Scarcity Pricing That Makes Economic Sense Frank A. Wolak Chair, - - PowerPoint PPT Presentation

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California Independent System Operator Corporation Scarcity Pricing That Makes Economic Sense Frank A. Wolak Chair, Market Surveillance Committee Market Surveillance Committee Meeting/ Stakeholder Meeting June 6, 2007 California Independent

SLIDE 1

California Independent System Operator Corporation

Scarcity Pricing That Makes Economic Sense

Frank A. Wolak Chair, Market Surveillance Committee Market Surveillance Committee Meeting/ Stakeholder Meeting June 6, 2007

SLIDE 2

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

Outline of Talk

How scarcity pricing works in other markets

– Examples from airlines, sporting events

True scarcity versus artificial scarcity

– The trouble with administrative scarcity pricing mechanisms

How it should work in electricity markets

– Coordinating scarcity pricing mechanism with active participation of final demand in wholesale market – Avoid administrative mechanisms that

How it can work under MRTU

– Minimum quantity price-responsive demand bids into ancillary services markets

SLIDE 3

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

Scarcity Pricing in Other Markets

Downward-sloping demand curve allocates a fixed supply

– Airlines charge extremely high prices for tickets as flight begins to fill up – Tickets to sold-out events sell for more than list price

P Q S(p) D(p)

SLIDE 4

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

Distinguishing True from Artificial Scarcity

Cost of an administrative procedure based on

system conditions to set “scarcity prices”

– Suppliers take actions to cause these system conditions to occur – Regulator-sanctioned form of exercising unilateral market power

Properly designed scarcity pricing mechanism

should limit opportunities for suppliers to exercise unilateral market power in short-term market

– Use actual demand-side of market to set scarcity prices not an administrative procedure that can be manipulated by suppliers

SLIDE 5

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

How Scarcity Pricing Should Work in Wholesale Electricity Markets

There is a substantial amount of price-responsive final

demand potential in all wholesale electricity markets – Experimental results with real-time pricing at both residential, commercial and industry levels

Approximately 15 percent demand reduction on critical peak

days in California

– Requires interval or hourly metering to implement any form

f real-time pricing

– Customers on critical peak pricing (CPP) tariffs are ideally suited to participate in ancillary services and real-time energy market

A retailer that has a substantial amount of load on a CPP

pricing plan can bid this load as non-spinning reserves – Strike price for energy in real-time market can be set equal to CPP price – Retailer calls CPP event on days that energy bid of load is likely to be accepted

SLIDE 6

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

How Scarcity Pricing Should Work in Wholesale Electricity Markets

Demand curve used to set “scarcity prices” should be derived

from willingness of customers to curtail load in response to higher reserve prices – Retailers offer these demand reductions into non-spinning reserve market

Use of administrative demand curve for reserve market can result

in reserve and real-time energy market outcomes that impose significant costs on consumers – Very high scarcity prices can be set when many customers would have curtailed demand instead of paying these prices

Markets work best when intelligent and financially

motivated supply competes against intelligent and financially motivated demand – Market power problems arise when intelligent and financially motivated supply competes against administratively determined demand

SLIDE 7

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

How Scarcity Pricing Can Work Under MRTU

The ISO can mandate that all load-serving entities must

submit non-spinning reserve ancillary services load bids at

r below bid cap equal to at least 10 percent of day-ahead

energy schedule – Bids on energy must be at or below bid cap on real-time energy market

This builds in feasible amount of demand response into

both ancillary services and real-time energy market – Eliminates need for administrative mechanism to set scarcity prices – Demand bids will set high energy prices and load will be curtailed in real-time market based on willingness to curtail

f loads

– Scarcity pricing will function in a very similar manner to how it functions in all other markets

Willingness to pay of final consumers determines price at which

available supply equals amount demanded at that price

SLIDE 8

California Independent System Operator Corporation

June 6, 2007 MSC Meeting

Concluding Comments

Scarcity pricing existing in all markets with

intelligent demand and supply

– No need for administrative scarcity pricing mechanism

Develop intelligent and financial motivated

demand side of wholesale market

– Administratively determined scarcity pricing mechanism very likely to simply reward suppliers for exercising unilateral market power

Economically meaningful scarcity pricing that

Scarcity Pricing That Makes Economic Sense

Frank A. Wolak Chair, Market Surveillance Committee Market Surveillance Committee Meeting/ Stakeholder Meeting June 6, 2007

Outline of Talk

– Examples from airlines, sporting events

– The trouble with administrative scarcity pricing mechanisms

– Coordinating scarcity pricing mechanism with active participation of final demand in wholesale market – Avoid administrative mechanisms that

– Minimum quantity price-responsive demand bids into ancillary services markets

Scarcity Pricing in Other Markets

– Airlines charge extremely high prices for tickets as flight begins to fill up – Tickets to sold-out events sell for more than list price

P Q S(p) D(p)

Distinguishing True from Artificial Scarcity

system conditions to set “scarcity prices”

– Suppliers take actions to cause these system conditions to occur – Regulator-sanctioned form of exercising unilateral market power

should limit opportunities for suppliers to exercise unilateral market power in short-term market

– Use actual demand-side of market to set scarcity prices not an administrative procedure that can be manipulated by suppliers

How Scarcity Pricing Should Work in Wholesale Electricity Markets

demand potential in all wholesale electricity markets – Experimental results with real-time pricing at both residential, commercial and industry levels

days in California

– Requires interval or hourly metering to implement any form

– Customers on critical peak pricing (CPP) tariffs are ideally suited to participate in ancillary services and real-time energy market

pricing plan can bid this load as non-spinning reserves – Strike price for energy in real-time market can be set equal to CPP price – Retailer calls CPP event on days that energy bid of load is likely to be accepted

How Scarcity Pricing Should Work in Wholesale Electricity Markets

from willingness of customers to curtail load in response to higher reserve prices – Retailers offer these demand reductions into non-spinning reserve market

in reserve and real-time energy market outcomes that impose significant costs on consumers – Very high scarcity prices can be set when many customers would have curtailed demand instead of paying these prices

motivated supply competes against intelligent and financially motivated demand – Market power problems arise when intelligent and financially motivated supply competes against administratively determined demand

How Scarcity Pricing Can Work Under MRTU

submit non-spinning reserve ancillary services load bids at

energy schedule – Bids on energy must be at or below bid cap on real-time energy market

both ancillary services and real-time energy market – Eliminates need for administrative mechanism to set scarcity prices – Demand bids will set high energy prices and load will be curtailed in real-time market based on willingness to curtail

– Scarcity pricing will function in a very similar manner to how it functions in all other markets

available supply equals amount demanded at that price

Concluding Comments

intelligent demand and supply

– No need for administrative scarcity pricing mechanism

demand side of wholesale market

– Administratively determined scarcity pricing mechanism very likely to simply reward suppliers for exercising unilateral market power

enhances market efficiency results from an active and intelligent demand side of wholesale market