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Electricity: More than a decade after Enron, how can energy trading companies still manipulate markets?

By Bob Shively, Enerdynamics President and Lead Instructor

Back in the days when Enron was a high-flying energy trading company, energy traders used to joke that when a new ISO tariff came out the trading companies would take their smartest analysts, lock them in a room with a large pizza, and not let them out until they had found all the profitable loopholes.  


Based on the recent stipulation between the Federal Energy Regulatory Commission (FERC) and JP Morgan’s energy trading arm, it sadly appears that such activities still exist[1]. More than a decade after Enron crashed in disgrace, and with the implementation of ISO Independent Market Monitors and FERC’s Office of Enforcement[2], how can energy trading companies still manipulate markets? 


To address this question, we’ll examine some of the strategies JP Morgan is alleged to have used.


One issue for competitive wholesale electric markets is they are inevitably complex, which opens up opportunities for traders to find ways to exploit the rules to increase profits. In the case of JP Morgan, FERC alleges that the company’s strategies crossed the line into market manipulation[3].


JP Morgan controlled bidding on various generating units in the California ISO (CAISO) and Midcontinent ISO (MISO, formerly known as Midwest ISO) market areas. These units were less efficient than other units in those regions, meaning they had higher costs of operation. Consequently, prior to implementation of new bidding strategies these units did not make much in the way of revenues and, in some cases, ran at a loss. Suddenly in 2010, some of these units' daily profits exceeded $120,000. So that you can understand how this can occur, we will give some examples of strategies used to exploit tariff loopholes[4].


First a little background information on CAISO markets:

  • CAISO pays generators the hourly locational marginal clearing (LMP) price based on the energy (MWh) each unit generates. But there are two sets of LMPs — day-ahead and real-time. Day-ahead LMPs are applied to MWh scheduled in the day-ahead, and real-time LMPs are applied to any difference in generation between the day-ahead schedule and actual output.

  • To protect generators from being run, but not covering all their costs, CAISO has “make-whole” mechanisms. One is that generators are allowed to include in their offer a lump sum payment know as Pmin. If the ISO dispatches that unit, the ISO must ensure that the unit receives at least Pmin in payments over the course of the day. Generators that are run during the day but do not make at least their Pmin revenue are given a make-whole payment to raise their daily revenues up to Pmin.

  • A second make-whole mechanism is that units that are dispatched for an operating hour are paid their offer price for the subsequent time required to ramp down when the ISO no longer needs the unit’s power.

  • Units are allowed to self-schedule, meaning they can set a specific operating level they want to be scheduled at and they will take whatever the market rate is for the hours self-scheduled.

  • The ISO’s optimization software works on a daily basis, meaning that generation offers associated with the following day are not included in the software optimization since these offers are not known until the following day.

With this knowledge, let’s look at few of the 12 strategies described in the stipulation:

  • In one strategy units offered a high Pmin, but then offered day-ahead energy at -30/MWh (meaning the unit would pay CAISO for the right to generate). The unit then offered to ramp down in real-time using a real-time price that made it highly likely that CAISO would ramp the unit down to its minimum operating level.  The result was the unit would only generate its minimum amount and would be paid for that at a level approximately equal to $90/MWh (when market prices were typically $30-35/MWh).

  • In another strategy, units submitted self-schedules every third hour, while submitting high prices of $73 to $98/MWh for the next two subsequent hours. The result was that CAISO would self-schedule the units as requested, but then would be obligated to pay the as-bid price for the next two hours as the unit ramped down.

  • In a third strategy, units submitted -$30/MWh day-ahead offers for the end of an operating day. For the next day, the unit submitted offers for the hours between midnight and 2 a.m. at $999/MWh. As with the prior example, CAISO would be obligated under its tariffs to pay the $999/MWh price while the unit ramped down.


What can we learn from this? 

First, it is extremely difficult, if not impossible, to write ISO tariffs that fairly reward generators for their costs while not providing opportunities for excessive profits. ISOs and their members must be continually alert for market participants' manipulating rules (CAISO has since rewritten its rules in an attempt to block such strategies).


And for companies involved in trading, strong processes are needed to rein in traders' proclivity for maximizing profits any way possible. As FERC has pointed out, compliance with tariffs is not sufficient to avoid running afoul of market manipulation statutes. And activities that are perceived to be market manipulation can be very expensive when you get caught. 


As one of my friends who works for a utility told me after attending market behavior compliance training – it is a lot safer for a generator to just offer its true costs and let the market reward units that deserve profitability. But not all companies are focused on being safe!




[1] On July 20, 2013 FERC and JP Morgan’s energy trading arm agreed to a stipulation whereby JP Morgan would pay a civil penalty of $285 million plus give back an additional $125 million of alleged unjust profits. The stipulation concludes an investigation opened by FERC’s Office of Enforcement in response to multiple referrals by CAISO and MISO Departments of Market Monitoring.  The case investigated JP Morgan’s bidding strategies during the time period September 2010 through November 2012 when JP Morgan was responsible for bidding the output of several gas-fired power plants into CAISO and MISO markets.

[2] Under the Energy Policy Act of 2005, the Federal Energy Regulatory Commission (FERC) has strong authority to act to combat gaming of energy markets. FERC is authorized to issue penalties as high as $1 million per day per incident and can also suspend an entities ability to charge market based rates for its services. To assist FERC, each ISO has an Independent Market Monitor (IMM).

[3] For more details on FERC’s case and the specific strategies used, see: Order Approving Stipulation and Consent Agreement, Dockets Nos. IN11-8-000 and IN13-5-000 available at http://www.ferc.gov/EventCalendar/Files/20130730080931-IN11-8-000.pdf


[4] The description of strategies is based on the description in the above stipulation.




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