Goldman’s ReNew Says India Wind-Forecast Rule Will Erase Profits

In regard to “Goldman’s ReNew Says India Wind-Forecast Rule Will Erase Profits”, Bloomberg News, July 28, 2013, (http://www.businessweek.com/news/2013-07-28/goldman-s-renew-says-india-wind-forecast-rule-will-erase-profits) the problem is not the forecast rule but that the Central Electricity Regulatory Commission (CERC) has begun moving away from the competitive market concepts that it installed 11 years ago, moving toward a system of penalties.

Under a competitive market, if one wind generator was 10 MWH over forecast and anther was 10 MWH under forecast, both would see the same price, though with opposite but offsetting financial effects.  The price might be very high which would please the generator that was over and displease the generator that was under.  Or the price might be very low which would please the generator that was under and displease the generator that was over.  But both would see the same price.  The utility would pay one wind generator the same amount for the overage that the utility collected from the other wind generator for the underage.

Under a penalty concept, both generators will be displeased, both facing an economic impact that was harmful to their financial interest.  The penalty would inure to the befit of the utility.  Even when the amount of wind forecast errors netted out to zero, the utility would make money because the penalties always flow to the utility.  Under a competitive market, the payments can balance out.

In the U.S., the Federal Energy Regulatory Commission (FERC) seems enamored with the imbalance penalty contained in Bonneville Power Administration’s tariff.  When a generator is too far out of balance (25%), penalties accrue, even if the imbalances of the various generators balance out.  The utility makes money on imbalances, just as is proposed by CERC.

I wrote about how to modify the BPA penalty concept in “Reply Comments Of Mark B. Lively In Regard To Using Prices Instead Of Penalties For (1) Regulation And Frequency Response, (2) Energy Imbalance, (3) Generator Imbalance, And (4) Inadvertent Energy,” Preventing Undue Discrimination and Preference in Transmission Services, FERC Docket No. RM05-25-000 and RM05-17-000, 2006 September 20.  (Go to http://www.livelyutility.com/library.php# and look for RM05-25.)  The result would be something like the imbalance mechanism that CERC is abandoning.

In 2002 and 2003, India implemented an imbalance mechanism that looked at the net imbalance on the network to set the price for imbalances at generators and loads.  When the system imbalance was a shortage, the price for generator and load imbalances would be high.  When the system imbalance was a surplus, the price for generator and load imbalances would be low.  Recently, CERC has been abandoning this competitive market for large imbalances and is moving toward the BPA penalty concept that FERC embraces.  I think this change is a step backwards and the wind scheduling issue is part of that backward movement.

I don’t think that the 2002 method for pricing imbalances is perfect.  The prices don’t get extreme enough.  The prices don’t change geographically.  The prices don’t reflect various market forces.  (See http://abt-india.blogspot.com/2007/10/windpower-discussion-on-inpowerg.html)  But the mechanism tries to create a competitive market structure instead of a penalty structure, a penalty structure that always rewards the utility.

FERC, Barclays, and Formulary Arbitrage

On 2013 July 16, FERC ordered Barclays bank to pay a half billion dollars for market manipulation.[1]  The next day Barclays responded by suing FERC in federal district court, forcing FERC to prove the allegations in a venue that Barclays feels would be a level playing field.  On July 22, a New York reporter called a friend of mine who is normally well versed in utility legal matters, having been a regulator and a utility executive, seeking to understand what Barclays did to get FERC upset, asking for a simplified explanation.  My friend suggested another industry expert and also called me.  I got back to my friend on July 23, heard the request, and wrote a message to him explaining what I understood Barclays to have done on a generic basis, without having read much more than articles in The Washington Post.  It is that message of yesterday that I am copying here.

Thanks for the call on Monday in response to a NYC reporter who was asking you for background or information about the Barclays spat with FERC.  I have not followed the details of the spat, but the way I find it easiest to describe is as a thinly traded formulary arbitrage.

An arbitrage is buying and selling related securities with the hope of making a profit on the difference.  For instance, one might buy oil for $90/bbl and sell at $100/bbl and make $10/bbl on the paired transactions.  If the transactions are for oil delivered in different locations, one might also have a transportation cost of $1/bbl, reducing the profit to $9/bbl.  There may be some insurance and other handling costs, but if they are minor, one makes a profit so long as the differential is greater than the cost of transportation.  The transactions can be for the same location but different times.  One might buy a May futures contract for $90/bbl and sell a June futures contract for $100/bbl and make $10/bbl on the paired transactions.  But one has to store the oil, which might again cost $1/bbl for going into and out of storage and for one month in storage.

My understanding is that futures contracts settle at the end of the month before at the average spot price of oil on the last few days of the month.  So, a May futures contract would be settled at the end of April based on the spot price on April 30, or some sort of average.  I call this a formulary settlement.

If one has bought a lot of May futures contracts, one would like to see them settle at a very high price.  So, one might buy lots of spot oil on April 30 to push up the price at which the May futures contracts would settle.  This would be a formulary arbitrage.

But considering that the spot market is very large, it is difficult to budge by buying a lot of spot oil on April 30.  One might need to buy enough oil to supply ExxonMobil.  That would be a thickly traded formulary arbitrage.

Some commodity exchanges offer electricity forwards markets which settle based on the actual spot price of electricity on some of the ISOs.  The ISO spot prices might be thinly traded.  A paired transaction on the electricity forwards market and the ISO market may be a thinly traded formulary arbitrage.  At least that is what I would have told the reporter had you directed him to me.

Hope this helps for the next time.



[1] The Federal Energy Regulatory Commission (FERC) today ordered Barclays Bank PLC and four of its traders to pay $453 million in civil penalties for manipulating electric energy prices in California and other western markets between November 2006 and December 2008. FERC also ordered Barclays to disgorge $34.9 million, plus interest, in unjust profits to the Low-Income Home Energy Assistance Programs of Arizona, California, Oregon, and Washington. FERC News Release https://www.ferc.gov/enforcement/market-manipulation.asp