Tuesday, September 26, 2006

NYISO Costs Skyrocket, Benefits Questioned

From Power Pool to ISO
The New York Power Pool (NYPP) was formed in 1966 to coordinate the state's electric power grid after the 1965 major blackout in New York City. By agreement of its member utilities (seven investor owned utilities and the New York Power Authority), NYPP dispatchers issued orders to control which generators run at any given moment. This was intended to balance generation with the demand of customers for electricity at least cost, consistent with reliability rules designed to minimize the probability of blackouts by maintaining adequate reserves, consistent voltage and stable frequency in the bulk power grid.

The New York Public Service Commssion's 1996 "vision order" invited vertically integrated utilities to divest their power plants and form new holding company structures, and urged formation of a new entity, the "New York Independent System Operator" (NYISO), to adjust power production to meet demand and to set uniform prices for the merchant generation sector.
The NYPP was transformed into the NYISO in 1999. The NYISO was certified by the NY PSC as a non profit electric company, and FERC approved its tariffs. The NYISO took on the new role of managing wholesale spot markets for energy and ancillary services in the state. Rather than dispatch generation based on utilities' cost of production, as the NYPP had done, the NYISO dispatches power based on sellers' spot market"bids," or prices demanded which need not be related to costs.

The Federal Energy Regulatory Commission (FERC) approves the NYISO tariffs and market rules for setting wholesale spot market rates of market participants -- a subdelegation of its powers to a private utility not directly accountable to the public. FERC also allowed most sellers of wholesale electricity in New York to dispense with advance public filing of all their rates, allowing them to change rates daily and hourly, and to demand what the market will bear in bids kept secret under the NYISO market rules. NYISO rules allow sellers to offer the output of power plants in segments priced so as to withhold a portion from the market, and to triple their rates, based on prior bids.

FERC allows sellers to have market rates based on assessment of each seller's individual capability to move the market, without regard to evidence that sellers lacking individual market power can achieve monopolistic results in the auction markets run by the NYISO. FERC has a rule against "market manipulation" but that does not bar strategic bidding.

Higher Prices in Uniform Clearing Price Auctions
Since the advent of the NYISO, New York electricity prices have risen substantially. When costs of fuel, notably natural gas, rise, electricity prices rise too because in many hours of the day natural gas fueled power plants are called to run. Under the NYISO uniform clearing price system all sellers are paid the same price regardless of their costs. As a result, sellers can obtain prices at the NYISO based on bids of natural gas power plants, even if their plants use cheaper coal or other fuels and can produce electricity at far lower costs. As a result, much of the value of lower cost energy in the state generated from from hydro, nuclear, and coal now goes to the merchant generation sector and energy traders rather than to consumers. When those plants were owned by the retail utilities, the cost of the plants was depreciated and over time customers would pay only for the running costs and an allowance for remaining undepreciated costs. Now the divested power plants are in the merchant generation sector, and have higher values because of the higher prices available in the NYISO markets.

Higher Prices Through Strategic Bidding
Deregulation proponents often claim that energy spot market sellers would offer their service at their operating costs. By doing this a seller would never lose money when they run and they would benefit whenever another (more expensive) producer clears the market and sets a higher price that is paid to all.

But even if paying all sellers the system marginal cost of generation were a good idea - a debatable proposition - that is not being achieved in the ISO markets that pay the marginal bid.

Mathematical game theory analysis has demonstrated that repetitive auction markets such as those run by the NYISO are gamable even if no single seller has the power, acting alone, to drive prices up. A "Nash equilibrium" can be reached in which participants in the repetitive auctions mutually learn to increase their profits and achieve oligopolistic pricing results without overt manipulaiton or collusion.

For example, if multiple sellers utilize "hockeystick" bidding tactics by offering their output in "blocks" with higher prices as more is sold, this collectively withholds power and drives prices up. FERC has approved such bidding practices.

Shortly after the NYISO began, staff of the NY Department of Public Service issued a Draft Report finding that NYISO markets are not competitive and are vulnerable to abuse, due in part to the exercise of market power by sellers. PULP filed comments urging public disclosure of the sellers' costs so it could be determined if sellers were gaming the market by strategic withholding or otherwise not bidding their output at cost.

No "final" report was issued by the PSC. Sellers' price demands are still filed secretly at the NYISO instead of publicly at FERC, as the plain language of Federal Power Act Section 205 requires. Sellers' bid data that is released by the NYISO is more than six months old and does not identify sellers.

The NYISO has engaged in continuous revision of its market rules, but they do not requre public filing of rates demanded and do not require disclosure of costs to determine if bids are excessive. The NYISO retains a "market monitor" consultant who issues annual reports which uniformly assert that sellers are, in general, not manipulating the NYISO spot markets. The tests used by the NYISO market monitor are not designed to detect hockeystick bidding or other strategies that result in higher market clearing prices.

Higher Prices for Capacity Payments to Existing Generators Did Not Induce Building of New Generation Plants or Transmission Lines
In an effort to substitute market mechanisms for energy planning, NYISO created a capacity market which now pays existing power plant owners more, through capacity payments, to induce the creation of additional power plants by them or others, with no commitment, however, that the recipients of the payments actually build power plants. In NYISO's comments on an August 2006 DOE transmission study it is claimed that
NYISO’s markets have had considerable success in attracting investment. Approximately 2,143 new Megawatts (“MW”) of generating capacity was built in New York City from 1999 to 2005.
It might be more accurate to state that the new generation resources have been created after the failure of NYISO capacity markets.

A closer look would find that of the 2,143 MW of new generation built in New York City since the advent of the NYISO, most of it was due to reliance on government and the traditional local utility, and not in response to the capacity charges paid to existing generators and added to customer bills.

For example, the New York Power Authority built a number of small gas turbine power plants totalling 450 MW. This was done to avert an impending price and supply crisis that became apparent in the summer of 2000 - the first summer of the NYISO's existence - when electricity prices in New York City soared 43% despite it being a cool summer. The Power Authority states
We had launched a crash program in late August 2000 to install these PowerNow! plants in response to warnings from officials in the public and private sectors that the New York City metropolitan area could face power shortages in the summer of 2001.
The small power plants were rationalized as a temporary expedient, on the grounds that a long queue of larger merchant power plant projects were in line to be built. But even though some of these merchant power projects received all permits to go ahead, they fizzled after the Enron debacle. The small NYPA gas turbine generators continue to run regularly, and again the state, through NYPA, had to step up to build a new 500 MW baseload plant, saying
The highly efficient combined-cycle power-generating facility will provide New York City with adequate, reliable power supplies in the new era of electricity-industry deregulation.
The "new era of electricity-industry deregulation" ushered in by the state Public Servce Commission clearly failed if one of its goals was to assure market-driven supply of sufficient power at reasonable prices, because 44% of the supply for which the NYISO takes credit was actually due to the state, through NYPA, stepping in at the last minute to avert price and potential blackout problems. In addition, due to the failure of the NYISO market-driven approach, the previously scheduled closure of a NYPA power plant in New York City will be delayed in order to avoid reduction of supply and breach of longstanding reliability requirements.

The NYISO market failure does not stop there. The traditional utility, Con Edison, had sold nearly all its power plants, to comport with a NY PSC vision, popularized by Enron, that electricity should be sold as a deregulated commodity. Counted in the NYISO claim of new generation is a new power/steam generation plant which added 288MW to the New York City fleet of power plants -- built by Con Edison.

A merchant power company built a new 500MW plant at Astoria, (now managed by a non-utility subsidiary of a Japanese holding company), but according to a 2006 New York City Report, "the financing of this project was enabled by a 10-year power purchase agreement with Consolidated Edison Company of New York, Inc."

Thus, another 37% of the new generation supply in New York City claimed by the NYISO as being due to its markets was actually built directly by Con Edison or only with the guarantee that Con Edison - and ultimately Con Edison customers -- would buy the capacity from the plant.

In addition, due to the failure of NYISO markets to stimulate the added energy supply needed to meet growing demand for electricity, NYPA is stepping in to support, through long term contracts, the building of a new transmission line to supply 500 MW capacity from the PJM markets in New Jersey, to meet the needs of its New York City customers now that it has divested its nuclear plant at Indian Point. Retirement of the NYPA baseload Poletti power plant in Queens, has been postponed to maintain reliability due to a looming capacity reserve shortage in the New York City area. The transmission line will take advantage of market prices in PJM that are lower than NYISO prices. The cross-Hudson transmission line, which will connect a New Jersey power plant and mid-Manhattan, was fully permitted by the New York PSC in 2003, after the PSC found it is "necessary to meet near-term and anticipated long-term electric growth in the New York City market and improve electric system reliability." The line was stalled for more than three years because of market failures, until NYPA began the process of contracting to use the line so that it can be financed and constructed.

So, more than 80% of the new power plant capacity built in New York City since the advent of the NYISO was not induced by its capacity markets. Rather, when proposed market-driven projects did not materialize, the plants were built by the state (NYPA) or in reliance upon the traditional utility (Con Edison), which still has the duty to serve the public with safe and adequate service sufficient to meet demand at reasonable rates.

Growing NYISO Costs
The NYISO has grown. In 1998 the NYPP had employed approximately 111 people and had a budget of $14.5 million. Initially, the transformation of the NYPP into the NYISO was estimated to cost less than $5 million per year more than the NYPP. This rosy estimate is reflected in a Report prepared by the State of Georgia indicating at p. 121 that "New York Power Pool estimates an annual budget of $20 million." That, in hindsight, was laughably low, indicative of the wishful thinking of "Disconnected Policymakers" about markets that substituted for analysis of the economic and reliability costs of restructuring.

Similarly optimistic, a 1998 report issued by the California ISO reviewing costs and operations of other grid management agencies, as New York was changing the NYPP into the NYISO, states:
The 1998 operating budget for the [New York] power pool is $14.8 M with an additional $3-5M of operating expenses being deferred this year as part of the transition to ISO status. The total deferred expense and capital investment for the transition will be $30M by December 1998. The pool currently uses a main building and fixed assets owned by Niagara Mohawk. * * * * The total revenue requirements of the ISO when initially formed is estimated to be about $45M/yr."
Thus, at the formative stage of the NYISO, the NYPP had estimated that the added functions of the NYISO - mainly related to managing the day ahead and real time spot markets, would bring its budget from $14.5 to approximately $45 million per year -- three times what the NYPP had cost.

Tripling the NYPP budget turned out to be a gross "misunderestimation." The actual cost of the NYISO skyrocketed far beyond the initial projections. The NYISO expense of $148 million is now more than $100 million per year more than originally anticipated.

The NYISO moved into one of the largest buildings in Rensselaer County, and now employs more than 400 people, more than 300 more than the NYPP needed to coordinate the grid.
An article 1n 2005 found that six NYISO executives were among the top 25 highest paid employees of non profit agencies in the Capital District, with the following salaries:
NYISO CEO $945,810
NYISO VP, Chief Information Officer $531,593
NYISO General Counsel $452,662
NYISO VP Market Services $411,534
NYISO Chief Administrative Officer $376,492
NYISO VP Operations & Reliability $361,558
NYISO VP Government Affairs & Communications $285,013
A 2006 article again notes the highly paid NYISO staff and board of this non profit electric company:
The former head of the nonprofit organization that runs the state's electric markets was paid $656,000 last year despite working for only five months, and directors were paid as much as $130,000 while declaring they worked for only 12 hours a month, according to the group's tax returns.

Critics say the payouts are excessive, while supporters say they're necessary to attract and keep qualified executives.

The organization, known as the Independent System Operator, spent more than $148 million last year. That included more than $5 million on outside lawyers paid around $250 per hour, $2.5 million for conventions, meetings and travel, and more than $10 million for other consultants.
NYISO Costs Passed Through to Retail Consumers
The costs of the NYISO are passed on to New York electric customers as a surcharge on wholesale electric rates. That surcharge is approved by FERC with no serious review for reasonableness. New York's retail utilities then pass on the NYISO costs, as part of the energy bills consumers pay.

Accountability to the Public
In contrast to the $148 million/year NYISO cost, the entire New York Public Service Commission, which oversees more utilities than the NYISO, has a staff of approximately 532 employees and a budget of $65.9 million per year, i.e., greater responsibility, more staff, at less than half the cost of the NYISO.

Thus, "deregulation" of generating plants in New York created a new layer of privatized electric utility "market price watchers" far more expensive than the traditional state PSC rate regulation function. Consumer interests in NYISO committees are currently marginalized, outweighed by industry representatives, and the independent" NYISO board lacks even a token member accountable to the public or consumers.

The NYISO is a private utility. The NYPSC can require all electric companies in the state, including the NYISO, to operate in the public interest, so the NYISO could be held more accountable to the public.

Oversight of Rates Set by NYISO
Neither the NYISO corporate objective nor NYISO tariffs contain any duty or goal to achieve just and reasonable rates in its spot markets. FERC has the duty to assure reasonability of rates and the power to oversee NYISO costs and rates, but has assumed the market rates set by the NYISO based on sellers' demands are reasonable. As industrial customers recently pointed out, FERC has no evidence that these market rates are reasonable, and there is no effective FERC remedy when NYISO market prices are not reasonable.

Cost Effectiveness in Doubt
Adding to concerns about the ballooning NYISO costs are growing doubts about the putative benefits of this little known monopoly utility. A recent report of the American Public Power Association shows at page 13 that New York's electric rates are now second only to the state of Hawaii. Multiple Intervenors, representing New York's largest industrial customers, once proponents of market rates, have joined with other industrial groups in objecting to the effects of the NYISO and other ISO/RTO markets.

Empirical studies by academic researchers who expose their methodology and data to review -- in contrast to proprietary reports touted by restructuring proponents -- have found no discernible benefit to consumers in states like New York that restructured their electric industry to rely on effectively deregulated merchant generators selling at market rates in markets run by ISOs and RTOs.


Anonymous said...

Lets not forget that primarily fuel costs have driven the market prices to where they are. Yes the ISO grossly overpays its executives, but that is commonplace in the energy industry, and they are paid "market rates."

Gerry Norlander said...

As pointed out in a more recent blog, the market design of the NYISO (putting aside its high operating costs and market gaming issues) pays all sellers at the level of the highest bid accepted every hour. This tends to overpay sellers with lower cost power plants. Rising costs of natural gas and oil did not raise the cost of water, coal, or uranium, yet NYISO rules allow plants with lower costs to be paid what a natural gas plant gets. See New York Restructuring, It Was About Price.October 4, 2007.