California Day 2:

1

• California Day 2
• Investigations into market manipulation
• CA refund proceeding other enforcement
• Implications for restructuring generally

2
Market Manipulation in CA Trading
Techniques Challenging the FERCs explanation

• FERCs initial investigations credited the
  perfect storm explanation supply shortages,
  high demand, fuel and emissions costs.
• By mid 2002, evidence of gaming techniques used
  by traders emerged. Disclosure of Enron memos
• Several studies published in 2002 suggested that
  adequate capacity did exist to serve CA demand in
  2000 and 2001.

3

• FERC grants of market-based ratemaking authority
  are conditioned on
• Not abusing market power
• Not gaming the system
• Not engaging in anomalous market behavior
• Liberalization ? Capturing benefits of a market

4

• CA system scheduling process
• PX conducts day ahead bid auctions, publishes
  market clearing prices
• PX submits load and generation data to ISO
• ISO balances load and generation identifies
  congestion problems. Schedules ancillary
  services.
• 4a. If no congestion, initial schedule of
  generation and load is used.
• 4b. If congestion is found, schedule is modified
  using adjustment bid process to charge users for,
  and compensate those who act to relieve,
  congestion.
• ISO real time market used to balance actual load
  in real time real time market prices often
  differed from day ahead prices.

5

• CA system price caps
• Late 2000 Early 2001 FERC imposed a changing
  series of price caps on wholesale prices
• Ranging from lt100/mwh to gt400/mwh
• First on CA market only, later on western
  market
• Hard caps vs. soft caps

6
Market Manipulation in CA Trading
Techniques Withholding Generation
Email exchange between Reliant traders We
decided prices were too low so we shut
down. Excellent. Excellent. We pulled about
2000 megs off the market. Thats sweet.
Everybody thought it was really exciting that
we were gonna play some market power. That was
fun!
7
Market Manipulation in CA Trading
Techniques Export strategies
At various points in the crisis, wholesale sales
in CA were subject to price caps of varying size.
Spot prices outside of CA in other western
markets were often higher than (capped or
uncapped) prices on the CA exchange. Often
real-time market prices were higher than day
ahead prices. Prior to must sell order by FERC,
shortages were exacerbated by generators/sellers
(1) taking advantage of better prices in other
markets outside CA, or (2) exporting for resale
back into CA at unconstrained prices during
emergencies. ?
8
Market Manipulation in CA Trading
Techniques Export strategies ricochet
Sales into CA from out of state were, at certain
times of inadequate supply, not subject to the
same caps as intrastate sales. E.g., Co.
A Co. B CA AZ Second sale is at
unconstrained higher price companies split gains
from arbitrage.
9
Market Manipulation in CA Trading
Techniques Incing (a/k/a fat boy)

• CA ISO scheduled generation to meet anticipated
  load (based on day ahead markets), paying all
  scheduled generators even if their generation
  wasnt ultimately needed in the real time market.
• Participants qualified to bid as both buyers and
  sellers overstate their anticipated load (demand
  needs) in the day ahead market.
• In the real time market, they took less than they
  had said they would, but got paid for making the
  generation available to meet the need the ISO had
  anticipated or if buyers underscheduled, for
  actually supplying the power.

10
Market Manipulation in CA Trading Techniques

• ISO paid a congestion relief subsidy to firms
  who reduced demand (took less power than they
  indicated theyd need in day ahead markets) to
  relieve congestion.
• Enron overstated day ahead loads in potentially
  congested areas in order to trigger the need to
  relieve congestion on lines.
• Then Enron took less than its forecast load in
  the real time market, receiving payments for
  helping to relieve congestion.
• See also wheel outs

11
Market Manipulation in CA Trading
Techniques Congestion load shift, death star and
wheel out
Seller 1 Seller 2 Seller 3 Enron Seller 4
Seller 5 Buyers Buyers Enron Buyers Buyers
12
Market Manipulation in CA Trading
Techniques Death Star

• ISO paid a congestion relief subsidy to firms
  who scheduled transactions requiring transmission
  in the opposite direction of the congestion,
  thereby requiring fewer electrons than usual to
  move in the direction of the congestion. came
  from congestion charge assessed to all who were
  using the congested route.
• Enron and others scheduled phony counterflow
  transactions in order to receive the congestion
  relief payments (sometimes in conjunction with
  load shift transactions).

13
Market Manipulation in CA Trading
Techniques wash exports

• Wash trades paired buys and sells with a 3d
  party, used to create impression of volume,
  higher price Why?

14
Market Manipulation in CA Trading
Techniques Get Shorty

• Enron sells ancillary services (usually spinning
  or other reserves) in day ahead market at price
  X.
• Enron buys ancillary services back in the real
  time market at price Y (YltX).

15
Market Manipulation in CA Trading
Techniques Gas Markets

• El Paso self dealing in gas markets
• Withholding gas to benefit own position in
  electricity markets
• Gas price indices Fraud

16
Market Manipulation in CA Trading Techniques
FERC Staff One expects that traders will
utilize various strategies in an effort to
maximize profits. But a fundamental aspect of
some of the Enron trading strategies is the
deliberate use of false information. A market
cannot operate properly without accurate
information. What is the difference between
exacting scarcity rents and exercising
impermissible market power?
17
Market Manipulation in CA Trading Techniques
FERC Staff Enrons corporate culture
fostered a callous disregard for the American
energy consumer and demonstrates the need for
aggressive market monitoring and
enforcement. Enron devised many of these, but
many other players used them more, and more
effectively, including some CA munies.
18

• Postscript
• CA refund proceeding FPA power issue
• CA claim 8.9 bln overcharges
• FERC 12/02 1.8 bln
• FERC 2003 approx. 3 bln
• Unpaid bills from CA buyers approx 3 bln
• CFTC, DOJ and FERC prosecutions for market abuse
  so far 6 bln in settlements

19

• Implications for Restructuring
• How can the FERC and/or states prevent a
  recurrence of the CA problem?
• Can electricity markets ever work satisfactorily?
  
• Can consumers live with price volatility the
  kind that sends signals that create long term
  efficiency?
• Is market manipulation inevitable?
• What can/should governments do to safeguard
  consumers AND let the market work?