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Texas 'small fish' rule bad for ERCOT, stakeholders say: analysis


By Mark Watson


December 03, 2013 - A Texas regulation allowing small electricity generation fleet owners to avoid being legally deemed to have market power does not prevent small fleet owners from, in practice, exercising system-wide market power in a way that is bad for the market as a whole, more than a dozen stakeholders and market watchers say.


Some of these stakeholders point to the actions of GDF Suez during this past summer in the Electric Reliability Council of Texas as an example of what they allege is a generator taking advantage of the so called “small fish" rule to boost real-time prices.


In an email, Julie Vitek, GDF Suez spokeswoman, said, "We believe that all of our actions have been fully transparent, compliant and approved by the [Public Utility Commission of Texas]." Vitek also said Potomac Economics, which serves as independent market monitor for ERCOT, "has complete knowledge and oversight" of market power issues.


The PUCT's Substantive Rule No. 25.504(c), states, "A single generation entity that controls less than 5% of the installed generation capacity in ERCOT … excluding uncontrollable renewable resources, is deemed not to have ERCOT-wide market power."


Analysis continues below...


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PUCT rule No. 25.5(60) defines "installed generation capacity" to include mothballed generation. As such, the most recent listing totals 81,597 MW of capacity, and 5% of that number is 4,080 MW.


Critics of the rule say the overly high number used for installed capacity creates a loophole that allows generators to legally avoid measures to curtail market power.


The rule only covers the exercise of system-wide market power and does not shield generators from measures designed to mitigate local market power.


Stakeholders critical of the rule have asked the ERCOT Wholesale Market Subcommittee for a nodal protocol revision that would prevent any generation owner, small or large, from changing its real-time energy offer curve in the middle of the day if they are committed in the day-ahead market. That revision is expected to be voted on by the subcommittee on Wednesday.


GDF Suez's Vitek said the company sees better alternatives to the “small fish" rule for dealing with pricing supply. "…[R]ather than a 'small fish' program, we would prefer a market framework that correctly prices scarcity of supply, reliability of supply [and] flexibility of supply," she said in an email. “If not, we're concerned that electric reliability could ultimately be compromised as plants with operating issues won't be retired or replaced by better performing plants while electricity demand in Texas continues to grow.”


The “small fish" rule is unique to ERCOT among US independent system operators. Spokesmen for several other ISOs said Federal Energy Regulatory Commission rules would prohibit such protection for operators of small generation fleets.


But ERCOT does not fall under FERC jurisdiction. The market operator lies entirely within the state of Texas and has only limited DC ties with other grids via "configured disconnect switches" that prevent electricity from moving between ERCOT and the Eastern Interconnection. Thus, ERCOT's system is not engaged in interstate commerce as defined by the Federal Power Act, and it does not come under FERC jurisdiction, leaving the PUC as ERCOT's main regulator.


Potomac Economics' ERCOT State of the Market Report for 2012, issued in June, made the case that a "small fish" generation operator could exert its power to affect prices.


"There were 450 hours over [2011 and 2012] with less than 4,000 MW of surplus capacity," states the report, which Potomac Economics prepared in its role as ERCOT independent market monitor. "During these times a large 'small fish' would be pivotal and able through their offers to increase the market clearing price, potentially as high as the system-wide offer cap."


Ken Anderson, the only member of the PUC who responded to requests for comment on the “small fish" rule, said he believes any generation fleet that raises the price on much of its capacity near the system-wide offer cap "is taking a huge risk" because of the potential lost revenue from power that is not sold into the market.


But according to the State of the Market Report, suppliers, by increasing real-time prices, may be able to increase overall profits if their gains in the closely linked financial markets, not operated by ERCOT, more than make up for losses from selling less capacity in the real-time market. "Because forward prices will generally be highly correlated with spot prices, price increases in the real-time energy market can also increase a supplier's profits in the bilateral energy market … if the withholding firm's incremental profit due to higher price is greater than the lost profit from the foregone sales of its withheld capacity."


Anderson said he does not know if any owner of less than 5% of installed capacity has used its rights under the "small fish" rule to affect other markets.


"If you don't have a position in another market, you are not manipulating anything," he said.


Ron McNamara, managing director of First Principles Economics, an independent economic consultancy with expertise in energy markets, said real-time, day-ahead, forward, financial and congestion rights markets are "interdependent and inextricably linked – i.e., these markets cannot be adequately or correctly understood in isolation from each other."


"In theory, the rule is intended to provide regulatory certainty (the benefit) against the potential abuse of market power (the cost) while promoting competitive outcomes," McNamara said in an email. "But I would first ask – Is regulatory uncertainty really a problem? … If it is, then why? … Let's try and determine the source of the uncertainty and deal with that directly. … The commercial purpose/intent of the interdependent system of markets is to deliver competitive results to the benefit of the aggregate economy; they were not put in place merely to be an amusement park for some of the participants."


Beth Garza, deputy director of Potomac Economics' independent market monitor office at ERCOT, said the "small fish" rule does not protect a market participant who engages in prohibited behavior from being disciplined. For example, market participants are prohibited from engaging in fraudulent behavior or colluding with other market participants to manipulate prices.


"As an agent of the PUC, we're supportive of all the rules and [the "small fish" rule] is one of the rules," she said. "It doesn't provide a safeguard against a finding of manipulative behavior, and manipulative behavior is prohibited under the PUC rules."


But the PUC's Anderson said "it would be pretty hard" for a company that qualifies as a "small fish" to be found guilty of market manipulation if such a firm, by definition, lacks market power. However, Anderson said, "We can always revisit the rule."


Stakeholders weigh in

A number of stakeholders say it is time to do so.


For example, an executive with a company holding more than 5% of ERCOT's installed generation capacity, who asked to remain unidentified because he is not authorized by his firm to speak publicly on the issue, said the "small fish" rule is a bad idea.


"Obviously, everyone should be treated the same," he said. "They need to take another look at some recent situations and understand that people who can push price aren't always those with large generation portfolios."


An energy consultant and former trader, who asked to remain unidentified because of the controversy surrounding the issue, said the "small fish" rule is "inherently flawed."


"Allowing any market participant the ability to disregard important market rules, such as fair bidding practices, also allows that market participant freedom [from] oversight from the IMM [independent market monitor]," the consultant said in an email. "Rules must be applied to all who participate in the market, and honestly, there is no logical reason why they shouldn't."


Anjali Sheffrin, research professor at the Tulane Energy Institute, served as market monitor at the California Independent System Operator during that state's 2000 crisis.


"I found that during the year 2000 in California, when reserve margins were very tight (less than 5% due to dry hydro conditions, hot weather and large outages), every generator had the ability to name their price in the market," Sheffrin said in an email. "Under these conditions, even small players had the ability to exercise market power, since the grid operator had no choice but to take their power at what they bid, and most bid right at the price cap."


The energy consultant and former trader said, "The CFTC has made it very clear that creating or attempting to create artificial price scarcity is behavior that is not appropriate."


Ten stakeholders allege that under the “small fish" rule GDF Suez was able to artificially raise real-time prices during peak hours this past summer under the “small fish" rule.


A Platts analysis of generation offer curves over nine separate days this summer shows that on each of these days, GDF Suez raised the price on about 564 to 1,332 MW of electricity, across ERCOT, to between $4,900 and $5,000/MWh, which is the system-wide offer cap. These price hikes were during the late afternoon, typically between 4 and 5 p.m. and lasted at least an hour.


This practice is known as "hockey-stick bidding," because the offer-curves are relatively flat for most of a generator's capacity, but spike up sharply, like the arm of a hockey stick, for the last trading-size quantity, which is typically 50 MWh or larger in ERCOT.


"The fact of the matter is, hockey-stick bidding, if you own less than 5% of installed capacity, is permitted under the rule," Anderson said. "In effect, the rule is that if you don't have market power, then you can bid pretty much any way you want with respect to the day-ahead and real-time markets."


In the hour before the GDF Suez generators collectively hiked their prices to near the system-wide offer cap, system-wide real-time clearing prices ranged between $42.69 and $107.96.


In the periods during which between 564 and 1,332 MW of GDF Suez power was offered near the system-wide offer cap, system-wide real-time clearing prices ranged between $45.52 and $4,900.


One of those days was September 3, when real-time power prices across ERCOT rose from about $50/MWh to about $4,900/MWh, which ERCOT said occurred because a 609-MW plant tripped off-line at about 4:45 p.m. But beginning at 4 p.m. and continuing to 5:45 p.m. on that date, GDF Suez raised the price on 564 MW of its generation to between $4,900 and $5,000/MWh.


During the nine days when GDF Suez engaged in similar pricing, in the hour after these generators collectively returned their prices to near the market-clearing price, system-wide real-time clearing prices ranged between $38.80 and $81.89.


A spot check of seven other randomly selected days over the period shows no other generator having priced power in this way.


Voluntary mitigation plans

GDF Suez has a "voluntary mitigation plan" on file at the PUC that specifically gives GDF Suez the right to make certain types of offers under the "small fish" rule. PUC spokesman Terry Hadley said the plan gives GDF Suez the right to price all of its 3,957 MW of capacity at the system-wide offer cap.


The PUC has approved two other voluntary mitigation plans, for NRG Energy and Calpine, but neither of these are under the "small fish" rule. NRG has about 11,900 MW of capacity in ERCOT, and Calpine's total is about 7,854 MW. Therefore, NRG operates about 14.6% of ERCOT's total installed capacity, while Calpine operates about 9.6%.


In NRG's voluntary mitigation plan, it could offer as much as 3% of its hourly dispatchable capacity (the difference between its maximum capacity and its minimum sustainable operating capacity) at the system-wide offer cap. This amounts to about 400 MW, according to the State of the Market Report.


In Calpine's case, it could offer as much as 5% of its hourly dispatchable capacity, which could be no more than 393 MW.


One GDF Suez plant, Coleto Creek, is coal-fired and has a capacity of 635 MW. The company's gas-fired plants in Texas are Ennis with 343 MW, Hays with 893 MW, Midlothian with 1,394 MW, Wharton with 67 MW and Wise County with 746 MW.


The company also has a 50% share (197 MW) of the Oyster Creek gas-fired plant, which has a capacity of 393 MW, but power from the Oyster Creek plant appears not to have been included in offering substantial amounts of generation near the system-wide offer cap.


Wharton is in the ERCOT Houston Hub. Coleto Creek, Hays and Oyster Creek are in the ERCOT South Hub. Ennis, Midlothian and Wise are in the ERCOT North Hub.


On six of the nine days when GDF Suez raised its power prices for between 564 and 1,332 MW near the system-wide offer cap--either during the price hike or in the first hour of trading thereafter--balance-of-day average peak power prices for deals made on the IntercontinentalExchange rose by 7% to 104%. On the other three days, the average balance-of-day power prices fell by 3% to 4%. The balance-of-day contract is a financial product traded on exchanges such as IntercontinentalExchange used to hedge intraday volatility.


On nine days when GDF Suez priced more than 500 MW at or near the system-wide offer cap, day-ahead prices during those peak hours in the market administered by ERCOT jumped by an average of 89%. On the other 113 days of June, July, August and September, the jump during those hours averaged about 34%.


A number of traders say they think that the substantial premium on summer 2014 and 2015 packages is another consequence of this hockey-stick bidding.


One ERCOT trader said the impact of GDF Suez's hockey-stick bidding "is it increases the 'fear' premium and it increases volatility."


Evidence of what some traders see as the "fear premium" of increased volatility in ERCOT may be seen in the fact that the July-August 2015 ERCOT North on-peak package was $87/MWh as of Nov. 5, compared with $36.75/MWh for the into-Entergy forwards market, and $41/MWh for the into-Southern forwards market. ERCOT North's futures are ERCOT's most actively traded on ICE.


Another trader who asked to remain unidentified because of the controversy surrounding the issue cited August 12, when GDF Suez raised its price on about 1,025 MW of power to between $4,900 and $5,000/MWh, as an example of the impact the behavior has on markets outside the control of ERCOT and its market monitor. The trader explained that the independent market monitor Potomac Economics, because its job is to look only at the physical markets run by ERCOT, would not necessarily see any impact from the hockey-stick bidding because the physical market cleared at $47.75/MWh.


"The market that is trading the [financial] contract, however, will view it entirely differently," the trader said in an email. "Since the [day-ahead] traded $39.55/MWh and the high on the [balance-of-day contract] was $130/MWh, a trader could have lost $72,360 on a 50-MW piece." The balance-of-day contract, a financial product traded on exchanges such as the IntercontinentalExchange, is outside the purview of ERCOT and its market monitor.


Thousands of megawatts traded in the range of $75 to $130/MWh, the trader said, showing "massive uncertainty."


"When [GDF] Suez decides to offer 800-1100 MW at the price cap on random days, it makes it very difficult to assess risk when trading," the trader said. "The uncertainty will surely filter into cash and term markets, causing them to trade up."


By one measure of volatility, standard deviation, forward on-peak July-August 2015 prices were about 18.1 times more volatile at the ERCOT North Hub from June 1 through November 5 than they were in the Entergy and Southern forward markets.


The trader who sees the behavior as creating a “fear premium” said his company's risk managers have seen this hockey-stick bidding as reason to minimize activity in ERCOT.


And while generators and traders are not required to participate in the ERCOT market, load-serving entities, such as retail electricity providers and utilities, have no choice but to buy power, the trader said.


"Ultimately, to the end users, the price is going to go up," he said. "It's not a functioning market, so it's going to drive people out, unless you are a generator."


The trader said market participants have made complaints tothe independent market monitor.


Potomac Economics' Garza said, "We don't comment one way or another on investigations."


If GDF Suez's pricing is affecting other markets, the PUC's Anderson said, he has no jurisdiction over non-ERCOT markets, such as ICE, that are not directly under PUC regulation.


The US Commodity Futures Trading Commission has authority over electricity commodity futures, spokeswoman Donna Faulk-White said, but she declined to discuss the specifics of GDF Suez's actions – even hypothetically.


Potomac Economics' Dan Jones, who heads Potomac’s independent market monitor operation at ERCOT, referred questions on whether GDF Suez's activities could be considered market manipulation to the PUC's Hadley.


Hadley said a "small fish" fleet owner's hockey-stick bidding is "not per se" market manipulation. "If there are other circumstances, that is something the IMM (independent market monitor) would bring to the PUC staff," Hadley said. He said he does not know whether Potomac Economics has done so.


On Wednesday, the ERCOT Wholesale Market Subcommittee will consider Nodal Protocol Revision Request No. 574, which would prevent any firm, large or small, from adjusting its real-time energy offer curve if it was committed in the day-ahead market.


Submitted October 23 by Mercuria Energy America, an independent power marketer, the request argues that current rules "can at times reflect an inaccurately low level of resource availability."


And in a filing supporting the revision request, Raiden Commodities' Patrick de Man asserts that the current system "leaves open the potential for market abuse as [qualified scheduling entities] are free to change their offer curves as they please, whether for valid, facility related reasons or for reasons tied to their physical or financial MW position in the market."


Raiden's filing asserts that NPRR 574 would lower the possibility of violating CFTC anti-market-manipulation rules.


The NPRR drew comments in opposition from GDF Suez, Calpine and NRG.


NRG's filing maintains that NPRR 574 strays into the realm of PUC authority in asserting how a properly designed market should function and that NPRR 574 countermands a rule that was approved unanimously by the ERCOT Technical Advisory Committee and board of directors.


Calpine's filing states that physical changes in equipment alter the marginal cost of a generator and such changes should be reflected in new offer curves.


GDF Suez's filing agrees with the arguments advocated by the other two, and adds that FERC recently approved a rule change allowing generators in ISO New England to changetheirenergy offer curves intra-day, as is currently the rule in ERCOT.


Chart: ERCOT-wide average price from generation








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