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prudently entered into under then-current market conditions will not be second-guessed

when conditions change. As indicated by the comments in FERC Docket AD07-7, many

LSEs and other parties continue to have concerns about the risk of being penalized for

entering long-term commitments at prices which turn out to be higher than spot prices,

resulting in stranded costs. State policies that specifically encourage or promote a

portfolio of contract durations could go a long way to alleviate these concerns.

Summaries of current state policies, along with sources for more information, are

presented in Appendix C.

6. Conclusion: Mixed Reviews

Overall, we find that today’s RTOs have failed to create a vibrant and competitive

environment for bilateral contracting, and that as a result, bilateral contracts are not

playing the role they should in maintaining prices for consumers at a level comparable to

the cost of providing service. We find that in many cases, the gap between what buyers

are willing to pay and what sellers are willing to accept under long-term contracts has

been too great to bridge. This has been partially the result of structural failings in the

market that increase the risk for long-term contracts, such as the lack of long-term FTRs

to hedge transmission risk and inadequate transmission planning in at least some cases.

However, the primary obstacle has been a fundamental asymmetry of risk, whereby it is

only buyers who are exposed to substantial risk in the spot markets. Sellers have

nothing to lose by waiting to transact in spot markets in which they will face bid-based

clearing prices, the potential for windfall profits, and very low risk because they cannot

be forced to sell below their offer prices. The movement of capacity markets into an

auction structure has only exacerbated this situation by creating yet another market in

which LSEs are forced to transact.

The one limited situation in which bilateral markets have performed their function is in

providing a source of secure revenue for certain types of new resources. This is

particularly the case with new renewable resources whose developers are smaller

entities without ready access to the large volume of capital that would otherwise be

required. In this case, developers have generally found willing buyers and little trouble

negotiating mutually agreeable terms.

Thus we conclude that the asymmetries of risk in the spot markets is probably the single

most important element impeding the development of bilateral contracts. Unless and

until RTOs are able to truly eliminate this problem and design spot markets that more

fully reflect production cost and address market power issues, these asymmetries will

persist and robust, competitive, long-term bilateral markets are unlikely to develop in

RTO regions.

At the same time, the existence of a robust bilateral market may be a crucial prerequisite

to mitigating market power in energy and capacity markets. For this to occur there has to

be a sufficient incentive for both parties to transact in the bilateral market, leading to

symmetrical risks and comparable judgments of an acceptable price at which to

transact. As long as resource owners can be confident of high profits in the spot markets

for capacity and energy, these conditions will not be met. Indeed, the new capacity

Bilateral Contracting Report ▪ 28

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