Hildebrandt - Further Analyses of the Exercise and Cost...

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Further Analyses of the Exercise and Cost Impacts of Market Power In California’s Wholesale Energy Market March 2001 Prepared by Eric Hildebrandt, Ph.D. Department of Market Analysis California Independent System Operator Corporation
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2 Executive Summary This report provides the results of additional analyses undertaken by the California Independent System Operator Corporation’s Department of Market Analysis (“DMA”) of the exercise and impact of market power in California’s wholesale energy markets. First, additional analysis of the impact of market power on overall wholesale energy prices is presented based on the price cost markup. 1 In this analysis, the potential impacts of NOx emissions costs and hours of potential resource scarcity are explicitly incorporated into the analysis. Results show that after incorporating potential NOx costs and hours of resource scarcity into the analysis, over 30% of wholesale energy costs over the last year can be attributed to market power, or a level that clearly exceeds the range that may be consistent with a workably competitive market. The results clearly show that market power is not limited to hours when a deficiency in operating reserves requires the ISO to declare the existence of a System Emergency. The resulting prices represent potential additional net costs to consumers of about $6.8 billion. About 80% of these additional costs are attributable to non-emergency hours when the ISO has not declared Stage 3 conditions. Second, wholesale prices are examined in relation to the cost of investment in new supply. Regulators and others have expressed concern that prices be sufficient to make investments in new supply profitable, so that the entry of additional supply is encouraged. Results of this analysis indicate that prices over the last 12 months have significantly exceeded the cost of new supply options. On an annualized basis, wholesale energy prices since January 2000 are exceeding the cost necessary for new investment by about 400%, and would allow recovery of an investment in new supply in a period of less than two years. Thus, this analysis indicates that market power mitigation plans can be adopted and designed to reduce significantly wholesale prices observed over the last year, while still providing sufficient opportunity for recovery of costs in new investment. 1. Background Previous DMA analyses have shown that the high prices observed since May 2000 have been due to the exercise of market power, in combination with several other underlying drivers that would be expected to increase costs even under perfectly 1 Previous analysis of market power based on price-cost markup was included in Comments of the ISO on November 1, 2000 Order ("November 1 Order"), Attachment A, November 22, 2000. Results of this analysis are consistent with other filings at FERC based on the price cost markup, including “Diagnosing Market Power in California’s Restructured Electricity Markets”, (Borenstein, Bushnell, and Wolak),
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This note was uploaded on 11/02/2011 for the course ECON 301 taught by Professor Gandhi during the Spring '01 term at Andhra University.

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Hildebrandt - Further Analyses of the Exercise and Cost...

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