Report to Congressional Requesters

United States General Accounting Office

GAO

June 2001 ENERGY MARKETS

Results of Studies

Assessing High

Electricity Prices in

California

GAO-01-857
Page 1 GAO-01-857 FERC Study of Electricity Outages

June 29, 2001

The Honorable Jay Inslee

The Honorable Peter A. DeFazio

House of Representatives

Wholesale electricity prices in California rose sharply in May 2000 and

have remained high. In addition, there were disruptions in service—

blackouts—this winter and spring. The California Independent System

Operator, the state agency in charge of balancing electricity supply with

demand, expects high prices and service disruptions to continue and

perhaps worsen this summer. Some other western states, including

Oregon and Washington, have also experienced increases in their

wholesale electricity prices since the summer of 2000.

A number of factors have likely contributed to these high wholesale

electricity prices and service disruptions, including rapid demand growth

since 1995 accompanied by slow growth in supply, higher-than-normal

natural gas prices, and flaws in the design and structure of California’s

electricity market. In addition to these factors, state officials and others

have attributed the problems, at least in part, to market power, exercised

by individual electricity-generating companies. Some have argued that

generating companies have staged outages of generating units to reduce

supply and drive up prices. As evidence, they point to a higher-than-normal

level of such outages since the summer of 2000.

In response to concerns about high prices and generator outages in

California, the Federal Energy Regulatory Commission (FERC) undertook

a study, released in February 2001, to determine whether outages were

being used to physically withhold power and drive up prices of electricity

in California. Other studies of the electricity market in California have

been conducted by economists and industry experts. One study,

conducted by three economists from Stanford University, the University of

California at Berkeley, and the University of California Energy Institute

examined whether market prices of electricity in California in 1998 and

1999 were higher than competitive levels. A second, similar study by two

economists—one from the Massachusetts Institute of Technology and one

from a private consulting firm—examined the California market during

2000.

Concerned about the potential use of market power to drive up electricity

prices, you asked us to evaluate the FERC study, as well as the two studies

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-01-857 FERC Study of Electricity Outages

on the California electricity market.1 As agreed with your offices, this

report addresses two questions: (1) How do the methodologies and results

of the three studies compare? (2) Was FERC’s study thorough enough to

support its conclusions?

FERC’s study used a very different methodological approach from the

approach used by the other two studies and reached different conclusions.

FERC used a case-study methodology analyzing a number of specific

generating plant outages to determine whether they were used

strategically by generating companies to push up prices of electricity or

whether they resulted from unavoidable or routine repairs or

maintenance. As part of this methodology, FERC conducted telephone

interviews with generating companies to verify the reasons for outages. It

also visited the headquarters of two companies and performed on-site

inspections at three generator plant sites. In every case, FERC found that

legitimate repairs or maintenance was performed on the downed

generating plants and on this basis, found that there was no evidence these

companies were using outages strategically to withhold power and

influence prices. However, FERC pointed out that its report did not

analyze whether companies were using other techniques to influence

prices, such as not offering bids to sell capacity at certain times, or bidding

at prices high enough to practically ensure that their supply would be

excluded from the market. The other two studies looked for evidence of

the existence and exercise of market power in the entire market, rather

than focusing on particular instances of generator outages. They

compared wholesale market prices with the costs to generate electricity to

determine if prices were significantly higher than would be expected if

generators were acting competitively. The authors of both studies

concluded that prices were higher than competitive levels, strongly

suggesting that market power has been used in California to increase

prices of electricity.

FERC’s study was not thorough enough to support its overall conclusion

that audited companies were not physically withholding electricity supply

to influence prices. FERC’s study was largely focused on determining

whether or not there were actual physical problems—such as leaks in

cooling tubes—in generating plants experiencing outages. However,

industry experts we spoke with generally agree that it is practically

impossible to accurately determine whether such physical outages are

 1

 See appendix I for bibliographic information about the studies.

Results in Brief
Page 3 GAO-01-857 FERC Study of Electricity Outages

legitimate or not because plants frequently run with physical problems,

and the timing of maintenance or repairs is often a judgment call on the

part of plant owners or operators. In discussions with FERC, officials

acknowledged that simply looking at outages and maintenance records of

generators is not sufficient to determine whether generating companies

are exercising market power to increase prices. A thorough study of

market power would combine the market-wide approach of the other two

studies with a quantification of the extent to which outages, or other

supply disruptions, were caused by factors other than companies’ attempts

to drive up prices. Because the other two studies did not evaluate all the

factors that could have led to an abnormally high level of generator

outages, their results are not conclusive with regard to the precise extent

that market power caused the observed high prices. To improve on its

market monitoring, FERC officials told us that the agency has recently

implemented a more comprehensive plan for detecting the exercise of

market power.

We provided the Chairman of FERC with a draft of this report for review

and comment. FERC agreed with the basic findings in the report but took

issue with our characterization of its conclusion, saying that FERC had

only concluded the absence of evidence of withholding electric power,

rather than the absence of withholding to influence prices. In addition,

FERC pointed out that it is important to make a distinction between its

study, which focused on engineering reasons for outages, and the other

two studies, which focused on economic reasons for withholding electric

power.

California moved to a deregulated electricity market in April 1998. For

roughly 2 years, wholesale prices were fairly low on average. However, the

state experienced periods of higher prices, especially during peak summer

hours. Average prices rose dramatically in May 2000 and remained high.

For example, average prices of electricity sold in the California Power

Exchange during the months of May through December 2000 were

between 2 and 13 times higher than in the same months of the previous

year. In addition to higher prices, the frequency and duration of periods

when the system is in danger of service disruptions have increased. Actual

rolling blackouts occurred on 6 separate days in winter and spring 2001,

for a total of 16 hours with shortfalls ranging from 400 to 1,000 MW.

Blackouts adversely affected consumers and caused business and traffic

disruptions.

The California electricity market operates within a larger western system

consisting roughly of 11 states, and while California relies on imports for

Background
Page 4 GAO-01-857 FERC Study of Electricity Outages

about 20 percent of its supplies, it also exports power at times to other

states. As a result of this interconnectedness, the price and availability of

power in California influence markets in other western states and vice

versa.

Industry experts and academics generally agree that a tight power supply

in California and other western states is one reason why prices increased

and service reliability deteriorated starting in May 2000. The demand for

electricity in California has grown rapidly since 1995, while very little new

generating capacity has been added. For example, from 1995 through 2000,

total electricity consumption grew by about 13 percent, compared with

about 2-percent growth in electricity generating capacity in the state. In

addition, last summer saw an increase in the price of natural gas—used to

produce about 40 percent of California’s electricity supply—and in the

price of emissions permits that are required to operate certain generators

in California. Lower levels of available hydroelectricity during summer

2000 in the Pacific Northwest reduced California’s access to imports of

hydroelectricity. Rapid demand growth in other states has also reduced

California’s ability to import electricity from those states. Finally, flaws in

market design in California are widely believed to have contributed to

California’s problems. For example restrictions on the use of long-term

contracts to purchase electricity increased the reliance of California’s

three investor-owned utilities on spot markets and left them substantially

exposed to market risks.

While these factors contributed to California’s electricity problems, a

number of state officials, economists, and industry experts now believe

that the market design adopted by California has enabled individual

electricity-generating companies to exercise market power by withholding

capacity when supplies are tight in order to drive up prices. They argue

that generating firms have withheld supplies of electricity by staging

outages in order to drive up prices, and point to higher-than-normal levels

of outages since summer 2000.

FERC’s study differed from the other two in its methodological approach

and reached different conclusions. In addition, all three studies covered

different time periods, so their results are not entirely comparable. FERC

performed an audit of specific generating plants and companies that had

experienced outages during December 2000. On the basis of these audits,

FERC found that there was no evidence that the audited companies were

incurring physical outages in an effort to drive up prices. The other two

studies examined market prices and compared them with estimates of the

costs of producing electricity to determine if prices were consistent with

Studies Used

Differing

Methodologies and

Reached Different

Conclusions
Page 5 GAO-01-857 FERC Study of Electricity Outages

generating companies’ exercising market power. Both of these studies,

conducted during different time periods, concluded that there was

evidence of market power used to increase electricity prices.

FERC followed a case-study methodology, analyzing generating plant

outages to determine if generating companies used them strategically to

push up electricity prices or if they resulted from unavoidable or routine

repairs or maintenance. FERC analysts conducted telephone interviews

with generating companies to verify the reasons for outages. These

telephone interviews covered about 60 percent of the reported outages. In

addition, they visited the headquarters of two companies whose

generating plants were down for maintenance or repairs to discuss in

more detail the companies’ repair policies, maintenance schedules, and

operating practices. They also performed on-site inspections of generators

at three plant sites and observed maintenance and repairs. In order to

evaluate the legitimacy of the repairs or maintenance being performed,

FERC employed private-sector consultants familiar with plant operations

to accompany FERC analysts during the on-site visits. In addition to the

audits, FERC examined market prices, levels of demand, and generator

outages for the month of December 2000 to determine whether high levels

of outages were correlated with higher prices of power.

Based on the results of its audits, FERC found that there was no evidence

that the audited generating companies were withholding power in an

attempt to influence prices. On the contrary, in every case, FERC found

that legitimate repairs or maintenance was performed on the downed

generating plants. Moreover, it found that these plants were typically

older—30 to 40 years old—and had been used more intensively than usual

during the summer and fall of 2000. In addition, FERC found that prices in

the month of December were not strongly correlated with levels of

outages. In fact, it found that the highest prices occurred during periods

with relatively lower levels of generator outages.

The other two studies looked for evidence of the existence and exercise of

market power in the entire market, rather than focusing on particular

instances of generator outages. They employed a methodology that

compared market prices with estimates of the marginal costs of producing

additional electricity. Marginal cost is the additional cost incurred to

produce one more unit of electricity. Prices close to the marginal cost are

consistent with a competitive market. High prices, however, may suggest

that the market is not competitive and that individual electricitygenerating companies can manipulate prices.

FERC’s February Review

of Outages Found No

Evidence of Supply

Withholding

Two Studies Comparing

Costs and Prices Suggest

That Market Power Exists
Page 6 GAO-01-857 FERC Study of Electricity Outages

The first study we examined, by Borenstein, Bushnell, and Wolak,

compared prices with estimated costs of producing electricity in the

period from June 1998 through September 1999. The authors constructed

the market supply of electricity by estimating the cost of generating each

additional unit of electricity, starting with the lowest-cost generating

plants and adding increasingly costly plants. They used statistical

simulation methods to take account of random generator outages, which

decrease the electricity supply as units go off-line for repairs or

maintenance and increase it as generating plants come back on-line. By

matching actual demand at any point in time with their simulated supply

of electricity, the authors were able to estimate the competitive price of

electricity—that is, the price equal to the marginal cost incurred to supply

the last unit of electricity demand. Then they compared the estimated

competitive price with the actual price.

Based on their analysis, Borenstein, Bushnell, and Wolak concluded that

there were periods of high prices and high demand from June1998 to

September 1999, which they attribute to the exercise of market power. The

authors found that on average, the prices during this period were 16

percent higher than they would have been had generators behaved

competitively. In discussion with one of the authors, we were told that

while their study provides strong evidence of market power, it does not

suggest any illegal activity on the part of electricity-generating companies.

On the contrary, he believes that individual companies are sometimes able

to exercise unilateral market power to raise prices without violating

antitrust laws. The authors did not examine outages to try to determine

whether the level or pattern was consistent with companies’ withholding

power, nor did they seek to determine precisely how generating

companies exercised market power. In discussions with one of the

authors, we were told that it is not possible to tell the difference between

an unavoidable outage and a strategic outage designed simply to drive up

prices. Moreover, a generating company might exercise market power in

other ways. For example, a company can simply submit selling bids that

are so high that all of its power will not be purchased, thus effectively

reducing the volume of electricity sold in the market and causing prices to

rise.

The second study, by Joskow and Kahn, examined electricity prices during

summer 2000. The authors conducted a similar study to that of Borenstein,

Bushnell, and Wolak, but their access to data was more limited. As a

result, Joskow and Kahn relied on publicly available data for some key

variables rather than the confidential and proprietary data used in the

other study. Their study also differed from the first in that Joskow and
Page 7 GAO-01-857 FERC Study of Electricity Outages

Kahn analyzed outages during June 2000 to determine the extent to which

withheld generating capacity was a factor in explaining high electricity

prices. In doing so, they compared the volume of electricity generated at

specific prices with their estimates of how much electricity could have

been produced profitably at those prices, taking into account normal

levels of unplanned outages and capacity held in reserve for system

reliability reasons.

Based on their analysis, Joskow and Kahn concluded that there was strong

evidence that market power was exercised to raise prices in summer 2000.

They found that higher prices of electricity were caused in part by higher

natural gas prices, increased demand, reduced availability of imports and

higher prices for air emissions permits. However, they also found that

prices in summer 2000 were greater than they would have been had the

market behaved competitively. In addition, they concluded that the level

of outages experienced during June 2000 cannot be explained by

reasonable expectations about repairs or maintenance requirements, or by

the need to hold power in reserve for system reliability reasons. However,

the authors acknowledge that data limitations make their analysis of

withheld generating capacity somewhat rough. Specifically, they lacked

data on generating units outside of but selling power in California and

contractual arrangements by electricity power marketers doing business in

the state. Therefore, they were unable to measure generator outages

outside of California.

FERC’s study of electricity generator outages was not thorough enough to

support its overall conclusion that the audited companies did not

physically withhold electricity supplies to influence prices. FERC’s study

was largely focused on determining whether or not there were actual

physical problems—such as leaks in cooling tubes—in generating units

experiencing outages. Under this approach, if FERC found that there were

physical problems with downed generating plants and that repairs or

maintenance were performed, then it concluded that the outage was

legitimate and not designed to simply reduce supply and push up prices. In

fact, FERC determined that most of one company’s generating plants were

old and suffered from mechanical problems. In addition, FERC found that

many of these plants had run at higher-than-usual rates in the summer and

fall of 2000, prior to their shutting down for repairs or maintenance. These

facts do suggest that a higher level of outages than normal should be

expected. However, the industry experts we spoke with generally agree

that it is practically impossible to accurately determine whether such

outages are legitimate or not because plants frequently run with physical

FERC’s Study Not

Thorough Enough to

Support Its

Conclusion
Page 8 GAO-01-857 FERC Study of Electricity Outages

problems, and the timing of maintenance or repairs is often a judgment

call on the part of plant owners or operators.

Another weakness in the FERC study—or any study that seeks to

determine whether specific outages are legitimate—is the lack of data for

past outages to use as a benchmark with which to compare the number,

type, and duration of outages during the study period. In discussions with

FERC, officials told us that accurate outage data do not exist for the years

prior to their study.2

 Without a baseline comparison, it is not possible to

conclude that observed outages are above normal in number, type, and

duration. Finally, strategic use of plant outages is not the only way that a

generating company could exercise market power, and FERC’s

methodology did not look at other ways. As FERC acknowledged in its

report, the agency did not analyze whether companies were using other

techniques to influence prices, such as not offering bids to sell some

capacity, or bidding at prices high enough to practically ensure exclusion

from the market.

A thorough and conclusive study of market power in California since May

2000 would combine the market-wide approach of the other two studies,

with a quantification of the extent to which outages or other supply

disruptions were caused by factors other than companies’ attempts to

drive up prices. In its study, FERC pointed out two such factors that could

lead to higher-than-normal levels of outages: (1) some plants had been run

at above-normal rates prior to being shut down for repairs or maintenance,

and (2) many plants that were shut down were older. A third factor,

suggested by other industry sources, is that a number of companies were

simply refusing to operate their generators at various times during 2000

because they had not been paid for electricity they had previously sold to

California’s utilities. None of the studies covered the entire period of high

prices, nor did they evaluate all the factors that could have led to greaterthan-normal levels of generator outages. Therefore, their results are

inconclusive about the precise extent to which market power versus these

other factors explains high electricity prices in California since May 2000.

However, the authors of the two market power studies believe, based on

their results and on results of other studies, that the case for the existence

 2

 In discussions with the California Independent System Operator, the body that collects

outage data, we were told that prior to the FERC study, outage data had not been

systematically reported by companies but that this information was now being collected.
Page 9 GAO-01-857 FERC Study of Electricity Outages

of market power has been conclusively made and that this is enough to

warrant a policy response from FERC and the state of California.

FERC officials acknowledge that simply looking at outages and

maintenance records of generators is not sufficient to determine whether

generating companies are exercising market power. Accordingly, they told

us that FERC has recently implemented a more comprehensive plan for

monitoring the exercise of market power. Under this plan, FERC will

continue to look at outages and to determine if the number, type and

duration of outages are warranted. In addition, FERC will monitor

generators’ bids to try to detect bidding behavior designed to exclude

generating capacity from the market. FERC officials also said they have

notified electricity generators that their ability to earn unregulated market

prices for electricity will be in jeopardy if they are found to be withholding

power in order to drive up prices. We did not evaluate FERC’s current plan

for monitoring generators’ behavior.

We provided the Chairman of FERC with a draft of this report for review

and comment. We also discussed the findings in our report with authors

of the other two studies. Generally, FERC and the academic authors

agreed with the basic findings in the report. However, FERC took issue

with our characterization of its conclusion, saying that FERC had only

concluded the absence of evidence of withholding electric power, rather

than the absence of withholding to influence prices. In addition, FERC

pointed out that it is important to make a distinction between its study,

which focused on engineering reasons for outages, and the other two

studies, which focused on economic reasons for withholding electric

power (see appendix II for a copy of the FERC’s comments). In addition,

two of the authors of the other studies added several clarifying points that

we have incorporated into the report.

In responding to FERC’s first comment, we believe that our

characterization of their overall conclusion is correct. In the conclusion

section of its report, FERC made several statements. First of all, FERC

stated that its “staff did not discover any evidence suggesting that the

audited companies were scheduling maintenance or incurring outages in

an effort to influence prices.” On the contrary, FERC stated that “it

appears that these companies accelerated maintenance and incurred

additional expense to accommodate the ISO’s [Independent System

Operator] operating needs.” FERC also pointed out the age and higherthan-normal usage of generating units as mitigating factors in explaining

outages. Finally, FERC stated that its detailed site reviews are consistent

Agency Comments
Page 10 GAO-01-857 FERC Study of Electricity Outages

with a finding that “prices are driven by demand, not the companies’

maintenance practices.” On the basis of these statements, we believe the

report concludes that the companies they audited were not physically

withholding electricity in an effort to influence prices. From a practical

standpoint, a public statement, made shortly after the FERC’s outage

report was released indicates that others felt the FERC was reaching such

conclusions. For example, an article in the Los Angeles Times on

February 3, 2001 quoted a spokesman for one of the generating companies

as saying that the FERC report affirms the company’s operating

procedures in the face of “incorrect and inflammatory allegations that we

have somehow been withholding power from our four plants in

California.”

The distinction between physical and economic withholding was pointed

out by FERC in its second comment. We agree with FERC that the other

two studies were wider in scope than its review of generator outages. As

we pointed out in our report, a thorough and conclusive study of market

power in California would combine the market wide approach of the other

two studies, with a quantification of the extent to which outages or other

supply disruptions were caused by factors other than companies’ attempts

to drive up prices. We have added clarifying language in the body of the

report that makes the distinction between the FERC report on physical

outages and the other two, which looked more broadly for evidence of

market power.

FERC’s report comes on the heels of some of the most dramatic electricity

price increases in history. These price increases caused consumers, other

market participants, and members of Congress to question whether

electricity-generating companies have been charging unfair prices and

making very large profits at their expense. In short, the public and others

were looking for clear answers as to whether sellers of electricity in

California were withholding power in an effort to raise prices. In this

environment, FERC’s report—“focusing on whether unplanned

maintenance or outages occurred to raise prices”—was important. In

addition, as the federal government’s market monitoring entity, FERC’s

views, opinions, and orders clearly send important signals to the

marketplace, including the investment community, and influence public

confidence. We believe that, as the federal government’s marketmonitoring entity, FERC has an important responsibility to fully

investigate potential market power and clearly report its results. In light

of changes in the electricity industry as it undergoes restructuring, and the

changing role of FERC in overseeing this industry, we recognize that
Page 11 GAO-01-857 FERC Study of Electricity Outages

FERC’s monitoring role is evolving and that its outage report was simply

one part of its ongoing effort.

To develop an understanding of the issues surrounding market power in

the electricity industry, we interviewed numerous economists from

Stanford University, the University of California, Berkeley, and the

University of California, Irvine, and reviewed written studies of market

power and related issues. We also interviewed officials from state and

federal energy agencies, including the California Public Utilities

Commission, the California Independent System Operator, and FERC.

To compare the FERC outage study and the other two studies on market

power, we reviewed the three studies, evaluating the methodologies used

and the results. After our initial review, we discussed our findings with

FERC officials and authors of the other studies. We also reviewed related

studies of market power.

To determine whether FERC’s methodology was thorough enough to

support its conclusion that generating capacity has not been withheld

without legitimate reason, we evaluated their methodology and results. We

also discussed our findings with state and federal energy officials and an

economist at the University of California, at Irvine who was familiar with

all three studies.

We performed our work from May through June 2001 in accordance with

generally accepted government auditing standards.

Unless you publicly announce its contents earlier, we plan no further

distribution of the report until 14 days after the date of the letter. At that

time, we will send copies of this report to FERC and the authors of the

two studies. We will also provide copies to others on request.

Scope and

Methodology
Page 12 GAO-01-857 FERC Study of Electricity Outages

If you or your staff have any questions about this report, please call me on

(202) 512-3841 or Dan Haas on (202) 512-9828. Other key contributors to

this report were Jon Ludwigson and Frank Rusco.

Jim Wells

Director, Natural Resources

and Environment
Appendix I: Study Titles and Author

Information

Page 13 GAO-01-857 FERC Study of Electricity Outages

“Report on Plant Outages in the State of California,” prepared by the Office

of the General Counsel, Market Oversight & Enforcement and the Office of

Markets, Tariffs and Rates, Division of Energy Markets, Federal Energy

Regulatory Commission, February 1, 2001.

“Diagnosing Market Power in California’s Restructured Wholesale

Electricity Market,” Severin Borenstein, James Bushnell, and Frank Wolak,

August 2000 [unpublished]. Severin Borenstein is a professor of business

economics in the Haas School of Business, University of California, and

Director of the University of California Energy Institute. James Bushnell is

a lecturer in the Haas School of Business, University of California, and a

Research Associate at the University of California Energy Institute. Frank

Wolak is a professor of economics at Stanford University and chairman of

the Market Surveillance Committee of the California Independent System

Operator.

“A Quantitative Analysis of Pricing Behavior in California’s Wholesale

Electricity Market During Summer 2000,” Paul Joskow and Edward Kahn,

January 2001 [unpublished]. Paul Joskow is the Elizabeth and James

Killian Professor of Economics and Management at the Massachusetts

Institute of Technology (MIT) and Director of the MIT Center for Energy

and Environmental Policy Research. Edward Kahn is a principal at

Analysis Group/Economics, a private consulting firm.

Appendix I: Study Titles and Author

Information
Appendix II: Comments From the Federal

Energy Regulatory Commission

Page 14 GAO-01-857 FERC Study of Electricity Outages

Appendix II: Comments From the Federal

Energy Regulatory Commission
Appendix II: Comments From the Federal

Energy Regulatory Commission

Page 15 GAO-01-857 FERC Study of Electricity Outages (360063)

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