Knowledge Problem

Michael Giberson

Today the FERC approved public release of the results of an internal staff investigation into allegations of “loop flow”-based market manipulations in the New York ISO market (see links below):

In this order, we authorize the public disclosure of the attached Office of Enforcement Staff Report (OE Report) addressing its non-public investigation of alleged market manipulation in the placing of circuitous schedules in the Lake Erie region. … For the reasons discussed below, we adopt the OE Report’s findings and conclusions that there was neither market manipulation nor tariff violations on the part of the entities placing these schedules. In addition, we have decided not to take further action on certain other tariff violation claims….

Generally speaking, the order indicated that the staff found no tariff violations nor market manipulation, but rather that certain market participants were simply reacting to market signals which induced them to schedule certain transactions from New York into PJM over ‘circuitous schedules’. (Strictly speaking, since charges for export transactions are often set administratively rather than by markets, I’d say market participants were opportunistically gaming the mixture of regulated rates and market prices offered up by the system.) FERC also directed the NYISO to develop a long-term solution to the problem within 180 days, and indicated that should the NYISO not file a solution that the FERC would take additional action.

The basic issue here arises because of the differences between how power transactions are scheduled for commercial purposes and how power actually flows between separately managed but interconnected power markets. A trader scheduling a power flow between New York and adjacent PJM could choose between a direct path or a more roundabout path (scheduling from New York through Ontario and the Midwest ISO, and entering PJM from the west). The choice of direct or indirect schedule doesn’t affect the actual power flow, just how the trader gets charged for the use of the transmission system.

When congestion costs became high in the NYISO system, it became cheaper for the trader to schedule a trade over the indirect path.  In the distinction introduced above, I’d say that charges for use of the direct path are more market-based, while trade over the indirect path mostly reflects regulated rates for export transactions. The problem arises because the trade will exacerbate the congestion problem in the system, but the trader will not be charged for all of the added costs. Instead, the costs get averaged into the bill of all system users.

While the actions apparently did not violate the NYISO tariffs or the commission’s market manipulation standards — I’m not an expert on those issues so I’ll take FERC’s conclusions on that issue — the indirect schedules clearly constitute an example of opportunistic behavior that should be discouraged. Opportunism in this context can be described as action which increases the profit of the trader but reduce the overall gains from trade (i.e. economic surplus or social welfare) produced in the market.* Because the indirect scheduling method reduced the costs paid by the trader, but caused the system as a whole to operate less efficiently, it is an opportunistic behavior.

It is an appropriate goal for public policy and the market operator to seek to deter opportunism in markets, so even in a case where no tariff violations were found it is clearly appropriate for the NYISO to revise its rules to prohibit such actions.

NOTES: Links to the FERC press release and order including staff report. This issue was previously discussed here, see my initial analysis and subsequent comments here and here.

*And therefore I think the term “gaming” appropriate. The definition of opportunism used derives from Amitai Aviram’s “Regulation by Networks,” BYU Law Review (2003), Aviram cites to Robert Cooter, “The Theory of Market Modernization of Law,” International Review of Law and Economics, (1996).