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New York City's chronic shortage of power plants was relieved this year when two new, state-of-the-art generators came online, boosting local generating capacity by more than 10 percent.
Yet the rates Con Edison and other retail suppliers paid generating firms for making their plants available -- fees known in the industry as "capacity payments" -- actually rose by 6 percent this summer, turning the law of supply and demand on its head and potentially inflating the cost to city electricity consumers by $30 million over the past three months.
Now some experts, politicians and the state Consumer Protection Board say the results prove that deep flaws in New York's competitive energy market were exploited by one or more of the city's three largest electricity-generating firms -- KeySpan Corp., NRG Inc. and Astoria Generating Co. LP.
Under a magnifying glass
Assemb. Paul Tonko, the chairman of the state Assembly's Energy Committee, told Newsday the generating companies had clearly "gamed" the market "at the expense of consumers."
"The Assembly Energy Committee will fully investigate these market manipulations that are artificially raising electric prices, and make those who are responsible for this disgrace accountable," said Tonko (D-Amsterdam).
The intense scrutiny could not come at a worse time for KeySpan, which is seeking the approval of state and federal regulators for its pending $11.8-billion takeover by British energy giant National Grid.
New York City, in its initial comments on the pending merger, told federal regulators that KeySpan's role in the market anomalies heightens concerns that the merger would give the newly combined companies too much power in the state's energy marketplace.
Although KeySpan manages the Long Island Power Authority's system and owns generators on Long Island that produce more than half of LIPA's power, the rates are fixed by contract and not affected by the current controversy.
KeySpan, the other power-plant owners and the New York Independent System Operator, the nonprofit organization that runs the state's energy markets, concede that the city market is far from fully competitive and that it offers advantages to the largest generating firms. But they insist the problems stem from compromises knowingly made in the past.
"Our conclusion is that neither the [system operator's rules] nor [the Federal Energy Regulatory Commission's] regulations have been violated," system operator president Mark Lynch said last month in a letter to FERC, which has jurisdiction over the rules of New York's energy markets.
The so-called capacity charges at the center of the controversy are little known outside of the industry, even though they have a significant impact on electric bills. Last month alone, the city's retail electricity providers, primarily Con Ed, paid generators more than $72 million for capacity bought through auctions conducted by the system operator. That doesn't include the 36 percent of total capacity that was sold through negotiated contracts whose terms are not publicly disclosed.
Capacity payments compensate plant owners for some expenses they incur to build plants and make them available to produce electricity. The companies derive the rest of their income from sales of electricity and other technical services that make the power grid hum.
Capacity for change
The main purpose of capacity charges is to lure new power plant development when it is needed. When supplies are tight, the theory goes, prices should rise to a level that will cover the cost of building a new plant -- an extremely expensive proposition in the city.
The same theory says prices should fall when there is excess capacity. But that didn't happen this summer. The reason why is clear to anyone who understands the history of the city's energy markets.
Beginning in the late 1990s, New York and many other states "deregulated" their electrical utilities, breaking up regulated monopolies like Con Ed, which owned all of the components of electric service -- power plants, high-voltage transmission networks and distribution wires.
Under the new order, companies could either own the wires that deliver electricity or the generators that create it, and electricity would be traded on a market like any other commodity. The newly competitive electric business, experts said, would produce efficiencies and savings that could never be matched by stodgy, regulated utilities.
Most of the plants once owned by Con Ed are now owned by KeySpan, NRG and Astoria Generating. Together, they command about 54 percent of all capacity available in the city this year and nearly 79 percent of capacity not already under contract.
Making the split
Steven Stoft, an economist who has written extensively about capacity markets, was an analyst with FERC when Con Ed began the process of selling its plants. He said he and a fellow analyst advised the commission that the plants had to be divvied up among more than three owners or they would each have the ability to control prices, giving them what economists call "market power." The commission ignored the advice, he said.
"On a deep level, when you get down to people who really know inside New York, they thought it was as good as they could do politically," he said. "You have all these stakeholders yelling at you, and they all only consider their own interests, so it's just about impossible to do anything intelligent."
The system operator says Con Ed, which has complained about this summer's capacity prices, pushed to sell the plants in large bundles because it believed it could get more of a premium that way. The system operator also says state and federal regulators agreed to limit market power to acceptable levels with caps on the price each generating firm could charge for its capacity.
Over the past few years, when the city barely had enough generating capacity to meet its needs, no one was surprised when prices remained at or near the caps. But this summer, when prices remained pegged at the top of the scale despite a significant surplus, regulators and independent experts took note.
In an analysis filed with the system operator, the Public Service Commission estimated that market strategies employed by the generators in last month's spot capacity auction artificially inflated prices in the city. The price ended up $7.42 a kilowatt higher than it would have been if the generators did not have market power, translating to a total cost of $9.7 million. The analysis concludes that auction results also affected prices in the rest of the state -- excluding Long Island -- though to a lesser degree.
Although June was the only month the PSC analyzed, the same strategies and outcomes appear to have occurred in May and July, according to auction results posted on the system operator's Web site. Although actual offers to sell generation and the identities of who made them are not publicly disclosed, experts say it is clear KeySpan set the price in the spot market for May, June and July because the clearing price exactly matches the company's price cap, which is the highest of the three companies'.
KeySpan, the largest generator in the city, has about 2,250 megawatts of capacity to sell, or 23 percent of the total. Astoria Generating has about 2,000 megawatts, or 20 percent. For NRG, the numbers are 1,356 megawatts and 14 percent.
Energy at any price
In a truly competitive market, with a large number of smaller suppliers, participants would have to price their capacity conservatively to be sure it would be bought. In the city, however, KeySpan and the other large generators know much of their capacity must be bought to meet minimum capacity requirements set by the system operator, no matter the price.
NRG spokeswoman Lori Neuman noted the caps on prices were designed to provide the generating companies with "known accepted levels" of compensation. Astoria Generating did not return calls for comment.
David Manning, a KeySpan senior vice president, said his company proved its commitment to the city by building a new, state-of-the-art power plant without any contracts assuring revenue. It came online in 2004.
"KeySpan has invested well over a billion dollars of shareholder money in this marketplace pursuant to the rules," Manning said.
Timothy Mount, a Cornell University professor who specializes in electricity markets, said he analyzed this summer's capacity auctions and it was not difficult to determine how each company should have bid to maximize its income, which he said they apparently did.
"It's a silly market," which is easily manipulated by participants, he said, adding it would be "irresponsible" for the generators to behave any other way because they wouldn't make as much money for their shareholders.
In addition to what KeySpan earns selling the capacity of its own plants, it has added incentive to keep prices high in the city. Earlier this year, the company entered into an agreement with Morgan Stanley to buy 1,800 megawatts of city capacity that Morgan Stanley had bought from Astoria Generating.
Under the three-year agreement that went into effect May 1, KeySpan pays Morgan Stanley a fixed rate of $7.57 per kilowatt per month, according to a copy of the contract KeySpan filed with the Securities and Exchange Commission. If the price of capacity clears higher than that, Morgan Stanley pays KeySpan the difference; if it clears at a lower price, KeySpan pays.
From May through July, when KeySpan used its market clout to set the price at $12.71 each month, the deal earned the company $27.8 million.
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