SPP-Entergy Market Power AnalysisSPP-Entergy Market Power Analysis

Presented By:Presented By:

David B. Patton, Ph.D.David B. Patton, Ph.D.President, Potomac EconomicsPresident, Potomac Economics

September 16, 2008September 16, 2008

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Market Power StudyMarket Power Study

• Potomac Economics has been engaged to:Potomac Economics has been engaged to:

Perform an evaluation of market power related to ETI joining the SPP; and Perform an evaluation of market power related to ETI joining the SPP; and

Identify mitigation options that would address any market power issues found.Identify mitigation options that would address any market power issues found.

• The study addresses:The study addresses:

The market power requirements of Texas Senate Bill 7 for the SPP to be a The market power requirements of Texas Senate Bill 7 for the SPP to be a Qualified Power Region (“QPR”); as well asQualified Power Region (“QPR”); as well as

Local market power issues associated with serving load in the ETI Area.Local market power issues associated with serving load in the ETI Area.

• It is the local market power analysis that is most likely to generate the need for It is the local market power analysis that is most likely to generate the need for some form of market power mitigation.some form of market power mitigation.

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Market Power StudyMarket Power Study

• For the prospective QPR region as a whole, Senate Bill 7 requires only that For the prospective QPR region as a whole, Senate Bill 7 requires only that suppliers’ market shares be less than 20 percent.suppliers’ market shares be less than 20 percent.

Hence, we will focus on this test for the SPP-wide analysis.Hence, we will focus on this test for the SPP-wide analysis.

• However, Senate Bill 7 and subsequent PUCT precedent do not provide specific However, Senate Bill 7 and subsequent PUCT precedent do not provide specific guidance or requirements for the evaluation of local market power. guidance or requirements for the evaluation of local market power.

• Therefore, we produce a number of market power indicators for the local ETI Area. Therefore, we produce a number of market power indicators for the local ETI Area.

• Because there are significant transmission constraints that bind Because there are significant transmission constraints that bind into into the ETI Area the ETI Area and and withinwithin the ETI Area, we define two relevant markets for these analyses: the ETI Area, we define two relevant markets for these analyses:

The entire ETI control area; andThe entire ETI control area; and

The Western Subregion of ETI (which is defined as the load and resources west of The Western Subregion of ETI (which is defined as the load and resources west of the Jacinto and Cypress substations).the Jacinto and Cypress substations).

Accordingly, we generally conducted our local market analyses for both ETI and the Accordingly, we generally conducted our local market analyses for both ETI and the Western Subregion of ETI.Western Subregion of ETI.

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Market Power StudyMarket Power Study

• To evaluate the SPP/ETI Area as a QPR, we perform a market share analysis to To evaluate the SPP/ETI Area as a QPR, we perform a market share analysis to determine whether any suppliers have a market share greater than 20 percent.determine whether any suppliers have a market share greater than 20 percent.

• To evaluate local market power, we conduct the following analyses:To evaluate local market power, we conduct the following analyses:

Market concentration based on installed capacity (i.e., capacity shares and HHI Market concentration based on installed capacity (i.e., capacity shares and HHI statistics);statistics);

Market concentration based on uncommitted capacity;Market concentration based on uncommitted capacity;

Pivotal supplier test for the ETI Area and Western Subregion, which seeks to Pivotal supplier test for the ETI Area and Western Subregion, which seeks to determine whether the load can be served if the largest supplier withholds its determine whether the load can be served if the largest supplier withholds its resources.resources.

• Load obligations have a significant effect on market power findings because a Load obligations have a significant effect on market power findings because a supplier will not have an incentive to withhold resources it needs to serve its load. supplier will not have an incentive to withhold resources it needs to serve its load.

Hence, we generally consider three alternative assumptions regarding the portion of Hence, we generally consider three alternative assumptions regarding the portion of utilities’ load it is obligated to serve (0 percent, 50 percent, and 100 percent.)utilities’ load it is obligated to serve (0 percent, 50 percent, and 100 percent.)

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Capacity Share in Combined SPP/ETI AreaCapacity Share in Combined SPP/ETI Area

• In the first analysis, we calculate simple installed capacity market shares for the In the first analysis, we calculate simple installed capacity market shares for the combined SPP/ETI Area.combined SPP/ETI Area.

To calculate the market shares, we use the maximum ratings from the SPP summer To calculate the market shares, we use the maximum ratings from the SPP summer power flow base case;power flow base case;

Imports from outside the SPP/ETI Area are not counted (hence, capacity shares are Imports from outside the SPP/ETI Area are not counted (hence, capacity shares are likely slightly understated);likely slightly understated);

The company totals represent a simple “steel in ground” figure. They do not reflect The company totals represent a simple “steel in ground” figure. They do not reflect contract sales, transmission limitations, or other complications. contract sales, transmission limitations, or other complications.

• The following table shows our analysis. ETI has a capacity share of 4.4 percent and The following table shows our analysis. ETI has a capacity share of 4.4 percent and no supplier has a market share greater than 20 percent.no supplier has a market share greater than 20 percent.

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Capacity Shares in Combined SPP and ETI AreaCapacity Shares in Combined SPP and ETI Area

Supplier Capacity

Share of Combined

RegionsAmerican Electric Power Co., Inc. 9,754 18.5%Westar Energy Inc. 6,568 12.4%OGE Energy Corp. 5,812 11.0%Xcel Energy, Inc. 4,195 7.9%Great Plains Energy Corp. 4,039 7.6%Tenaska, Inc. 2,348 4.4%ETI 2,300 4.4%Calpine Corp. 1,352 2.6%Western Farmers Electric Coop 1,292 2.4%Empire District Electric Co. 1,263 2.4%Kelson Energy 1,250 2.4%Bechtel Group, Inc. 1,200 2.3%All others less than 2% 11,449 21.7%

Total 52,823 100.0%

Analysis of Local Market Power Analysis of Local Market Power in ETI Areain ETI Area

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Market Concentration in the ETI AreaMarket Concentration in the ETI Area

• We use the Herfindahl-Hirschman Index (“HHI”) to measure market concentration.We use the Herfindahl-Hirschman Index (“HHI”) to measure market concentration. The HHI is a measure of market concentration and is calculated as the sum of the The HHI is a measure of market concentration and is calculated as the sum of the

squares of the market shares of each individual firm.squares of the market shares of each individual firm. The index ranges from 0 to 10,000, increasing as suppliers’ market shares increase The index ranges from 0 to 10,000, increasing as suppliers’ market shares increase

and the number of suppliers serving the market falls.and the number of suppliers serving the market falls. Economists use the HHI index because there is evidence in some markets that the Economists use the HHI index because there is evidence in some markets that the

competitive performance improves as the HHI decreases.competitive performance improves as the HHI decreases. The antitrust agencies consider a market with HHI greater than 1800 as highly The antitrust agencies consider a market with HHI greater than 1800 as highly

concentrated, but HHIs in the range of 2000 to 2500 have been considered workably concentrated, but HHIs in the range of 2000 to 2500 have been considered workably competitive in electricity markets. competitive in electricity markets.

• We calculate the HHI using two capacity metrics:We calculate the HHI using two capacity metrics: Installed Capacity: calculated based on the summer ratings of all supply in the Installed Capacity: calculated based on the summer ratings of all supply in the

market and import capability into the market (with no offset for load obligations).market and import capability into the market (with no offset for load obligations). Uncommitted Capacity: calculated based on the installed capacity minus load Uncommitted Capacity: calculated based on the installed capacity minus load

obligations of each supplier – this metric better addresses the effect on incentives of obligations of each supplier – this metric better addresses the effect on incentives of being obligated to serve load at a fixed price.being obligated to serve load at a fixed price.

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Market Concentration in the ETI Area: Market Concentration in the ETI Area: Installed CapacityInstalled Capacity

• The following table shows the HHI calculation in the ETI Area for the installed capacity The following table shows the HHI calculation in the ETI Area for the installed capacity measure. The table shows:measure. The table shows:

The HHI in the ETI Area is under 2,100.;The HHI in the ETI Area is under 2,100.;

ETI has a market share of 42.5 percent; and ETI has a market share of 42.5 percent; and

There are over 900 MW of imports, mostly from Entergy units in Louisiana to ETI load, There are over 900 MW of imports, mostly from Entergy units in Louisiana to ETI load, although some imports serve municipal entities.although some imports serve municipal entities.

• Due to the potential that Cottonwood may disconnect from the Eastern Interconnect, we Due to the potential that Cottonwood may disconnect from the Eastern Interconnect, we calculated an HHI assuming Cottonwood has 0 MW in ETI. calculated an HHI assuming Cottonwood has 0 MW in ETI.

The HHI in this case was 2,416.The HHI in this case was 2,416.

This is high for levels that would typically be deemed workably competitive. This is high for levels that would typically be deemed workably competitive.

– However, it does not account for the effects of load obligations, excess capacity and other However, it does not account for the effects of load obligations, excess capacity and other factors that improve the competitiveness of the market.factors that improve the competitiveness of the market.

– It is below the 2500 benchmark used in the prior study.It is below the 2500 benchmark used in the prior study.

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HHI for Installed Capacity in ETI AreaHHI for Installed Capacity in ETI Area

SupplierOwned capacity

Capacity Purchases/

ImportsCapacity

SalesNet

Capacity ShareArcLight Capital Prtrs/Reliant Energy 115 - - 115 1.7%ConocoPhillips/NRG Energy 555 - - 555 8.0%Dupont 75 - - 75 1.1%East Texas Electric Coop, Inc. 340 239 - 579 8.4%ETI 2,300 643 - 2,943 42.5%Exxon Mobil Corp. 495 - - 495 7.1%Kelson Energy 600 600 8.7%SRMPA - 77 - 77 1.1%Sabine River Authority of Louisiana 91 - 91 (0) 0.0%Southwestern Power Administration 52 - 52 - 0.0%Tenaska, Inc. 300 - - 300 4.3%ATC 1,185 0.0%

Total 4,923 960 143 6,925

HHI: 2,091

Note: Withholding of ATC is assumed to impossible so market share is assumed to be zero. Reliability investments increase ATC 460 MW. Cottonwood limited to 600 MW, Tenaska to 300 MW, and joint-owned plants operated jointly.

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HHI Calculations for ETI AreaHHI Calculations for ETI AreaMitigation ResultsMitigation Results

• Based on the prior results, we evaluated two types of market power mitigation:Based on the prior results, we evaluated two types of market power mitigation: Expansion of the transmission capacity into ETI, which would allow increased Expansion of the transmission capacity into ETI, which would allow increased

competition from external suppliers; and competition from external suppliers; and Capacity sales by ETI, which would reduce ETI’s market share. We start at 500 MW Capacity sales by ETI, which would reduce ETI’s market share. We start at 500 MW

because it is 15 percent of ETI’s capacity in the area (the floor in Senate Bill 7).because it is 15 percent of ETI’s capacity in the area (the floor in Senate Bill 7).

• The following Table shows the results of the mitigation analyses assuming The following Table shows the results of the mitigation analyses assuming Cottonwood with 600 MW of capability and 0 MW of capability.Cottonwood with 600 MW of capability and 0 MW of capability.

• Both mitigation approaches are effective at reducing market concentration to less Both mitigation approaches are effective at reducing market concentration to less than 2000, but capacity sales are generally more effective because they reduce the than 2000, but capacity sales are generally more effective because they reduce the market share of the largest supplier more quickly.market share of the largest supplier more quickly. With Cottonwood out of the market, 500 MW of capacity sales reduces the HHI to With Cottonwood out of the market, 500 MW of capacity sales reduces the HHI to

1782 while the same amount of new transmission reduces it to 2050.1782 while the same amount of new transmission reduces it to 2050. These approaches may be combined: 200 MW of each reduces the HHI below 2000.These approaches may be combined: 200 MW of each reduces the HHI below 2000.

• As explained later in the study, however, we do not find that mitigation is necessary As explained later in the study, however, we do not find that mitigation is necessary in either the ETI Area or the Western Subregion.in either the ETI Area or the Western Subregion. HHI analyses ignore the effects of load obligations, excess capacity, and RMR HHI analyses ignore the effects of load obligations, excess capacity, and RMR

obligations that are better captured in the uncommitted capacity and pivotal supplier obligations that are better captured in the uncommitted capacity and pivotal supplier analyses discussed below.analyses discussed below.

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Summary of HHI Impact of Mitigation MeasuresSummary of HHI Impact of Mitigation Measures

CaseATC

MitigationCap Sale

MitigationETI

ShareTotal

Capacity HHI(MW) (MW) (MW)

Cases with Cottonwood @ 600 MWNo Mitigation 0 0 42.5% 6,925 2,091

500 MW ATC Mitigation 500 0 39.4% 7,425 1,807

500 MW Capacity Sale (~15% Sale) 0 500 35.0% 6,925 1,561

Cases with Cottonwood @ 0 MWNo Mitigation 0 0 46.5% 6,325 2,416

500 MW ATC Mitigation 500 0 42.8% 6,825 2,050750 MW ATC Mitigation 750 0 41.3% 7,075 1,908

500 MW Capacity Sale (~15% Sale) 0 500 38.3% 6,325 1,782

200 MW ATC + 200 MW Capacity Sale 200 200 40.5% 6,725 1,871

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Market Concentration in the ETI Area:Market Concentration in the ETI Area:Uncommitted CapacityUncommitted Capacity

• The next analysis of uncommitted capacity shares accounts for load obligations by The next analysis of uncommitted capacity shares accounts for load obligations by subtracting the peak load obligation from the LSE’s total resources.subtracting the peak load obligation from the LSE’s total resources. This measure is typically a more accurate indicator of market power because it This measure is typically a more accurate indicator of market power because it

reflects the mitigation effects of load obligations (i.e., there is no incentive to reflects the mitigation effects of load obligations (i.e., there is no incentive to withhold resources needed to serve load).withhold resources needed to serve load).

• The move toward retail competition complicates assumptions regarding the load The move toward retail competition complicates assumptions regarding the load obligations. Hence, we consider multiple scenarios:obligations. Hence, we consider multiple scenarios: 100 percent load obligation case (no retail load switching).100 percent load obligation case (no retail load switching). 50 percent load obligation (reflective of the load switching experience in ERCOT 50 percent load obligation (reflective of the load switching experience in ERCOT

with ~40 percent switching);with ~40 percent switching); 0 percent load obligation (same as installed capacity analysis presented above); 0 percent load obligation (same as installed capacity analysis presented above);

• The 100 percent case indicates an HHI of less than 1000.The 100 percent case indicates an HHI of less than 1000.

• The 50 percent case is shown in the following figure. The 50 percent case is shown in the following figure. It also shows an HHI of less than 1000. It also shows an HHI of less than 1000.

• These results do not raise any competitive concerns or indicate the need for market These results do not raise any competitive concerns or indicate the need for market power mitigation.power mitigation.

Market Concentration in ETI: Uncommitted CapacityMarket Concentration in ETI: Uncommitted Capacity50 Percent Load Obligation Case 50 Percent Load Obligation Case

SupplierOwned

Capacity

Firm Purchases/Imports

Firm Sales

Net Capacity

Load Obligation

Uncommitted Capacity

Share of Uncommitted

CapacityETI 2300 643 0 2943 2066 877 20.4%Kelson Energy 600 0 0 600 0 600 13.9%Tenaska, Inc. 300 0 0 300 0 300 7.0%East Texas Electric Coop, Inc. 340 189 0 529 479 50 1.2%Exxon Mobil Corp. 495 0 0 495 0 495 11.5%ConocoPhillips/NRG Energy 555 0 0 555 0 555 12.9%SRMPA 0 127 0 127 89 38 0.9%Dupont 75 0 0 75 0 75 1.7%ArcLight Capital Partners/Reliant Energy 115 0 0 115 0 115 2.7%Sabine River Authority of Louisiana 91 0 72 19 0 19 0.4%Southwestern Power Administration 52 0 52 0 0 0 0.0%ATC 1185 0 0 1185 0 1185 0.0%

Total 4923 960 124 5759 2634 4310HHI 967

Note : Cottonwood(Kelson Energy) limited to 600 MW and Tenaska limited to 300. Withholding of ATC assumed to be impossible so market share is 0. Jointly-owned plants assumed to be operated jointly.

Should link this back to HHI_Analyisis_v

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Pivotal Supplier in ETI AreaPivotal Supplier in ETI Area

• Our next analysis sought to determine if and under what conditions there is a Our next analysis sought to determine if and under what conditions there is a “Pivotal Supplier” in the ETI Area. “Pivotal Supplier” in the ETI Area.

A supplier is pivotal if the load and reserves within the area (“ETI Area”) A supplier is pivotal if the load and reserves within the area (“ETI Area”) cannot be satisfied without the resources of the supplier (“ETI”).cannot be satisfied without the resources of the supplier (“ETI”).

Pivotal supplier analyses provide a more reliable indicator of market power Pivotal supplier analyses provide a more reliable indicator of market power than HHI analyses in electricity markets because they capture the effects of than HHI analyses in electricity markets because they capture the effects of excess capacity and other factors that affect the competitiveness of the excess capacity and other factors that affect the competitiveness of the market. market.

• We examine four cases:We examine four cases:

We determine whether ETI is pivotal when it must serve 100%, 50%, or 0% We determine whether ETI is pivotal when it must serve 100%, 50%, or 0% of its load. of its load.

We perform the analysis with and without the Cottonwood facility.We perform the analysis with and without the Cottonwood facility.

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Pivotal Supplier in ETI AreaPivotal Supplier in ETI Area

• The results of our analysis show that ETI is only pivotal in the 0% load case. The results of our analysis show that ETI is only pivotal in the 0% load case.

• Although this result raises potential competitive concerns, we do not find that Although this result raises potential competitive concerns, we do not find that market power mitigation is necessary for the following reasons:market power mitigation is necessary for the following reasons: A significant portion of ETI’s capacity is “reliability must run”, which means that A significant portion of ETI’s capacity is “reliability must run”, which means that

they must be operated to support the transmission system. ETI is not pivotal if it they must be operated to support the transmission system. ETI is not pivotal if it cannot withhold such capacity.cannot withhold such capacity.

ETI will likely continue to be obligated to serve load as a provider of last resort ETI will likely continue to be obligated to serve load as a provider of last resort (POLR). (POLR).

– POLR prices in ERCOT are capped relative to prevailing wholesale prices. It POLR prices in ERCOT are capped relative to prevailing wholesale prices. It is unclear what price-to-beat or POLR provisions would be applied in ETI.is unclear what price-to-beat or POLR provisions would be applied in ETI.

– Given the quantity that ETI would have to withhold to be pivotal, withholding Given the quantity that ETI would have to withhold to be pivotal, withholding to receive the price-to-beat or POLR price from the remaining retail customers to receive the price-to-beat or POLR price from the remaining retail customers would not likely be economic.would not likely be economic.

The SPP market monitor could easily detect the magnitude withholding that would The SPP market monitor could easily detect the magnitude withholding that would be necessary for ETI to take advantage of its pivotal supplier status.be necessary for ETI to take advantage of its pivotal supplier status.

Lastly, the peak load assumed in the pivotal supplier test is substantially higher Lastly, the peak load assumed in the pivotal supplier test is substantially higher than the average load – ETI would not be pivotal in most hours.than the average load – ETI would not be pivotal in most hours.

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Pivotal Supplier Analysis -- ETI AreaPivotal Supplier Analysis -- ETI Area

ETI Net Supply

ETI Load Obligation

Uncommit. ETI

SupplyETI Area

Supply

ETI Area Supply w/o ETI

ETI Area Load +

Reserves Pivotal

Cases with Cottonwood at 600 MW100% Load Obligation 2943 4131 0 6925 6925 4841 No50% Load Obligation 2943 2066 877 6925 6048 4841 No0% Load Obligation 2300 0 2300 6925 4625 4841 Yes

Cases with Cottonwood Removed100% Load Obligation 2943 4131 0 6325 6325 4841 No50% Load Obligation 2943 2066 877 6325 5448 4841 No0% Load Obligation 2300 0 2300 6325 4025 4841 Yes

All values in MW. ETI net supply decreases in no-load obligation case because ETI is assumed to no longer control firm transmission into ETI.

Analysis of Local Market Power Analysis of Local Market Power in Western Subregion of ETIin Western Subregion of ETI

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Market Concentration in the Western Region:Market Concentration in the Western Region:Installed CapacityInstalled Capacity

• We cannot show specific results for the Western Subregion of the ETI Area because We cannot show specific results for the Western Subregion of the ETI Area because these results would allow one to calculate the import capability into the area, which is these results would allow one to calculate the import capability into the area, which is confidential information.confidential information.

• Rights to the import capability (which can be used to serve a large share of the load in Rights to the import capability (which can be used to serve a large share of the load in the area) can only be held by entities serving load in the area. the area) can only be held by entities serving load in the area.

Hence, we assume the rights cannot be hoarded.Hence, we assume the rights cannot be hoarded.

• Our analysis of the Western Subregion shows:Our analysis of the Western Subregion shows:

Installed capacity (0 percent load obligation)Installed capacity (0 percent load obligation): the HHI in the Western region was less : the HHI in the Western region was less than 1,000 due in part to the mitigating effects of the import capability.than 1,000 due in part to the mitigating effects of the import capability.

Uncommitted capacity, 50 percent case:Uncommitted capacity, 50 percent case: HHI is close to 1500. HHI is close to 1500.

Uncommitted capacity, 100 percent case:Uncommitted capacity, 100 percent case: HHI is high, but all load serving entities HHI is high, but all load serving entities have sufficient capacity to serve their own load so competitive concerns are limited.have sufficient capacity to serve their own load so competitive concerns are limited.

• These results raise no significant market power concerns.These results raise no significant market power concerns.

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Pivotal Supplier in Western SubregionPivotal Supplier in Western Subregion

• We also performed a pivotal supplier analysis for the Western Subregion for We also performed a pivotal supplier analysis for the Western Subregion for the 0 percent, 50 percent load obligation case and the 100 percent load the 0 percent, 50 percent load obligation case and the 100 percent load obligation case.obligation case.

We found that ETI is not pivotal in any of the cases;We found that ETI is not pivotal in any of the cases;

This result is due primarily to the import capability into the Western This result is due primarily to the import capability into the Western Subregion, which we assume cannot be withheld by ETI to the extent that it is Subregion, which we assume cannot be withheld by ETI to the extent that it is not serving load in the area;not serving load in the area;

• Our analysis contains confidential information that prevent us from showing Our analysis contains confidential information that prevent us from showing more detailed results.more detailed results.

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ConclusionsConclusions

• The SPP/ETI Area satisfies the QPR standards.The SPP/ETI Area satisfies the QPR standards.

• We performed an array of local market power analyses for both the ETI Area and We performed an array of local market power analyses for both the ETI Area and the Western Subregion (within the ETI Area). the Western Subregion (within the ETI Area).

• The cases that are reflective of the future retail competition in the area are the 0 The cases that are reflective of the future retail competition in the area are the 0 percent and 50 percent load obligation cases, which indicate the following:percent and 50 percent load obligation cases, which indicate the following:

The market concentration results raise no competitive concerns.The market concentration results raise no competitive concerns.

ETI is not a pivotal supplier in the Western Subregion.ETI is not a pivotal supplier in the Western Subregion.

In the ETI Area, ETI is only pivotal in the 0 percent load obligation case. We find In the ETI Area, ETI is only pivotal in the 0 percent load obligation case. We find that this does not raise significant competitive concerns due to:that this does not raise significant competitive concerns due to:

– ETI’s RMR obligations;ETI’s RMR obligations;

– ETI’s load obligations as a provider of last resort (POLR). ETI’s load obligations as a provider of last resort (POLR).

– The ease with which the SPP market monitor could detect the withholding that would The ease with which the SPP market monitor could detect the withholding that would be needed for ETI to take advantage of its pivotal supplier status.be needed for ETI to take advantage of its pivotal supplier status.