Lack of coordination between RTOs provides multi-million dollar gaming opportunity to some market participants – at the expense of others

Michael Giberson

On July 21, the New York Independent System Operator (NYISO) filed what was in effect an emergency rule change – proposed to go into effect the morning of the next day unless FERC stopped it (and FERC didn’t stop it) – in order to bring to a halt certain gaming activities pursued by some market participants.

In the filing, the NYISO described how a market participant could schedule power flows between New York and neighboring PJM in two ways – a direct path and an indirect path. The indirect path – using external transactions looping around Lake Erie (scheduling through Ontario and the Midwest ISO, and entering PJM from the west) – is essentially a false schedule. Power generally flows in the interconnected AC system over the path of least resistance, so transactions scheduled using the indirect “Lake Erie looping” path end up mostly flowing over the direct links between New York and PJM.

When the difference between the New York price received for power imported from PJM and the New York price charged for power exported to Ontario is greater than the cost of scheduling external transactions around the Lake Erie loop, a market participant can make money by scheduling the indirect path.

Because the actual flow will tend to be directly from western New York across the NYISO-managed transmission system to the PJM border, but isn’t scheduled on that path, the flows create west-to-east congestion costs that are paid by all transmission users (and not solely by the transmission users who caused the congestion). The market participant in effect uses the NYISO-managed grid without paying full price for it. In addition, the practice would tend to depress prices in western New York and increase prices in eastern New York and create ‘phantom congestion’ over the external paths around the Lake Erie loop. The result would be potentially significant economic losses in all affected regional power grids because of the inefficient use of the interconnections between regions and less efficient unit commitment and dispatch.

NYISO said that the scheduling practice seemed to emerge in early 2008 and tended to increase over time. The Public Utility Law Project blog (PULP Network) has noted estimates of the costs created by the Lake Erie looping strategy ranging as high as $290 million. (The PULP Network has also posted a more detailed description of the filing and a discussion of various comments filed in the proceeding by it and other stakeholders. See also this story by Platts.) The NYISO filing proposed to stop the practice going forward, but didn’t propose to penalize the market participants for using the indirect paths prior to the rule change. Many stakeholders urged the Commission to use its anti-energy market manipulation authority to penalize market participants who employed the inefficient-but-profitable Lake Erie looping strategy.

By the way, the emergency filing of rule changes appears to have had the desired effect. The NYISO reported to FERC on July 31 that in the seven days immediately after the filing power flows around Lake Erie returned to levels typical of 2007.

Ironically, one of the factors contributing to the economic viability of the Lake Erie looping strategy was the reduction or elimination of charges on transactions between PJM and MISO, a policy long advocated by transmission users and supported by FERC as a way of reducing “seams.” The lower the costs for external transactions between regions around Lake Erie, the more likely it would have been economical to engage in the Lake Erie looping schedule. However, the implication is not to re-raise the costs of external transactions but to more fully coordinate power scheduling in neighboring regions. Improving coordination between RTOs will improve system efficiency and on net lower prices to consumers.

FERC has long said elimination of seams between power markets is one of its priorities; it is past time to actually make it a priority.

(NOTE: While until recently I worked for the firm that provides market monitoring services to the NYISO, I did not work on the related analyses or participate in the development of related reports. My commentary here is based solely on the NYISO filing and other public documents linked to above. -MG)

EZ-Zone? FreeFlow? Would congestion pricing by another name, smell sweeter?

Michael Giberson

Tom Weber said that neither word in the phrase “congestion pricing” is too upbeat, and strung together “the combination evokes thoughts of opening one’s wallet while suffering a sinus headache.” He suggests that the unappealing phrase may have had something to do with the failure of Mayor Michael Bloomberg’s congestion pricing plan for New York City.

Zubin Jelveh, at Odd Numbers, collects some alternatives from branding experts and others, including “EZ-Zone,” “FreeFlow,” and “StreetSmart.” But Jelveh notes that most congestion pricing plans in place around the world don’t seem to need an appealing brand name to succeed: in London the phrase used is “Congestion Charge,” and in Singapore their program is “Electronic Road Pricing.”

On the other hand, Jelveh notes that Milan has styled their plan as “EcoPass.”

Beginning in January this year, to enter the central district of Milan with an automobile required purchase of a pass, with the fee tied to the emissions level of the car. One early report suggests the plan is working to improve air quality in the city. (Of course, improving air quality is easy — economists would want to know how much it is costing to achieve the improvements.) I was unable to locate a more current report in English.

RELATED: In 2006, Lynne posted on Road Congestion Pricing in Stockholm. Last October, I argued that, “Economists do not understand the opposition to congestion pricing.”

Whatever happened to the FCC’s big spectrum auction?

Michael Giberson

If you, like me, were looking forward to the FCC’s auction of prime 700 MHz wireless spectrum — and frankly who wouldn’t be interested in seeing how the FCC’s new hierarchical package bidding rules worked out in the C-block auction — you may have noticed the distinct lack of news on the topic in the major press.

Jump to the FCC’s auction website, however, and you’ll see the auction action continues. Auction round 175 will start in about 30 minutes.

Only 13 new bids were received in round 174, with licenses still contested for places like Minot, ND and Salisbury, MD. Just about all of the major results are already resolved, except that technically all auctions remain open until they all are ready to close. But C-block hasn’t seen a new bid since round 90. D-block, the spectrum loaded with public service obligations, received a single bid back in round 1.

There is light at the end of the tunnel. The FCC has ramped up the pace to 10 rounds per day, and an industry analyst was quoted by Reuters as saying the auction should be wrapped up within a week.

What institutional framework for electric power transmission?

Michael Giberson

From the EU Energy Policy Blog, Thomas-Olivier Léautier contemplates the factors that contribute to efficient investment and management of transmission systems:

As power engineers and economists have known for a long-time, the transmission grid is essential to the operation of well-functioning electric power markets. Yet, grid expansion in several regions has been nil or slow. By reviewing the main prescriptions from academic literature and comparing them with case studies from over 16 jurisdictions we find that unless the governance structure is appropriate and specific incentives are provided, grid expansion proves elusive.

After a brief examination of how physical limits and operational practices jointly contribute to transmission capacity, Léautier summarizes the results of theoretical and empirical work he did with Véronique Thelen:

The empirical evidence collected in this study appears consistent with theoretical prescriptions: creation of an independent transmission company subject to strong grid expansion incentives lead to congestion alleviation (e.g., England and Wales).

On the other hand, the Independent System Operator (ISO) model pursued in the United States, where operation but not ownership of the grid is vertically unbundled, does not appear to have performed well. This is consistent with “theoretical” predictions: transmission asset owners in the ISO model face mixed incentives for expansion resulting from limited vertical unbundling of the assets.

Pre-auction jitters at the FCC

Michael Giberson

Over 200 companies have qualified to participate in the upcoming FCC spectrum auction. While that sounds like enough to create a lot of competition, as the auction approaches FCC chairman Kevin Martin is beginning to sound a little nervous. Yesterday he expressed concern that problems in the credit markets and general economic conditions may discourage some bidders or limit their ability to participate, Reuters reported. However, “Martin said the auction must go forward since Congress has ordered the FCC to begin the auction by January 28.”

Contributing to pre-auction jitters at the FCC may be the recent demise of Frontline LLC. Frontline had been expected to be one of the primary bidders for the “D Block” spectrum, the band of airwaves that is being offered with a bunch of strings attached in terms of priorities for public safety usage, build-out requirements, and other limits. The Frontline folks were heavily engaged in the regulatory processes at the FCC creating the D Block requirements. Last week the company concluded it didn’t have enough financing to go into the auction, so it closed up shop. (Grant Eskelsen at the Progress and Freedom Foundation says the failure of Frontline should be no surprise, and hopes it will be the “end of what has been a tragically flawed experiment in the D-block from the outset.”)

What happens if the auction is a bust? The reserve prices adopted for each block are: Block A – $1.8 billion; Block B – $1.37 billion; Block C – $4.6 billion; Block D – $1.33 billion; and Block E – $900 million. If the reserve prices for blocks A, B, C, and/or E are not met in the auction, the FCC will close the auction for that block and set a new date to auction the unsold spectrum. According to this summary of the FCC auction rules, the new auction would use the same reserve prices as before, but the FCC may alter performance or access requirements imposed on the winners. The new auction would have to begin within a few weeks of the conclusion of the first auction.

According to the FCC rules, “If the reserve price established for the D Block of the 700 MHz Band is not satisfied by the results of Auction 73, the Commission may decide to re-offer that license subject to the same service rules or reconsider the rules applicable to that block.” The WSJ reported yesterday that the FCC could give the spectrum to the highest bidder even if the bidder didn’t reach the $1.33 billion reserve. Silicon Alley Insider suggests that some interesting gaming may result.

Congestion fees coming to airports?

Michael Giberson

The Federal Aviation Administration is proposing to change its policy toward landing fees to “provide greater flexibility to operators of congested airports to use landing fees to provide incentives to air carriers to use the airport at less congested times or to use alternate airports to meet regional air service needs.” As explained in the notice issued by the FAA, the proposed policy change will not allow true congestion pricing, because they will not allow airport authorities to charge prices sufficient to balance demand will capacity without regard to “allowable costs of airfield facilities and services.” Instead, the FAA is proposing to allow airports to re-shuffle currently allowed costs in ways which reflect congestion at airports.

However, the proposal would clarify existing policy that allows airports to charge “dual element” landing fees. Most airports rely on a single element weight-based landing fee. The notice explains that an airport’s fees could be revised to incorporate both a per-operation component and a aircraft weight component “so long as the two-part fee reasonably allocates costs to the appropriate users on a rational and economically justified basis.” Such a shift would at the margin tend to promote use of larger aircraft into the airport without any other changes in rates. The FAA said the presence of congestion would be one factor that could be taken into account in revising rates. In particular, the per-operation component of the landing fee should vary according to the times congestion is present, said the FAA, if congestion is used to justify the change in fees.

Any airport can switch to a two-part landing fee. The FAA is proposing two other changes that only congested airports would be permitted to use. One change is a proposed ability to add the costs of facilities under construction into current rates (at present airports are allowed only to charge for facilities in use). The second change would allow airport authorities operating multiple airports to shift some costs from uncongested regional airports into the fees charged by the authorities congestion airports. This second proposed change is subject to several limits generally intended to insure that users of the congested airport can benefit from the shift in traffic expected to follow a shifting in costs.

As the Washington Post reports, not all in the air travel business are happy with the proposal, but that reaction is not a surprise. Here at Knowledge Problem we have long favored the economically-sensible approach of airport congestion pricing. While the proposal may not be pure congestion pricing, it would appear to allow airports to make significant steps in that direction.

The FAA is accepting public comments on the proposal, see the FAA notice for details.

Extra credit topic: Research in networks suggests that congestion rents can in some cases flow to non-congested network elements. Think, for example, of a generator connected to a high demand area by a congested line. Rather than the transmission line capturing all of economic rents, the generator may find it can profitably raise its rates and capture some congestion rents itself. The idea suggest the possibility that airports with departures headed into congested airports might find a way to extract some of the possible rents. Of course, that would require a little strategic sophistication on the part of airport rate authorities, and given the reactions reported in the Post‘s story it seems that airports are not exactly excited about using the modest amount of rate flexibility they already have.

Regulation of networks when networks cross political borders

Michael Giberson

The New Jersey experience illustrates one other key insight into regulation of a network. In a network industry such as electricity, where the network extends across state lines, it is possible for one state to exert significance externalities on others. The siting of transmission lines or an electricity generator in one state can alter supply conditions in other states. Moreover, if transmission is natural monopoly, one has to decide how to pay for it. Attempts by one state to pay less could increase the burden on other states. It is not obvious that the optimal geographic scope for unified regulation necessarily follows state or country boundaries.

That’s from “Mergers in Regulated Industries: Electricity,” by Dennis Carlton of the University of Chicago, currently serving as the Deputy Assistant Attorney General for Economic Analysis. As the title of the paper indicates, the subject is primarily merger analysis in electric power markets. Carlton uses the abandoned merger between Exelon and PSEG for illustrative purposes. The “New Jersey experience” he refers to is the inability of the merging companies to sufficiently satisfy regulatory demands made by the state.

While a now-abandoned merger proposal may in itself be of little interest, the more general issue of mergers in network industries remains important. What’s more, the question of appropriate policy for networks crossing political borders will only become more important as the efficient size of networks grows larger and larger.

(HT to the Antitrust & Competition Policy Blog.)