Enron's Top Recommendations for Fixing the California Electricity Market

[First Draft of Proposed Outline - Carl Imparato, September 19, 2000]

I.  Introduction and Overview

•	Focus of the recommendations in this paper is long-term structural solutions (vs. interim bandaids and fixes of myriad of smaller problems)

•	Briefly state that it is already widely acknowledged (cite ISO Market Surveillance Committee/Frank Wolak report) that the fundamental problems stem from the regulatory and institutional barriers to long-term hedging (include CPUC mandate but also mention ISO market design which incites SCs to rely on the ISO rather than on longer-term markets), regulatory disincentives for demand-side price responsiveness (due to price freeze), and lack of new supply-side investment (which is not only a regulatory hurdle, but which is also disincented through market intervention including price caps, and through other institutionally-created barriers to entry (tee up the issue that will be discussed i the body of the text).  Explain that these disincentives and institutional price distortions (e.g., price caps) outlined above also create perverse incentives (e.g., for under-scheduling of demand until real-time).    
•	We should probably not put much effort into justifying this, since most people already accept the premises above and we don’t want to waste our “5 minutes of reader attention” on repeating this.  Instead, use it as a way to link the issues that we will lay out below to the now-conventional wisdom.  Some of the work that Seabron has done in his “Top 5” paper could be pulled in here; but does anyone see the need to have to make arguments as to why forward market hedging and demand responsiveness are important, or can we take these as givens?

II.  The Recommendations

1.  Forward Markets

•	Need to eliminate the disincentives against the greater use of forward markets for energy, transportation and ancillary services.

•	Explain briefly (Seabron?) why these are important in every other industry and that electric power is no exception.  

•	Explain that focus on a real-time market has been misplaced.  Indeed an efficient spot market is very important (as an inefficient spot market will lead to inefficient forward market decisions as well through arbitrage between the two)… but that this attention to the spot market (including day-ahead centralized trading forums - whether state-sanctioned PXs or Poolco PXs that are integrated with the ISO) has unfortunately led to the unsupportable conclusions that market activity should be focused in those markets and that such markets are central monoliths rather than distributed mechanisms which operate in parallel.  These two unquestioned premises have almost single-handedly been responsible for the biggest problems.  Use this intro to tee-up our arguments that the solutions are the following.

•	Forward, continuous trading in external-to-the-ISO markets

•	Need remove the regulatory and institutional barriers and biases against market activity here. If these biases are taken out of the way, the marketplace will decide how much activity should go into the various marketplaces and timeframes through normal risk management activities).

•	Markets for power, for transmission rights (FTRs) and Ancillary Services

•	Operate continuously, year-ahead through (and including!) real-time (through after-the-fact trading of real-time energy imbalances)

•	In order for these markets to operate, need liquidity (so 100% FTR release) and need to remove incentives/subsidies for market participants to rely on the ISO (so we want SCs to rely more on self-provision and we do not want to say that the ISO should create bigger, more-sophisticated Ancillary Services procurement - this moves in precisely the wrong direction)  

•	Here we can list a number of the things that need to be done to remove barriers to use of forward markets - but also need to be careful that we do not state that utilities should have free reign to operate and procure in these markets because we don’t want them to become competitors to the ESPs who are supposed to be handling procurement and risk management for the bundled loads.  Need to advocate in the context of complete separation of T&D wires from the utility energy procurement function and that the has utility procurement function should be a default provider of last resort only and possibly should be handled through outsourcing to market ESPs.

•	Also, to make these markets work, need a manageable and transparent commercial model (will be discussed in item 2).

2.  Market Transparency

•	Information is extremely important for markets.  (Can Seabron explain why, make analogies to other markets?  Note that SCs can reduce the problems if they are given the knowledge and the incentives.  Without knowledge, at best they may inadvertently make matters worse; and without information, they cannot respond to incentives, so we are left with inherently inefficient command and control.).  I.e., make the case as to why “black box” model of ISO operation is inherently a problem.

•	After teeing-up the issue, list various areas in which major improvements can be made

•	More Public Market Information (PMI):  Obtain wish list from traders.

•	Path 15: transparency regarding how this significant interface operates

•	How Existing Contracts are interpreted and managed by the ISO (since this results in consumption of scarce transportation capacity)

•	Congestion management model needs to be more transparent: applaud ISO’s move in its Congestion Management Reform process , to implement a simplified, flowgate-based commercial model.  (Note: we should generally state support of the CMR proposals, with the exception of price caps and the focus on centralized vs. market-based management of Local Reliability Area congestion). ISO’s congestion management algorithm: applaud ISO’s move to use a simplified commercial model… but state importance of releasing it to the marketplace, not keeping it holed up in Folsom.

•	Since silence on the matter of price caps might be interpreted as leaving out a big piece of the problem, address it here:  state that demand responsiveness (discussed later) will deal with system-wide price spikes; and that locational market power mitigation is generally well-addressed by the ISO’s CMR proposal (but that any locational caps should ensure that they allow for recovery of system-wide energy prices plus necessary locational incentives to locate new resources/DSM in such locations) 

•	OOM:  need to know more about how it works; and address issues that ISO pays more than the price cap, but price doesn’t get reflected in market price (creating bad incentives) and that some market participants are not asked to provide it (raising the cost).  [Note: consider whether OOM should be here or with the Real-Time Market recommendations.]

3.  Demand Responsiveness

•	Argue for the importance of demand elasticity.  Point out that the major benefit of restructuring of retail markets is to allow ESPs to provide this product… that this will lead to better wholesale markets as well… that this is the solution to the price caps issue… See Seabron’s arguments re participation of load in forward markets, cite Wolak report.

•	But need to be very careful that our proposal is not to make the utilities the providers of such DSM products or risk management services.  Need to advocate an approach which requires complete separation of T&D wires from utility energy procurement function and that the utility procurement function should be a default provider of last resort only and possibly should be handled through outsourcing to market ESPs.  (I.e., we don’t want the utilities to become competitors to the ESPs who are supposed to be handling procurement and risk management for the bundled loads.) 

4.  New Generation Incentives

•	Make the general argument that need more supply-side resources.

•	Creation of new supply-side resources means removal of barriers to entry.  These are both external to the ISO (siting processes, state requirements, etc.) and within the ISO’s purview (below).

•	Argue for adequate locational siting incentives (i.e., methods for mitigation of locational market power - bid caps - must provide sufficiently high prices to incite new generation); elimination of ISO regulatory barriers (bid caps should not apply to any new resources - after all, they can only help the problem, not hurt it); and for a congestion management structure which creates certainty and good siting decisions (i.e., the real-world barriers to entry are not associated with having to pay for location-specific transmission upgrades; instead they are associated with possibility that a futuregen will trigger creation of a new mini-zone and that the congestion rents will destroy the economics of the newgen).

5.  Efficient, Liquid, Real-Time Market

[Consider whether this should be a separate item (if want to emphasize its importance) of whether it should be merged with item 1 (since an efficient spot market is one of the prerequisites for efficient forward markets)]

[This was an important issue for Tim Belden in June... need to check re its ongoing importance and whether it should be on this list.]

•	Basic argument (Seabron?) is that we need an efficient real-time market in which to liquidate small imbalances.  

•	This market does not have to be within the ISO - could be handled outside the ISO through coordinated imbalances between SCs and through after-the-fact energy imbalance trading between SCs

•	This does not mean that massive under-scheduling would be the result.  In fact the under-scheduling is due to other perverse incentives (price caps, etc.)

•	Need to take a proactive approach on this argument because Wolak report would screw up the real-time market even further.  Report seems to want to push everything into the ISO’s day-ahead process through real-time penalties (e.g., if an SC both overproduces 5 MW and overconsumes 5 MW for a net of zero imbalance, it would be imposed two penalties - one for the overproduction and one for the overconsumption!), ISO de facto commandeering of all unused generation, etc.   Instead, we need to argue that need a single real-time clearing price, penalties only on very large load deviations and very large energy imbalances, and that we need to enable the external-to-the-ISO markets and ISO’s real-time market to complement one another rather than create new gaps between them.

•	Incorporate the following item here?  “Inc/dec problem pointed out in Amendment 29 filing… result is less power being sold to the ISO’s market because customers do not want to take the risk that they will bid in an incremental prices and end up having to pay a decremental price…?

•	Consider whether the OOM issue belongs here instead of in Market Transparency item.

6.  Oppose Draconian measures to “fix” market

     [Should we make this a “conclusion” vs. a recommendation?]

•	Do not combine ISO and PX.  

•	Oppose return to cost-based rates

•	Oppose requirement for FERC-approval of forward contracts

•	Oppose Wolak’s proposals to enable ISO to commandeer all resources into day-ahead and Wolak’s proposals for real-time penalties

7.  Not on the List (should we put them on?) 

•	Governance: make the argument that the long-term solution is that the governance of institutions involved in regional energy markets (i.e. the ISO) must not be subject to state control, that there is a federal interest in ensuring that regional markets are not distorted for the benefit of local interests (as has been the case in California), that local solutions create bigger region-wide dislocations.   ( Note:  this is a separate issue from the non-stakeholder board). 

•	“California checkouts in intra-hour changes: other control areas won’t do it (especially BPA).  ISO wants us to negotiate with the other Control Areas.”  (I don’t know what the issue is, whether it is a big one, and if it is, whether or not it could be merged into one of the major topics above.)

[CFI - enrontop5.rtf - 091900]