“Recent Electricity Auctions”

Dr. David J. SalantSenior Vice PresidentNational Economic Research Associates

June 2003

2

Agenda

Electricity restructuring, auctions and new markets

New Jersey Basic Generation Service auction Texas Capacity auctions CALPX/CAISO Alberta FTR auctions Parallels in other states and other types of

electricity markets

3

Auctions and Regulation

Auctions have been used increasingly to replace regulatory processes

Spectrum auctions replaced beauty contests and lotteriesDefault Service Auctions

Customers who are not being served by a competitive “third party” supplier must be served by the electricity distribution company at regulated rates

Auctions now have been used for utility energy purchases to serve these consumers

RFPs tend to be followed by bilateral negotiations, providing more scope for regulators to question the results.

Entitlements and PPAsUtilities required to divest assetsRather than sell off entire assets, auctions now are used to

sell entitlements, strips, PPAs, as in Texas and Alberta

4

New Types of Electricity Auctions

Simultaneous clock auctions Used for buying or selling multiple units of a few types of lots or

products, such as system slices or energy entitlements. First application for default service procurement was

Simultaneous Descending Clock Auction (SDCA) which NERA developed for New Jersey.

Variations of clock auctions have been used to sell energy entitlements in Texas capacity auctions and French VPPs.

Clock auctions are well suit for interconnection capacity. Simultaneous multiple round auctions has been used on one

occasion for selling PPAs in Alberta. Other, more traditional, auctions such as Yankee auctions and

English auctions used for energy entitlements in Alberta and for interconnection in Netherlands did not work well.

5

Auction Design Objectives

Simultaneous multiple round/clock auctions are appropriate for efficiently allocating multiple lots, with value interdependencies, such as energy entitlements, capacity and spectrum licenses

Theory suggests that simultaneous auctions will result in economically efficient assignments assuming substitutes and “straightforward” bidding

Simultaneous auctions work adequately when bidders have similar views about complements

Clock auctions are well suited for dividing shares of load.

Simultaneous auctions can create some incentives for bidders to withhold supply, but these incentives can be mitigated with volume adjustments

Simultaneous auctions work less well with strong, overlapping complements

Auction design adopted should best match objectives

The New JerseyBGS Auction

6

7

The New Jersey BGS Auction

Four utilities were under legislative mandate to purchase energy in a competitive bidding process. NJ EDCs needed to secure one-year forward supplies for

approximately 17,000 MW of forecast peak load Auction was for one year forward contracts.

The auction outome Prices appeared to be competitive, between 4.87¢ and 5.82 ¢

for entire year. Over 20 bidders competed to sell and there were 15 winners. in first ever simultaneous descending price clock auction.

New Jersey Board rendered decision on auction results within 48 hours of the close of the auction

8

New Jersey Winning Bidders

BGS Winning Bidders for Year 4 Winning Bidder Number of Tranches

Won per EDC territoryPSE&G JCP&L Conectiv RECO

5.112 ¢/kWh 15

9 115 5

13

205

10 2 51

53

1 15 56 9 47 3

12 8

FIRSTENERGY SOLUTIONS CORP

ALLEGHENY ENERGY SUPPLYAMERADA HESS CORPORATIONAQUILA ENERGY MARKETINGCONECTIV ENERGY SUPPLY INCCONSOLIDATED EDISON ENERGYDTE ENERGY TRADING INCDUKE ENERGY TRADING

MIECONRG ENERGYPPL ENERGY PLUS CORPSELECT ENERGY INC

TXU ENERGY TRADINGWILLIAMS ENERGY MARKETING & TRADING

SEMPRA ENERGY TRADING CORP

4.865 ¢/kWh 5.117 ¢/kWh 5.819 ¢/kWh

9

What was Being Purchased?

Full requirements slices of BGS load of each EDC Payments will be based on load measured at the PJM

interface—no risk of losses Slices set at roughly 100 MW resulted in

96 PSE&G tranches 51 GPUE/JCP&L tranches 19 Conectiv tranches 4 RECO tranches

Starting prices set by auction manager/EDCs Maximum and minimum possible starting prices in the EDC filing Not capped by shopping credits Will be based on indicative bids Will provide adequate risk premiums

Auction manager had discretion to restrict auction volume if competition proves very limited

10

Market Background

NJ EDCs BGS requirements of nearly 17,000 MWs represented over 95% of all NJ energy consumption

Total native capacity of approximately 20,000 MW including some NUGs (although 29,600 MW showed up at the start of the auction)

- PS Power controlled 57% of native resources- The top four firm concentration, HH4 = 76%- Limited import capacity from South and West through PJM- Energy prices North and East in NYISO tends to be higher than

in NJ PJM structure facilitated competition in the auction

- FTR allocation coordinated with BGS contract- PJM spot market provided options for both buyers and sellers

The New Jersey Year 5 BGS Auction

11

12

Changes to the BGS Auction in Y5

BGS Load Split into two groups: Hourly Electric Price (CIEP/HEP) for large corporate and

industrial customers Fixed Price (FP) for small and residential customers

Separate but concurrent SDCAs will be held: HEP Auction is for capacity ($/MW-day) FP Auction is for all-inclusive price (¢/kWh, same as Y4)

Regulatory approval for each auction’s result is separate. Winning Bidders sign different contracts; BGS-HEP

Supplier Master Agreement and BGS-FP Supplier Master Agreement differ.

Design of the New Jersey BGS Auction

13

14

BGS Auction Rules—Overview

The standard Simultaneous Multiple Round (SMR) auction format

Bidding in rounds Reverse auctions—the sellers bid Uniform pricing Form of bids—quantities instead of prices Total bids cannot increase Switching—suppliers can switch between EDCs

during auction Ending the auction

15

Sample Results – Start of Auction

1

2$63.44$62.90$63.37$60.45

1628631

6

285

1.691.691.631.50

1.6765

$65.00$65.00$70.00$62.00

EDCPSEGJCP&LConectivRECO

Totals

1428455

6

9651194

287

1.481.652.891.50

1.6882

2.40%3.24%9.47%2.50%

3.44%3.43%3.16%2.50%

Round

# Bid # Available Ratio Price %Δ

# Bid # Available Ratio P rice %Δ

Round

170

965119

4

EDCPSEGJCP&LConectivRECO

Totals 170

16

Sample Results – Near Auction End

EDCPSEGJCP&LConectivRECO

Totals

EDCPSEGJCP&LConectivRECO

Totals

$52.10$53.10$49.50$56.40

Round43

$51.94$52.53$49.37$56.40

# Bid # Available Ratio Price % Δ 102

6220

4

188

# Bid # Available Ratio Price %Δ 100

6320

4

187

96 1.06 0.31%51 1.22 1.08%19 1.05

4 1.00

170 1.1059

96 1.0451 1.2419 1.05

4 1.00

170 1.1

0.26%0.00%

0.21%1.18%0.26%0.00%

Round42

17

Exit Bids

The following situation is possible:

Tranches bid

51

19

4

Round 45 price /kWh

5.175¢

5.1¢

5.05¢

6.2¢

Tranches bid

97

51

19

Round 44 price /kWh

5.2¢

5.1¢

5.05¢

6.2¢

PSE&G (20)

JCP&L (12)

Conectiv (5)

RECO (1) 4

94

18

Exit Bids

When bidders reduce their quantity, they can elect to submit an exit price

An exit price is a final price for a slice on which a bidder will no longer be bidding.

Exit prices are EDC specific Required to be below the previous round’s going price and

above the current round’s price e.g., between 5.2¢ and 5.175¢

If auction ends, slices would be allocated at the exit price of the slice that just fills the load for the product

19

Other Auction Features

Additional Rules Size of decrement depended on excess of tranches subscribed

over number of tranches available If an EDC’s tranches are just subscribed or under-subscribed,

bidders were not allowed to decrease number of tranches offered Switching restrictions—switching was not allowed if it would

result in under-subscription Load caps—each EDC imposed a maximum on the number of

tranches that a bidder can supply Pace

Length of rounds were kept as short as possible, but to still allow bidders time to decide on when to reduce eligibility or switch

Bidders allowed limited recesses toward end of auction

20

Auction Closing Rules

As long as there is some excess supply for at least one product (more slices subscribed than available) Bidding continues Prices continue to tick down from one round to the next

At a given point in the auction there can be excess supply for one product but not for others

For auction to end Bidding on all products must have stopped The offered supply equals the number of available slices

for all products Bidders are paid the closing prices per MWh

21

Starting Prices andAuction Volume Adjustments

Starting prices and auction volume adjustments are two instruments to limit adverse consequences if there is limited competition in the auction

The Auction Manager announced starting prices three days prior to auction Starting prices were required to be above PJM forward

curve by a percentage that was approved by the BPU Indicative bids were due two weeks prior to the auction

will factor into the setting of the starting prices

22

Starting Prices andAuction Volume Adjustments

Target auction volume could be adjusted based on total interest If supply, as expressed in the indicative bids is limited,

auction volume could have been reduced Target auction volume was to have been set at no more

than a multiple of initial supply Further auction volume adjustments permitted based on

competition

Continued…

23

Auction Design Issues

Factors affecting expected supplier costs/bidder values NUG contracts—tranche size depended on existing NUG

contracts Line losses in the distribution system Capacity obligations BGS suppliers are required to satisfy the renewable energy

(green) standards. Combined rate ranges from 3% in 2002 gradually up to 6.5% in 2012

Starting prices Back-up provisions if supply was limited—auction volume

adjustments Minimum stay rules, customer switching, slamming Implementation—credit, qualification, software

The Texas Capacity Auctions

24

25

The Texas Capacity Auctions

The Texas Public Utility Commission (PUC) mandated auctions of capacity by Power Generation Companies (PGCs) beginning August 23, 2001

All the PGCs (AEP, Reliant and TXU) have been required to sell at least 15% of total capacity

The PUC has imposed specific auction mechanics—including simultaneous auctions of all PGC capacity of a given duration: Auctions were initially parallel and simultaneous auctions Activity rules initially were not comparable to usual SMR

auction formats Due to price gaps, PUCT adopted switching rule

26

The Texas Capacity Auctions

Sellers were provided some latitude in setting starting prices and minimum bid increments

Differences in approaches to starting prices and bid increments drove auction dynamics in some cases

Continued…

27

Auction Background

Products are 25 MW entitlements defined byZone (North, South, West and Houston (except first

auction))Type (baseload, gas-intermediate, gas-cyclic, gas-peaking)Seller (AEP, Reliant, TXU)Term (2-year, 1-year, 1-month)

TimingQuarterly auctionsAt each quarterly auction, there were:

All 2-year contracts were auctioned simultaneously (all types in all zones by all PGCs)

Then, all 1-year contracts were auctioned simultaneously

All 1-month contracts were auctioned simultaneously were auctioned last

28

Implications of Texas Experience for FTR/CRR and Capacity Auctions

FTR auctions in CA and elsewhere do not allow switching between substitute paths

As in Texas, equivalent FTRs can and are likely to sell for much different prices

Lack of switching implies Bidders need to guess when developing bidding strategy Allocative inefficiency when higher value bid on one FTR

loses to lower value bid on a near or perfect substitute FTR (or CRR)

NYISO, ISO-NE, PJM are also planning to run parallel auctions for each zone

29

Additional Factors in CRR/FTR Auction Design

Kirchoff’s law implies possible non-convexities in set of feasible power transfers

Non-convexities of feasible set will imply that support prices (LMP) will result in corner solutions

Implications for auction is that strong incentives can exist for bidders to strategically under or over report net demands

Package bidding and contingent bidding can be useful in finding optimal allocations

Testing can involve simulation and experiments Recent developments in package bidding include SAAPB

adopted by FCC and Ausubel-Milgrom proxy bidding procedures

Alberta PPA Auctions

30

31

Alberta PPA and MAP Auctions

Alberta conducted two sets of auctions PPA auction for 12 PPAs in late 2000 MAP auction for strips from unsold PPAs in

2001PPAs for energy entitlements of

generating unitsAuction was a variation SMR auction

format used in NJ BGS and developed for FCC spectrum auctions

32

PPAWinning Bidder Fuel

Capacity (MW)

PPA Term

Minimum Opening Bid (C$)

Amount Bid (C$ Million) Merit Order

Battle RiverEPCOR Coal 663 2020 $50 $84.90 BaseloadClover Bar Gas n/a 2010 ($96) did not sell PeakerGenesee Coal n/a 2020 ($300) did not sell BaseloadKeephills Enmax Coal 766 2020 $50 $240.70 BaseloadRainbow Engage Gas 93 2005 ($21) ($21) PeakerRossdale Engage Gas 203 2003 $0 0 PeakerSheerness Coal n/a 2020 ($200) did not sell BaseloadSturgeon Gas n/a 2005 $0 did not sell Not RunningSundance ATransCan. Coal 560 2017 $50 $211.90 BaseloadSundance BEnron Coal 706 2020 $50 $294.80 BaseloadSundance CEPCOR Coal 710 2020 $50 $268.50 BaseloadWabamun Enmax Coal 548 2003 $25 $75.10 Baseload

Note:

Alberta Power Purchase Arrangement:Auction Results

CALPX/CAISO

33

34

California Energy Markets

Three utilities – PGE, SDG&E/Sempra and Southern California EdisonPeak demands of approximately 45K MW in summer months

18% of supplies from imports Five main generators controlled nearly half of fossil fuel generation

within CASummer 2000 crisis began and continued past the close of the CALPX in Feb. 2001 with

Stage 2 emergencies declared on scattered days in May – September 2000

Stage 3 emergencies in Dec. 2000 (1 day), January 2001 (18 days), February 2001 (16 days), March 2001 (2 days) and May 2001 (2 days).

Average loads of < 33K MW through the latter part of the crisisAB 1890 mandate IOUs purchase energy through CALPX/CAISO

35

Some Explanations of What Happened?

Strategic withholding of supplies (JK & BBW) and less than perfectly competitive behavior (Puller)

Lack of forward contracts CALPX had block forward market, IOUs were permitted to purchase much more block forward

than they did and they could hedge with derivatives Ex post regulatory review of forward/derivative purchases

placed all the downside risk with IOU, so this was not a factor Ability of other WECC buyers to be active in forward markets

and inability of CA IOUs placed burden on latter (Allaz and Vila/Salant&Loxley – NJ experience)

Lack of capacity credits/markets or regulation Nature of equilibrium in CALPX/CAISO SFE type auctions

36

NJ vs. California

CA 3 large utilities Moderate HHI in generation Capacity and other reserves

needed to respond to demand peaks no longer mandated

CAISO/WECC – provides links between zones

High price spikes CALPX/CPUC did not give

utilities much of an out Theoretically unsound Supply

Function Auction format

NJ 3 large utilities High HHI > 3200 in generation Significant transmission constraints

to the remain of PJM Capacity credit market mandates

reserve margins Outcome competitive average 5.1¢

for entire year Combination of primary long term

contracts and options for spot and short term contracts gave more flexibility for buyers to get a more competitive price

Clock auction designed to attenuate market power of the sellers

37

One buyer who demands D units at any price up to R.

Two sellers. Each seller can produce up to its capacity K at zero marginal cost.

K < D, so neither seller can supply the whole market. Sellers compete in prices – each seller names a

single price at which it will sell up to K units. Supply is dispatched in order of increasing price,

and sellers are paid as bid.

Example: Price Competition with Capacity Constraints

38

No MC Equilibrium

Profmin

Price

Units

R

Dp1 = 0

Demand

Supply

If both set p = MC, then each sells D/2 at price 0, earning a profit of 0

If Seller 2 charged R instead, it would sell D – K earning a profit of Profmin = R(D – K).

K

p2 =

Applicability of SDCA in Other States

39

40

US Experience with Competition in Generation Services

State PopulationCustomers of Competitive

Suppliers

Total Customers Eligible for Retail

Choice

M igration Rate

Report Date

Competitive Residential

Load

Competitive Commercial

Load

 Both C&I Load

Competitive Industrial

Load

Total Competitive

Load

Report Date

Arizona 5,456,453 n/a n/a n/a n/a 0.00% 0 0.00% 0.00% 2-OctCalifornia 35,116,033 72,422 10,580,906 0.68% 2-Dec 0.80% 1.4*/13.9# 35.70% 13.30% 2-AugConnecticut 3,460,503 n/a n/a n/a n/a 1.30% 0.20% 1.20% 2-SepDistrict of Columbia 570,898 25,115 197,359 12.73% 2-Sep 11.10% 59.60% 49.40% 2-AugDelaware 807,385 n/a n/a n/a n/a n/a n/a n/a 2-SepIllinois 12,600,620 27,896 687,980 4.06% 2-Oct 0.00% 26.90% 50.10% 25.80% 2-JulMaine 1,294,464 8,713 3-Jan 1.60% 30.40% 72.10% 34.80% 2-SepMaryland 5,458,137 74,870 2,074,243 3.61% 2-Dec 3.90% 29.10% 17.20% 2-AugMassachusetts 6,427,801 84,532 2,544,495 3.32% 2-Nov 2.20% 11.4*/17.4# 43.50% 21.60% 2-AugMichigan 10,050,446 n/a n/a n/a n/a n/a n/a n/a 7.30% 2-Jul

New Jersey 8,590,300 2,573 3,651,148 0.07% 2-Dec n/a n/a 1.80%Jun/02-Aug/02

New York 19,157,532 388,308 7,279,618 5.33% 2-Nov 5.50% 26.20% 18.90% 2-MayOhio 11,421,267 747,951 4,681,053 15.98% 2-Sep 13.90% 15.20% 11.70% 12.90% 2-JunOregon 3,521,515 36,503 1,213,858 3.01% 2-Dec n/a 0.00% 0.00% 2-SepPennsylvania 12,335,091 278,429 n/a n/a 3-Jan 5.60% 10.70% 11.00% 8.70% 2-OctRhode Island 1,069,725 2,132 468,015 0.46% 2-Dec n/a n/a n/a 12.90% 2-JunTexas 21,779,893 469,106 n/a n/a 2-Sep 4.80% 27.20% 81.10% 38.20% 2-JulVirginia 7,293,542 2,584 1,300,763 0.20% 2-Aug n/a n/a n/a n/a n/a n/a

Customer Participation in Retail Access

#Large Commercial; *Small Commercial; n/ a = Not Available; n/ o = Not Open

41

Division of Load and Contract Terms

Many options for dividing up load Uniform slices of system Division by customer segment Firm and non-firm tranches Metered vs. non-metered customer segments

Contract terms Wholesale vs. resale Fixed price service vs. variable (market) price Seasonal adjustments Duration

Uniform vs. non-uniform Length

42

Contract Duration

SDCA can permit contracts of different durations – e.g., Texas capacity auctions

Some longer term contracts can facilitate bidder financing

Some shorter term contracts can allow bidders to adjust portfolios, and can be especially useful for bidders with plants coming on or going off line.

43

CA: Demand and Supply Concentration

As in NJ experience, CA has three main utilities Supply in California is less concentrated than in NJ Import capacity comparable in both regions Affiliation of PS Power with PSEG for approximately

50% of native energy was potential limitation of benefits of the auction

PJM FTR approach facilitated competition in auction for default service load procurement

CAISO only control intra-state transmission, inter-state transmission with rest of WECC could limit competition in an auction

44

Forward vs. Day Ahead Markets

Auction volume adjustments left open possibility of load procurement in day ahead or hour ahead markets

Suppliers apparently wanted to avoid having to sell in what could be a competitive day ahead market, and so had incentives to bid aggressively in BGS auction

Starting prices and process were reviewed and approved by BPU in advance of auction

Auction process required BPU review within 48 hours of auction close

EDC and supplier exposure to risks were both mitigated by prior approval and transparency of process