Is the Deregulated Market in the Ercot Region Sufficiently Competitive?

Michael Giberson

Two groups of municipal utilities in Texas, long critical of electric power deregulation in Texas and ERCOT in particular, have joined forces to issue a report, “The story of ERCOT: The grid operator, power market & prices under Texas electric deregulation.” The municipals describe the report as examining “governance issues related to ERCOT as an organization as well as deregulation issues related to ERCOT as a region.” In general, they assert that ERCOT has been costly, has suffered some significant episodes of mismanagement, the market hasn’t been as competitive as needed, and that power prices have been too high in the ERCOT region as a result.

Overall “The story of ERCOT” looks like a pretty good effort. ERCOT is a complicated entity, but worth understanding. The report contributes to a better understanding of ERCOT. But in the one section I chose to examine carefully, I was less satisfied.

Among the questions they ask is the one I pulled for the title, “Is the deregulated market in the ERCOT region sufficiently competitive?”, addressed specifically on pages 70-71. Here the report authors have a handful of complaints:

  1. “Questionable trading practices … very similar to those that helped undermine the California market … known as ‘hockey stick’ bidding.”
  2. The largest generator, TXU (now Luminant), was frequently a pivotal supplier in the market – able to set market price regardless of the actions of competitors.
  3. TXU was charged with market power abuse by the PUC in 2005. (A recommended fine of $210 was later reduced to $15 million.)
  4. Another company acknowledged in engaging in practices very much like hockey-stick bidding in 2007, “which has been found to violate market rules elsewhere in the nation.”

Hockey stick bidding, in which a generator offers the last few megawatts of power at a price substantially above the marginal cost of supplying that power, is a problem. If the power market were always competitive, consumers could be agnostic about individual generator’s offers; occasionally conditions will give generators temporary-but-substantial amounts of market power. These brief moments of market power are not always predictable, but hockey stick bidding means that generators don’t have to guess when they have market power, they just use a bidding strategy in which most of their power is offered at competitive levels and the last tiny bit at monopoly prices. The market in effect reveals that the generator has market power by dispatching all of the unit’s power, and having revealed the market power the market then does the generator the favor of automatically exercising it on the generator’s behalf.

There are arguments for and against allowing generators full flexibility in their offers, including allowing hockey stick bids, but on net consumers are right to oppose the practice. (I’m not at all sure what they mean by “very similar to those that helped undermine the California market”; California’s market fell mostly due to a host of other kinds of bad market design choices which exposed the market to manipulation and kept the consumer-side of the market mostly unable to protect itself.)

Luminant remains a large player in the market, with a market share that should continue warranting special attention from the PUC and ERCOT’s independent market monitor. The report doesn’t mention that Luminant has entered into a “Voluntary Mitigation Plan” (VMP) in 2008 as part of the settlement producing the $15 million fine. The point of the VMP was to deprive Luminant of the ability to exercise any market power.  If the municipals have continuing concerns with Luminant then it would be useful to know what is wrong with the VMP.

I tried tracking down the reference to “another company … engaging in practices very much like hockey-stick bidding in 2007.” A footnote points to page 11 in Jay Zarnikau and Parviz Adib, “Will the Texas market succeed, where so many others have now failed?” (Available from Frontier Economics), but I didn’t find an explanation there. Generally speaking, the Zarnikau and Adib paper takes a more optimistic tone than the municipals’ report does.

Overall, in this brief section of the paper, I would have liked a little more analysis and not just a list of complaints. It is one thing to see apparent problems, but much more useful to diagnose the sources of the problem and suggest improvements.

2 thoughts on “Is the Deregulated Market in the Ercot Region Sufficiently Competitive?

  1. California was exposed to market manipulation by bad market design and short-sightedness in planning and regulation, but it required a severe physical shortage throughout the Western interconnect for it to make a visible difference. It is still far from clear how much of that crisis can be attributed to manipulation, much less hockey-stick bidding. (My guess is the manipulation cost millions of dollars. The crisis cost billions of dollars, and there’s plenty of physical evidence to show why.) The fact that people in Texas and the eastern markets even bring California up is testament to the lack of understanding about what caused it.

    Hockey-stick bidding is not a problem until there is true scarcity, i.e., an emergency. Often a generator has some emergency capacity that it can offer in an emergency, but only at higher expense and risk of damage. Don’t you want that generator to offer his emergency capacity at a high price? Doesn’t this sound a bit like your gouging arguments? If market cries a market-power foul every time prices hit the cap in an emergency, then how do you ever get scarcity pricing? You may as well regulate prices. Or pass anti-gouging laws.

    I’ve read that competition shouldn’t be thought of as the process whereby markets search for a price among a variety of offers for a commodity product. Competition is a dynamic process of creativity and change. Yet in power markets we maintain this concept of “sufficiently competitive” as a characteristic that exists moment by moment, depending on supply being in sufficient surplus for everybody to be happy with the price.

  2. DOUG, clearly emergency capacity offered at a high price is no problem when that price reflects the high costs of providing that capacity. So we agree at least on this much. And I think ‘scarcity pricing’ rules are a good thing for the market.

    When the high price reflects the exercise of market power, then the question becomes more interesting. One consistent approach is to simply allow market power to be exercised when the opportunity arises and “let the market sort it out.” I think the Texas market is relatively well-arranged to let this work, as retailers will simply be inspired to more fully contract up for times that market power may be exercised and that is probably a beneficial effect.

    On the other hand, the transition from regulated to deregulated didn’t leave all consumers similarly situated with respect to exposure to market power. It seems not unreasonable for policy to discourage the exercise of market power as a (potentially) low cost way of protecting some consumers post-regulation.

    Of course actually implementing market power mitigation raises some difficult issues – namely, how do you distinguish between actual high costs of operation and offer prices that represent the exercise of market power. But carefully managed mitigation of market power seems to me to be efficiency-enhancing.

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