Defining a market: market mitigation by theory versus convenience

The events of the California energy crisis of 2000 quickly led to complaints being filed at the Federal Energy Regulatory Commission (FERC) and subsequent prolonged litigation over prices and profits. The simplicity (perhaps excessively so) of the commission´s procedure for determining mitigated market prices rapidly fell prey to the litigation proceedings and quickly lost any connection it might initially have had to either power engineering or economic reality. This paper examines selected aspects of the California market mitigation process, comparing theoretically desired outcomes of market mitigation with the actual process in California. Results are presented that demonstrate the distortion of such basic steps as market definition and the identification of full incremental costs. The mitigation results and the lessons learned by the various groups involved are analyzed both with respect to engineering and economic realities and with respect to political exigencies. The results in California are then placed in the broader context of a likely end phase of electric industry restructuring.