Robert M. La Follette School of Public Affairs
Tuesday, October 4, 2011

Journal publishes student project on electrical transmission finance

Photo by Megan McCormick, The Badger Herald
Corey Singletary

Dan Molzahn

Article available

The Electricity Journal published "An Empirical Investigation of Speculation in the MISO Financial Transmission Rights Auction Market" by student Dan Molzahn and 2010 alum Corey Singletary in June.

A project for the public affairs course 819 Advanced Quantitative Methods for Public Policy is the basis of an article written by a student and an alum that appears this month in an academic journal.

TheElectricity Journal published "An Empirical Investigation of Speculation in the MISO Financial Transmission Rights Auction Market" by student Dan Molzahn and 2010 alum Corey Singletary in June. The article estimates the profits obtained by speculators through financial electric transmission rights auctions.

Many areas of the U.S. electric grid have wholesale markets for buying and selling power, Molzahn explains. Prices vary within geographic areas where the transmission of electricity is constrained, and companies bid on the rights to transmit and sell the electricity as a means of hedging against price risk associated with those constraints.

"Utilities and large financial institutions can speculate in these financial transmission rights markets," Molzahn says. "Utilities have little incentive to speculate because their profits are regulated, so we hypothesized that speculators made a large share of the transactions and the profits in FTR markets. Our investigation validated this hypothesis."

The authors used a statistical model to determine whether each participant in the Midwest Independent System Operator was speculating. "The best estimates from our sensitivity analysis suggest speculator profits of 152 percent of total market profits, equal to $283 million over three years," Molzahn notes. "Utilities and, ultimately, ratepayers bear the cost of these profits."

Because market policy was not the focus of the investigation, the authors warn against arriving at any policy conclusions based solely on the study's results. "One might be tempted to say that the current market structure is 'bad' purely in light of the profits that accrue to market speculators or the losses felt by utilities," Singletary notes. "As a policy question, a better approach would be to consider, for example, if utilities would lose more money or be exposed to more risk but for the financial transmission rights market. If so, is speculator participation a key part of that market?"

The original paper the two produced for PA819 in spring 2010 was more focused on the statistical analysis (the process) than on the results, which the journal article emphasized, Molzahn says. "The journal's readers are not focused on the statistical technicalities of the study as was necessary to provide in the class project report. We had to eliminate the formulas we used to describe our statistical models because the journal editor indicated that they would likely be more confusing for the intended audience of the article. This was somewhat shocking to me given my engineering background; some of my previous engineering publications have sections comprised almost entirely by equations."

Molzahn says his adviser, professor Bernard Lesieutre of the Electrical and Computer Engineering Department, where Molzahn is working on a doctorate, in addition to a Master of Public Affairs degree, suggested the project after a conversation with a Wisconsin Public Service Commission official, and Molzahn suggested he and Singletary complete the project in 819.

A version of this article appears in the fall 2011 La Follette Notes newsletter for alumni and friends