Counter-Intuitive Pricing in Ontario's Electricity Market

November 2011

• The total cost of the energy commodity for Ontario consumers includes the spot price for electricity plus the allocated Global Adjustment charge. This can lead to confusing, even counter-intuitive, price signals.
• For example, total Ontario energy consumption in July of this year was 23% higher than in May. The expectation then would be that energy prices should have been higher in July. However, the total energy commodity price was 11% lower in July. A total cost of energy that is lower when demand is higher seems to break the laws of supply and demand.
• Counter-intuitive price signals could have important implications for consumer behavior, conservation programs, and other energy policy concerns.

A key sign of a properly functioning commodity market is that consumers receive price signals that make sense, with higher demand leading to higher prices and vice versa. Everything else being equal, consumers then tend to reduce demand when prices are high and increase demand when prices are low.

Recent experience in Ontario

Ontario's Independent Electricity System Operator (IESO) would likely argue that the Ontario electricity market functions properly. This is not surprising given that the IESO's primary focus is the spot market where the market clearing price is determined based on demand, supply and bid/offer prices.

One measure of the quality of spot market price signals is the correlation between demand and price. Looking at hourly Ontario demand and price values for January 2011 through October 2011, the correlation was 0.44 - suggesting a significant, positive correlation. When demand was higher, prices were generally higher.

The total cost of the energy commodity for Ontario consumers includes the spot price for electricity plus the allocated Global Adjustment charge. If we turn our attention to monthly values, broaden our perspective to include the total commodity cost and compare May 2011 and July 2011, the signals are a little more confusing.

1. TWh,as per IESO; equal to Allocated Quantity of Energy Withdrawn plus embedded generation
2. $/MWh
3. Paid by class B customers, i.e. those with average monthly demands less than 5 MW

Total Ontario energy consumption in July was 23% higher than in May. The expectation then would be that energy prices should have been higher in July. This was the case for the spot price, with the simple average, or HOEP, being 45% higher in July. The total commodity price however told a different story. It was 11% lower in July. A total cost of energy that is lower when demand is higher seems to break the laws of supply and demand.

Causes of the counter-intuitive price outcome

In July, HOEP was higher than in May by $ 10.87/MWh, but this was more than offset by the Global Adjustment being lower by $ 18.75/MWh. The Global Adjustment played a key role in the counter-intuitive price signal.

The Global Adjustment is an Ontario electricity market mechanism used to transfer certain types of costs among generators, agencies and consumers. The nature of the many contracts underlying the GA is varied. Some of the contracts guarantee generators a certain price for their output, so when spot prices are low, the cost to the Global Adjustment is higher. Some contracts represent a fixed cost, so when energy use is in Ontario is higher, the unit cost of these contracts is lower since the fixed cost is amortized over more units of consumption. In general, when spot prices rise the Global Adjustment drops and vice versa. In part, this is because the guaranteed price contracts pay less when the spot price is higher, and in part because higher spot prices reflect higher demand so the fixed cost contracts are spread over more units of consumption.

As well, there may be a certain "lumpiness" to GA sub-component cash flows, meaning the payments occur in months other than when related activities occur.

Most important though are the following factors:

• For Class B consumers, the unit cost paid each month is a uniform rate - the result of dividing total Class B share of GA costs by the total energy consumed by Class B.
• The Class A share of costs is not related to the quantity of energy consumed; rather they pay a percentage of total GA dollars.
• Class A's aggregate energy consumption is fairly non-temperature-sensitive and so is relatively constant. This means that while total Ontario consumption was 23% higher in July than in May, the largely temperature-sensitive Class B consumption was an even more pronounced 27% higher in July than in May.

The result of all this is the total commodity price paid on average by Ontario electricity consumers (those on the spot price and also, effectively, those on the Regulated Price Plan) was notably higher during the weather-benign month of May than it was in the scorching month of July - a clearly counter-intuitive outcome. Even if the total commodity price information was known by Class B consumers in real-time, they would have been less concerned in July, when demand was much higher, than in May, when demand was much lower.

These counter-intuitive price signals could have important implications for consumer behavior, conservation programs, and other energy policy concerns.

Reallocation of Global Adjustment Costs: An Update Read more »

Global Adjustment: Problem or Symptom? Read more »

Global Adjustment: Change in Behaviour Has Implications for Hedging Read more »