By Rich Heidorn Jr.

FERC on Wednesday reaffirmed its conclusion that bidding results in ISO-NE’s 2013/14 Winter Reliability Program were just and reasonable despite the fact that the largest participants may have had market power (ER13-2266-004).

ISO-NE’s program offered compensation to demand response and generators able to burn oil to prevent New England from falling short of power in the winter because of the retirement of coal-fired units and tight natural gas supplies.

Wednesday’s order was prompted by a D.C. Circuit Court of Appeals ruling in December 2015 that said the commission had failed to justify its approval of the auction results. Although ISO-NE estimated the program would cost no more than $43 million for up to 2.4 million MWh of energy, the RTO filed for approval of bids totaling 1.95 million MWh at a cost of $75 million.

The court said that in approving the auction results, FERC failed to address how much of the program’s cost was attributable to profit and risk mark-up or to explain the economic forces that it believed restrained participants from submitting excessive bids.

The court was acting on an appeal by TransCanada Power Marketing, which contended ISO-NE’s pay-as-bid auction resulted in excessive costs because resources were incented to raise their bid prices knowing they would probably be accepted.

In response to the D.C. Circuit’s remand, FERC directed ISO-NE to query bidders on the process they used to formulate their offers. It also ordered the RTO and its Independent Market Monitor to opine on the reasonableness of the bids based on that information. (See ISO-NE Ordered to Justify Cost of Winter Reliability Program.)

The IMM found that each participant had market power because there was insufficient supply to meet the RTO’s 2.4 million MWh procurement target and that the program did not include a mechanism for mitigating their leverage. It said market participants were aware of their market power because the first auction failed to attract sufficient supply to meet the target.

About 70% of the supply offered into the auction came from only four participants, a concentration that the IMM said allowed them to submit bids above a competitive level.

After the remand by the D.C. Circuit, the IMM calculated that the supply curve would intersect with the assumed procurement level of 1.95 million MWh — the amount procured in the second auction — at a marginal cost of $15.08/MWh-month.

The Monitor boosted that price to $18.85/MWh-month — a 25% risk premium reflecting participants’ limited information regarding the auction’s supply and demand curves and uncertainties over how the RTO would value resources in what was the first year of the program.

The IMM estimated the auction resulted in potential cost overages of $6.6 million, compared to what the program would have cost if all bids were at or below $18.85/MWh-month. The IMM concluded that 75% of the supply offered was competitive, but the remaining 25% “included sufficiently high markups to raise concerns that participants submitting bids for this supply may have exercised market power.”

“Market design issues, lack of information, uncertainty and measurement accuracy issues … prevent us from concluding, with certainty, the extent to which participants exercised market power or the impact it had on program cost,” the Monitor said.

ISO-NE conducted a similar analysis but assumed a supply curve of 2.25 million MWh, which it said would result in a clearing price of $24.86/MWh-month, or $31.08/MWh-month including the 25% adder.

It concluded there was no evidence that market power was exercised because there were no bids above $31.08/MWh-month. Using $24.86/MWh-month, it estimated $1.72 million in potential cost overages.

“We find that although the IMM found that the auction was not structurally competitive, ISO-NE nevertheless demonstrated that the Winter Reliability Program prices were just and reasonable because there were factors that sufficiently restrained parties’ ability to exercise market power,” FERC said. “These factors included the facts that, ahead of the auction, participants lacked information about ISO-NE’s chosen level of procurement, the costs and strategy of their competitors, and how ISO-NE would value the non-cost reliability factors that it would consider in addition to price when selecting bids.”

FERC compared the $75 million cost of the program to ISO-NE’s estimate in 2013 that the value of lost load “could reach into billions of dollars for a region the size of New England.” The RTO had cited estimates of the costs of the 2003 Northeast blackout, which ranged from $4 billion to $10 billion ($2003).

For a “competitive benchmark,” FERC looked at what costs would have been had the RTO used a single-price clearing auction — which incents bidding based on individual resource’s marginal cost — rather than pay-as-bid, in which participants seek to bid just below their estimate of the clearing price.

If resources bid based on marginal costs, FERC said the auction would have cleared at $15.08/MWh-month for a total of $88 million — above the actual total of $75 million ($12.82/MWh-month).

TransCanada protested the auction results, saying that ISO-NE’s “reliability need … created an essentially inelastic vertical demand that suppliers were aware of.”

FERC disagreed, saying that while the RTO said it would purchase “up to” 2.4 million MWh of winter reliability service, it ultimately purchased only 1.95 million MWh. “Contrary to TransCanada’s view, structural market power alone (i.e., a structurally uncompetitive market) does not necessarily result in unjust and unreasonable rates,” the commission said.

FERC also disputed the IMM’s conclusion that the 70% market share held by the four largest participants — the result of a C4 concentration test — was evidence that the auction was uncompetitive.

The commission said its preferred concentration test, the Herfindahl-Hirschman Index (HHI) — which sums the squares of the market shares of each market participant — resulted in an HHI of 1,462, “indicating a moderately concentrated, but not a highly concentrated, market.”

Even assuming there was structural market power, “there is no conclusive evidence that participants knew they had structural market power; therefore, participants would have bid competitively,” FERC said. “This is particularly likely given that the Winter Reliability Program presented a new product market with no prior auctions, making it more difficult to determine which other oil-fired generators would choose to participate and then what quantity of service each would bid (to cover their respective costs and include profits sufficient to warrant their participation in the auction).”