Martin, Lance

What do you think?

Vince

 -----Original Message-----
From: 	"Frank A. Wolak" <wolak@zia.Stanford.EDU>@ENRON  
Sent:	Friday, October 19, 2001 4:28 PM
To:	Kaminski, Vince J
Subject:	 

Vince,

  I've been hearing rumors that Enron has decided to endorse
the nodal pricing model as implemented in PJM.
I just wanted to warn you that I'm not sure
this is in Enron's long-term interest at all.  Let me explain
why.  Feel free to give me a call if you'd like to talk
more about this.

  First, let me say that I firmly believe in locational pricing
and specifically pricing congestion.  However, the way that PJM
implements nodal pricing is to eliminate as much price volatility
and reduce the transparency of the market.  Specifically, the
PJM tariff gives the ISO the ability to mitigate to cost plus a
%10 adder the bids of any market participant that the ISO deems
is out of merit in one of the three zones in region.  (The fact
that a nodal market is talking about zones should give you cause for alarm.)
Then the ISO takes this mitigated bid and re-runs its price-setting
software to compute new nodal prices.  The way I have (somewhat
unfairly) decribed this price-setting process is that the
PJM ISO decides what prices it would like
for a given day and mitigates bids until it gets them.  This is not
a transparent market, nor one where it makes any sense to buy
the risk management services that Enron provides.  The
only price volatility you have to worry about in the PJM market is
that kind that comes about if they need imports into their control area
to meet demand.  Under these circumstances, you need to pay the
imports whatever is necessary to get them to come to your market.

  However, bear in mind FERC's desire to make a large RTO on the
East Coast.  This will effectively mean little imports
to the East Coast RTO, so all bids can be mitigated at
the discretion of the ISO.  Paying market-clearing prices to cost-of-service
mitigated bids is just paying too much to eliminate price volatility.
It effectively kills off the development of risk management at
the wholesale and retail level.  Power marketing becomes much less
profitable because retailers know you can always buy at cost-mitigated
prices.

  In short, the PJM model is not market.  It is just an alternative
form of regulation that is politically attractive because it reduces
price volatility, but it is not good for consumers or traders because they just
get a higher cost form of regulation than traditional cost-of-service
regulation. You pay market-clearing prices to cost-of-service
mitigated bids, but under regulation you could just pay cost-of-service
prices and eliminate the infra-marginal profits to low cost generators.

  As we discussed during our dinner, I think the two biggest sources
of benefits from re-structuring will come from getting the demand-side
involved in the market and from more efficient risk management.  A
necessary condition for both of these to occur is prices that reflect
actual conditions in the market (including the extent of market power
exercised).  Masking these signals dulls any incentive for market
participants to make the investment necessary to management.  The PJM
model is just way to have a market in name without achieving any
significant benefits to consumers or energy traders.

Frank