Contract Killings

How the state's contracts with crucial electric power providers actually encourage them to gouge us

Wolak, the Stanford professor, puts it in terms that any Econ 101 student could grasp: "What's the cost of doing this [market manipulation]? Zero. What's the benefit? A whole lot of money. To expect someone -- especially these generators -- to sit back and be civic-minded is ridiculous."


It would be relatively easy for power generators to feign debilitating conditions that require "must-run" plants not to run. Wolak likens unscheduled power plant outages to sick days, in which the complexity of the machinery involved allows generators to do the equivalent of faking a cough into a cell phone while calling from the beach.

Deregulated generators do tend to call in sick considerably more than their regulated counterparts. A 1999 study of the recently deregulated New England market -- which features prominent California players such as Mirant, Calpine, and the parent company of PG&E -- found power plant outages increased 47 percent within the new system's first year. And California market watchers say they've seen a similar, if later-blooming, trend unfold here. California Energy Commission data from April show a nearly 400 percent increase in the curtailment of energy generation from a year earlier.

Reliability contracts, which were supposed to protect the grid from this behavior, haven't succeeded in keeping plants running. In the case of AES/Williams -- and other energy providers, according to Wolak, who says he's seen "pretty good evidence" of "must-run" market manipulation in other parts of the state -- this "must not run" phenomenon can be traced to the loophole in the ISO's reliability contracts.

But extremely tight electric supply conditions have made it advantageous for reliability units to withhold capacity even when they can't exploit the loophole by substituting much-higher-priced power from another plant in the same geographic area.

In the most power-strapped areas of the state -- the Bay Area and the San Diego Basin -- every electricity generating plant is under a reliability contract. The flaw in their "must-run" contracts does not, therefore, give the generators an incentive to keep their plants down; there are no unregulated power plants to substitute into the grid, at a 1,000 percent markup.

But power generators still have a nearly unchecked ability to manipulate prices by withholding capacity from a tight market. Brian Theaker, an ISO lawyer involved in the reliability contract process, says a generator such as Mirant, which controls more than half of the Bay Area's capacity, is "definitely" in a position to garner higher prices for itself by cutting back the amount of electricity it generates. Mirant's "must-run" contracts make this possible by allowing it to choose between selling its energy at a predetermined contract price that essentially covers its costs, or to sell its power for a market price. These days, with prices skyrocketing, it's not much of a choice.

And because the grid is so close to collapse during this supply crisis, every megawatt that generators withhold from the market winds up having an impact on the prices for their remaining plants. Mirant's own outages, clearly, have impacted prices. Despite having all of its plants under reliability contracts, this spring the company, on average, shut down more than 1,040 megawatts of its capacity a day, roughly a third of its generation. That's more than enough energy to power 1 million homes.

In April, when the company collected a near-record $533 million check from the state for power, Mirant's electricity curtailments were actually about 10 megawatts per day higher than they had been earlier in the year. Even without the loophole, it seems, the reliability pacts are doing little to stifle generators' market power now, when that power is at its most potent.

"The presumption was that the overall, global market would be competitive," the ISO's Theaker says. "These contracts were designed for local concerns. So when you have a global, overall supply problem like this, [the "must-run" contract is] not an effective Band-Aid for that. It doesn't really work for that."

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