Friday, February 05, 2010

The Untaxed NYISO "Virtual" Market

The New York Independent System Operator (NYISO) is a New York utility, formed as a not for profit corporation at the request of the New York State Public Service Commission (PSC) following its 1996 "vision order" for deregulation. In November, 1999 the NYISO took over the role of the former New York Power Pool to dispatch power in the state's bulk power grid, telling power producers when to start up or shut down their generators to match the load from variable consumer usage in a way that maintains reliability, and operating the high voltage transmission grid. The Power Pool formerly dispatched electricity based on its cost of production, using the lowest cost power available consistent with reliability standards. The NYISO now dispatches power based on market price, i.e., what the sellers with "market based rate" dispensations from FERC demand in spot markets now operated by the NYISO. All energy sellers are paid the same market clearing price in the NYISO markets, regardless of their cost of producing it. All sellers thus benefit if the clearing price is increased.

Although the rates charged by sellers at the NYISO are under FERC jurisdiction, as are the rules or tariffs of the NYISO, the utility is still under the jurisdiction of the PSC for some purposes. These, we believe, include the duty to operate in the public interest of the people of New York, to foster greater transparency in its markets, and to control and remedy the exercise of market power by players in its markets.

The Untaxed NYISO "Virtual" Electricity Market
In addition to markets for energy and capacity, NYISO operates a non-physical, "virtual" market in which speculators can buy and sell positions based on electricity prices in the NYISO day ahead spot market (DAM) and real time spot market. According to the NYISO
Participants effectively buy (or sell) power at the day-ahead price and then sell (or buy) it back at the real-time price without having to actually produce or take delivery of the power.

The virtual market allows participants to arbitrage the difference between day-ahead and real-time prices. Virtual bidding has been shown to increase market efficiency.
A NYISO "State of the Markets" Report for 2008 indicates that "Virtual supply sold in the day ahead market is automatically purchased back from the real-time market. So, the virtual seller earns the quantity of the sale in MWh multiplied by the day-ahead price minus the real-time price."

NYISO says little if anything about the amount of the sales and purchases in its virtual markets in its 2008 annual financial report. Recent NYISO documents indicate that the costs to NYISO of operating the virtual market are not being paid by virtual market participants, but are being passed through to buyers, and ultimately paid by customers.

The New York State Tax Department has issued several advisory rulings - comfort letters to virtual market speculators - which opine that sales in the NYISO virtual market are exempt from the state sales tax. See, for example, NY Adv Op Comm T & F TSB-A-08-(3)S.

The Sales Tax Law, however, very broadly requires state sales tax to be paid on nonresidential electric service:
The amount of the sale price of any property and the charge for any service taxable under this article, including gas and gas service and electricity and electric service of whatever nature . . . .
Virtual market participants could be seen as selling and buying property - a contract or bet on what tomorrow's real time market price will be. Also, virtual transactions could be viewed as a part of electric service as broadly defined in the Tax Law. Indeed, the NYISO claims the transactions perform a valuable service and make its energy markets more efficient. When utilities like Con Edison make financial transactions to hedge electricity prices, the cost of the transactions is included in the retail price of electricity and sales tax is paid on it by consumers. Con Edison's Market Supply Charge tariff includes charges for
all costs incurred and benefits received from financial hedging instruments associated with transactions intended to reduce price volatility to customers (e.g., transaction costs, such as option premiums, costs of providing credit support and margin requirements, and professional fees, and gains and losses associated with such transactions made in the commodities exchanges and with other counterparties)
Con Edison customers pay sales tax when the cost of hedging instruments such as those sold at the NYISO virtual market are passed through to them. At the NYISO, some speculator participants are using the virtual market services directly, and not reselling the service and so should pay sales tax on it. The amount of the dollar value of the transactions in the NYISO virtual market is hard to find. For example, we cannot find any mention of it the NYISO Annual Report for 2008.

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Participants in the NYISO virtual market include hedge funds such as Centaurus Energy. The head of Centaurus is John Arnold, a billionaire former Enron energy trader. Brian Hunter, an energy trader recently found by a FERC ALJ to have manipulated markets, reportedly "referred to a trader from another firm, John Arnold of Centaurus, as the 'master of moving the close'” on the NYMEX exchange. See page 51 of the ALJ's decision, linked at FERC ALJ Finds Amaranth Trader Manipulated Natural Gas Markets, PULP Network, Jan. 23, 2010.

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