The Dogs that Never Bark
and the Second Coming
A NETWIT special report
Within days of sending our latest analysis to NIH, an op-ed piece appeared in the Notional Pest jointly authored by one Michael Trebilcock. Dr Trebilcock modestly does not report that he was, according to our sources, the Director of Research for Ontario's Market Design Committee (MDC), which, despite the subsequent demurrals of some of its members, was undoubtedly the greatest single influence on Ontario's Byzantine electricity Market Rules, the keeper of which is now the Independent Market Operator (IMO). It is not surprising, therefore, that his analysis of Ontario's woes lines up with the rest of the True Believers: the failures are a result of "not going far enough" to respect the free market vision of the MDC.
What is surprising is his apparent lack of understanding of the basics of how bulk electricity systems work in general and of some of the key specific features of the "market" he helped to design.
The piece notes that natural gas fired units cannot be expected to run for less than about $60 to $65per MWh (megawatt-hour, a thousand kWh) and that the overall market average price is roughly the same. Readers of our other piece will know that it was $62. The article implies that the "market" has settled at the average price of the "marginal generating type" - natural gas. To those who don't understand the merit order dispatch principle (explained in previous pieces, and below) that has governed modern central bulk power systems for 50 years or more, with or without "market" shenanigans, this sounds plausible.
Let us briefly recap how this works. For each hour the system operator (the IMO in Ontario's case) forecasts electrical load and picks from the "stack" of available generating capacity enough to meet that load plus a "reserve margin". The stack is ordered according to cost, with lowest cost units at the bottom. This is the "merit order" principle. The units are then "dispatched" - ordered on or off - for each hour, taking into account their ability to increase or decrease output ("ramp") at different rates and various other technical parameters. The last unit required to meet load for each hour is the "marginal" unit.
This point is crucial for understanding the difference between the old system and the so-called market. Under the old despised Ontario Hydro (OH) monopoly the cost of production for each hour was simply the sum of the costs of all of then dispatched units. Under the new system, the IMO runs an auction and selects the lowest "offer" to meet load and everyone gets paid the offer price of the last or marginal plant. Applying this knowledge we can now unravel the deceptions hidden in the Trebilcock piece.
For the market average price to be about the same as the cost of electricity from natural gas the natural gas plants would have to be "on the margin" for every hour, unless there were some higher-cost supply. In reports available on the IMO websitethe production of electricity is given for each plant in Ontario, at a six month lag. From this we can see that natural gas units provided only about 8% of the energy from May to October. The largest gas plant is the Lennox plant, owned by Ontario Power Generation (OPG), which had a "capacity factor" of 13% (the ratio of actual output to maximum output). This must mean that Lennox, which has 2GW capacity, was only dispatched a relatively small number of hours when load was very high and it is highly probable that for most of these hours it was the price-setting or "marginal" plant.
In our companion piece, we show that prices for capacity dispatched only when load reached 21 gigawatts (GW) or higher are different for the period before Bill 210 than after by a degree that can only be explained by chance at a high level of improbability. This is the range of load in which a "peaking" plant like Lennox operates. The average prices in the two periods were $124 and $107 per MWh, for a rough average over the year of about $115. Note that this is not close to $60-65, the marginal cost of gas fired plants, according to Trebilcock. In fact, we can say that OPG must have been offering Lennox to the IMO at roughly double its marginal cost of production. This is how Ontarians are being doubly hosed by the fake market. It would be bad enough if Lennox alone were paid double what it would have cost if it were still under OH. It's much worse that all of the other plants dispatched at the same time, with much lower costs, also get paid $115 or so instead of their own marginal operating costs. That's how Ontarians ended up paying about $3 billion more for generation than they would have had OH not been broken up.
In an amazing schizoid argument, Trebilcock goes on to say that despite this, there's no evidence of market power abuse, yet the long-term solution is to divest more plant to prevent market power abuse!
One of Sherlock Holmes' famous cases involved the dog that didn't bark. It didn't bark because the interloper was its owner. Similarly, the Market Surveillance unit of the IMO didn't find any market power abuse because that would greatly displease both the Board of the IMO and the government. The same is true of the other competition watchdogs. There's simply no way that a "free market" would allow the price to be set at twice marginal cost (for the hours in which Lennox must have set the price).
The byline for Trebilcock's piece highlights the idea that government policy is solving non-existent problems: the "market" is working fine (if it's allowed to, with some "tweaks") and the government's intervention is misplaced. We agree the government intervention is misplaced but the entire restructuring policy was an attempt to fix a problem that didn't exist. The problem, defined as too-expensive electricity, was a myth. Ontario's previous regime was as cheap as could be achieved for the levels of reliability that seem to enjoy broad consensus. Restructuring could only make it more expensive and less reliable - and it has!
This is not to say there wasn't a problem. There was but it was a different problem. The real problem was that the Hydro monopoly system would always be a dead hand resisting technological change that otherwise would occur and should occur. Centralized grid electricity uses very mature technology that is highly optimized, the long run costs of which have been slowly but steadily on the rise for 30 years. In contrast, small-scale "distributed" generation and energy efficiency employ a wide variety of technologies whose costs are falling and can only fall further, especially with mass production. Thus, inadvertently, an opportunity has been created.
The opportunity is to move Ontario's electricity system onto a long term path that emphasizes small, predominantly renewable energy "distributed" generating sources and energy efficiency. In this vision by mid 21st century the central grid system would function as a cheap reserve, powered only by the hydraulic plants (about 40 terawatt-hours - tWh - a year; a tWh is a million MWh). The nukes and fossil plants would all be retired. Total load would be perhaps two thirds of the 160 tWh now consumed. This system would cost no more in conventional dollar terms than a projection of the current system to perhaps 200tWh of largely-centralized power and its environmental impacts magnitudes less.
Advocates of restructuring have tried to claim that their vision is somehow compatible with this alternate vision. It's impossible to completely refute such claims but let us make two points.
First, they're in love with the idea of the centralized operator acting like the "Walrasian auctioneer" (described in Economics for Humans, part 4) beloved of the wild-eyed economic theorists who have captured and driven the restructuring agenda. Their record is consistently to advocate regulatory policies that prop up the centralized "market" systems. For example, despite the obvious inconsistency with the canons of economic theory that they otherwise advocate with passion, the restructurers favour systems that make new distributed generators pay for the grid, thereby much reducing their current financial viability. Second, just reread our capsule comparison above; it's simply wildly implausible that anyone can simultaneously pursue paths that lead to such radical different outcomes in the far future.
Unfortunately no-one in Ontario has clearly articulated this choice yet. As the restructuring debacle continues to unwind and the contradictions inherent in all political parties policies become apparent, we must hope that Ontarians will start asking the right questions. For example, all parties now seem to be in favour of closing the coal plants, although their timing varies. Yet their views on how 5GW of capacity will miraculously appear to replace them (in the difficult and crucial "intermediate load" part of the system) are hopelessly vague. In fairness, the NDP takes some steps in the direction we favour but appear to be fuzzy about how to marshal a coherent strategy and are focusing on the issue of public ownership.
Our answer is clear. Begin setting up the institutions that will radically lower load through efficiency while bringing on line thousands, tens of thousands of small distributed generators powered by wind and sun. This will not happen through tinkering with tax breaks and the "let's pretend" IMO market. It will take time and determined commitment. Ontario needs nothing less than a powerhouse public institution, backed by Provincial resources, that champions energy efficiency and distributed generation in the same way Adam Beck and the original Hydro-Electric Power Commission of Ontario (HEPCO, later Ontario Hydro) championed the "people's power". Arise Sir Adam, your Province needs you!
The Dogs that Never Bark and the Second Coming
© Coolth, 2003Posted June 5, 2003
