Economic Withholding by Generators in Alberta’s Electricity Market

Economic withholding is now a questionable pricing strategy for generators to use in Alberta due to the May 26, 2017 decision of Alberta’s Market Surveillance Administrator (MSA) to revoke its Offer Behaviour Enforcement Guidelines (OBEG). Economic withholding has not been expressly prohibited by the MSA, but the revocation of OBEG by the MSA means that the practice is no longer expressly permitted to be used by generators who sell electricity in Alberta’s Power Pool.

The Power Pool is Alberta’s competitive wholesale electricity market where all electricity is priced in real-time using supply and demand principles to determine the hourly Pool Price that generators receive for their electricity.  For more information on how Pool Prices are determined see page #17 of New Opportunities in the Alberta Electricity Market.  The Electric Utilities Act (Alberta) is the primary legislation that governs the Power Pool. This legislation requires that the Power Pool be an efficient market for electricity that is based on fair and open competition.  Accordingly, there is a legal obligation for all electricity market participants in Alberta to conduct themselves in a manner that supports the fair, efficient and openly competitive operation of the electricity market.  This is generally referred to as the “FEOC Principle”. The MSA is the public agency in Alberta that, among other things, ensures that market participants are complying with the FEOC Principle.  It can prosecute a market participant who breaches the FEOC Principle. Accordingly, generators must offer/sell their electricity into the Power Pool in compliance with the FEOC Principle or risk prosecution by the MSA.

The exertion of market power by large generators is something that has always been a concern in Alberta. Market Power is often defined by economists as the ability to profitably and sustainably increase prices above competitive levels. The fear is that large generators will offer, or not offer, their electricity into the Power Pool in a manner that is inconsistent with the FEOC Principle in order to inflate Pool Prices.

The “must offer, must comply” Power Pool rule is designed to mitigate some of that concern.  That rule applies to facilities of 5 MW or more, and requires them to offer all of the electricity that they are capable of generating, and will not consume on site, to the Power Pool.  The rule prevents a large generator (with multiple facilities) from exerting market power by physically withholding some of its electricity in order to increase the Pool Price, i.e. create price spikes to increase its profits. However, the “must offer, must comply” rule does not specify the price at which the generator must offer its electricity to the Power Pool. The only pricing restriction is that the offer price must be more than $0 (price floor) and less than $1,000.00 (price cap).

The “must offer, must comply” rule therefore leaves a generator with the opportunity to exert its market power by offering some of its electricity at high uncompetitive prices in order to effectively “withhold” that electricity.  This practice is called economic withholding – intentionally withholding electricity by pricing it at an uncompetitive price that is above the generator’s marginal costs and opportunity costs so that the market operator is forced to move up the merit order resulting in a Pool Price that is higher than it would otherwise be. For example, a generator could economically withhold a facility’s electricity by offering all or a portion of it to the Power Pool at $999.99, as it would know that, at that price, the electricity will never be the least cost (in economic merit), and therefore never be dispatched. Economic withholding permits a generator with a portfolio of generating facilities in Alberta to increase Pool Prices by embarking on a pricing strategy that involves economically withholding some of its electricity at a particular time to maximize the overall profits it earns from its remaining portfolio of generating facilities at that time.  This only works when the lost profit from the electricity that is economically withheld by a generator is less than the increase in profits earned from the generator’s remaining electricity that is in merit and dispatched and paid the resulting higher Pool Price.

The MSA has historically permitted economic withholding in Alberta. Why?  According to the recently revoked OBEG, the MSA believed that, because Alberta did not have a capacity market, the losses in efficiency caused by economic withholding at a particular moment in time (static efficiency) were offset by the gains in efficiency over time (dynamic efficiency). The longer term dynamic efficiency gains came because economic withholding encouraged additional investment in new and existing generation.  In other words, there was a net efficiency gain by allowing economic withholding.  In non-economic plain English, the MSA believed that if generators were not allowed to exercise market power by economically withholding electricity to increase Pool Prices from time to time then the generators would be hesitant to invest in new generation for Alberta’s energy-only Power Pool.  The electricity market was better off (more efficient) in the aggregate if economic withholding was allowed to occur so that generators could maximize their profits and earn the returns needed to support the development of new generation.

However, after consultation with and despite strong opposition from Alberta generators, the MSA revoked OBEG late last month. It revoked OBEG mainly because Alberta has announced that it will transition from an energy-only market to both an energy market and a capacity market.  The first capacity procurement will occur in 2019 for delivery in 2021.  Therefore, the main reason for expressly permitting economic withholding – to incent investment in new generation – no longer exists because the promise of a new capacity market in Alberta will now, in the MSA’s view, incent new generation.

So, is economic withholding now prohibited in Alberta? No, not expressly according to the MSA, but the MSA’s decision to revoke OBEG made clear that “the MSA will look closely at offer behaviour and efficiency in the context of the legislative framework during the transition to a capacity market.”  This is not a change in the FEOC Principle, but it is a change in the enforcement stance of the MSA when it comes to how economic withholding may be viewed in the context of the FEOC Principle.  The result is that generators need to be cautious and can no longer rely on OBEG as justification for economically withholding electricity.  The MSA has expressed an interest in talking with generators and working cooperatively to provide guidance on different offer scenarios until the capacity market is actually implemented in Alberta.  Any generator developing a pricing strategy for its generation that could be construed as economic withholding should take the MSA up on that offer given the uncertainty that now exists for the practice of economic withholding in Alberta.

For those looking to learn more about economic withholding you should read the excellent article The End of Economic Witholding in Alberta? that Nigel Bankes, a professor at the University of Calgary, wrote here .

KENT HOWIE

Kent Howie is a partner in the Electricity Markets Group at the Calgary, Alberta office of the national law firm Borden Ladner Gervais LLP.  He is the editor of AlbertaPowerMarket.com.

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