Bilateral Contracting in Deregulated Electricity Markets - American ...

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Bilateral Contracting in Deregulated Electricity Markets - American ...

• Order 2000 (December 1999) asks all transmission-owning utilities, including

non-public utilities, to place their transmission facilities under the control of an

RTO.

• Orders 889 (April 1996) and Order 2004 (November 2003) establish standards

of conduct prohibiting communication between public utility transmission and

wholesale merchant personnel.

• Order 2003 (July 2003) and Order 2006 (June 2005) establish standardized

generator interconnection procedures for large and small electric generators.

These market structure reforms, particularly the requirement for open-access

transmission, appear to have mitigated much of the potential for the exercise of vertical

market power at the wholesale level, although transmission constraints still allow many

dominant sellers to exercise market power. Thus, it appears that the more important role

for bilateral contracts is in mitigating horizontal market power, as discussed below.

Horizontal market power

In electric energy and capacity markets, a party that controls a significant percentage of

electric energy or capacity in a particular region has the potential to exercise horizontal

market power in any of the markets for wholesale electricity products. Here we focus on

the potential for horizontal market power in the two major wholesale markets, electric

energy and capacity.

The potential exercise of horizontal market power in spot electric energy markets,

considered difficult to identify 22 and to eliminate, 23 has received considerable attention

from FERC, RTOs and state regulators. Market power is most easily exercised in spot

markets. Buyers are captive in the market and cannot exercise market power. They will

have to pay any arbitrarily high market clearing price (the price bid by the most

expensive successful bidder) in order to meet their supply obligations. In the absence of

adequate regulatory market abuse detection and mitigation, the risk for producers who

withhold resources, or who bid them far above cost, is only that they will miss an

opportunity to recover a contribution to capital cost or make a profit for that market

period. This is an inherently asymmetric risk situation in which buyers are at a

substantial disadvantage, especially in markets (like almost all electricity markets) that

are not truly restrained by competitive forces among the sellers themselves.

Any option that enables buyers to reduce the quantity of electric energy they purchase

from the spot market will tend to reduce the financial incentive for producers to exercise

whatever horizontal market power they hold in that market. Such options include:

• reducing the quantity of electric energy required from those markets through

energy efficiency;

• local and/or distributed generation or other forms of self-supply; and/or

• acquiring electric energy via bilateral contracts.

22 Adamson, Seabron and Wellenius, Kevin, Determination of Horizontal Market Power Abuse in Wholesale

Electricity Markets, Frontier Economics, Cambridge, MA. December 1999.

23 Energy Information Administration, 2000, Chapter 7.

Bilateral Contracting Report ▪ 18

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