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1 Report on the Appropriateness of the Three Pivotal Supplier Test and Alternative Competitive Screens

and Conclusions In its March 1, 2012 Order, 1 the Federal Energy Regulatory Commission (FERC) accepted the proposed tariff revisions of the California Independent System Operator (ISO) to the ISO's local market power mitigation (LMPM) mechanism. As part of that ruling, the Commission ordered that " the CAISO's market surveillance committee is hereby directed to report its findings regarding the appropriateness of the three-pivotal-supplier test and whether an alternative competitive screen to identify market power opportunities for generation in load pockets is necessary by May 1, 2013. " On April 24, 2013, the California ISO filed on our behalf a motion for an extension of time until June 28, 2012, which was approved by FERC. 2 The purpose of this report is to respond to the Commission's charge. We first describe the role of a LMPM mechanism in a bid-based, short-term wholesale electricity market and briefly explain the difference between structure-based mitigation approaches such as LMPM and other alternatives such as the conduct and impact-based mitigation. We then discuss the potential for both over-mitigation and under-mitigation of generation units under the California ISO's LMPM procedures. Over-mitigation is defined as a false positive in which bids are adjusted by a LMPM procedure to levels that subsequently result in market inefficiencies. Under-mitigation is similarly defined as a false negative, in which bids that should have been mitigated are not, resulting in prices that are not just and reasonable, unjustified wealth transfers from consumers to producers, and possible market inefficiencies. In particular we examine how a market screen based on a number of joint pivotal suppliers could result in such over-or under-mitigation. Finally, with the assistance of the California ISO Department of Market Monitoring (DMM), we have analyzed market data drawn from the CAISO first year implementation of LMPM in the day-ahead market in order to assess the outcomes of the three pivotal supplier screen relative to counterfactual screens based on two or four pivotal suppliers. These outcomes include frequency of bids that are significantly above default energy bids (DEBs), which are proxies for marginal costs, and the frequency of mitigation. However, for two reasons, it is not possible to assess whether the outcomes of alternative screens would result in significant changes in market prices and efficiency. The first reason is that it is not possible for us to rerun the market software to generate prices based on alternative pivotal supplier tests. The …