Suppliers in MISO Exploiting Tariff for Larger Make-Whole Payments

May 16, 2011
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The Midwest ISO has filed expedited tariff changes at FERC to prevent the current exploitation of a flaw by certain market participants which allows suppliers to inflate make-whole payments by inducing reductions in output through their own changes in day-ahead and real-time offers.

MISO's Independent Market Monitor recently identified a gap in the tariff that gives market participants an undue opportunity to game Day-Ahead Margin Assurance Payment (DAMAP) make-whole payments. The DAMAP payment is one of two make-whole payments implemented by MISO in early 2009 to address issues arising from price volatility. The purpose of DAMAP is to provide an incentive for Market Participants to be flexible in their offers in the real-time market.

The DAMAP compensates suppliers when (i) the real-time dispatch of a resource is reduced below the day-ahead schedule's level, and (ii) the market participant would have been financially better off in real-time had it operated at its day-ahead schedule.

The identified a flaw in the current DAMAP provisions could allow a market participant to trigger a DAMAP payment by making a low day-ahead offer that understates the production costs, and then making a higher real-time offer to compel the Midwest ISO to reduce its real-time output.

In other words, a supplier can offer its generation resource into the day-ahead market below cost (in the extreme, as low as -$500/MWh), making it look extremely economic to commit and dispatch the resource up to its maximum output level. The market participant can then increase its real-time offer to cause its dispatch level to fall to its minimum. The resource would then be paid for the difference between its day-ahead offer and the real-time LMP ($/MWh) times the difference between the day-ahead scheduled MW and the real-time scheduled MW.

"Essentially, the supplier is reimbursed for its cost of buying back its Day-Ahead Schedule minus the production cost savings resulting from producing less output in the real-time market," MISO said. "Such assumed production cost savings, however, are based only on the suppliers' low day-ahead Offer. The Market Participant's actual production cost savings would not be accurately reflected if the Market Participant has intentionally understated its day-ahead offer. In fact, if the Market Participant offers in the day-ahead market at a negative price, the assumed production cost savings that would normally reduce the DAMAP payment will instead increase the DAMAP payment (because deducting a negative number)."

For example, an uneconomic resource with marginal costs of $50 per MWh could earn substantial DAMAP even when it is not economic to dispatch the resource because the day-ahead and real-time prices are both $30 per MWh (i.e., below the $50 production cost). In this example, if a 500 MW generator with a 200 MW minimum offers into the day-ahead market at -$500 per MWh, and into the real-time market at its actual cost, it will earn $775 per MWh.

If the supplier engages in this offer strategy for 24 hours, it would extract DAMAP payments of $3.7 million per day for this one hypothetical unit.

The IMM has detected that certain market participant(s) are, "now actively engaging in bidding strategies that appear to specifically target this flaw," MISO reported. Of course, the market participants who are gainfully exploiting this tariff loophole are likely some of the same market participants who ran crying to FERC to prevent the New Jersey BPU from engaging in "buyer side market power" when all New Jersey did was essentially the same thing -- identify a section of the current tariff (specifically, the net short requirement for RPM buyer-side mitigation) which could be used to maximize value to New Jersey ratepayer interests.

MISO proposed modifying the DAMAP formula in the tariff to deduct from DAMAP payments the higher of the day-ahead or real-time energy production costs, rather than the day-ahead energy offer alone.

"This modification will prevent suppliers from improperly extracting DAMAP payments based on real-time reductions in output that are due to their own actions, such as understating production costs in their day-ahead offers and then increasing their real-time offer prices. Instead, the proposed Tariff revisions will enable MISO to appropriately evaluate any increase in Real-Time Offer prices in relation to any putative loss of day-head margin," MISO said.

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