iStock
Late last week, on December 31, the Federal Energy Regulatory Commission (FERC) rang in the New Year by resolving to stand by Illinois consumers and fix two key flaws in the 2015-16 Southern Illinois electricity futures (capacity) market. These market flaws had enabled downstate power producers to reap windfall profits from unfair charges to customers. For example, Dynegy, which controls almost half of the potential generation in the Southern Illinois market, reaped huge rewards from the 900 percent increase in capacity prices, giving the company a windfall profit of more than $100 million.[1] In fact, there is an ongoing investigation into whether Dynegy unlawfully manipulated the market to cause this price spike (more on that later).
To understand what happened here, it helps to understand how electricity futures, or “capacity” markets, operate. To ensure that the lights stay on even during times of peak demand or severe weather events and other emergencies, power grid operators like the Midcontinent Independent System Operator (MISO) buy promises from power generators that they maintain their potential generation, or “capacity,” to provide electricity as needed.
To save time—and usually money—a system operator like MISO will typically secure these promises by setting up regional auctions, where all power suppliers in a given region tell the operator what they want to be paid to keep their generation available to call on as needed (their “bid”). These auctions—called capacity auctions—allow the system operator to line up every regional bid from lowest to highest, figure out how much capacity it needs to keep the lights on, and pay only the power suppliers that offered to provide that capacity at the lowest cost. The trick here is that, to encourage power suppliers only to bid what they actually would need to be paid to provide capacity, the system operator pays all power suppliers for their capacity at the exact same rate: that bid by the most expensive power supplier whose capacity was needed to keep the lights on. This high bid is called the “market clearing price.”
In MISO’s Zone 4, covering Southern Illinois, Dynegy’s bids into this market established the market clearing price due both to Dynegy’s market dominance and to the MISO rules that were at issue in this case. In March 2013, Dynegy applied to acquire Ameren Energy’s entire fleet of coal plants in Southern Illinois for no cash (it simply agreed to take on the plants’ liabilities). At the time, Dynegy and Ameren each owned roughly a quarter of the power-generation potential in Southern Illinois, and so the Sierra Club filed objections to the transfer. Among the objections the Sierra Club raised was a concern that once Dynegy owned almost half the power generation potential in Southern Illinois, it could manipulate energy markets to its advantage. Specifically, Dynegy suddenly found itself in control of a set of power suppliers at least some of whose capacity MISO had to purchase in order to ensure that the lights stayed on in Southern Illinois. In other words, Dynegy became a “pivotal” supplier of capacity to MISO’s Southern Illinois market, and therefore was able to set the “market clearing price” for the entire market. The Sierra Club’s (and others’) objections now seem prophetic given what happened in the 2015-16 capacity auction.
System operators do have tools available to them to avoid paying and/or to discourage unreasonably high bids submitted by power suppliers. For instance, MISO can import electricity from neighboring areas, including from other zones within MISO. This imported electricity can significantly reduce its reliance on local power suppliers, expanding the supply and thus reducing the market-clearing price. Furthermore, in order to prevent abusive bidding practices, MISO provides a reference price, called the “Initial Reference Level,” that provides a guidepost for how expensive power suppliers should make their bids into the capacity auction: Any capacity auction result that is above this reference price will trigger an automatic review of the bidding process by MISO’s “Independent Market Monitor.” In theory, the reference price is set by estimating how much money power suppliers could get for their capacity by selling it to other viable purchasers, including other system operators.
Unfortunately, for the 2015-16 capacity auction, two aspects of MISO’s market rules enabled an unprecedentedly high market clearing price. First, MISO set the reference price at $155 per megawatt-day (mwd) of electricity, far above the $16/mwd price that prevailed in the previous auction. This reference price was based on prices in PJM, a neighboring system operator in a region that has much more limited capacity and significant transmission constraints. It is flawed because it is based on the incorrect assumption that power suppliers in Southern Illinois can sell their capacity to PJM: in fact, strict market rules severely limit how much outside suppliers can sell into the PJM capacity market. And yet, this $155 reference price allowed MISO’s historically high $150/mwd market clearing price to stand without any review by MISO’s Independent Market Monitor.
Second, before the 2015-16 auction, MISO tightened its own analysis of how much electricity could be imported from other regions using power lines. Most significantly, MISO failed to account for power that was exported from Southern Illinois to elsewhere, which creates space for more power to be imported to Southern Illinois from other regions. These changes significantly reduced the amount of electricity MISO felt it could reliably import from other regions, thereby increasing its reliance on the Southern Illinois power market that Dynegy dominates. Thus MISO’s auction price became needlessly tied to PJM, and artificially dependent on capacity from power plants located in Dynegy-dominated Zone 4.
FERC’s December 31 order should fix both of these problems. First, it requires MISO to use a default Initial Reference Level of $0/mwd, with the (reasonable) understanding that if an individual power supplier can demonstrate the ability to sell its capacity elsewhere, that number can be raised. And second, it requires MISO to make one of the two key changes we requested to its calculations that will increase the operator’s perceived ability to import capacity from other regions. We did not secure all of the calculation fixes we asked for, but the two changes FERC has mandated would on their own have been sufficient to bring the 2015-16 capacity auction prices down from $150/mwd, to $8/mwd, and should ensure reasonable (low) capacity prices going forward. FERC has ordered these rule changes to be made before the next capacity auction.
Just as important, FERC rejected calls by Dynegy and MISO’s Independent Monitor to make sweeping changes to its market rules that could have driven up capacity prices in the long term. And FERC’s ruling openly referenced a possible refund of the 2015-16 auction payments, keeping open the hope that Illinois ratepayers will be reimbursed for the extra money they paid for their power capacity this year.
Finally, FERC is continuing to investigate whether Dynegy purposefully and unlawfully manipulated the 2015-16 capacity auction for its own benefit. The Sierra Club joined the Illinois Attorney General and Public Citizen (among others) in urging FERC to pursue this investigation.
[1] The market price also was more than 40 times what consumers in neighboring Indiana, Missouri, Iowa, Wisconsin, Minnesota, and Michigan paid for the same services. You can see the 2015-16 MISO capacity auction results in full at http://www.rtoinsider.com/miso-auction-14412 (last visited Jan. 7, 2016).