Phew, that was close!

In September 2008, Constellation Energy, a major electric utility in the US, was on the verge of bankruptcy—see my analysis here. That rang alarm bells throughout the territory covered by the PJM Interconnection, one of the largest electric power marketplaces in the world, stretching from New Jersey, Pennsylvania and Maryland in the east to Illinois in the west. Because of Constellation’s many transactions in the PJM market, a default by Constellation could have saddled PJM with an unpaid bill of more than $100 million. No one knew what might have happened next, especially since this incident was happening just as the global financial crisis was threatening the economy everywhere. Would liquidity in the electricity market dry up? Would buyers and sellers come forward with bids for the coming days transactions? Would the PJM market itself survive? If the market was in jeopardy, how would the supply and demand of electricity in this vast region be matched? Who would dispatch the many generators, and with what authority? How would prices be set? The chaos that followed the collapse of the California Power Exchange in 2000 provided one somber scenario, despite the fact that there was a much longer advanced warning for that collapse.

Fortunately, Constellation did not go bankrupt and we’ll never know exactly what the consequences would have been.

Fortunately, too, that didn’t stop the Federal Energy Regulatory Commission (FERC) from taking notice of this close call and identifying necessary changes in the credit system to minimize the chance of a similar event wreaking havoc on the electricity system in the future.

In January 2009, FERC organized a technical conference to analyze the credit issues and identify measures that ought to be considered. This initiated a long period of discussion among the many stakeholders, including electricity suppliers, local public utilities, cooperatives, and financial players.

In January 2010, FERC raised this discussion to a higher level with a Notice of Proposed Rulemaking (NOPR) in which it outlined a set of possible new regulations regarding the use of credit in wholesale electricity markets. This initiated the formal process of public comment. Commission staff held another technical conference in May 2010.*

In October 2010, FERC issued Order No. 741, Credit Reforms in Organized Wholesale Electric Markets. The order outlined a number of actions:

  • implementation of a billing period of no more than 7 days and a settlement period of no more than 7 days, thereby reducing the total scale of credit exposures in the system at one time;
  • a limit on the allowed use of unsecured credit per market participant;
  • elimination of unsecured credit for FTR markets, a special instrument in wholesale electricity markets where large credit exposures can suddenly arise and which are very illiquid;
  • clarification of the status of the wholesale market organization (ISO or RTO—e.g. PJM) as a party to each buy and sell transaction and the ability to net or offset obligations;
  • establishment of minimum criteria for market participation;
  • clarification of when additional collateral might be required;
  • establishment of a standard grace period to “cure” collateral calls.

Whether these actions are the right ones, and exactly how successful they may be in preventing a future crisis are important questions that are open to debate. The public comments on FERC’s proposals included many divergent opinions. Electricity markets are complicated beasts. There is no simple blueprint for the optimal design. Nevertheless, I think they undoubtedly represent a thoughtful and serious effort to learn from the close call in 2008 and reform the system to operate more safely in the future.

In a future post I will delve a little deeper in the central issue that I believe propelled FERC’s course of action and how that pertains to the parallel debate about the Dodd-Frank reforms of the OTC derivative markets.


* To review the complete file of public comments as well as the transcript from the technical conference, go to and put ‘RM10-13’ in the ‘Docket Number’ and 3 years in the date range.

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  1. […] an earlier post by the same title, I described the near default event in the PJM electricity market in 2008 that […]

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