For class tomorrow I’m reading up on things Enron and California power market melt-down related.
I’m a fan, for example, of Jonathan Falk’s 2002 article in the Electricity Journal on the infamous “Smoking Gun” memo which detailed Enron’s colorfully-named trading strategies like “get shorty” and “death star.” Among other things, Falk points out the several of the strategies provided arbitrage services between the many power markets in and around California, and at least some of the strategies likely helped the California market work more efficiently.
Richard J. Pierce, Jr. has what might be seen as a follow-up article in 2003, also in the Electricity Journal. Pierce agrees with Falk that many of Enron’s strategies could be fairly described as arbitraging the California market, but he also asserts that many of the strategies also could be fairly described a manipulative. As a kind of aside, Pierce said, “If the California debacle has taught us nothing else, it should persuade us that arbitragers should never be given a role in structuring a market. They have a powerful incentive to maximize the flaws in the market design in order to maximize potential arbitrage profits.” (p. 40, emphasis added)
Pierce exaggerates a bit; it is unlikely that maximizing flaws will maximize potential profits. Rather, some optimum amount of relatively minor flaws probably promises the most overall profit for arbitragers. But Pierce reminded me of the role that arbitragers have played on seams issues between the New York ISO and ISO New England markets.
For years, market monitors for the regions and some market participants have encouraged the New York and New England markets to exchange real-time market information and coordinate power flows as necessary to eliminate price distortions along the border between the markets. For years, other market participants (primarily traders participating in both markets) have continued to support alternative market changes that have the effect of continuing the special role played by traders in determining power flows between the markets. The Federal Energy Regulatory Commission has directed the markets to fix the seams issue in cooperation with market participants, but for years the ISOs have decided that other market changes were higher priority. For years, FERC has accepted that answer from the ISOs.
An estimate by Potomac Economics, external market monitor for the New York ISO, suggested that the net cost of power to New York consumers would have been $177 million lower in 2007 had the two markets better coordinated the power flows between the regions.* Still, the issue is not a priority at the ISOs or the FERC. Maybe when someone notices that efficient market-to-market coordination of power flows between regions would make better use of renewable power and demand-side resources participating in New York and New England markets, then we will see FERC make resolving this seams issue a higher priority. Until then, FERC and the ISOs continue implicitly to support the arbitragers’ favored approach to managing the seams.
(*See Table 1 on page 28 of Potomac’s “2007 State of the Market Report: New York ISO.”
DISCLOSURE: I contributed to the drafting of the 2007 market report as an employee of Potomac Economics last year before taking my current position at Texas Tech University. Of course, nothing I post here should be taken as expressing the views of either my former or current employer.)