Tuesday, October 21, 2008

Lehman Bankruptcy Affects NYISO Markets and Constellation Nuclear Plants

The larger story of the meltdown of the unregulated mortgage-based derivatives market has overshadowed impacts on the NYISO spot markets and the ownership of nuclear plants in New York state. In addition to energy and ancillary services spot markets for the sale of electricity by those who produce it, the NYISO also runs "virtual" electricity trading markets, which total more than $10 billion per year in transactions between parties that neither make nor take electricity. The "virtual" market involves the sale and purchase of derivative instruments based on NYISO electricity spot market prices. Perhaps the size of the virtual market and the interest of its players aids in explaining why the "organized" markets continue, in the absence of consumer support. States with organized markets have higher electricity prices than the states that did not unleash their state-regulatedutilities, and the difference is growing.

Participants in the functionally deregulated NYISO "virtual" markets are required by the NYISO to maintain non-junk credit ratings and to post some, but perhaps not enough, collateral against possible default in paying off on their contracts. As stated by the NYISO in its newsletter
the NYISO establishes credit requirements applicable to market participants and the basis for allocating payment default amounts to market participants. If a participant defaults on its payment obligations to the NYISO, other market participants are liable for a portion of the default.
Apparently the NYISO "virtual" market casino had to pay off on some bets that were not covered when Lehman Brothers Commodity Services' (LBCS) parent company went bankrupt. In a cryptically worded announcement last Friday, the NYISO listed several participants in its markets who have defaulted in paying off their commitments. One of the participants is LBCS.
Lehman Brothers Commodity Services, Inc. ("LBCS") is in default under the NYISO tariffs. The NYISO is in possession of collateral and is in the process of evaluating the extent to which that collateral will cover LBCS's obligations due to the NYISO.

Pro-Energy Development LLC ("PED") is in default under the NYISO tariffs. The NYISO is in possession of collateral and is in the process of evaluating the extent to which that collateral will cover PED's obligations due to the NYISO.

Quark Power LLC is in default under the NYISO tariffs. The NYISO does not consider Quark to be a material source of default exposure and continues to evaluate legal strategies to collect this default.
The different wording of the last paragraph involving Quark Power, to the effect that it is not deemed to be a "material source of default exposure", suggests that the LBCS and Pro-Energy defaults may be material and significant. According to Platts Power Market Week 1/20/08 (PMW),
When LBCS filed for Chapter 11 bankruptcy protection, it did not list its total debts and assets, but rather simply marked a box declaring its liabilities at “more than $1 billion."
The NYISO either does not know or will not say how much of the $1 billion is owed by LBCS and Pro-Energy to the NYISO, ultimately to be paid by New York's electricity customers.

According to PMW, 10/20/08, "[t]he board of directors of PJM on Thursday authorized the grid operator to spread among its members about $12.5 million of losses resulting from the default of Lehman BrothersCommodity Services." In contrast, again according to Platts PMW, another wholesale electricity market operator, MISO, apparently was not stung when LBCS went down:
Bankrupt Lehman Brothers Commodity Services has defaulted on a payment obligation, the Midwest Independent Transmission System Operator said Tuesday. The ISO did not disclose the amount of the default, but CFO Michael Holstein said the entire amount is covered by collateral and there will be no impact on market participants.
The NYISO Business Issues Committee will be meeting tomorrow to recommend to tighten credit requirements in the NYISO "virtual" markets and its markets for transmission congestion contracts (TCCs):
The Business Issues Committee (BIC) hereby recommends that the Management Committee (MC) approve revisions to the NYISO’s tariffs to enhance the credit requirements for TCCs and Virtual Transactions in conjunction with the implementation of the automated Credit Management System, as more fully described in the presentation made to the BIC at the October 22, 2008
The NYISO, alone among similar private electricity markets, had been settling accounts with traders monthly, rather than weekly, and so on September 29 it was proposed to move to more frequent settling of the traders accounts, to "[a]ccelerate cash clearing to reduce credit requirements, default exposure and the risk of socializing bad debt losses among all remaining Market Participants."

The NYISO is a private utility, ostensibly under FERC regulation, whose market rules are not backed up with the force of law, other than private contract enforcement, which typically does not protect ultimate consumers and which can be avoided in bankruptcy. The NYISO is set up as a non profit organization, and thus it has no shareholders. We rather doubt it will change its tariffs and assess the other virtual market sellers, who enjoy its lax market rules and who dominate its governance structures, or step forward to pay off any LBCS defaults by reducing NYISO costs, executive perks, salaries or consultant budgets, or taking other measures to control NYISO costs. See NYISO Costs Skyrocket, Benefits Questioned.

Rather, any cost of private marketeers' defaults will be "socialized" by the NYISO simply assessing a charge to utilities who buy energy there for their customers (instead of making it at utility owned power plants, most of which have been divested under prodding from the PSC). Any assessment for market players' credit defaults, in turn, will be flowed through by the utilities to New York's retail electricity consumers. NYISO rates are subject to FERC review, but FERC does not seriously scrutinize them. See NYISO Governance.

Perhaps an incidental impact of the Lehman bankruptcy may have weakened Constellation, the large utility that owns and operates two nuclear power plants near Oswego, NY. According to the trade press, there were "mark to market" accounting issues and possible losses of Constellation's holding company affiliates, who in turn may have been involved with energy trading and were affected by the Lehman Brothers bankruptcy. The value of Constellation plummeted this year, and it became the recent takeover target of Warren Buffet's Mid American. LIPA owns a share of one of the Constellation nuclear plants, so perhaps it will be able to obtain power at reasonable rates in long term rates unaffected by NYISO prices from the plant under new ownership, assuming the PSC and FERC approve the transfer. A FERC proceeding has been commenced and there is a brief public comment period on the proposed takeover. Mid American has also filed a merger petition with the New York PSC.

10/22/08 -- According to Platts, the NYISO released some information today regarding the impact of the LBCS default.
LBCS' charges are just under $2.50 million at this point but are expected to rise to about $4 million by the end of the next billing period. NYISO holds about $10 million in cash collateral from LBCS but the money was frozen by the bankruptcy court and the operator does not have access to the fund right now.
New York ISO sees no major losses from three recent defaults. It is not clear whether the relatively small potential NYISO charges discussed above -- $2.5 million now and $4 million by the end of the next billing period -- is the end of the story regarding NYISO losses. If the ISOs and RTOs had only minor losses, that is some comfort to consumers. It remains to be seen who lost when LBCS went bankrupt with $1 billion in net liabilities.

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