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From: "Kaminski, Vince J" <Vince.J.Kaminski@ENRON.com>
To: "Lin, Martin" <Martin.Lin@ENRON.com>
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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


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