25

Prices provide useful information 

on how markets are functioning 

and serve as a primary basis for 

customer choices. 

IV. Price Information

As energy markets become more competitive, prices assume several

increasingly important roles. As one of the primary means of conveying

information in a market-based system, prices give market participants the

practical mechanism to make transaction choices. Prices also convey useful

information, which can be used to understand how the markets are functioning

and suggest ways to improve market structures, particularly during crucial

transitions in market development.

Price formation is a critical part of market mechanisms. As individual

decision-makers in the market interact and conduct transactions, competing

sellers offering comparable goods or services effectively present a series of

bids. Buyers also effectively bid on the goods or services, since buyers

offering various prices present a choice to the seller. 

As transactions occur, repeated interactions of individuals over time produce

price information that makes its way into the market through a variety of

means. The details of price formation vary from market to market because

there are many different types of market interaction, from private contracts

through centrally cleared auction floors, trading centers, and other types of

spot markets, pools, etc. Economic theory often refers simply to the

auctioneer in this context, but the details are important when market

transitions occur. This will be discussed further below, in the performance

indicator examples.

However prices arise, once they become available in a market they serve a

variety of purposes. Allowing transactions between distant parties is one

central role of prices, but the complexity underlying market conditions,

including factors affecting supply and demand, also creates other informationrelated roles for prices. For example, the pattern of price movement over time

presents opportunities to anticipate future prices and take actions based on

anticipated prices. This is the basis for risk hedging and arbitrage in

commodity markets, as discussed in Section III, New Service Availability. 

The Commission faces the challenge of understanding and reviewing the

design and operation of efficient markets. Prices play a key role in

determining both short-run incentives, which affect immediate production

decisions, and long-run incentives, which affect investment and planning

decisions. The role of price incentives in long-term decision making has

important implications for system reliability over time, for example, and it is

part of the Commission’s responsibility to understand how prices in network

industries affect capacity planning and reliability. This is especially true in the

formation of RTOs in the interstate electric power markets, since under Order

No. 2000 it is envisioned that RTOs will have a formal role in system planning

and capacity expansion decisions. Pipeline networks are also affected by such

Background and

Regulatory Context
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

26

Network industries, such as 

natural gas and electric power, 

tend to exhibit particular types of 

price behavior. 

considerations and the Commission continues to work to improve its

approaches to pipeline capacity expansion, including the role of price

incentives over time.

Performance indicators in the area of prices should take into account the

variety of roles that prices play in market systems. Most fundamentally,

variations in prices allow for analysis of how and why the markets are

working. For example, weather affects energy prices because of strong

linkages between temperature and demand for end use energy services such

as space heating and air conditioning. Analysis of the interaction between

weather and prices allows for such cost-saving practices as designing

maintenance schedules to avoid having equipment unavailable during periods

of high demand. During periods of restructuring or the creation of new

markets, prices can also be used to understand how the market is functioning,

and this is the basis of some of the performance indicators applied in this

section.

In network industries, such as natural gas and electric power, the

transportation system is physically interconnected and is often subject to

constraints on the physical capability to deliver the commodity. Such network

industries exhibit characteristic types of price behavior, and this has

implications both for market design and for the kinds of price patterns which

can be expected in the new energy markets.

Some of the important characteristics of prices in network industries include:

• Variability. Regulated rates were generally stable, even if some timedifferentiated rates such as peak and non-peak period pricing were offered

to a few customers. In contrast, the new energy markets exhibit great

price responsiveness, or variability. Some of the factors contributing to

price variability in commodity energy markets include rapid changes in

demand, variations in production costs, and the lack of effective storage

technology for electricity. Price variability is important because it reflects

changes in the underlying physical status of the commodity markets.

Without price variability these physical changes would lead to implicit

prices, and could distort incentives to market participants.

• Step functions/threshold effects. Network industries are typically subject

to limits on the ability of the transportation network to deliver goods and

services. These limits can create sudden changes in prices because a limit

may be reached which forces the curtailment of transactions, or the

rerouting of transactions to more costly routes on the network. The

resulting price behavior can be described as a step function or a threshold

effect, since the prices will make a rapid transition from one state to

another. This can be seen, for example, as a rapid price rise when a

network constraint is encountered. 

Developing

Performance

Indicators: Methods

and Data
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

27

Despite some limitations, much 

can be learned by analyzing 

prices. 

• Locational interdependence of prices. Because a network industry has

a strongly linked transportation system, changes in the factors underlying

prices in one area can have immediate impacts on prices in other areas.

These effects assume a dynamic over time in which prices are partially

dependent on prices in other areas, and this adds to the complexity of

price information in the marketplace. It also means that market design in

one area can impact markets and price patterns in other areas (for

instance, a market may attract goods and services away from another

market because it offers a better price).

• Implicit value of transportation constraints. Constraints on the

transportation network can cause price effects, and this means that the

constraints themselves have a market value. Pricing of these constraints,

whether explicit or implicit, will play a role in the efficiency of the market

incentives for short-term operating practices and long term investment

decisions. For example, it is important to have price information on the

value of upgrading a transmission link as opposed to providing new

generation on either side of the constraint.

• Linkages between services and interactions between related markets. Just

as the strong linkages in the transportation system create linkages between

prices in locationally distinct markets, they also create linkages between

the prices for related goods and services. This is most apparent in electric

power reserve or balancing markets, where changes in the bulk

commodity price can be reflected in changes in price for related goods and

services. Efficient markets will develop these linkages in a way which

allows the market to make resource allocations based on cost, so that

energy suppliers can move their product from reserve markets to spot

energy markets, etc., as market conditions change.

Even with an understanding of the basic mechanisms of price formation and

behavior in network industries, the interpretation of price data is extremely

difficult and remains subject to uncertainty. The Commission is not in a

position to create definitive or automatic procedures for the analysis and

interpretation of price information. Informed analysis can add to the

knowledge base the Commission uses to arrive at decisions, but strong

caveats must be applied to any simplistic interpretation of price information.

Nevertheless, this uncertainty does not mean that no clear lessons can be

learned from price analysis. Nor does it mean that the Commission cannot

develop general sets of issues and outcomes for use in analyzing a specific

situation. Two key points which go beyond the details of specific markets

are:

• Market-based price information can lead to lowered costs and enhanced

efficiency. The presence of competing prices is what allows arbitrage or
Federal Energy Regulatory Commission State of the Markets 2000

28

bargain hunting. Getting price information into the marketplace is a basic

step in creating the possibility of efficient, lower-cost outcomes, while

also offering market participants the incentives to create new types of

goods and services. Even if price information does not always lead to

lower costs, it is a necessary element where the opportunity for efficiency

gains exists.

• Prices will proliferate as more new markets develop. There has been a

dramatic growth in the amount of price information and the types of

goods and services being priced. This proliferation of prices indicates that

market participants are finding ways to make transactions in the new

energy markets. In general, more services being priced means that market

forces are leading to creative strategies and innovation in goods and

services, and indicate that the markets are functioning.

In developing performance indicators related to prices, an understanding of

the complexity of prices and the transitional nature of the markets are

essential. Applying a rigid set of standards to the evaluation of prices would

not reflect these realities, because such standards cannot be designed in a way

that fully anticipates how the markets and their pricing mechanisms will

evolve. In order to be responsive and informed in its decisions, the

Commission must instead develop the analytic methods which yield the most

sophisticated understanding of specific markets at specific points in their

development. These methods will vary according to the situation where they

are applied.

Performance indicators in the area of price information, then, should show

how the Commission succeeds in using price information to inform its

decisions and thus affect external outcomes in the energy markets.

Furthermore, these performance indicators should be tailored to reflect the

important network-related characteristics of the energy markets.

In addition to presenting performance indicators that are directly tied to the

Commission’s mission and goals, this section also presents background

material on prices. Such background material is really the raw data underlying

more sophisticated analyses and is the starting point for research. The

objective in presenting this information is to allow the Commission’s

customers a chance to evaluate the developing energy markets and to fulfill

a basic public information responsibility. The price information in the

background section is for reference purposes and is not a direct indicator of

Commission performance. However, the very existence of these prices

reflects the Commission’s success at fostering competitive commodity energy

markets and thereby also the basis for many newly-developing markets for

related goods and services (as discussed in Section II, Commodity Markets

and Section III, New Service Availability).
Federal Energy Regulatory Commission State of the Markets 2000

29

Natural Gas Spot Price vs Heating Degree Days

Chicago (LDCs and Large End Users)

Jan-93 Feb-93 Mar-93 Apr-93 May-93 Jun-93 Jul-93 Aug-93 Sep-93 Oct-93 Nov-93 Dec-93 Jan-94 Feb-94 Mar-94 Apr-94 May-94 Jun-94 Jul-94 Aug-94 Sep-94 Oct-94 Nov-94 Dec-94 Jan-95 Feb-95 Mar-95 Apr-95 May-95 Jun-95 Jul-95 Aug-95 Sep-95 Oct-95 Nov-95 Dec-95 Jan-96 Feb-96 Mar-96 Apr-96 May-96 Jun-96 Jul-96 Aug-96 Sep-96 Oct-96 Nov-96 Dec-96 Jan-97 Feb-97 Mar-97 Apr-97 May-97 Jun-97 Jul-97 Aug-97 Sep-97 Oct-97 Nov-97 Dec-97

$0

$5

$10

$15

$20

$25

$30

$35

0

20

40

60

80

100

Daily Price ($/MMBtu)

Heating Degree Days

92/93 93/94 94/95 95/96 96/97 97/98

HDD

Price

Performance indicators in the area of price information should reflect the main

features of price behavior in network industries, and should show how the

Commission uses price information to learn about the markets, identify

problems, and make reasoned decisions. The examples of performance

indicators in this section demonstrate several forms of analysis using price

information as well as presenting background information in the form of

selected price data series. 

This example demonstrates some of the complex relationships between prices

and physical events. Heating degree days reflect the need for space heating

during cold weather, indicating how many degrees the mean temperature fell

below 65 degrees for the day. For example, if a day’s mean temperature were

45 degrees, there would be 20 degree days for that day. Their seasonal

variation is apparent from the figure. The natural gas spot price appears to

react to this seasonal variation in a number of distinct ways. First, note that

there are some seasons in which the spot prices shows no apparent response

to the change in heating degree days. In some other years, there is an increase

in the spot price (of roughly 100 per cent, or a doubling) which coincides with

the maximum in heating degree days. But in one year, there is an even more

dramatic increase in the spot price, which also coincides with that season’s

heating degree day maximum.

Performance

Indicators: Examples
Federal Energy Regulatory Commission State of the Markets 2000

30

The explanation for this complex relationship between price and the weather

calls upon several key elements. First, the fact that in some years the price

does not react at all indicates that there are other factors which help to

determine the spot price. These include demand for natural gas in other parts

of the country, the adequacy of seasonal storage, and transportation

availability. Second, the variety of responses in different years indicates the

presence of threshold effects, in which the combination of factors determining

the price can lead to rapid price changes (that is, the price response is not

continuous or smooth). Such threshold effects are characteristic of network

industries in which the transportation infrastructure can become constrained,

or bottlenecked, leading to the isolation of portions of the market in which

more expensive supply is required to meet demand. Third, the very large

price response in one year may reflect inexperience on the part of market

participants, as opposed to an underlying market imperfection which might

warrant a change in policy.

An example of the Commission using price information to understand and

identify an issue in an electric power market is shown below. The example is

from the New England regional market for operating reserves. It is generally

expected that for any specific generator, it costs more to provide reserves that

can be used immediately than those that take time to access. In the New

England market, the initial market design accepted bids for these operating

reserve markets at the same time but then cleared each market sequentially.

This, along with other incentives, allowed artificial shortages to emerge in

some of the reserve markets. This can be seen in the figure below as periods

in which types of reserve power that should be cheaper to produce were

actually priced higher than other types of reserve power (10 minute spin),

which should be more expensive. The appearance of this inefficient result in

the reserve market indicated the need for institutional changes to head off

similar events in the future. 
Federal Energy Regulatory Commission State of the Markets 2000

31

NEPOOL Operating Reserve Prices, July 7-8, 1999

0

100

200

300

400

500

600

700

800

900

13579

11131517192123252729313335373941434547

Hours

$/MWh

10 Minute Spin ($/MWh)

10 Minute Non-Spin ($/MWh)

30 Minute Reserve ($/MWh)

The example below shows one way to measure the convergence of prices.

Correlating the natural gas prices in neighboring states, it is evident that there

was a dramatic change in early 1996. Before that period, the prices only

loosely correlated, while after that period, the correlation increased and

stabilized at a nearly perfect 1.0. This means that by 1997, if one knew the

price of gas in Texas one essentially knew what the price should be in

Louisiana. Efficient market arbitrage allows the prices to equilibrate at a rapid

pace, without the need for intrusive regulatory action. However, in an

efficient market these kinds of correlations will not always be perfect, since

there will at times be constraints on the transportation system which will (and

in fact should) lead to price divergences.
Federal Energy Regulatory Commission State of the Markets 2000

32

Correlation of Natural Gas Prices in Louisiana and Texas

0.7

0.8

0.9

1.0

Jan-93

Jul-93

Jan-94

Jul-94

Jan-95

Jul-95

Jan-96

Jul-96

Jan-97

Jul-97

Jan-98

Starting Date of Period

Correlation Coefficient

Next Twelve Months

Next Two Years

The following graphs show background information on electric power and

natural gas prices by region, and futures prices for electricity at two trading

hubs (Cinergy and Entergy).

(These graphs appear in the Appendix.)
33

V. Market Power

Developing competitive energy markets for the benefit of consumers depends

on successfully addressing market power in all segments of the relevant

energy markets, maintaining oversight of monopoly transportation networks,

and pursuing a continuing set of activities to identify and address ongoing

residual market power.

The Commission’s public interest mission is explicitly intended to encompass

consumer protection and national economic well-being. In order to

accomplish this mission, the Commission seeks to protect consumers from the

exercise of market power in energy markets. Different market segments and

service areas are prone to differing types and degrees of potential for the

exercise of market power, and this in turn has implications for the

Commission’s role in identifying and addressing that potential.

Market power is defined as the ability to withhold capacity or services, to

foreclose input markets, or to raise rival firms’ costs in order to increase

prices to consumers on a sustained basis without related increases in cost or

value. In general, markets are subject to the exercise of market power

through two basic mechanisms: explicit or tacit collusion among firms, and/or

the presence of fundamental economic conditions for dominance by large

firms which effectively exclude competitors. This second kind of market

power development is known as natural monopoly, because the structure of

the market itself creates incentives for market power to develop without the

need for collusion.

It is important to note that the root cause of all market power (along with

demand for the service) lies in barriers to the entry of competing firms into the

relevant market. Both collusion and natural monopoly would not be possible

if the presence of above-normal profits could attract new entrants, which

would undercut the higher prices set by the firms exercising market power.

Barriers to entry take two main forms: legal barriers and technical barriers.

Legal barriers create the conditions for market concentration and collusion,

while technical barriers create the conditions for natural monopoly. Both

types of barriers to entry may exist in a single market, and in fact this has

often been the case with Commission-jurisdictional energy markets. 

Legal barriers include patents, which exclude other firms from specialized

knowledge required to compete in the market; control via exclusive property

rights over a necessary input such as an essential raw material (bauxite in

aluminum production, for example); and exclusive government franchises.

Legal barriers to entry may exist for valid reasons, leading to tradeoffs

between fully competitive markets and other goals and therefore a continuing

need for regulatory oversight of the market.

Background and

Regulatory Context
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

34

The Commission shares

authority for addressing

collusive practices with the 

Department of Justice, the 

Federal Trade Commission, and 

the Securities and Exchange 

Commission. 

Technical barriers generally result from underlying technological or cost

characteristics which result in large economies of scale; that is, costs decline

as more of the relevant good or service is produced. Capital-intensive

industries, including segments of the energy markets, are prone to technical

barriers to entry and thus are often regulated to some degree.

The difference between how natural monopoly and collusion develop is that

in a market with the conditions for natural monopoly, cost characteristics will

tend to lead directly to dominance by a single firm with market power, while

collusion occurs when multiple viable firms engage in non-competitive

behavior while being protected (by legal barriers to entry) against new firms

entering the market. 

Collusion among firms in a market which could in principle be competitive is

one means by which market power can develop. Firms sometimes collude

explicitly, that is, come to agreements on price-fixing or other anticompetitive practices. More often, however, collusion is implicit. For

example, an airline may raise prices to some degree in the hope that other

airlines will do likewise, as opposed to undercutting the first firm’s price and

luring away customers. If an implicit bargain can be struck on the tradeoff

between increases in price and relative market share for each firm, than

implicit or tacit collusion may occur, resulting in the potential exercise of

market power and losses to the consumer and to the economy as a whole.

Natural monopoly, on the other hand, can occur spontaneously due to the

presence of technical barriers to entry (large economies of scale) in the

relevant market. When such underlying economic conditions are present and

production costs decrease with greater scales of production, a single firm will

tend to gain more and more market share since it can charge a lower price

than smaller firms. Once dominance has been achieved new firms can be

excluded and the natural monopolist can still charge prices above its

production costs, leading to the potential exercise of market power.

Market power, whether exercised through collusion or through dominance by

a natural monopoly, must be addressed by legal and regulatory policy in order

to protect consumers and promote economic efficiency. Because specific

segments of the energy markets can be subject to both legal and technical

barriers to entry, legal and regulatory policies appropriate to address both

collusion and natural monopoly situations are needed in certain circumstances,

even as the Commission seeks to reduce the need for regulation through the

development of robust competitive markets whenever possible.

Collusion by firms in potentially competitive markets is the subject of most

anti-trust law (beginning with the Sherman Anti-Trust Act of 1890) and

related regulatory policy. The courts have confirmed that the Commission

shares the responsibility for addressing collusive practices with other anti-trust

agencies such as the Department of Justice, the Federal Trade Commission,
Federal Energy Regulatory Commission State of the Markets 2000

35

and the Securities and Exchange Commission. Natural monopolies, in

contrast to collusive practices, generally require explicit regulatory strategies

which seek to establish incentives for the natural monopolist to charge

efficient prices, or to impose such prices in the form of regulated rates for

goods and services. 

The series of actions taken by the Commission in order to promote more

competitive energy markets is fundamentally aimed at tailoring regulatory

policy in ways which allow for as much competition as possible throughout

all segments of the affected industries (see the discussions of regulatory

context in section II, Commodity Markets, and Section III, New Service

Availability, for more detail on the specific actions taken by the Commission).

The importance of unbundling in this context is that vertical separation and

unbundled services allow for each market segment and service to be evaluated

in terms of its specific characteristics, so that appropriate approaches can be

applied by the Commission. Some markets are by nature more competitive

than others, and although the benefits of competition should be fostered in as

many markets as possible, there remain parts of energy markets which are

subject to legal and/or technical barriers to entry. Potential market power in

these market segments and service areas must be identified and addressed in

an ongoing fashion, albeit through the most market-oriented set of policies

that can be implemented.

In particular, the transportation networks for electric power, natural gas and

petroleum can be regarded as natural monopolies. These networks are capital

intensive and require highly specialized operating systems and expertise to

maintain at acceptable levels of reliability. Legal barriers to entry also exist

in these transportation networks. Because of these underlying factors, some

type of regulatory oversight will be required in order to protect consumers

and ensure that the benefits of more competitive market segments are realized.

Current major Commission rulemakings – Order No. 2000 concerning electric

power and Order No. 637 concerning natural gas – are intended to develop

better approaches to continuing issues, including the potential for ongoing

market power, in the transportation networks.

On the other hand, many segments and specific markets can and should be

quite competitive, and in these markets the Commission is committed to

fostering the fullest possible degree of competition. In these more competitive

markets, the challenge now facing the Commission is one of reengineering its

own policies and activities in a way which allows markets to function

unimpeded, while developing appropriate market analysis tools to identify and

address any remaining needs for Commission action. During the transition to

more competitive markets, such needs may be extensive, as extremely difficult

topics in market design, governance, and operation are taken up by market

participants and public institutions.
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

36

The Commission is continuing to 

improve its policy regarding 

merger applications. 

In addition to major rulemakings and market design decisions and approvals,

the Commission must continue to advance its practice concerning merger

applications. This is proceeding through continuing improvements in merger

policy as reflected in the Merger Policy Statement issued in 1996, and through

ongoing efforts to improve the filing process and the Commission’s analytic

capabilities in order to better understand and respond to specific mergers’

effects on the potential for market power abuses. The Commission’s merger

policy is aimed at two objectives:

• allowing industry to restructure and adapt to changing market conditions;

and

• not allowing that restructuring to work to the detriment of the evolving

markets (i.e. lead to inefficient results, such as increased potential for the

exercise of market power).

Performance indicators related to market power should be based on the

Commission’s ongoing efforts to understand and respond to the changing

nature of the energy markets. Ideally, the Commission could show how its

use of information and analysis informs appropriate decisions in merger filings,

regional market structure oversight, and general rulemakings through the

development and presentation of well-tailored performance indicators.

Indicators may also allow for a continuing picture of the structure and levels

of concentration in relevant markets, although this goal may be difficult to

achieve due to the challenging nature of market definition.

Additionally, as analytic tools and information become more sophisticated, the

Commission must continue to develop better tools and procedures to

understand markets and identify and address ongoing market power issues.

At the present time there are analytic tools at the Commission’s disposal

which, while resource-intensive, can be applied in certain circumstances when

traditional means of analysis do not yield enough information or when

interested parties have especially large stakes in the outcome of a decision.

In the area of market power, the Commission employs a variety of techniques

to determine whether market power is present, and the degree of potential for

market power going forward. These techniques vary to some extent

depending on whether the issue at hand involves a merger filing, a filing

concerning a regional market structure, filings for market-based generation of

gas transportation or storage rates, or the general ‘pulse-taking’ or market

analysis activities which inform the Commission of market conditions on a

day-to-day basis. However, for the purposes of developing performance

indicators it is more useful to discuss these methods and data requirements

together; their application will of course depend on the context.

A useful distinction may be made between quantitative and non-quantitative

methods, since the Commission employs both kinds of information gathering

Developing

Performance

Indicators: Methods

and Data
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

37

The Commission uses a number 

of non-quantitative methods to 

determine and understand the 

workings of the energy markets, 

especially the exercise of market 

power.

and analysis. Non-quantitative methods are discussed first, followed by

traditional quantitative analysis as presented in the Merger Guidelines, and

finally the development of newer quantitative tools such as computer

simulation modeling.

Non-quantitative methods. One of the principal means by which the

Commission develops an understanding of market conditions, and specifically

the potential exercise of market power, is through direct contact with

customers. Every day the Commission hears from various firms, individuals,

and institutions about what is going on in their markets. The information thus

gathered is of immense value, and one of the Commission’s ongoing

challenges involves how to improve and systematize this set of information

flows.

There are several primary channels of communication with outside parties,

some of which are initiated by the parties and some by the Commission:

Comments. The comment process is arguably the most important source of

information at the Commission’s disposal during a specific decisional process.

Comments are directly relevant to the issues at hand, and the commenting

parties are aware that a decision is being considered, giving them a chance to

influence the outcome. Hence important cases, and particularly major

rulemakings, often attract hundreds of comments which comprise thousands

of pages of information. If market power is an explicit part of the decision at

hand, as it is in merger and regional market structure filings, then commenting

parties provide the Commission extensive information on the parties’

perceptions of market power, and in many instances evidentiary support for

their perceptions.

Complaints. Formal complaints are another important source of information

for the Commission, since they often contain specific complaints and evidence

to back up those complaints. The Commission also established its

Enforcement Hotline in 1987 with the specific intent of making it easier for

market participants anywhere in the country to inform the Commission of

problems they might be having, including instances of the exercise of market

power. Complaints can be lodged regardless of the time or place and

regardless of whether the Commission is considering a decision in the

complaining parties’ particular market. 

Surveys. When the Commission seeks further information about a specific

issue, it can develop and implement surveys to gather information from a

broad set of its customers. Market power is an issue which the Commission

is currently pursuing through a survey approach. Blanket survey authority

from the Office of Management and Budget would allow the Commission to

coordinate its survey activity and receive approval for specific surveys within

ten days. The Commission is currently in the process of obtaining such
Federal Energy Regulatory Commission Federal Energy Regulatory Commission State of the Markets 2000 State of the Markets 2000

38

Quantitative analysis of market 

power relies on using the

appropriate definitions of the 

relevant market.

blanket survey authority, and expects to develop the methods for a market

power survey in the near future. 

Investigations. Another approach is to launch an investigation or audit into a

specific problem such as a particular instance or instances of the exercise of

market power. This can vary in complexity, time frame, and resources,

running the gamut from a nonpublic investigation (one step beyond a Hotline

complaint) to a formal inquiry in the nature of a full-scale Commission

proceeding. Whatever the appropriate level of investigation, this is a major

method by which the Commission educates itself about market conditions, and

serves as a basis for informed market-related decision making by the agency.

In dealing with the information gathered by these methods, the Commission

must develop ways to catagorize and evaluate what is essentially a collection

of customer perceptions, with supplemental evidence that may be more or less

detailed and more or less quantitative. Analytic approaches for handling this

kind of information are now quite sophisticated and the Commission intends

to pursue a more systematic approach to handling these information flows

over time. This should create the opportunity to develop performance

indicators that track how customer perceptions change over time, and make

use of customer-provided evidence to track instances of market power.

Quantitative methods. In addition to the valuable information provided by

direct contact with customers, the Commission is able to carry out extensive

analysis of market power issues using reported data and a set of quantitative

methods. These methods cannot tell the whole story by themselves, but are

an essential part of understanding how changes can affect market

concentration and the potential for market power.

There are several types of quantitative analysis which the Commission

employs in this context. The Commission uses analytic techniques based upon

the FTC/DOJ Merger Guidelines, and these techniques are the main approach

taken by the Commission when analyzing merger filings. The Merger

Guidelines also suggest the development of computer simulation modeling,

and these models can be useful not only in merger filings but also in market

structure analysis and the general development of the Commission’s

understanding of how the markets are working. The Commission also

employs a market power analyses when determining requests for marketbased pricing for electric wholesale power rates, gas storage rates and gas

transportation, which can also serve overall Commission market analysis.

All types of quantitative market power analysis depend critically upon

appropriate definitions of the relevant market, in terms of the services being

offered and geographic scope. This is an extremely complex and difficult

step, and there are fundamental uncertainties and judgment calls involved.

However, quantitative analysis offers insights which customer perceptions and

evidence cannot provide, especially in the area of anticipating the effect of
Federal Energy Regulatory Commission State of the Markets 2000

39

changes on the potential for the exercise of market power. It is part of the

Commission’s responsibility to make a reasoned use of all of the information

developed through all types of analysis.

Merger Guideline Analysis. The FTC/DOJ Merger Guidelines, as adopted

by the Commission for use in merger analysis, lay out a detailed analytic

approach. This consists of a five-step process:

1. Assess whether the merger would significantly increase concentration and

result in a concentrated market, properly defined and measured.

2. Assess whether the merger, in light of market concentration and other

factors that characterize the market, raises concern about potential

adverse competitive effects.

3. Assess whether entry would be timely, likely and sufficient either to deter

or to counteract the competitive effects of concern. 

4. Assess any efficiency gains that reasonably cannot be achieved by the

parties through other means. 

5. Assess whether, but for the merger, either party would be likely to fail,

causing its assets to exit the market.

In determining the likely impacts of a merger on market structure and the

potential for market power, the Commission relies mainly on information

provided by the merging parties and by intervening parties. This information

in many cases includes extremely extensive quantitative data, customized

models and other sophisticated analytic material. Additionally, in many cases

the information is proprietary and company-specific. These factors make it

difficult to rely directly upon merger case filings to develop performance

indicators. However, it may be possible to generalize conclusions and make

quantitative assessments of market concentration and the potential for market

power using the analytic methods set out in the Merger Guidelines, thereby

allowing for the development of meaningful performance indicators.

Market-Based Rates. Pipeline applicants for market-based storage or

transportation rates must demonstrate that they cannot withhold services to

increase and maintain prices above competitive levels or unduly discriminate

among customers. In this context, a pipeline lacks significant market power

if its customers have sufficient good alternatives, or if the Commission can

mitigate the market power through appropriate conditions. In analyzing the

pipeline’s market power, the Commission:

• defines the product market (e.g., short-term storage, long-term firm

transportation, etc.) and the geographic market;

• measures market share and concentration; and
Federal Energy Regulatory Commission State of the Markets 2000

40

• considers entry barrier and other relevant factors.

Similarly, an applicant for market-based electric wholesale rates must show

that it does not dominate any relevant generation market, has no transmission

market power, and has no control over other barriers to entry.

As with mergers, in market-based gas and electric proceedings, the

Commission historically relies on information provided by the parties.

However, the Commission’s approach in this area supplies a source of

quantitative assessments. 

Newer simulation models. Over the past several years new types of models,

and more effective computers, have enabled the Commission to deploy new

analytic tools with many uses. The main types of models now in use are

optimization models of the planning and operation of the relevant system, load

flow models of the actual power flows on the electric transmission grid, and

models of strategic firm behavior in network industries (based on principles

of game theory). In recent years optimization models which are also load

flow models have been made available. Increased computing power and

advances in programming have enabled the Commission to work with models

which present a reasonable level of detail and can assist in understanding

market conditions, and the ways in which market power can affect costs and

prices. 

Simulation modeling of the electric power system has been used in recent

merger cases, to highlight the role of vertical integration and the possibility of

using control over the transmission grid to cut off competing supplies and

force higher-cost plants to run. When conditioning merger cases, such

detailed simulations can help the concerned parties and the Commission target

mitigation measures at the facilities that make a difference, whether they are

transmission facilities or generating plants. The details matter in network

industries and simulation modeling can help to understand what changes when

specific facilities are operated differently.

Ongoing issues raised by modeling include the suitability of the data which the

Commission uses in modeling, and the degree to which results can be

interpreted in their proper context. While modeling is potentially attractive

in the context of developing performance indicators, a great deal of caution

is advisable in the use and interpretation of results. 

Performance measures in the area of market power should show how the

Commission’s actions affect relevant institutions and markets and lead to

changes in the potential for the exercise of market power. As discussed

previously, defining markets for the purposes of market power analysis is

often done on a case-by-case basis in order to ensure that the proper services,

suppliers, and scope of that particular market are applied. This makes it

Performance

Indicators: Examples
Federal Energy Regulatory Commission State of the Markets 2000

41

difficult to develop market power analyses that are general enough to use as

performance indicators.

One broad indicator, however, is the development of open access tariffs and

independent system operators (ISOs) in electric power markets. Such tariffs

allow other users to access a transmission system under the same rates, terms

and conditions as the owner would receive, and make it more difficult to

exercise market power by enabling access to competing commodity sources.

Open access transmission tariffs were only available in a few parts of the

nation as recently as 1991, prior to the passage of the Energy Policy Act. The

following map shows the open access transmission tariffs in place at that time:

By the beginning of 2000, ISOs were serving many of the same purposes for

regions that open access transmission tariffs did for individual firms. They

also allow for greater coordination of grid operations, better reliability and

system expansion planning, more trust and credibility from customers, and

elimination of rate pancaking. The Commission issued Order No. 2000 in

1999 to encourage the further development of ISOs and other types of

regional transmission operators (RTOs) in all regions. The next map shows

the status of ISOs across the nation as of October 1999 (operational

institutions are shown in solid colors while anticipated institutions are

crosshatched):
Federal Energy Regulatory Commission State of the Markets 2000

42
43

Appendix: Electric and Natural Gas Price Graphs

The following graphs show background information on electric power and

natural gas prices by region, and futures prices for electricity at two trading

hubs (Cinergy and Entergy).