State of Energy Markets

January 1, 2002–June 30, 2003:

Staff Report to the Commission

January 22, 2004

Office of Market Oversight and Investigati

Federal Energy Regulatory Commission
Objective of the reportAssess the performance of energy markets during the period January 1, 2002–June 30, 2003 againsmeasurable characteristics of a well-functioning competitive market.
Energy markets managed serious challenges and made marginal improvements

• Market liquidity declined as a result of deterior

financial conditions and credit-worthiness.

• There was a corresponding decline in use of r

management tools.

• The transparency and reliability of energy pric

formation was challenged.

• Mixed incentives for energy investment. • Increasing interdependence between natural g

electricity market operations and prices.
Market events seriously challenged market liquidity and credibility during the report period

Note: Gas Daily spot prices at Henry Hub provided to illustrate two years of U.S. gas commodity price behavior swinter 2001/02. An average of peak hour prices in PJM’s day-ahead market provided as an example of regional Source: PJM, Platts Gas Daily and trade press

Updated March 10
Electricity: Solid performance 

despite tough market challeng
Organized electricity markets, operating and forming, served 67 percent of the U.S. population during the assessment period

Source: P

Up
Organized markets delivered electricity to custat average regional prices lower than in 2001Notes: Megawatt Daily and ICE data are volume-weighted day-ahead peak prices. ISO data are averages of real-time hopeak hours. NYPP Zone G (Hudson Valley) contracts do not have an active market on ICE. Source: Platts Megawatt D

NYISO, PJM, ERCOT and CAISO.

Updated March 1
Bilateral prices outside regions with organized markets lower-than-2001 levels, trending upward in summer 2002 during the February/March 2003 natural gas price spike

Notes: Florida and SPP North do not have an active market on ICE. Source: Platts Megawatt Daily a

Megawatt Daily (MWD)Intercontinental Exchange (ICE)

Updated March 10, 200
Generation ownership concentration was low in with organized markets and higher in those wit

Source: Platts POWERdat, Modeled Production Costs-Ownership-Based dataset for calendar year 2002.
High generation ownership concentration characterized some load pockets in organized 

Source: Platts POWERdat, Modeled Production Costs-Ownership-Based dataset for calendar year 2002.

NYPP: Regional Market Share

Updated March 10
High generation ownership concentration characterized the Southern subregion of SERC

Source: Platts POWERdat, Modeled Production Costs-Ownership-Based dataset for calendar year 2002.

SOUTHERN: Regional Market Share

Updated March 10, 2
Notes: *Designates a market operated by an ISO. (1) Ancillary services were provided at cost-based tariff rates or nebilaterally. (2) ISO conducts an auction-based capacity market. Bilateral contracts and self-supply were also allowedproducts were available more widely within other regions, products were only available for a single price point in this reSource: OMOI.

Customers had superior market options in orgmarkets

Legend:  = Yes

z = No

Bilateral 

transactions Real-time market 

Dayahead 

market 

Ancillary 

services 

markets 

Capacity 

market 

Active 

physical 

day-ahead 

ICE market 

Futures 

market 

Fi

t

m

r

ISO-NE 



* * * * (2) 



z

NYISO 



* * * * (2) 

z

z

PJM 



* * * * (2) 





ERCOT 



* z

* z



z

CAISO 



* z

* z



z

Southeast 



z

z

z (1) 

z

 (3) 

Entergy 

z

Florida 



z

z

z (1) 

z

z

z

Midwest 



z

z

z (1) 

z



z

South 

Central 



z

z

z (1) 

z

z

z

Southwest 



z

z

z (1) 

z



z

Northwest 



z

z

z (1) 

z



z

Upd
Price formation was less transparent in regions without organized marketsNote: (1) Losses are allocated to market participants based on a pro-rata share of total transmission losses. (2) Losses asellers using generation meter multipliers, which reflect scaled marginal losses. (3) CAISO and ERCOT did not have daymarkets; economic dispatch was used in their real-time balancing markets only. Source: OMOI.

Regions with 

organized markets 

Regions without 

organized markets 

Legend: 

 = Yes

z = No

 = Not market based

Services Provided 

ISONE NYISO PJM ERCOT CAISO South- east Florida Midwest South Central 

Real-time energy market 











z

z

z

z

Locational energy price 











z

z

z

z

Hourly energy price 











z

z

z

z

Congestion price 











z

z

z

z

Losses price 





z (1)



 (2)

z

z

z

z

Regional transmission scheduling 











z

z



z

Regional economic dispatch 







 (3)

 (3)

z

z

z

z

Regional transmission planning 











z

z



z

Regional interconnection process 











z

z



z

Independent market monitor 











z

z



z

Up
Operational “seams” erect barriers to efficient trading between regionsInterregional price differences vary widely across the United States. Note: Annual comparisons based on January–Septeonly. Source: Platts Megawatt Daily

Updated March 10, 2004
Price differences can exist between regions due to differences in products, pricing and market rules between regions

New England-New York price differences narrow when there congestion, but remain significant.

Note: Average price difference between New York and New England, uncongested hours. Source: Virtual Regional DispEvaluation, and Proposal, Joint Working Paper, ISO New England, Inc. and New York ISO, Inc., Appendix D, p. 20.

Updated March 10, 20
Operational “seams” erect barriers to efficient between electricity and natural gas industries

• Operational timelines for scheduling gas and bidding 

power vary. 

• Although uniform minimum standards exist for gas m

participants’ nomination of and scheduling of gas ointerstate pipelines, similar standards related to biddscheduling power do not exist in electricity markets. 

• Inter-industry seams increase transactional costs.

Notes: All times are Eastern Standard Time. Source: Based on tariff terms and conditions for FERC-regulated gas pipel
Electricity price volatility generally declined in with organized markets, but generally increaseregions without organized markets

Regions with 

organized markets

Regions witho

organized mark

Note: Volatility calculation is based on all trading days during calendar year. *Volatility calculations begin in 2002. Florida 

intermittently reported prior to January 2002. Source: Platts Megawatt Daily.

Updated March 10, 2004 
Introduction of the futures contract improved long-term price transparency in PJM

PJM Western Hub monthly electricity futures volume and open interest has grown since the introduction of the contract. Source: Nymex; CFTC, Commitment of Traders Report 

Updated March 10
Usage of available electric risk management tools varied

• Credit-worthiness affected usage of available fo

products traded bilaterally.

• FTRs auctions were conducted in CAISO, ISO-N

NYISO and PJM and were fully subscribed. 

• FTR options were introduced in PJM in 2003 to 

supplement existing FTR obligations.
Generating capacity additions completed durinassessment period were predominantly gas-firincreased total U.S. capacity by 12 percent

New additions increased U.S. capacity by 12 percent. Source: Platts POWERdat, Utility Non-Utility Ownership dataset

Updated 
Market incentives during the period for additiofuture investment were mixed

• Financial downturns for energy suppliers accom

the emergence of concerns about the transparecredibility of price formation.

• Reserve margin expansions, in conjunction with 

spark spreads and moderate weather patterns, declining energy and capacity prices during the assessment period. 

• In contrast to prior construction cycles, investors 

newly constructed generation have primarily borisks of lower than expected revenues, rather thuse customers.
Despite market price signals that new resourceneeded in load pockets, investment was limited

Incentives to invest:• Interconnection process• Adequate transmission 

infrastructure

• Transmission availability 

(short-term dispatch)

• Locational energy pricing• Locational capacity 

pricing

• Economic dispatch

Impediments to in• Siting and enviro

permitting

• Limited site avail• Fuel supply• Regulatory—mar

design risk

• Mitigation • Reserve margins• Difficult financing 

markets and weafinancial strength merchants
Lack of demand responsiveness to price harms competitive wholesale markets

Demand response would have been cost effective in some key locations including New York City (above), southwest ConnDelmarva Peninsula. Source: OMOI analysis, based on price data from NYISO and Platts Gas Daily.

Updated March 10, 2004
Market design and structure changes during thassessment period improved operations

• ISO-NE successfully introduced a day-ahead m• NYISO refined pricing and market rules and add

successful virtual transaction product. 

• PJM successfully expanded to include APS, ope

spinning reserve market and improved the FTR process. 

• Prices stabilized in California with the addition o

MW of new generation, improved hydro conditiomoderate demand compared to 2001

• A significant amount of new, efficient IPP gener

capacity was installed in the Southeast but encodifficulty reaching the market.
Natural Gas: Solid 

performance despite stress
Average natural gas spot prices increased

Source: Platts Gas Daily and ICE.

Updated March 10, 2004
Storage swings reflected tight supplies and contributed to higher prices Source: EIA

Updated March 10, 200
Gap in deliverability coincided with February/March 2003 price spikeSource: EIA consumption, storage, supply and import/export data from the EIA website; some supply data provided to EI

Mineral Management Service; import/export data are from the DOE’s “Quarterly Natural Gas Import and Export Sales an

Updated March 10, 2004
Consumption shifted with higher pricesNote: Natural gas consumption by vehicles represents less than 1 percent and is not shown. Source: EIA data compiled EIA forms 759, 857 and 895.

Updated March 10
Transactions to manage greater price volatility declined in face of credit crisisTop figure: Source: Nymex. Bottom figure: Source: CFTC, Commitment of Traders Report. 

Upd

Updated March 10, 2004
Credit crisis was partially offset by new participants and products

New Participants

• Producers’ marketing 

affiliates

• LDCs• Financial firms (Goldman 

Sachs, Morgan-Stanley)

• Hedge funds

New Produc

• Nymex and ICE c

clearing products
The volume of Henry Hub indexreported transactions deteriorated 

• Volumes reported to Gas Daily ultimately converged with volumes transacted on ICE. Note: ICE data have been mod

comparable to Gas Daily data. Since Gas Daily volumes include both buy and sell sides of transactions and ICE volu

the sell side of transactions, ICE volumes were doubled. Source: Platts Gas Daily and ICE.

Updated March 10
Forward price expectations shifted upward dur2003Source: Platts Gas Daily for Nymex forward curve

Updated March 10, 200
Drilling response was not robust, despite stronprice signalsNote: Prices not adjusted for inflation. Source: Platts GASdat, Platts Gas Daily and Baker-Hughes.

Updated March 10, 2004
Storage investment was small and pipeline investments moderated

• Storage capacity increased 0.3 percent from 20

2002, down from an increase of 1.4 percent the previous year.

• Pipeline investment appeared to moderate in 20

3 years of annual increases.

– 2002 $4.3 billion (3,571 miles)– 2003 ~$4.0 billion (2,911 miles)

• Investment in LNG expected to augment domes

production.
Natural gas market performance consistent witfundamental forces of supply, demand and sea

Successes

• Products delivered on 

time

• Reasonable levels of 

investment

• Alternatives for managing 

risk

Challenges

• Tight supplies 

– Severe storage v

swings

– Deliverability con– Higher prices– Greater price vol

• Thinly reported m

activity

– Credit problems– Decreasing volum

trades 

– Index credibility e
Next steps for this report

• Development of this report has strengthened OM

ability to identify and analyze market structure aperformance issues.

• The report will guide OMOI’s allocation of resou

monitoring regions with organized markets and without organized markets.

• OMOI will use the report as a foundation for ide

other areas for further analysis of energy markepossible Commission action.