Fortnightly
PoolCo vs. Bilateral Markets
January 01, 1995Ashley Brown
Ashley Brown
Executive Director Harvard Electricity Policy Group
I favor both a centralized pool that dispatches generation as well as the setting of real-time spot prices. I also strongly favor the formation of markets that separate the financial instruments from product delivery, a more probable outcome of implementing a pool than of a bilateral model.
Ten years as a retail regulator have left me with a prism through which to view fundamental policy choices. This vision is characterized by the "Three E's": efficiency, equity, and expectation of service. On each of these "E" counts, the pool model is more attractive.
On the efficiency issue, the pool model results in the least-cost generators being dispatched first and selling at the highest margin. Moreover, the dispatch order is simple and unaffected by a large number of individual contracts. Though some argue that simplicity may deprive the market of the full benefits of clever buyers or sellers, it nonetheless rewards efficient producers and puts the inefficient at the highest risk. Significantly, by employing real-time prices, the pool does, in fact, reward the most clever and nimble of producers and users as well. Also, the separation of the contracts and dispatch function in the pool provides enormous opportunities for entrepreneurs and others to devise instruments that capture potential benefits for actors in the marketplace.
On the equity level, the bilateral market is somewhat more troublesome from the perspective of distributing the benefits of com-petition. While markets are inherently tilted in favor of big players and those with sufficient interest and ability to play the niches, the transition to a competitive retail electricity market after years of monopoly will be difficult if the flow of information is restricted and nontransparent \(em an almost inevitable, perhaps even defining, result of a bilateral market. In that event, the benefits of the change to competition would be limited to a powerful subset of customers rather than being more widely spread among all classes. The lack of transparency and inadequate flow of information will likely lead to significant upward pressure on the rates of captive, small customers while concurrently reducing the rates of large consumers. That would constitute a very likely prescription for political backlash and other complications. Such divergent pressures on different classes of customers may be exacerbated in those jurisdictions that have rate structures that subsidize residential customers, but the basic reason for the disparate pressures is the virtually irresistible temptation on the part of enterprises engaged in both competitive and noncompetitive markets (a fact of life in electricity, at least during the transition) to extract the maximum rent from captive customers in order to optimize one's position in competitive markets.
With regard to expectations, the pool market tends to conform more to the experience of customers because the dispatch function and the reliable flow of electrons are completely independent of the contract flow of dollars. Disputes over service quality, reliability, and the like are resolved independently of whether the lights go on when the switch is flipped. That is entirely consistent with the experience and expectations of American consumers of electric power, and makes the transition to competition less disruptive. That is not to suggest that a well-coordinated bilateral market would inherently compromise reliability, but rather that it would unnecessarily complicate matters. While such change may be, to some degree, inevitable in the long run, the transition need not be inordinately complicated, particularly where the benefits of such change are less than clear.
Notwithstanding my preference for the pool model, I must note that many of the benefits from a bilateral market can be blended quite comfortably into a pool arrangement. The pool, for example, is greatly enhanced by the existence of auxiliary or associated markets comprised of a variety of bilateral contractual arrangements (such as contracts for differences). Moreover, any system that segregates operations from the flow of dollars holds out the promise of an array of bilateral transactions that will enrich the marketplace. t
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