UNITED STATES OF AMERICA86 ferc  61, 059 FEDERAL ENERGY REGULATORY COMMISSION Before Commissioners: James J. Hoecker, Chairman; Vicky A. Bailey, William L. Massey, Linda Breathitt, and Curt H‚bert, Jr. California Independent System ) Docket No. ER99-826-000 Operator Corporation ) ORDER REJECTING PROPOSED TARIFF AMENDMENT, AUTHORIZING INTERIM ACTION, AND REQUIRING MARKET MONITORING REPORTS (Issued January 27, 1999) In this order, we reject the proposal of the California Independent System Operator Corporation (ISO) to amend the ISO Tariff to establish price caps on bids in the imbalance energy market, grant the ISO interim authority to impose purchase price caps, and direct the ISO and the California Power Exchange Corporation (PX) to direct the ISO's Market Surveillance Committee (MSC) and the PX's Market Monitoring Committee (MMC), respectively, to provide them with market monitoring reports concerning the imbalance energy market and to file such Committee reports with the Commission. Background The ISO develops day-ahead and hour-ahead schedules based on nominations submitted to it by the PX and other scheduling coordinators. In real-time, the ISO is responsible for making up the difference between scheduled and actual energy injections and withdrawals in order to ensure that the grid is balanced. To do so, it operates the real-time energy imbalance market. In pre- operational testing, the ISO had determined that its balancing energy software 1/ was defective in that it would compute the market clearing price for imbalance energy based on a dispatch order that was not necessarily consistent with the actual dispatch. Therefore, the ISO proposed a temporary bid price cap, to remain in effect until the BEEP software is corrected. By order issued on May 28, 1998, 2/ the Commission, among other things, conditionally accepted, as modified, a revision to the 1/ That software is referred to as the Balancing Energy and Ex Post Price (BEEP) software. 2/ California Independent System Operator Corporation, 83 FERC  61,209 (1998), reh'g pending (May 28 Order). Docket No. ER99-826-000 -2- ISO tariff that allows the ISO to cap bids for energy imbalance service until the ISO corrects the BEEP software. 3/ In the instant filing, the ISO states that it expects to eliminate the BEEP software problems with new software that will be operational by January 15, 1999. However, the ISO contends that it is necessary that it maintain the authority to cap prices paid for real-time imbalance energy, even after it has fixed the BEEP software. The ISO explains that, as is the case with ancillary services, imbalance energy is a product that it must purchase regardless of the price. The ISO states that its MSC and the internal Market Surveillance Unit (MSU) have concluded that, as in the ancillary services market, it may be inappropriate to rely upon market forces to adequately discipline the price for energy imbalance transactions until some or all of the planned market design changes are implemented. 4/ The MSU and MSC are also concerned that releasing the imbalance market from price caps, while maintaining a cap on ancillary services, may distort one or both markets. The ISO states that a continuation of the bid price cap has been under discussion among stakeholders for some time and that the instant proposal reflects the results of that stakeholder process. The ISO proposes to initially maintain the current bid price cap of $250/MWh until the ISO has completed changes to the ancillary services market, which will be the subject of a filing with the Commission on March 1, 1999. The ISO proposes to raise the bid price cap to $750/MWh after it completes the coordinated changes necessary to ensure that energy and ancillary services markets function effectively. 5/ The ISO further proposes to 3/ The bid price cap is currently $250/MWh. The May 28 Order modified the ISO's proposal to clarify that the ISO's authority to cap bids will not prevent a unit that is actually called upon from receiving a price at least equal to its bid price for that time period for any deliveries it actually makes. 4/ See AES Redondo Beach, et al., 85 FERC  61,123 (1998), reh'g pending. The market design changes were spurred by evidence that the ancillary service markets were not functioning properly. However, the dysfunction in the ancillary service markets is affected by the design of other features in the market, one of which is the unexpected reliance on the real-time balancing function as an alternative to proper prescheduling. 5/ The ISO expects to make those changes by May 31, 1999, but (continued...) Docket No. ER99-826-000 -3- establish a bid price cap of $2,500/MWh, to become effective on October 1, 1999. 6/ The ISO explains that the proposed $2,500/MWh price cap would serve only as insurance against an extreme exercise of market power. The ISO states that it did not treat this issue lightly, but "was convinced by the market design experts, including the independent [MSC] that this phased approach to lifting the BEEP cap is necessary to protect consumers as we gain knowledge not simply about the software flaws, but also about design flaws, in these new markets." 7/ The ISO requests waiver of notice to permit the amendment to become effective as early as January 23, 1999, when the existing cap may expire by its own terms (pursuant to the ISO Tariff, the bid cap will expire 7 days after the ISO corrects the software defect). Notice of the ISO's filing was published in the Federal Register, 8/ with protests and motions to intervene due on or before December 28, 1998. The Public Utilities Commission of the State of California (California Commission) filed a notice of intervention. Timely motions to intervene were filed by Bonneville Power Administration (BPA); California Electricity Oversight Board (Oversight Board); Cities of Anaheim, Azusa, Banning, Colton, and Riverside, California (Southern Cities); Cities of Redding and Santa Clara, California and M-S-R Public Power Agency (Cities/M-S-R); Duke Energy Trading and Marketing, L.L.C. (DETM); Electric Clearinghouse, Inc. (Clearinghouse); Los Angeles Department of Water and Power (LADWP); Metropolitan Water District of Southern California (Metropolitan); Modesto Irrigation District (Modesto); Northern California Power Agency (NCPA); Pacific Gas and Electric Company (PG&E); PSEG Resources, Inc. (PSEG); Sacramento Municipal Utility District (SMUD); San Diego Gas & Electric Company (SDG&E); Southern California Edison Company (SoCal Edison); Transmission Agency of Southern California (TANC); and The Utility Reform Network (TURN) and Utility Consumer Action Network (UCAN) (jointly, TURN/UCAN). 5/ (...continued) it states that the timing of the implementation of those changes is currently uncertain. 6/ The $2,500/MWh bid cap would take effect without regard to whether the ISO has actually implemented the changes that it intends to make by May 31, 1999. See supra n.5. 7/ ISO's December 4, 1998 Transmittal Letter, p. 5. 8/ 63 Fed. Reg. 69,275 (1998). Docket No. ER99-826-000 -4- Houston Industries Power Generation, Inc. (Houston Industries) filed a late motion to intervene. 9/ The California Commission, Clearinghouse, PG&E, SDG&E, and TURN/UCAN support the ISO's proposals. SoCal Edison, LADWP, Metropolitan, Modesto, TANC, Cities/M-S-R, SMUD, and Southern Cities oppose the ISO's proposal to increase the bid price cap above $250/MWh. BPA, DETM, Houston Industries, the Oversight Board, NCPA, and PSEG raise no substantive issues. The intervenors who support the ISO's proposal view the proposal as a reasonable compromise among differing stakeholder opinions. However, some intervenors argue that giving the ISO the authority to impose bid caps constitutes an impermissible delegation of the Commission's authority to set rates. 10/ They further contend that the ISO has not demonstrated that its proposal will result in a price cap that produces just and reasonable rates. Several intervenors argue that: the ISO's proposal for adopting a $2,500/MWh cap leaves too much to the ISO's discretion and does not adequately define criteria for when the ISO would eliminate the cap, or establish a different cap; the ISO should not adopt the October 1, 1999 cap until after it has analyzed summer 1999 peak period market data; and adopting, at this time, a cap to become effective October 1, 1999 requires parties to file complaints under section 206 of the Federal Power Act in the future rather than protests under section 205 if the ISO were to propose the cap at a later date. Several intervenors request that the ISO conform its proposal to the criteria required by the Commission concerning the ISO's ancillary services and replacement reserves. SoCal Edison argues that the Commission should not allow the bid price cap to be raised until there is some certainty that the market is workably competitive. SoCal Edison states that reports by the MSC, the MSU, an audit by Price Waterhouse Coopers, and an analysis by Professor Paul Joskow on behalf of SoCal Edison have all raised significant concerns about structural and operational 9/ Houston Industries explains that initially it was unaware that the ISO's filing had been assigned a new docket number. 10/ Protests of Metropolitan at 13, TANC at 9, Cities/M-S-R at 7. Cities/M-S-R acknowledges that the Commission has held that allowing the ISO to establish purchase price caps for ancillary services and replacement reserves does not constitute a delegation of ratemaking authority. But, Cities/M-S-R claims that the ISO is a massive purchaser of these services with the ISO having the responsibility to obtain these services, when needed. Thus, claims Cities/M- S-R, the imposition of a purchase price cap by the ISO effectively establishes the rate for these services. Docket No. ER99-826-000 -5- flaws in all of the California markets, including the PX's day- ahead market. SoCal Edison argues that these markets are all so closely related that market behavior, structure and other disruptions in any one market can affect the other. SoCal Edison asserts that comparisons with historical prices demonstrate market flaws. 11/ SoCal Edison claims that, in addition to the possibility that the interplay of these markets masks defects in one or more markets, the lack of demand side elasticity, particularly with respect to real-time balancing energy, can exacerbate the market imperfections. SoCal Edison quotes the Director of the MSC as stating, in a November 13, 1998 memorandum, that: there is a current lack of demand elasticity in the real-time market, i.e., ability of buyers to say no by curtailing demand in real time. In most markets alternatives exist such as interruptible contracts, demand-side management, or the ability to hedg[e] against price spikes are available. But these options are not currently available in this market . . . . [12/] SoCal Edison argues that, in the absence of any demand elasticity, customers cannot refuse delivery and, as structured, price discovery in the real-time market occurs after the fact, so that consumers cannot take anticipatory actions to avoid the high prices. SoCal Edison further argues that the Commission may permit unfettered market-based pricing only if it finds that competitive forces will keep prices at a just and reasonable level, and, in this instance, there is substantial evidence that this is not the case. SoCal Edison asserts that, if the energy imbalance cap indeed disciplined the PX price during the 44 hours when the energy imbalance prices reached the $250/MWh bid price cap last summer, and that bid price cap had been $750/MWh or 11/ SoCal Edison argues that before the summer of 1998, it had never paid more than $110/MWh for energy or ancillary services in wholesale markets, and that there were only 5 hours in the prior 5 years when it paid more than $100/MWh. SoCal Edison contrasts that with the summer of 1998 when the energy imbalance cap was triggered at $250/MWh during 44 hours, ancillary service markets hit their caps 415 times, and the PX day-ahead market had prices above $100/MWh during 132 hours. SoCal Edison further notes that ancillary service prices hit their caps during about 60 hours during the fall. SoCal Edison's Comments, pp. 8-9. 12/ SoCal Edison's Comments, pp. 11-12 (citation omitted). Docket No. ER99-826-000 -6- $2500/MWh, the cost to consumers for the 44 hour period would be about $1 billion or $3.5 billion, respectively. Discussion A. Procedural Matters Pursuant to Rule 214 of the Commission's Rules of Practice and Procedure, 18 C.F.R.  385.214 (1998), the notice of intervention of the California Commission and the timely, unopposed motions to intervene of BPA, the Oversight Board, Southern Cities, Cities/M-S-R, DETM, Clearinghouse, LADWP, Metropolitan, Modesto, NCPA, PG&E, PSEG, SMUD, SDG&E, SoCal Edison, TANC, and TURN/UCAN serve to make them parties to this proceeding. In view of the early stage of this proceeding and the lack of any undue delay or prejudice, we will grant Houston Industries' motion to intervene out of time for good cause shown. Our regulations generally do not permit answers to protests. 13/ However, the ISO's and Houston Industries' answers have aided us in understanding the issues, and we will permit them. B. The ISO's Proposals While the ISO's concerns about the impact of market flaws on its real-time imbalance operations are valid, we reject the ISO's proposal to maintain a bid price cap in the ISO Tariff. In the May 28 Order, we approved the tariff-imposed cap as a temporary measure to be removed when the BEEP software defect was corrected. There is no justification for retaining this particular tariff provision once the software defect is remedied. Given that the genesis of these concerns is the same situation as the Commission addressed in AES Redondo Beach, et al., 14/ it is appropriate to rely on the same approach in dealing with those concerns. In AES, the Commission found it reasonable for the ISO to reject bids in excess of whatever price levels the ISO believes are reasonable. After reviewing the initial reports of the market surveillance committees, the Commission found it reasonable for the ISO to continue the purchase price cap until market design flaws that were causing the dysfunction in the ancillary service markets are remedied. The Commission noted that the ISO would be making a filing by March 1, 1999, addressing the problem areas identified by the market surveillance committees, and the Commission directed the 13/ 18 C.F.R.  385.213 (1998). 14/ 84 FERC  61,046, order on reh'g and clarification, 85 FERC  61,123 (1998), reh'g pending (AES). Docket No. ER99-826-000 -7- ISO to address in that filing whether it intends to continue or eliminate its discretion to use a purchase price cap and, if so, the criteria under which it would exercise that discretion in the future. While the real-time imbalance market was not the subject of those orders because it already operated under a tariff- imposed bid cap, we see no reason to adopt a different approach for the imbalance energy market. Imbalance energy is a complementary product which, like ancillary services, the ISO is required to obtain through that market process and cannot refuse on the basis of price without adversely affecting reliability. Accordingly, we direct the ISO to address its concerns about the real-time energy market in the same manner that it is addressing its concerns about the other markets it operates, subject to the requirement that, in its March 1, 1999 filing, the ISO explain and justify its longer-term plans. Until that time, the ISO may adopt a purchase price cap for imbalance energy at whatever level it deems necessary and appropriate. 15/ As in the case of the purchase price cap for ancillary services, the imbalance cap would allow the ISO to limit the prices that it pays for imbalance energy. 16/ Consistent with our orders on ancillary services, we authorize the ISO to waive tariff provisions, to the extent necessary, to implement the purchase price cap. 17/ We reject the arguments that it exceeds our statutory authority to authorize the ISO to impose purchase price caps. As we held in AES, the purchaser has the discretion to reject excessive bids. 18/ As we did in AES with respect to ancillary services and replacement reserves, we solicit the MSC's and MMC's independent views. 19/ Thus, we direct the ISO and PX to direct the MSC and MMC, respectively, to monitor the imbalance energy market with respect to the implementation of the ISO's reforms and further direct the ISO and PX to file the MSC's and MMC's respective 15/ The ISO should post such changes on its WENet page. 16/ The level of the purchase price cap the ISO adopts, if any, is committed to its discretion. We note that this will afford the ISO the ability to select whatever purchase price cap it finds appropriate, including, e.g., the levels established in the ISO Stakeholder process or other levels it believes appropriate. 17/ AES, 85 FERC at 61,463. 18/ Id. at 61,462-63. 19/ Id. at 61,464. Docket No. ER99-826-000 -8- reports with this Commission by October 15, 1999. 20/ To ensure that the final reports are complete, we will direct the ISO and PX to provide their respective Committees with all of the information in their possession that the Committees request. 21/ Furthermore, we will direct the ISO and PX to have their respective Committees prepare comments on the ISO's March 1, 1999 filing, as it relates to the imbalance energy market, independently advising this Commission on the viability of the revised market structure and whether the continuation or elimination of purchase price caps is appropriate; the ISO and PX are further directed to file the Committees' comments with the Commission. The Commission orders: (A) The ISO's proposed amendment to the ISO Tariff is hereby rejected. (B) The ISO is hereby authorized to implement interim actions, with the conditions discussed in the body of this order. (C) The ISO is hereby directed to direct its MSC to prepare a report and comments, and the ISO is further directed to file the MSC report and comments with the Commission, as discussed in the body of this order. (D) The PX is hereby directed to direct its MMC to prepare a report and comments, and the PX is further directed to file the MSC report and comments with the Commission, as discussed in the body of this order. (E) The ISO and the PX are hereby directed to provide their respective Committees with all of the information in their possession that the Committees request, as discussed in the body of this order. (F) The ISO is hereby authorized to waive tariff provisions, to the extent necessary, to implement the purchase price cap, as discussed in the body of this order. 20/ The ISO's and PX's market monitoring and information protocols provide that Committee reports must be made public as filed with the ISO and PX without change. 21/ In the meantime, we encourage the ISO's MSC and the PX's MMC to share their views with the ISO and the market participants to facilitate the stakeholder process to redesign these markets. Id. Docket No. ER99-826-000 -9- (G) The Secretary shall serve a copy of this order on the PX. By the Commission. ( S E A L ) Linwood A. Watson, Jr., Acting Secretary.