Speculators Profit from “Congestion” Payments in NY ISO

The NY Times has an interesting article today on electricity speculators DC Energy and their exploitation of exotic financial instruments to profit at times of peak demand in NY ISO, New York state’s regional transmission organization.

Wholesale electricity prices skyrocket in times of high demand.  The term congestion is used when there is not enough transmission capacity to bring the lowest cost electricity into a particular area during peak load events.  Electricity still flows to these areas, but it is purchased at higher prices from more local higher cost generators.  RTOs have different methods of spreading this extra cost across their systems, insulating rate payers from most of these costs.

Power companies, particularly distribution owners who have to purchase higher cost peak energy, execute derivatives designed to hedge against peak load congestion costs.  These hedging contracts (essentially insurance premiums) are costs that are passed on to rate payers.

The NY Times article describes how speculators like DC Energy exploit these hedging contracts to skim off money that should have been credited back to NY ISO rate payers.

For DC Energy, the derivatives seem close to a sure thing. Former employees said the executives had told staff members that the firm lost money for two months in its decade-long history. DC Energy bought the same Northport-Port Jefferson contracts on Long Island 47 times since 2005, earning $2 million, The Times found.

Dr. Stevens said via email that the firm was involved in markets across the country. “We invest in hundreds of thousands of contracts across the marketplace,” Dr. Stevens said. “Any subset of these contracts in some subset of time will show gains, while another subset will show losses.”

Yet in places like upstate New York or Long Island, the market is so small, and the participants for certain contracts so few, that knowledgeable traders can collect rich rewards. Frank A. Wolak, an economics professor at Stanford who studies commodities, said the congestion markets created perverse incentives because profits rise when grid congestion becomes worse.

“If traders are making money, then consumers are paying more,” Mr. Wolak said. “The money that these guys are making has to come from somewhere.”

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