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Archive for February, 2013

The California PUC has upheld refunds for electricity consumers for electricity market manipulations dating back to the Enron era. And it took only 13 years.

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Every Thursday at 10:30 a.m. EST, the Energy Information Administration releases the weekly gas storage/injection/withdrawal figures. This data affects the price of natural gas in markets across the country. The WSJ reports that this has now become the domain of high-speed traders, and the Commodities Futures Trading Commission is investigating large price swings that preceded the EIA announcements by seconds (or fractions of seconds). High-speed traders make money on volatility, not fundamentals. Maybe there wasn’t enough volatility, so they decided to create some of their own.

This is much less amusing than it sounds since those swings affect the price of natural gas paid by end-users every day, as well as the price of electricity in markets in which that price is set by natural gas at the margin.

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The Illinois Renewable Portfolio Standard is a broken mechanism. Recently, the Illinois Solar Energy Association posted a webinar on Fixing the Illinois Renewable Portfolio Standard which explains how this happened and what we can do to remedy the situation. Your humble correspondent provided the voice-over, so now you can hear as well as read me. You can see the webinar (and listen to moi) here. Once you’ve seen the webinar, please pursue the recommended action steps that you can take to help make renewable energy a reality in Illinois. (Your great-grandchildren will thank you for it.)

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Years ago the Virginia state tourism agency’s campaign slogan was “Virginia is For Lovers,” which was the wind-up for ads filled with golf courses, elegant seafood dinners and couples walking hand-in-hand on some sandy beach at sunset. But if you’re interested in mining uranium in Virginia, stay home.

Last Thursday, the sponsors of a bill to lift Virginia’s 3-decades old ban on uranium mining pulled the bill just before it was to go to the state senate’s natural resources committee, where it was sure to be defeated. There’s a farm outside Chatham, Virginia that’s sitting on an estimated 119,000,000 pounds of uranium oxide, the largest known undeveloped uranium deposit in the U.S., said to be worth at least $7 Billion.

A coalition of environmentalists, municipal leaders and farmers (presumably excluding the farmer sitting on all that uranium) opposed the legislation lifting the ban, which was being pushed by Virginia Uranium, Inc.  Their concern is that uranium mining would endanger the environment and the water supply. The bill’s sponsor said that any radioactive pollution at the mine could be contained, and he was frustrated that he was unable to convince his colleagues that uranium mining can be done safely and economically in Virginia.

Virginia is an example of the Deepwater/Fukushima Dividend at work. The public no longer believes that government regulators, much less the energy companies themselves, are credible.  This comes at a time, after the Wall Street-driven financial meltdown, when Americans’ confidence in public institutions has fallen to record lows. That Virginia is either a “purple” or “red” state doesn’t matter that much if voters think that their drinking water will be giving them and their children cancer in a few years.

In the Deepwater Horizon case, the regulators were (literally) sleeping with the regulated and sharing illegal drugs. The contractors on the Deepwater Horizon drilling rig cut corners on cementing the well and other safety measures because the rig was costing them $525,000 a day to rent from Transocean, and the project was already $58MM over budget. Those were the considerations driving operational and safety decisions on the Deepwater Horizon. The amounts are laughable when compared to tens (if not hundreds) of billions of economic and environmental damage done to the Gulf of Mexico from the worst oil spill in the history of the United States. Even during the height of the oil spill, BP claimed falsely that the oil leaking away a mile below the surface was only a fraction of what government officials were estimating.

Those steps are not well-calculated to inspire confidence.

Fukushima and its surrounding region learned the real meaning of Japan’s “nuclear village,” a euphemism for the state of regulatory capture in which the country’s nuclear regulators would leave the agency, usually in their 50’s, and take a nice cushy job at Tokyo Electric Power Company that paid far above what they earned working for the government. There was even a name for it: amakudari, or “ascent into heaven.” The ascent of these bureaucrats was, of course, not as momentous as that of the radioactive plume that contaminated a large swath of Japan’s countryside north and west of the Fukushima plant. If you think regulatory capture happens only in Japan, think again.

The fact that the Virginia bill’s sponsor said it would take a few more legislative sessions to get the ban lifted shows that the energy industry has not yet come to grips with the effects of Deepwater Horizon and Fukushima.  They have a lot of catching up to do, and if the public believes that government watchdogs will soon become industry lapdogs, it’ll be long time before that farmer in Chatham gets a warm glow from all that uranium under his land.

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You may have thought that Enron was dead and buried, but that would not be quite right. FERC’s levy of a $1.5 million fine on Deutsche Bank Energy Trading, LLC for manipulating the California wholesale electricity market  shows not only that hair and nails continue to sprout on Enron’s putrescent corpse, but that Deutsche Bank is not above raiding the tomb and scurrying off with a few clippings. After all, if you can no longer rig LIBOR, you may as well see what you can do in the energy markets.

First off, electricity is not the only commodity traded on an electricity market. In addition to the market for commodity electricy supply, an independent system operator like PJM Interconnection or the California Independent System Operator (CAISO), where Deutsche Bank was a player, also runs markets for capacity, ancillary services, and financial transmission rights (FTRs), which are rights to use the transmission system on which that electricity flows.

Just like a highway, every transmission path has a certain capacity, a limit on how much electricity it can carry before it becomes overloaded. And, just like a highway during rush hour, there are peak times when many generators and power marketers are trying to send electricity to serve their customers. Things get backed up, a condition referred to as congestion. During these peak times, FTRs are like passes to the express lane. In the CAISO market, they’re called Congestion Revenue Rights, or CRRs.

Every day, CAISO schedules the delivery of electricity to serve the load in its control area (native load). If CAISO schedules power from outside its control area to serve its native load, that’s an import. Conversely, if CAISO schedules power from generation within its control area to serve load outside, that’s an export. Congestion can occur in one direction but not the other at a given interface between two control areas (an intertie or flowgate). Imports may be congested while exports may not be, just like the north- and southbound lanes of a highway. If imports are congested but exports aren’t, scheduling an export at that intertie (a counterflow) will relieve some of that congestion and would entitle the scheduler to be paid for doing so.

If a transmission path is congested, like any other commodity for which demand increases when supply is unchanged, the price goes up. To protect itself against such unpredictable price increases, a generator may purchase FTR’s or CRR’s for certain hours (e.g., peak or off-peak), and a transmission system operator like CAISO may hold auctions for just this purpose. A CRR may be purchased by a generator or power marketer as a hedge, or even by a purely financial player as a speculative investment. The owner of the CRR at a congested intertie can make a profit by selling it to another market participant.

During the California energy crisis of 2000-2001, Enron ran a scam called “Death Star” based on an abuse of the electricity trading rules of CAISO. (Enron’s traders had other electricity trading scams with equally sophomoric names like “Get Shorty” and “Fat Boy.”) Enron’s goal was to get paid for appearing to have relieved congestion at an intertie by scheduling electricity in a direction opposite that of the congestion. However, it was nothing more than an appearance: Under Death Star, Enron neither put power into the grid nor took it off. To pull this trick off, Enron would arrange for transmission of power in the same direction as the congestion, but along a transmission path not controlled by CAISO. Like paired long and short futures contracts, the two transactions would offset each other, meaning that Enron never had to put a single kilowatt of power into the system. But because CAISO was not aware of the offsetting transmission outside its control area, it couldn’t see the scam in Enron’s scheduling. Enron’s trades existed only on paper, but its impact on the California electrical system was real enough. It raised the costs paid by other market participants, and trades such as this caused CAISO to call a Stage 2 Emergency in December 2000.

Back to Deutsche Bank in 2012. Deutsche Bank’s traders determined that CAISO’s intertie at Silver Peak, California, which connected to another transmission system run by Sierra Pacific Power (SPPC), was historically congested in the export direction, so they built up a position in export CRRs at Silver Peak. This meant that if Silver Peak continued to experience export congestion, Deutsche Bank’s export CRRs (the right to use export transmission at a fixed price that was much lower than the congested price) would become much more valuable. However, if Silver Peak became import, rather than export congested, those export CRR’s would decline in value. For most of 2009, they guessed right and made about $5 million in profits on CRRs. So far, so good.

Then CAISO “derated” (i.e., partially shut down,) flows in the import direction at Silver Peak for substation maintenance, and reduced export flows. This caused import congestion, and Deutsche Bank started to lose money on its CRR’s.

Deutsche Bank decided to solve this problem on its own by exporting power from Silver Peak to the SPPC system in order to reduce the import congestion. However, Deutsche Bank didn’t have a customer to export the power to. Not to worry. Borrowing the Death Star strategy from Enron, Deutsche Bank just scheduled an equivalent amount of power from SPPC’s control area into CAISO at a different intertie called Summit. Deutsche Bank lost money on every one of these trades, but that didn’t matter because its purpose was to neither serve load nor make a profit. Its only goal was to preserve the value of its CRRs by making it look like congestion had been relieved at Silver Peak.

Deutsche Bank’s ploy to preserve the value of its Silver Peak CRRs was so successful that it started to make a real profit on them. In fact, its paired, imaginary export-import trades were so lucrative that it increased its Silver Peak export CRR exposure, even though that intertie was still derated. Deutsche Bank only stopped when the CAISO market monitor finally learned what was going on and confronted them.

Ultimately, FERC imposed a civil penalty of $1.5 million plus disgorgement of profits for this market manipulation. That might sound like a lot, but Deutsche Bank’s 2011 net revenue was Euro4.326 Bn (USD5.883 Bn, based on a $1.36 exchange rate). FERC’s fine is about 0.00025 of what Deutsche Bank made that year, net. So, while FERC may view its fine as a deterrent, Deutsche Bank more likely views it as a rounding error.

What’s also striking is the utter lack of originality of Deutsche Bank’s scheme. If you’re going to manipulate a market, at least be innovative about it, especially if you bill yourself as a high-flying financier that purports to offer “unparalleled financial services throughout the world.”

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