1 Discussion of Baldick-Hogan, “Stability of SFE” Brandts et al., “Efficiency&Comp.” Focusing on Role of SFE Robert Wilson EPRI and Stanford POWER Conference UCB, 3/22/02

2 A Puzzle u Borenstein-Bushnell-Wolak, 2/27/02: —In California, June-October 2000, the ratio Actual/Competitive Payments > 2 —In all years, Lerner Index rises steadily with load served by in-state gas-fired plants u Baldick-Hogan: Affine SFE  much smaller ratio »Unless firms are capacity constrained u Brandts et al.: Supply function bids mimic Cournot »As expected when there is no uncertainty or averaging u Puzzle: Which better explains CA’s crisis ? SFE, Cournot, or “Pivotal Monopoly”

3 Borenstein-Bushnell-Wolak’s Explanation of CA’s Crisis u Demand: up by  7 % – demand was inelastic, no rate increases Imports: down by  50 % – hydro supplies from Northwest curtailed  In-state gas-fired generation: up by  80 % – from 5 main non-utility firms with similar capacities u Supply factors: Total capacity close to required reserve margin Rise in prices of gas and NOx permits Transmission congestion u How does SFE complete this explanation ?

4 SFE with Elastic Residual Demand Residual Demand Offered Supply Function Quantity Price Marginal Cost Note: Both papers use linear elastic demand

5 SFE with Pivotal Supplier Residual Demand Offered Supply Function Marginal Cost Quantity Price Baldick-Hogan use elastic demand & load-duration curve — no supplier is pivotal — but full paper studies capacity constraints Capacity

6 Implications for CA’s Crisis u SFE is a theory about pricing marginal units of supply Differential equations – cannot explain payments higher by factor  2 – cannot explain prices higher by factor  10 unless analysis recognizes pivotal suppliers – “pivotal” is a theory of total supply vs. residual demand »SFE & pivotal suppliers do not imply conspiracy, collusion, etc. »They do imply folly of insufficient capacity, dependence on imports, incautious divestiture, exclusion of long-term contracts u Policy Implications »ACAP or ICAP requirements are prudent safeguards »Allow limited divestiture for utilities with default service obligations »Encourage demand responses and pass-through of wholesale prices

7 The End