Power markets are the new killer app. They are rewarding efficient producers and punishing laggards. Regionally, these markets work well. Nationally, they tend to fall apart. The problem appears to be the transmission lines. There is not enough capacity. Without enough capacity, regional price disparities arise. Those disparities can raise havoc with power generators.
One market that has chronic price disparities is the Midwest Independent Transmission System Operator (MISO). As the name implies, MISO manages the power market for several Midwestern states. But contrary to its name, MISO will soon add some Gulf Coast states to its market and tie into the Texas market.
MISO is plagued by inadequate transmission lines. Several times a week, massive amounts of power become stranded within tight geographic boundaries. When power is stranded, it cannot reach the consuming markets, and regional price disparities emerge. Sometimes those disparities can be dramatic.
For example, last Saturday evening, some prices within MISO dropped below zero while nearby prices jumped above $100 per megawatt-hour. In fact, some of the low prices passed zero and continued dropping until they reached minus $100 per megawatt-hour, while nearby prices climbed above $150. This means a lot of inexpensive power could not reach the market.
Geographic price disparities mean one thing: There are serious constraints on transmission lines, and power cannot move out of the region. Since power must be consumed the second it is produced, bottlenecks pose immediate and serious problems for grid managers.
It also causes problems for producers. Low process means low margins for affected producers. Unregulated producers rely on the power markets for prices and margins. When producers such as Exelon (EXC), American Electric Power (AEP) and Ameren (AEE) have assets caught in MISO's constrained regions, margins become difficult, and operations become unsustainable.
Some claim that the root problem has little to do with existing transmission lines and a lot to do with too much renewable energy. Exelon has been arguing that there is too much wind power in the region that is competing against its fleet of nuclear power plants.
It is a silly argument. First, the market does not care if the power was produced by renewable energy or nuclear energy. Power is power, and it is fungible.
Second, if the region's delivery systems were adequate, there would not be locational price disparities. The problem is transmission line capacity.
There are four solutions. One is to do nothing. Doing nothing would motivate producers such as Dominion Resources (D) to exit MISO's market. If enough producers were to exit, local supplies would ultimately meet local demand, and prices would stabilize.
The second option is to build new transmission capacity. American Energy Power, Duke Energy (DUK) and ITC Holdings (ITC) see building and owning new capacity as a profitable business. Today, they are investing in new transmission projects by adding capacity within MISO and other markets.
The third option is to encourage distributed generation. By distributing generation across the market, production is not concentrated in tight areas, and production is near consumption.
Solar power is an example of distributed energy. Solar panels can be added in regions that are near consumption. Since solar produces power during peak periods of the day, it acts as a natural peaking facility, it reduces the need to dispatch peaking plants, and it reduces the demand on transmission lines.
Fuel cells are another form of distributed power. Using natural gas as fuel and efficient production technologies, power from fuel cells is often consumed locally. Better, local generation avoids transmission costs, and as such, it becomes competitively priced.
The fourth solution is to encourage deployment of demand-response programs. Demand-response programs like those offered by Exelon and EnerNOC (ENOC) motivate consumers to react and respond to market conditions. As market prices increase, consumers should react by consuming less. By providing consumers with market signals, demand-response not only reduces demand on power generation, it also reduces demand on transmission lines.
The key to power markets is locational marginal pricing. Unlike other energy markets, power markets provide hundreds of simultaneous prices that are spread across a geographical region. When the geographic prices differ, the market is signaling a problem and an opportunity. That problem and an opportunity will motivate market participants' behavior.
As a killer app, the power market creates interesting opportunities beyond setting energy prices. It also creates new opportunities for distributed power and demand response. Because they take advantage of market prices, distributed energy and demand-response become second-generation killer apps.