This article could've stood to have fewer empty quotes from a podunk mayor and some kind of an explanation of the contracts themselves instead. There's just "congestion = profit" repeated over and over again, presumably as some kind of dog whistle to the average NYT reader.
This is how I understand the stakes at the point immediately preceding the grid hiccup:
DC Energy Trading Firm: Out a sizable chunk of money. Incentive to stir trouble in the energy grid. No evidence that they did.
Power company: Has extra money from selling the contract and double incentive to spend that money in a manner that would prevent price differences between Northport and Port Jefferson.
----------------------------
CMV, but it sounds like the market is doing exactly what it is supposed to be doing. DC Energy placed a bet that others were underestimating the probability of trouble between Northport and Port Jefferson. They created an incentive for other market players (especially power companies) to take action against this possibility and install backup capacity, perform preventative maintenance, or generally to do whatever a power company can do to prevent problems like the one that happened. Since these measures weren't taken DC energy now gets their payout for having "told them so." At least, that's how I understand it. If my understanding is correct it seems like everything is on the up-and-up. Consumers were victims of power companies that not only failed to anticipate the problem but didn't take the hint when trading firms offered to bet that there would be a problem.
The thing that would make this a scandal would be if it were discovered that DC Energy had, say, payed someone at the power company to "pull an Enron" and sabotage maintenance. The danger of this kind of scheme is obviously real (see: the audio clips of Enron traders giggling like kids stealing cookies (yes, really) as they ordered power plants offline in California, driving up prices by creating an artificial shortage that eventually became known as the infamous rolling blackouts). However, it doesn't look like there is any evidence that the same conflict of interest is happening here.
Is the article arguing that these markets shouldn't exist because this kind of behavior would be nearly impossible to detect, making for tremendous moral hazard? That's the only "point" I can extrapolate from its discussion. It's not an unreasonable question. I could forgive its clickbaity title if only the article itself had been clearer about its own purpose.
> Consumers were victims of power companies that ignored market signals, not a crafty scheme to leverage them out of their money.
DC Energy didn't exactly go to the power companies and say, "Hey guys, when I bet against your power capacity, it means put more money in it so I can lose my investment!" That's just completely absurd.
From the article:
> The contracts were intended to protect the electricity producers, utilities and industries that need to buy power. The thinking was that the contracts would help them hedge against sharp price swings caused by competition as well as the weather, plant failures or equipment problems. Those lower costs could reduce consumers’ bills.
> But Wall Street banks and other investors have stepped in, siphoning off much of the money. In New York, DC Energy accounted for more than a quarter of the total $639 million in profits in the congestion markets between 2003 and 2013, The Times found. Some of DC Energy’s biggest paydays involved Port Jefferson, a village 60 miles east of Manhattan. Because of the geography of the grid, moving power from one point to another means demand often briefly outstrips supply here.
It's exploitation by DC Energy pure and simple. Exploitation is a foundation of Capitalism. What occurred is inadequate protections, whether intentional or not. The lack of a working strategy to protect electric producers is the true 'signal' that DC Energy conveyed.
> DC Energy didn't exactly go to the power companies and say, "Hey guys, when I bet against your power capacity, it means put more money in it so I can lose my investment!" That's just completely absurd.
That's exactly what they did, although they used money instead of words to send the message. If you bet your buddy that he can't handle 10 shots of Tequila without throwing up, you have provided him with incentive to handle 10 shots of Tequila without throwing up. If DC Energy bets PowerCo lots of money that price differences are small, DC Energy has provided PowerCo with incentive to keep differences small (e.g. by performing preemptive maintenance).
> It's exploitation by DC Energy pure and simple. Exploitation is a foundation of Capitalism.
Yes. The method to the madness of capitalism is the idea of giving up compensatory justice in exchange for having correct marginal incentives. If you could sum up the capitalist hypothesis in a sentence it would be "correct marginal incentives are more important than compensatory justice." It's a sad hypothesis but IMO probably a true one.
> What occurred is inadequate protections
You say it with hindsight. DC $aid the same thing but with foresight.
> The lack of a working strategy to protect electric producers is the true 'signal' that DC Energy conveyed.
You make it sound like a trivial observation. Remember that someone else was willing to bet against them. This transaction did three things:
1. It punished that party that incorrectly believed the grid would be functional when it wasn't.
2. It provided a market signal predicting a problem before the problem happened, while there was still time to fix it.
3. Assuming the power company was on the other side of the transaction, it provided incentive for the power company to fix the problem (again, before the problem happened).
> What no one here knew that day, May 30, 2013, was that the investment company, DC Energy, was reaping rewards from the swelter
Price offset gained was greater 1.5 million (* this is on one occurence of a grid overburden. The wholesale price jump was 550%, which is somewhat of a hint to the initial investment).
> Those profits are a small fraction of the fortune that traders at DC Energy and elsewhere have pocketed because of maneuvers involving the nation’s congested grid.
Key term here is 'maneuvers'. They don't plot down a one big bet scheme. How sophisticated? Here, let's look at the article:
> Across the nation, investment funds and major banks are wagering billions on similar trades using computer algorithms and teams of Ph.D.s, as they chase profits in an arcane arena that rarely attracts attention.
Their _intent is to ensure they are not signalling_.
Yes, I saw the "shock and awe" soundbytes too. I ignored them. They are irrelevant to the question of whether what is happening is good or whether it should be stopped.
> Price offset gained was greater 1.5 million
What does the scale have to do with any of this?
> Key term here is 'maneuvers'
I'm not interested in who used which loaded term. I am interested in the marginal incentives provided by these trades. Do they point in a direction that benefits society or in a direction that hurts society?
> Their _intent is to ensure they are not signalling_.
If their teams of Ph.Ds had figured out a way to avoid the signaling inherent in the price changes due to supply/demand swings, they wouldn't be wasting their time in a specialized energy firm. Instead, they would be making trillions of dollars by robbing blind every financial institution in the world.
Here's what it looks like to me: The smart PhDs figured out that the energy firm was performing too little maintenance. The energy firm was not willing to employ them to learn this for itself but it was willing to bet against them. The PhDs won and the power company lost.
Justice was not served: although it is good that the PhDs got paid for predicting a problem, it is bad that consumers wound up paying double for the problem. HOWEVER, marginal incentives were corrected. If the trend continues, the incentives will continue to be correct tomorrow, and hopefully the power company will wake up and start paying attention to the predictions so that it can head off problem before they occur. The hypothesis of capitalism is that these incentives to fix the actual physical transmission line problem are more important than the unjust costs conveyed to consumers.
> If their teams of Ph.Ds had figured out a way to avoid the signaling inherent in the price changes due to supply/demand swings, they wouldn't be wasting their time in a specialized energy firm. Instead, they would be making trillions of dollars by robbing blind every financial institution in the world.
Detecting signaling is a financial game, not a concern of power companies. If capitalism requires you to hire PhD's who specialize in detecting complex financial bets against your company, the system is inefficient.
> Here's what it looks like to me: The smart PhDs figured out that the energy firm was performing too little maintenance. The energy firm was not willing to employ them to learn this for itself but it was willing to bet against them. The PhDs won and the power company lost.
Oh, btw, the power company serve human beings, the financial traders represent the worst of everything about capitalism.
The power companies are not required to detect complex bets against them. They could decline to offer the bet in the first place. Why is DC Energy to blame for accepting a bet that was offered to them?
> If capitalism requires you to hire PhD's who specialize in detecting complex financial bets
It doesn't. That's the point. That's why the power company is selling these financial instruments, not buying them: so that somebody else does the hard thinking.
The price is the signal. You don't need a PhD to determine the message implied by the fact that energy traders are willing to give good odds (i.e. pay more than expected) to bet that your grid will fail in a certain locale on a certain date.
> the power company serve human beings
The power company not only dropped the ball but dropped the ball after someone told it in no uncertain terms that it would drop the ball in the time and place that it eventually did.
If they clean up their act they stand to make good money by selling similar securities.
> the financial traders represent the worst of everything about capitalism
Correct incentives are the best part of capitalism.
> They are irrelevant to the question of whether what is happening is good or whether it should be stopped.
I think the key to this question is whether the price differential on the node at Northport was due to natural congestion in the market or virtual congestion caused by traders. Traders like DC energy can participate in day-ahead and real-time energy markets in addition to purchasing FTR deriviates. This is generally a good thing because the traders can compete to supply power in constrained areas. However, it is possible to make uneconomic bids in these markets, especially day-ahead markets, that cause congestion on the grid while only causing a small financial loss for the trader. If a trader can cause virtual congestion on a power line where they own an FTR derivative, then that perceived congestion can cause large price differentials, which causes the derivatives to pay out much more than the day-ahead market loss. And the payout scales with the amount of power on the line where they own a derivative. It appears that the geography bottlenecks in this area, so it's a safe bet that any power lines going through there are very high voltage and moving lots of MWs. In this kind of situation, the trader's virtual load or generation does not indicate an issue with the grid such as poor planning or lack of maintenance. It means that the day-ahead market did not accurately predict actual energy demand due to virtual transactions. If you're interested, here's a paper from a couple years ago with more information about this trading strategy and how RTOs/ISOs could prevent this type of manipulation: http://www.hks.harvard.edu/hepg/Papers/2012/Virtuals%20and%2...
Most people accept the notion that access to things like electricity, road capacity, heating gas and similar commodities are different than other commodities.
It's ridiculous that it is acceptable for the owners of critical infrastructure to stand back and allow easily foreseeable market disruptions to take place. In businesses where meaningful competition exists, doing so puts you out of business. Peak energy demand is very easy to project with great accuracy, there is no excuse for a saturated/failed electrical grid.
Government isn't here to promote capitalism -- it's broad charter is to promote the general welfare if its citizens. Unstable market prices for electricity is a market and governance failure, period.
The quality of the decision made by either party does not invalidate that capitalism is a collection of voluntary activity. It's when government is involved that there is restriction on that activity, which frequently has unintended effects. If there is inadequate planning for future demand then prices may certainly vary more than is considered acceptable. Poor planning on a utility's part is not the fault of capitalism, but which seems to be the major point of the article and the original poster. Indeed, selling future contracts is generally viewed as a good way to stabilize future prices as it gives a signal as to general (market) consensus - if insurance for some activity is considered expensive then it should tell even the minimal of planners that an activity has unevaluated risk. An inability to act properly on such signals does indeed indicate poor planning on one party's part.
That's a very sophisticated way of saying that utility companies have some magical entitlement to say "Fuck you, pay me".
There's another answer that that a 5 year old could come up with, and happened to work very effectively for 75+ years: when the electrical grid is out of electrical transmission capacity, add more capacity.
Writing future contracts doesn't accomplish much, other than create jobs trading electricity, because the supply problem isn't generation, it's distribution. There is no market for electrical infrastructure.
I actually agree with disjointrevelry on this one.
> For every voluntary buyer in capitalism there is a voluntary seller.
Choice does not imply consent [1]. The word "voluntary" is ambiguous as to which concept it refers to and you can march a $70T element through the resulting loophole.
Capitalism is the philosophy of ditching compensatory justice in order to preserve marginal incentives (esp. with regard to supply and demand). Socialism is the philosophy of prioritizing compensatory justice over marginal incentives ("to each according to his contribution"). Like most people here, I side with the capitalist prioritization order, at least in markets that don't have a long record of market failure. In other words, I believe that it is more important for people to have incentives to fix supply/demand imbalances (e.g. for working power lines!) than it is for people to be rewarded for honest effort and punished for culpability (i.e. what I consider justice).
I think the article at hand is a perfect example of how markets sacrifice justice for correct incentives. What were the effects of the congestion contract?
1. It punished the power company for being incorrect regarding necessary maintenance. It also indirectly punished consumers. Did the consumers deserve to be punished for their power company's poor choices? No, of course not. Yet that's what this market transaction did. So it failed on the "justice" dimension.
2. It increased the financial stakes for the power company to meet its own estimations regarding online capacity. So it succeeded on the "incentives" dimension.
Justice was sacrificed in order to obtain correct incentives. Exactly as advertised.
-------------------------
[1] Suppose a serial killer kidnaps you tomorrow and gives you the choice of death by machete or death by shotgun (if you try get smart about it, he chooses the machete for you). At his trial, should the fact that you chose "shotgun" be seen as proof that you consented to getting shot? Of course not.
I agree that the article is unclear. Perhaps this is a dubious analogy, but this sounds sort of like Twitter making a bet that their site won't go down in order to fund improvements to the system so that the site won't go down. This would seem to increase the consequences of failure, which is the opposite of what a reasonable engineer should do.
So I understand why financial firms might want to buy these contracts. I don't understand why anyone is selling them. It seems like a big distraction from the energy company's actual business. Don't they have enough incentive to keep the system running already? Shouldn't they be building their own monitoring and models to predict energy supply and demand? It seems like that would provide more useful information than a market, which is noisy and opaque even when it's working properly.
From reading this article, it appears that these are not Over The Counter bets that are placed between one Investment bank with another. Rather this is a product created and sold by the grid operator NYISO in order to hedge price volatility and collect a fee.
While there is a mention of price manipulation, the article fails to clarify exactly how the prices are "manipulated" in order to favor the banks. The focus seems to be more on "bad banks" making money.
Well yeah but they're hiring PHDs to write PHP? I would think their proprietary trading algorithms (which I was talking about) would be...not written in that.
25 comments
[ 2.7 ms ] story [ 63.0 ms ] threadhttp://i.imgur.com/L6adSdy.jpg
DC Energy Trading Firm: Out a sizable chunk of money. Incentive to stir trouble in the energy grid. No evidence that they did.
Power company: Has extra money from selling the contract and double incentive to spend that money in a manner that would prevent price differences between Northport and Port Jefferson.
----------------------------
CMV, but it sounds like the market is doing exactly what it is supposed to be doing. DC Energy placed a bet that others were underestimating the probability of trouble between Northport and Port Jefferson. They created an incentive for other market players (especially power companies) to take action against this possibility and install backup capacity, perform preventative maintenance, or generally to do whatever a power company can do to prevent problems like the one that happened. Since these measures weren't taken DC energy now gets their payout for having "told them so." At least, that's how I understand it. If my understanding is correct it seems like everything is on the up-and-up. Consumers were victims of power companies that not only failed to anticipate the problem but didn't take the hint when trading firms offered to bet that there would be a problem.
The thing that would make this a scandal would be if it were discovered that DC Energy had, say, payed someone at the power company to "pull an Enron" and sabotage maintenance. The danger of this kind of scheme is obviously real (see: the audio clips of Enron traders giggling like kids stealing cookies (yes, really) as they ordered power plants offline in California, driving up prices by creating an artificial shortage that eventually became known as the infamous rolling blackouts). However, it doesn't look like there is any evidence that the same conflict of interest is happening here.
Is the article arguing that these markets shouldn't exist because this kind of behavior would be nearly impossible to detect, making for tremendous moral hazard? That's the only "point" I can extrapolate from its discussion. It's not an unreasonable question. I could forgive its clickbaity title if only the article itself had been clearer about its own purpose.
DC Energy didn't exactly go to the power companies and say, "Hey guys, when I bet against your power capacity, it means put more money in it so I can lose my investment!" That's just completely absurd.
From the article: > The contracts were intended to protect the electricity producers, utilities and industries that need to buy power. The thinking was that the contracts would help them hedge against sharp price swings caused by competition as well as the weather, plant failures or equipment problems. Those lower costs could reduce consumers’ bills.
> But Wall Street banks and other investors have stepped in, siphoning off much of the money. In New York, DC Energy accounted for more than a quarter of the total $639 million in profits in the congestion markets between 2003 and 2013, The Times found. Some of DC Energy’s biggest paydays involved Port Jefferson, a village 60 miles east of Manhattan. Because of the geography of the grid, moving power from one point to another means demand often briefly outstrips supply here.
It's exploitation by DC Energy pure and simple. Exploitation is a foundation of Capitalism. What occurred is inadequate protections, whether intentional or not. The lack of a working strategy to protect electric producers is the true 'signal' that DC Energy conveyed.
That's exactly what they did, although they used money instead of words to send the message. If you bet your buddy that he can't handle 10 shots of Tequila without throwing up, you have provided him with incentive to handle 10 shots of Tequila without throwing up. If DC Energy bets PowerCo lots of money that price differences are small, DC Energy has provided PowerCo with incentive to keep differences small (e.g. by performing preemptive maintenance).
> It's exploitation by DC Energy pure and simple. Exploitation is a foundation of Capitalism.
Yes. The method to the madness of capitalism is the idea of giving up compensatory justice in exchange for having correct marginal incentives. If you could sum up the capitalist hypothesis in a sentence it would be "correct marginal incentives are more important than compensatory justice." It's a sad hypothesis but IMO probably a true one.
> What occurred is inadequate protections
You say it with hindsight. DC $aid the same thing but with foresight.
> The lack of a working strategy to protect electric producers is the true 'signal' that DC Energy conveyed.
You make it sound like a trivial observation. Remember that someone else was willing to bet against them. This transaction did three things:
1. It punished that party that incorrectly believed the grid would be functional when it wasn't.
2. It provided a market signal predicting a problem before the problem happened, while there was still time to fix it.
3. Assuming the power company was on the other side of the transaction, it provided incentive for the power company to fix the problem (again, before the problem happened).
> What no one here knew that day, May 30, 2013, was that the investment company, DC Energy, was reaping rewards from the swelter
Price offset gained was greater 1.5 million (* this is on one occurence of a grid overburden. The wholesale price jump was 550%, which is somewhat of a hint to the initial investment).
> Those profits are a small fraction of the fortune that traders at DC Energy and elsewhere have pocketed because of maneuvers involving the nation’s congested grid.
Key term here is 'maneuvers'. They don't plot down a one big bet scheme. How sophisticated? Here, let's look at the article:
> Across the nation, investment funds and major banks are wagering billions on similar trades using computer algorithms and teams of Ph.D.s, as they chase profits in an arcane arena that rarely attracts attention.
Their _intent is to ensure they are not signalling_.
(editted: *)
Yes, I saw the "shock and awe" soundbytes too. I ignored them. They are irrelevant to the question of whether what is happening is good or whether it should be stopped.
> Price offset gained was greater 1.5 million
What does the scale have to do with any of this?
> Key term here is 'maneuvers'
I'm not interested in who used which loaded term. I am interested in the marginal incentives provided by these trades. Do they point in a direction that benefits society or in a direction that hurts society?
> Their _intent is to ensure they are not signalling_.
If their teams of Ph.Ds had figured out a way to avoid the signaling inherent in the price changes due to supply/demand swings, they wouldn't be wasting their time in a specialized energy firm. Instead, they would be making trillions of dollars by robbing blind every financial institution in the world.
Here's what it looks like to me: The smart PhDs figured out that the energy firm was performing too little maintenance. The energy firm was not willing to employ them to learn this for itself but it was willing to bet against them. The PhDs won and the power company lost.
Justice was not served: although it is good that the PhDs got paid for predicting a problem, it is bad that consumers wound up paying double for the problem. HOWEVER, marginal incentives were corrected. If the trend continues, the incentives will continue to be correct tomorrow, and hopefully the power company will wake up and start paying attention to the predictions so that it can head off problem before they occur. The hypothesis of capitalism is that these incentives to fix the actual physical transmission line problem are more important than the unjust costs conveyed to consumers.
Detecting signaling is a financial game, not a concern of power companies. If capitalism requires you to hire PhD's who specialize in detecting complex financial bets against your company, the system is inefficient.
> Here's what it looks like to me: The smart PhDs figured out that the energy firm was performing too little maintenance. The energy firm was not willing to employ them to learn this for itself but it was willing to bet against them. The PhDs won and the power company lost.
Oh, btw, the power company serve human beings, the financial traders represent the worst of everything about capitalism.
It doesn't. That's the point. That's why the power company is selling these financial instruments, not buying them: so that somebody else does the hard thinking.
The price is the signal. You don't need a PhD to determine the message implied by the fact that energy traders are willing to give good odds (i.e. pay more than expected) to bet that your grid will fail in a certain locale on a certain date.
> the power company serve human beings
The power company not only dropped the ball but dropped the ball after someone told it in no uncertain terms that it would drop the ball in the time and place that it eventually did.
If they clean up their act they stand to make good money by selling similar securities.
> the financial traders represent the worst of everything about capitalism
Correct incentives are the best part of capitalism.
I think the key to this question is whether the price differential on the node at Northport was due to natural congestion in the market or virtual congestion caused by traders. Traders like DC energy can participate in day-ahead and real-time energy markets in addition to purchasing FTR deriviates. This is generally a good thing because the traders can compete to supply power in constrained areas. However, it is possible to make uneconomic bids in these markets, especially day-ahead markets, that cause congestion on the grid while only causing a small financial loss for the trader. If a trader can cause virtual congestion on a power line where they own an FTR derivative, then that perceived congestion can cause large price differentials, which causes the derivatives to pay out much more than the day-ahead market loss. And the payout scales with the amount of power on the line where they own a derivative. It appears that the geography bottlenecks in this area, so it's a safe bet that any power lines going through there are very high voltage and moving lots of MWs. In this kind of situation, the trader's virtual load or generation does not indicate an issue with the grid such as poor planning or lack of maintenance. It means that the day-ahead market did not accurately predict actual energy demand due to virtual transactions. If you're interested, here's a paper from a couple years ago with more information about this trading strategy and how RTOs/ISOs could prevent this type of manipulation: http://www.hks.harvard.edu/hepg/Papers/2012/Virtuals%20and%2...
For every voluntary buyer in capitalism there is a voluntary seller. The NY Times presents this as exploitation.
It's ridiculous that it is acceptable for the owners of critical infrastructure to stand back and allow easily foreseeable market disruptions to take place. In businesses where meaningful competition exists, doing so puts you out of business. Peak energy demand is very easy to project with great accuracy, there is no excuse for a saturated/failed electrical grid.
Government isn't here to promote capitalism -- it's broad charter is to promote the general welfare if its citizens. Unstable market prices for electricity is a market and governance failure, period.
There's another answer that that a 5 year old could come up with, and happened to work very effectively for 75+ years: when the electrical grid is out of electrical transmission capacity, add more capacity.
Writing future contracts doesn't accomplish much, other than create jobs trading electricity, because the supply problem isn't generation, it's distribution. There is no market for electrical infrastructure.
> For every voluntary buyer in capitalism there is a voluntary seller.
Choice does not imply consent [1]. The word "voluntary" is ambiguous as to which concept it refers to and you can march a $70T element through the resulting loophole.
Capitalism is the philosophy of ditching compensatory justice in order to preserve marginal incentives (esp. with regard to supply and demand). Socialism is the philosophy of prioritizing compensatory justice over marginal incentives ("to each according to his contribution"). Like most people here, I side with the capitalist prioritization order, at least in markets that don't have a long record of market failure. In other words, I believe that it is more important for people to have incentives to fix supply/demand imbalances (e.g. for working power lines!) than it is for people to be rewarded for honest effort and punished for culpability (i.e. what I consider justice).
I think the article at hand is a perfect example of how markets sacrifice justice for correct incentives. What were the effects of the congestion contract?
1. It punished the power company for being incorrect regarding necessary maintenance. It also indirectly punished consumers. Did the consumers deserve to be punished for their power company's poor choices? No, of course not. Yet that's what this market transaction did. So it failed on the "justice" dimension.
2. It increased the financial stakes for the power company to meet its own estimations regarding online capacity. So it succeeded on the "incentives" dimension.
Justice was sacrificed in order to obtain correct incentives. Exactly as advertised.
-------------------------
[1] Suppose a serial killer kidnaps you tomorrow and gives you the choice of death by machete or death by shotgun (if you try get smart about it, he chooses the machete for you). At his trial, should the fact that you chose "shotgun" be seen as proof that you consented to getting shot? Of course not.
So I understand why financial firms might want to buy these contracts. I don't understand why anyone is selling them. It seems like a big distraction from the energy company's actual business. Don't they have enough incentive to keep the system running already? Shouldn't they be building their own monitoring and models to predict energy supply and demand? It seems like that would provide more useful information than a market, which is noisy and opaque even when it's working properly.
While there is a mention of price manipulation, the article fails to clarify exactly how the prices are "manipulated" in order to favor the banks. The focus seems to be more on "bad banks" making money.
It boggles my mind to think they're writing their systems in PHP.