Wholesale Price Spikes: June 1998
"People are scared about Thursday and Friday."
Imagine opening your home electric bill and finding you owe $5000. Customers in parts of the American Midwest might have faced exactly this situation this past summer if astronomical prices paid for wholesale electricity had been passed on to them. The events of the last week of June 1998 shook the power industry like an minor earthquake. As of this update, there has been a Congressional hearing, an investigation by the Federal Energy Regulatory Commission (FERC), firings, corporate reshufflings, law-suits, and re-evaluations of how best to proceed with restructuring.
Here, briefly, are the facts as currently known: from 24 to 30 June 1998, the wholesale price of electricity in the Midwest and, to a lesser extent the South, became very unstable. Prices which usually averaged from $25 to $40 per megawatt-hour (mwh) soared to record highs. Recall that electricity prices fluctuate in response to constantly fluctuating demand.
During that particular week however, prices climbed into the thousands of dollars per mwh at times of peak demand. The highest price paid for wholesale electricity was reportedly around $7,500 per mwh by one company on June 25. On June 30, according to EnergyOnline Daily News, "Commonwealth Edison [Chicago] at one point paid $4 million for $100,000 worth of power."
Residential consumers were untouched by these prices because the retail price of electricity is still regulated, and the wholesale Price Spikes could not be passed on to consumers by electric companies. Causes of the unprecedented and unexpected price spikes are still under investigation, but it seems that several factors combined to create the situation:
Any one of these factors might not have been serious, but when they all occurred, the overall situation became critical. As Fitch IBCA (a corporate rating service) noted in a recent report: "The U.S. wholesale power market in late June 1998 provided a real-time stress case that allowed many market participants to test the effectiveness of their risk management procedures and practices. Many participants were woefully ill prepared."
An active market for wholesale power contracts has been operating since FERC Order #888 opened transmission grids to parties other than the grid owners. Buyers and sellers base their decisions on many factors, one of which is forecasted weather, since air conditioners consume a lot of electricity. Power companies were not expecting 100o temperatures in late June, and many had scheduled routine plant maintenance for this time. As the temperature rose, the demand for power rose along with it. Utilities brought their reserve generators on-line and regional transmission grids began importing power from neighboring grids. Electricity supplies were finite, however, and limits on transmission capacities restricted flows. Basic supply & demand economics took hold -- unregulated wholesale prices climbed.
On Monday, June 22, power sold between $100 and $300 per mwh in the Midwest and in the South at times of peak demand. Peak prices the previous Monday had ranged between $30 and $50 per mwh. As demand surged, Ontario-Hydro curtailed power transmission through their grid due to Loop Flow problems.
The North American Electric Reliability Council (NERC), established in the wake of the 1965 Northeast Blackout, oversees grid reliability. They had recently developed a new system of Transmission Loading Relief procedures which allowed grid operators to cut power transactions if destabilizing power flows occurred. Traders began to sit up and take notice. One told industry publication, Megawatt Daily, "People are scared about Thursday and Friday."
On Tuesday, June 23, peak prices approached $600 per mwh, more than ten times normal. Power-marketer Federal Energy Sales reportedly began warning customers they would be unable to deliver power due the following day. Power-marketers sell electricity weeks or months in advance of scheduled delivery. If the power is not available when the delivery time arrives, they have to buy power where they can and pay market rates.
Many marketers do not own generating plants. In ordinary circumstances, they might shrug-off a loss and try to recover it the next day. With prices climbing rapidly, however, marketers needed massive capital reserves in order to pay the high rates. Federal, and later, Power Co. of America and others apparently just ran out of money.
These defaults had a domino effect, as companies "downstream" from the default found themselves, in turn, unable to deliver. City Water, Light and Power, the municipal utility of Springfield, Illinois became one such domino. Prices continued rising, prompting a trader's remark to Megawatt Daily, that "[anyone who] sold $170 today [and bought at $128 yesterday] would've made $1.5 million in one day. You could've built a [generating] unit for that."
Wednesday the 24th brought the situation to a boil. Temperatures remained high and a scramble ensued among companies which had expected to receive power from defaulted suppliers -- especially those with commitments to resell the power to other utilities (a practice referred to as "sleeving"). Prices broke $1,000 per mwh as accusations began to fly that some companies were "gaming the system" by refusing to honor $40 mwh contracts so as to cash in on the high-prices.
That evening, a tornado hit the 900mw Davis-Besse nuclear power plant in Ohio. While the reactor sustained no damage, the plant shut-down as a precaution. Storms also knocked out several fossil-fuel plants and transmission lines throughout the region. The situation neared crisis level. Prices on Thursday the 25th exceeded $5,000 per mwh, reaching a high-water mark of $7,500 at one point.
Many industrial customers take advantage of "interruptible-power contracts." They receive a discount on their electricity bills in exchange for allowing the utility to cut their power first in an emergency. Affected utilities began cutting power to these customers, two of which, Ford Motors and Honda, closed assembly plants as a result. Commonwealth Edison, Illinois Power, American Electric Power, Consumers Energy and many other utilities issued urgent appeals for all customers to conserve energy to prevent the need for "rolling blackouts."
The Pennsylvania-New Jersey-Maryland Interconnection (PJM), which had been exporting substantial amounts of power into the Midwest grids, declared a state of "maximum emergency" at 11am and began curtailing power exports. The problems on the Midwest grid were creating instabilities in the transmission system, and PJM's Susquehanna #2 nuclear unit had tripped off-line on Monday with a minor problem, which reduced their reserve capacity. With the hot weather moving east, PJM wanted to take no chances. Unfortunately, this made the situation in the Midwest that much worse. Another line of thunderstorms moved through the region that evening.
On Friday the 26th, EnergyOnline reported, "more than 20 Midwestern and Canadian nuclear power units are unavailable ... and several fossil-fueled power plants are off-line either for scheduled maintenance ... or unanticipated repairs." However, with operational plants running at full capacity, conservation measures beginning to take effect, and temperatures starting to moderate, prices began moving back toward normal levels - topping out this day around $2,500 per mwh.
This moderating trend began none too soon. Around 9:00 pm on Saturday the 27th, one of two nuclear units at Quad Cities (in Cordova, Illinois) went down with a switch failure. Lightning hit the second unit about eight hours later and it tripped off-line. Though no lasting damage occurred and both units returned to service within a week, a total of 1620 mw left the system.
The temperature continued falling to levels normal for June, demand and prices fell, and the investigations commenced. The legal and financial ramifications of the June Price Spikes are still playing out. What no-one doubts is that this episode has served as a major jolt to the entire industry. A few of the short-term affects have been:
For the short term, most power professionals are treating the Price Spikes as a learning experience. Plans are in the works for the summer of 1999, since any new power plants or transmission lines that might be built cannot be operational so soon. Futures-contracts in the Cinergy and Entergy grids are already selling at over $100 per mwh for next July and August. Some experts are predicting a recurrence -- others say it was an event unlikely to happen again.
In terms of the overall course of restructuring, the insiders seem to agree with Senator Frank Murkowski's view that, "These price spikes are neither a green light nor a red light on the road to competition. They are a yellow light. They tell us to proceed with caution."