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A Movable Feast

This is a picture of my daughter, Miles, with all the “critters” of the house surrounding her. Perhaps our two mutts and cat can sense she will be leaving soon. It’s mid-August and my daughter is getting ready for her first year of college. My son will soon begin his second year of matriculating. It will be a quiet house; my wife and I will move into the next phase of our life. We’re still “parents” but it will be different. I can’t help but be a bit melancholy at the prospect of this new life. I know it has possibilities that were unknown to us the last 19 years, but I will miss those kids.

Fortunately, the summer has been so busy with meetings (Western NARUC), settlement meetings (RA in California), WPTF Roundtables (Portland and DC), and the WPTF Summer Meeting (Tahoe) that I have barely had time to ponder the changes about to occur in my life what with all the changes that seem to be washing over our industry. We all know that many policy makers are pushing for drastic changes in how electricity is generated and consumed. But it was a sea change when an article appeared in the Wall Street Journal last month announcing that Shell will be radically changing its business to get out of the processing of hydrocarbons and with an eye to becoming the largest trader of electricity. Allow me to underscore the fact that Shell is not the owner of the production of electricity here, but the trader of the commodity.

Why would Shell – one of the oldest oil companies in the World, the agent for the first exploitation of Middle Eastern oil at the behest of the British Royal Navy – tilt toward the peddling of power? They’ve always been a trader of energy products, but this is a big push of chips to the middle of the table that contemplates selling stuff without first producing it. It appears to be a play that is rooted in the bet on the electrification of the economies of the developed world.

The Start of a Real Market?

In this scenario, many homes, businesses and communities will have access to their own renewable and distributed sources of electricity. But the sale and movement of this power to the grid to share elsewhere, combined with some wholesale sources of power will need a broker – or several brokers. Such a future could begin to look like the early days of commodity exchanges London, Amsterdam, New York, Chicago, Shanghai, Bombay (now Mumbai), Singapore.  These, among others, were the original marketplaces where products from many small producers were collected by the few large players. These large players, of course, were the ones with capital to sell the products to those who required an extension of credit to purchase.

But aren’t these the functions of ISOs and RTOs? Well, not really. These vital institutions are necessary to keep the “roads” of transmission open and functioning. In this new world view, the RTOs would keep the grid open for the movement of energy from many smaller producers of power to willing buyers and sellers. In this impending reality, the power trader is like the brokers gathering outside Lloyds of London, the British East India Company, or the Buttonwood Tree on Wall Street to buy and sell differentiated electrons to each other. Having the “balance sheet” and credibility to buy and sell large quantities, they can buy from small producers and extend credit to those wishing to buy.

This is how other commodity markets began: those with means competing to buy and sell a commodity from farmers, small farmers with product to sell without the means to move products on their own. These producers needed a big “middle person” to provide the liquidity necessary to pay one producer for a sale while extending credit to a consumer for payment later. We didn’t have this in the electric market at first because – goes the theory in this scenario – the industry was dominated by large, well-capitalized utilities who had little need of a broker.

But those who prophesy that the future is one of distributed generation and thus of near zero marginal costs don’t often realize that in most times of consumption, the power that is produced may not have an ability to be consumed in the same area. There will be needs for power to be moved somewhere toward scarcity to help keep the lights on. If the view of many small producers and consumers without expertise in power management is realized, a “broker” with a strong balance sheet and talented people and algorithms will be needed to ensure the delivery of this essential product.

This world view is a real possibility. But if we move in that direction, we may finally have to treat the power market like any other commodity market. We will have to tolerate brokers making money by using their balance sheets, extending credit. We will even have to tolerate them losing money, laying off talent which goes somewhere else and provides for competition to keep innovation moving forward.

Time for a fresh look…

What am I saying? Well, the organized power markets we now know are the only commodity markets in the world that have interventions – we call them mitigation – before the market clears. We measure whether a market is competitive over hours or days. In other markets, pricing anomalies and measurements of “market power” are measured over weeks, months, or even longer before a regulator might intervene. The latter measurement is based on the “anti-trust” standard, whereas in the power business we use a “just and reasonable” standard that should be flexible enough to tolerate high and low market pricing. In practice, though, this regime keeps prices looking like they did the day before, the summer before, the way it looked “back in my parents’ day”.

ERCOT – the power market for most of Texas – has just gone through a week of extremely high prices. It was hot, and the market for power generation had very little surplus (5-9% above estimated peak). Prices shot up toward $9,000/MWh. ERCOT was designed to be a market that relied upon prices to determine investment. This is very different from all other organized markets in the US where capacity purchases above the amount of “load” one is expected to serve are mandatory. ERCOT margins being razor thin had the expected price outcome with prolonged heat. Will regulators – even in Texas – have the fortitude to let the market work as intended?

Here is how a normal commodity market is supposed to work: Scarcity = Volatility/high prices. High prices are supposed to = investment. UNLESS, regulators or policy makers create uncertainty by even hinting at intervention. Then, uncertainty = money going elsewhere.

If the world is moving toward a disaggregated power future, the players in it may not have the platforms (large utilities) left to act on their behalf at the direction of enlightened regulators (the “Philosopher Kings”). If the load continues to migrate away from utilities as it is in California, buyers will likely need brokers to buy, package and sell to many disaggregated buyers. But for this to work, they need a competitive market. A real one.

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