By Rich Heidorn Jr. and Rory D. Sweeney

FERC last week approved PJM’s proposal to reduce by almost 90% the number of bidding locations for increment offers (INCs), decrement bids (DECs) and up-to-congestion transactions (UTCs) (ER18-88).

Known as virtual transactions, these trades can be used to arbitrage price differences between the day-ahead and real-time markets and hedge financial exposure to physical positions. PJM contends that while the trading can mitigate supply-side and demand-side market power by allowing those without physical assets to compete with asset owners and load-serving entities, too many of the trades provide no benefit to the market and can increase market solution times and skew transmission flows.

Following a white paper published in 2015, the RTO won Members Committee approval for the changes in June. (See “Stakeholders Endorse Third Phase of PJM’s Uplift Solution Despite Opposition,” PJM MRC/MC Briefs: June 22, 2017.)

PJM’s proposal, filed last October, asked FERC to limit INCs and DECs to nodes where either generation, load or interchange transactions are settled, or at trading hubs where forward positions can be taken. The RTO said this would ensure the day-ahead market produces a resource commitment close to the set of resources required for real-time operations.

The changes reduced the number of INC/DEC trading nodes from 11,727 to 1,563, retaining all hub and interface nodes but eliminating some aggregate and generator nodes. Also retained were residual metered nodes — locations at which load settles the remaining portion of a zone that is not settled at a more granular aggregate location.

The new rules also eliminate zone, Extra High Voltage (EHV) and individual load nodes as trading points for both UTCs and INCs/DECs. Also barred from UTC trades are some interface nodes, while the number of eligible residual metered and hub nodes was increased. In total, the number of UTC trading points was reduced to 49 from 418.

Under the former rules, PJM said, some traders took very small, low-risk positions in the day-ahead market over weeks waiting for a single path to bind in real time. Others bid at locations with systematic price differences between the day-ahead and real-time markets because of a modeling difference between the two markets, according to the RTO.

“The extremely broad set of eligible nodes for virtual transactions that exist today also expose PJM market participants to increased financial exposure due to discrepancies between the day-ahead energy market and real-time energy market network models,” PJM said in its filing. “Something as simple as an inconsistent breaker status (open or closed) from the day-ahead energy market to the real-time energy market can create a systematic difference between day-ahead and real-time prices that provide a revenue opportunity for virtual transactions without the ability to provide any convergence between the day-ahead energy market and real-time energy market. Because individual nodes are more highly impacted by modeling discrepancies than aggregated locations due to averaging, they are often locations where virtual transactions can profit. Profits collected by virtual transactions in these cases lead to additional costs for PJM members without any benefits.”

The changes were backed by the Independent Market Monitor and some generators and LSEs, but they were opposed by financial traders, who said it would lead to less efficient, less granular markets.

“With 80% of INC/DEC activity occurring at pricing nodes of type hub, zone and interface, according to PJM’s own empirical analysis, eliminating zone for INC and DEC virtual transactions can be disruptive to the market,” said Macquarie Energy.

Some opponents contended PJM had not made its case because it did not perform any quantitative analysis to compare the potential benefits with potential harms at individual load buses.

FERC sided with PJM, saying the RTO had provided sufficient evidence to support its proposal without such an analysis.

The commission said PJM’s proposal to remove zone nodes from INC/DEC trading will not significantly hinder market participants’ ability to manage exposure at the zones. “Given that market participants may bid at residual metered nodes and aggregate nodes where load is settled, they maintain a reasonable ability to manage their risk, including the risk of their day-ahead positions,” FERC said. “We note that market participants will continue to be able to hedge exposure at the zones on [Intercontinental Exchange] and Nodal Exchange and that PJM will continue to post LMPs at the locations where these futures contracts will settle.”

UTCs

Most of the commissioners also backed PJM’s reasoning for reducing UTC trading points. The RTO said UTCs create a divergence in either the source or sink location in 90% of occurrences. The transactions cannot reliably drive convergence in commitment, dispatch and pricing between the day-ahead and real-time markets because UTCs have no real-time equivalent, PJM said.

The Monitor said some traders had pursued a “penny bid strategy” — high volumes of low-risk, low-cost bids that can win large profits during low-probability events causing significant real-time price spreads. (See chart.)

Opponents of the changes insisted UTCs do have real-time equivalents in ISO-NE and ERCOT and noted that MISO and NYISO are considering adding UTC trading to improve price convergence.

The commission said it agreed with the Monitor that limiting UTC bidding to interfaces, zones and hubs “will minimize false arbitrage opportunities for UTCs currently being pursued through penny bids, as the effect of modeling differences between the day-ahead and real-time markets are minimized at these aggregates.”

FERC also agreed with PJM that reducing the biddable UTC locations should reduce the time to solve the day-ahead market, although it acknowledged the “reductions may be modest under most circumstances.”

“We acknowledge that the instant proposal may greatly reduce the opportunity to utilize UTCs in general, as well as the level of granularity at which UTCs can be utilized. We also acknowledge that the biddable points PJM proposes to delete may provide some value to the market,” FERC said. “We are not persuaded by protestors that forgoing some of the theoretical benefits associated with retaining the bidding points for UTCs at zone, EHV or aggregate nodes necessarily renders PJM’s proposal unjust and unreasonable.”

Commissioner Cheryl LaFleur dissented, saying PJM and the Monitor had “not demonstrated that eliminating certain types of biddable points is a targeted solution to address the problematic usage of UTC transactions.”

“UTCs can provide value by converging the congestion and losses component of LMPs and allowing market participants to hedge potential congestion,” she continued. “Given these potential benefits, I feel that moving in the direction of reduced granularity for the use of these products is a move in the wrong direction. However, I would be open to other solutions more targeted to the specific problems that PJM has identified.”

At the Markets and Reliability Committee meeting last week, PJM’s Adam Keech announced that staff had revised the list of biddable points to reflect the Feb. 20 order, but they planned to ask FERC how to address results since the order’s effective date of Jan. 16.

UTCs have seen explosive growth since 2011, in part because — unlike INCs and DECs — they were not assessed uplift costs. Last month, FERC denied PJM’s plan to allocate uplift to the transactions, another part of its three-phase solution to address uplift. The commissioners said it’s unfair to apply uplift to UTCs in the same way it’s applied to INCs and DECs (ER18-86).

PJM said last month that it believes FERC erred in its logic and might ask the commission to suspend UTCs until an approved solution can be worked out. (See “PJM Not Done on UTCs,” PJM MRC/MC Briefs: Jan. 25, 2018.)