins (p - MC) and Lerner Indices (p-MC)/p**
**Borenstein, Bushnell & Wolak (California)**
**Mansur (PJM)**
**Bushnell & Saravia (New England)**

## US Electricity Restructuring:a generic blueprint

**Deregulate power production**
**in some areas many assets retained by IOUs**
**Create ISOs responsible for operating grid and maintaining system balance**
**ISOs run operating reserve and `imbalance energy’ markets**
**market-based prices for energy overseen by FERC**
**Customers can choose their retailers**
**but most of  the retailers buy power from the same place at the same price**
**‘****default’ rates frozen for transition period**
**mechanism for funding `stranded’ investments (i.e. nukes)  by locking in `high’ retail rates for some period**
**transition charge cannot be bypassed by switching retail providers**
**No serious efforts to implement direct demand-side participation in wholesale markets**

## Important differences between US electricity markets

**Ownership structure**
**eastern markets more concentrated**
**more capacity was retained by incumbent utilities in PJM than other markets (roughly 50%)**
**sale of capacity usually accompanied by ‘buy-back’ contracts in the east**
**by this measure, California was more ‘deregulated’**
**Market Design**
**Eastern markets are more ‘centralized’ (PJM >>NE>>Cal)**
**history of integrated operations**
**Differences in transmission pricing (PJM >>Cal>>NE)**
**Regulation**
**price-caps (California & PJM ) vs. bid-caps (NE, PJM)**
**Relative capacity?**

## Slide 8

## Market Power

**Market power is the ability to raise prices above marginal costs**
**It exists in a lot of industries**
**although a lot of commodity markets are perfectly competitive**
**Unilateral market power is not illegal (in U.S.)**
**Electricity markets are particularly vulnerable**
**lack of storage, **
**binding capacity limits, **
**lack of price-responsive demand**
**It does not require near scarcity or collusion to exist**
**Lerner Index  (p-mc)/p  ~ ********/(n********)**

## Slide 10

## Slide 11

## Measuring Relative Demand

**Is California producing higher margins because of `tight’ capacity conditions?**
**How to compare market tightness?**
***Residual Demand - *****demand net of **
**imports**
**hydro & nuclear**
**very small thermal, renewables, cogeneration**
***Residual Capacity***** -  capacity of large fossil-fired generation within the ISO system**

## Slide 13

## Slide 14

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## Slide 18

## Slide 19

## What we do know

**Electricity markets are vulnerable to market power**
**collusion not necessary to create large transfers**
**Eastern markets have experienced less market power than California**
**at least when markets are not highly capacity constrained**
**The higher market power in California does not appear to be due to `tighter’ markets**
**the *****dollar***** consequences of that market power are**
**Transmission pricing methods do not explain these differences**
**New England (1 zone) and PJM (4000 zones) perform comparably, California (23 zones) does worse**

## What We Don’t Know

**Why did the eastern markets do better?**
**Mix of generation technologies?**
**More vertical integration & buy-back contracts?**
**Tougher market power mitigation measures?**
**Market design?**
**How have the markets performed according to other standards?**
**Costs of transmission congestion?**
**Efficiency of operations (& reserves)?**
**Environmental consequences?**
**Investment environment?**
**What’s the best market standard?**
**Is restructuring a good idea?**