You’d think regulators and the public would remember how badly California was burned by Enron’s electricity price manipulations, which cost each resident more than $1300 in higher energy bills, and would be eager to avoid a rerun.
But memories are short. As David Cay Johnston reported in an important story at Aljazeera, Energy Partners, a Goldman-linked investment group, looks set to repeat Enron’s ploy on the East Coast.
I strongly suggest you read Johnston’s account in full, but here’s the short version. The key to energy price manipulation now is how tight the market is overall and how few participants bid at particular auctions.
Electricity is sold at what are called “clearing price auctions”. The price set for all bidders is based on the highest price that still helps fill the overall order. In other words, if A bids $5 for 20 units of energy, and B bids $10 for 5 units, but the need at that point is for 45 units, higher bids will be treated as filling the order. In our example, we are only at 25 units out of 45 so far. So then order C for 15 units at $25 is waved in, and the final bid, for 30 units at $50, is partially filled. The last bidder supplies only 5 units of the total, but his $50 bid is the clearing price, and everyone who bid lower also gets their offers filled at $50.
So if you reduce capacity (supply), all participants will tend to bid at higher prices because they know their odds of getting all or part of a bid are better than before. And a reduction in the number of bidders also makes it easier for the suppliers to collude informally. As Johnston explains:
Trading records and experiments conducted by Professor Sarosh Talukdar at Carnegie Mellon University and others show that the electricity auction rules tend to drive prices up, not down, until they approach the level that an unregulated monopolist could charge.
This occurs because suppliers learn to arrange their bids to ensure the highest price, a good example of how competition does not always favor customers or lower prices. While collusion among suppliers is illegal, learning how to jack up prices by studying bidding patterns is perfectly legal.
The original market rules, by the way, were drafted by a massive fraud posing as an electricity trading company named Enron.
Yes, sports fans, the “rules” that Enron devised so it could game energy markets are still in force!
So what, exactly, is the Energy Partners scheme? It bought three energy generating plants for $650 million. A mere five weeks after the deal closed, it said it needs to shutter Brayton Point, the second largest producer in New England, claiming it will cost the investors more than it’s worth to keep the plan running. Regulatory filings show that the electricity system in the region has gone from surplus to deficit, and baseline prices were already projected to double. Clearly, removing a major producer would lead to even greater price increases.
With Brayton Point closed, New England consumers and businesses will spend as much as $2.6 billion more per year for electricity, critics of the deal suggest in documents filed with the Federal Energy Regulatory Commission.
That estimate will turn out to be conservative, I expect, based on what Enron traders did to California, Oregon and Washington electricity customers starting in 2000. In California alone the short-term market manipulations cost each resident more than $1,300, a total burden of about $45 billion.
One regulator that could block the closure of the plant, the Independent System Operator –New England, washed its hands of the matter, saying it’s not its job to worry its head about whether Energy Partners is really closing the plant so as to better manipulate the markets. Johnston called its decision “shocking” because this regulator’s supposed raison d’etre is to prevent price manipulation. If this isn’t in its wheelhouse, pray tell what is?
But the Independent System Operator isn’t the only regulator that has to bless this proposal. The Federal Energy Regulatory Commission also needs to approve or deny it. And FERC rules prohibit withholding capacity to manipulate rates or produce unjust and unreasonable rates.
The investors’ excuse that they made a big mistake and now realize they have to close the plant doesn’t pass the smell test. Johnston quotes FERC testimony from Tyson Slocum of Public Citizen:
In the world of business, a firm announcing that an asset purchased just 5 weeks ago is actually uneconomical to operate would be called incompetent, and such a firm would have difficulty attracting capital and staying in business. But the managing partners of Energy Capital Partners are a highly sophisticated all-star crew of former Wall Street financiers: four of the five managing partners are Goldman Sachs veterans, and the firm’s vice-presidents and principals are alumni of JP Morgan, Morgan Stanley, Bank of America, Credit Suisse and other financial powerhouses. These are not your run-of-the-mill owners and operators of power plants. They are Wall Streeters highly motivated to exploit the intricacies of power markets to make as much money as possible for their Cayman Islands-based affiliates.
Johntson also points to auction records that show that immediately after they acquired Brayton Point, Energy Partners started withholding all of Brayton Point’s capacity from auctions. No wonder they’d rather close the plant and be done with it.
Curiously, Connecticut Attorney General George Jepsen seems to be the only state official alert enough to recognize what Energy Partners is up to and to oppose their scheme.
If you live on the East Coast, and don’t want to be victimized like Californians were 14 years ago, urge your Senators and Representatives, as well as your state attorney general, to tell FERC that they are firmly opposed to closing Brayton Point. Otherwise, you can expect to be in for a hot and very costly summer.