When Enron collapsed, electricity markets were prone to gaming and corruption. And, it turns out, they still are. Shrewd energy traders are still at it, discovering and exploiting flaws and loopholes, often at the general public’s expense.
In deregulated electricity markets, limits on transmission lines make prices fluctuate wildly. Utilities try their best to limit price disparities by asking strategically located power plants to turn themselves on and off throughout the day.
The resulting patchwork is like a “whack-a-mole” game in which prices for electricity quickly soar and collapse. Prices can change within minutes by a factor of 300 without warning, or even become negative. In those cases, consumers actually get paid to consume energy.
Because the market is so complicated and risky, rate structures are anything but straightforward and the entire industry is prone to corruption. It’s very hard for utilities to set appropriate rates for consumers when they have trouble predicting their own revenues. Cost volatility also complicates planning for the multi-year investments needed to expand generating capacity.
Consumers would of course be baffled if their power providers rapidly changed their billing rate. To get around this problem, utilities purchase derivatives in the futures market to lock in long-term rates. In this system, banks assume the risks inherent in the price of electricity. It’s just like what happens when you insure your car. You know that you’ll probably lose money over time, but that risk is more than compensated in knowing you’ll be covered if you get into a bad accident.
|Creative Commons image by twicepix.|
These markets are governed by rules too confusing for outsiders to understand. Plus, they change all the time. For example, there are over 50 pending revisions to the more than 1,100 mind-numbing pages of market rules in Texas. These rules are intended to protect the electricity system from manipulation, but often the details provide the very vulnerabilities that energy traders exploit for personal gain.
Traders in the Texas electricity market found a new game they couldn’t lose when they acquired extraordinary quantities of free options between two power plants located at the same site. These options were like lottery tickets that would only pay off if the price of power ever differed between the two plants. Only in this lottery, the energy traders would always win, and win big, because they exploited an obscure rule that artificially changed the settlement price for certain shut-down plants.
Even though the traders didn’t pay a dime for these options and there was no reason for them to be worth anything, the flawed rule made these options extremely valuable.
Traders fleeced the market for $3 million with this scam beginning in December 2010. Luminant and other energy companies had to the pay the bill, ultimately passing these costs to their customers. Two months later the Texas electricity operators identified the scam and fixed the glitch, just as many other traders tried to get in on the action and pocket $20 million.
As of July 2011, Texas still hasn’t forced the culprits to return these funds. Energy traders argue that changing the rules after the fact would open up a Pandora’s Box by making market conditions less predictable and raising risk premiums. Ultimately, they claim, consumers would have to shell out even more money.
The industry’s deregulation created an overly complex and risky market. We all pay the price when energy traders abuse market loopholes, and then we pay again when the authorities try to fix their mistakes. We need simpler markets to ensure that power companies will focus on efficiently delivering electricity to consumers without giving traders opportunities to pilfer funds. Corruption, fraud, and manipulation will persist as long as the market for electric power remains too bewildering to police.
OtherWords commentaries are free to re-publish in print and online — all it takes is a simple attribution to OtherWords.org. To get a roundup of our work each Wednesday, sign up for our free weekly newsletter here.