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PORT JEFFERSON, N.Y. — By 10 a.m. the heat was closing in on the North Shore of Long Island. But 300 miles down the seaboard, at an obscure investment company near Washington, the forecast pointed to something else: profit.
As the temperatures climbed toward the 90s here and air-conditioners turned on, the electric grid struggled to meet the demand. By midafternoon, the wholesale price of electricity had jumped nearly 550 percent.
What no one here knew that day, May 30, 2013, was that the investment company, DC Energy, was reaping rewards from the swelter. Within 48 hours the firm, based in Vienna, Va., had made more than $1.5 million by cashing in on so-called congestion contracts, complex financial instruments that gain value when the grid becomes overburdened, according to an analysis of trading data by The New York Times.
Those profits are a small fraction of the fortune that traders at DC Energy and elsewhere have pocketed because of maneuvers involving the nation’s congested grid. Over the last decade, DC Energy has made about $180 million in New York State alone.
Across the nation, investment funds and major banks are wagering billions on similar trades using computer algorithms and teams of Ph.D.s, as they chase profits in an arcane arena that rarely attracts attention.
Congestion occurs when demand for electricity outstrips the immediate supply, sending prices higher as the grid strains to deliver power from distant and often more expensive locations to meet the demand. To help power companies and others offset the higher costs, regional grid operators, which manage the nation’s transmission lines and wholesale power markets, auction off congestion contracts, derivatives linked to thousands of locations on the grid. When electricity prices spike, contract holders collect the difference in prices between points from the grid operators. If the congestion moves in the opposite direction, holders pay the operators.
The contracts were intended to protect the electricity producers, utilities and industries that need to buy power. The thinking was that the contracts would help them hedge against sharp price swings caused by competition as well as the weather, plant failures or equipment problems. Those lower costs could reduce consumers’ bills.
But Wall Street banks and other investors have stepped in, siphoning off much of the money. In New York, DC Energy accounted for more than a quarter of the total $639 million in profits in the congestion markets between 2003 and 2013, The Times found. Some of DC Energy’s biggest paydays involved Port Jefferson, a village 60 miles east of Manhattan. Because of the geography of the grid, moving power from one point to another means demand often briefly outstrips supply here.
DC Energy — and its profits — are an unexpected result of the deregulation of the nation’s electric grid. The idea behind deregulation was to eliminate old monopolies and create robust, competitive markets that would encourage investment and ultimately lower costs for consumers. (
) But in most places, electricity bills have been rising, not falling. While fuel prices, taxes and fees have added directly to the costs, Wall Street-style traders have contributed in subtle ways by turning new markets, like the trading of congestion contracts, to their advantage, The Times analysis found.
The contracts have attracted big money: More than $2 billion has been invested nationwide in the monthly auctions for contracts since 2011, according to Platts, a trade publication.
DC Energy had bet there would be trouble. That spring, its traders bought a number of congestion contracts at a monthly Nyiso (pronounced NIGH-so) auction. Those derivatives entitled the firm to collect the difference in power prices between multiple points on the Long Island grid, including between Port Jefferson and Northport, 20 miles to the west.l
On that May morning, transmission lines near a power plant in Northport were down for maintenance just as the heat arrived. The Northport area had plenty of electricity for itself but could not send more to communities like Port Jefferson. So while prices in Northport climbed to more than $129 a megawatt hour, prices in Port Jefferson jumped to $324 — a boon for DC Energy, which held congestion contracts tied to price differences between the two points.
The derivatives were not primarily devised for Wall Street. But in New York and elsewhere, many power companies are smaller players in the market compared to Wall Street banks like Goldman Sachs, and trading firms like DC Energy.
It is unclear how much the activity in the markets, particularly by the banks, is speculation versus hedging on behalf of clients. Still, many of the most active participants are investment firms.
The utilities and power companies suggest they cannot win against trading outfits that employ math specialists, often called “quants,” to spot lucrative opportunities. With transmission contracts, there are tens of thousands of tradable combinations.
“The financial players have the resources, the smart people that discovered there is a great opportunity to make money here,” said Hany A. Shawky, a professor of finance and economics at the University at Albany who has studied the electricity markets. “The utilities are sometimes missing opportunities to hedge because of the competition coming in from financial players.”
Trading firms like DC Energy say they ultimately benefit consumers by bearing financial risks and fostering competition. They argue that power companies can hedge only if someone else is willing to speculate. Market forces, they say, can also help power companies determine where to invest in the grid.
“We believe this type of activity should cause prices to better reflect true costs and thus create a more efficient electricity infrastructure that should better serve the retail customer,” Andrew J. Stevens, a co-founder of DC Energy, said in an email. DC Energy executives declined to be interviewed for this article but answered questions by email.
For DC Energy, the derivatives seem close to a sure thing. Former employees said the executives had told staff members that the firm lost money for two months in its decade-long history. DC Energy bought the same Northport-Port Jefferson contracts on Long Island 47 times since 2005, earning $2 million, The Times found.
Dr. Stevens said via email that the firm was involved in markets across the country. “We invest in hundreds of thousands of contracts across the marketplace,” Dr. Stevens said. “Any subset of these contracts in some subset of time will show gains, while another subset will show losses.”
Yet in places like upstate New York or Long Island, the market is so small, and the participants for certain contracts so few, that knowledgeable traders can collect rich rewards. Frank A. Wolak, an economics professor at Stanford who studies commodities, said the congestion markets created perverse incentives because profits rise when grid congestion becomes worse.
"If traders are making money, then consumers are paying more,” Mr. Wolak said. “The money that these guys are making has to come from somewhere.”
A major concern for federal regulators is that congestion contracts are one way to manipulate electricity prices. While trading by financial players is legal and DC Energy has not been accused of any wrongdoing, the Federal Energy Regulatory Commission has since 2012 proposed penalties or reached settlements with three large banks and several investment firms, accusing each of manipulation of some type.
In one of the cases, Louis Dreyfus Energy Services, an energy trading company, began buying contracts linked to the grid around Velva, N.D., where winds off the prairie spin the turbines of a wind farm, in spring 2009.
First, Xu Cheng, an employee at Louis Dreyfus Energy, which at the time was partly owned by a J. P. Morgan hedge fund, placed a bet that congestion would drive up electricity prices. Then, FERC later charged, Louis Dreyfus set out to make sure those bets would pay off. Trading in another corner of the electricity market, a second trader created the impression that congestion was hitting the Velva area, the commission concluded. Mr. Cheng had examined just such a situation in his doctoral dissertation at the University of Illinois at Urbana-Champaign, noting that traders could “make extra profit by creating nonreal congestion.”
The payoff for Louis Dreyfus was a quick $3.3 million in profits.
The commission smelled trouble and began to investigate. In February, Louis Dreyfus agreed to pay $7.4 million to settle allegations that it had manipulated prices. As is often the case in such settlements, the firm neither admitted nor denied wrongdoing.
The commission has been trying to crack down in the electricity market lately, but for years it has been outmaneuvered by the traders it is supposed to police.
As the temperatures climbed toward the 90s here and air-conditioners turned on, the electric grid struggled to meet the demand. By midafternoon, the wholesale price of electricity had jumped nearly 550 percent.
What no one here knew that day, May 30, 2013, was that the investment company, DC Energy, was reaping rewards from the swelter. Within 48 hours the firm, based in Vienna, Va., had made more than $1.5 million by cashing in on so-called congestion contracts, complex financial instruments that gain value when the grid becomes overburdened, according to an analysis of trading data by The New York Times.
Those profits are a small fraction of the fortune that traders at DC Energy and elsewhere have pocketed because of maneuvers involving the nation’s congested grid. Over the last decade, DC Energy has made about $180 million in New York State alone.
Across the nation, investment funds and major banks are wagering billions on similar trades using computer algorithms and teams of Ph.D.s, as they chase profits in an arcane arena that rarely attracts attention.
Congestion occurs when demand for electricity outstrips the immediate supply, sending prices higher as the grid strains to deliver power from distant and often more expensive locations to meet the demand. To help power companies and others offset the higher costs, regional grid operators, which manage the nation’s transmission lines and wholesale power markets, auction off congestion contracts, derivatives linked to thousands of locations on the grid. When electricity prices spike, contract holders collect the difference in prices between points from the grid operators. If the congestion moves in the opposite direction, holders pay the operators.
The contracts were intended to protect the electricity producers, utilities and industries that need to buy power. The thinking was that the contracts would help them hedge against sharp price swings caused by competition as well as the weather, plant failures or equipment problems. Those lower costs could reduce consumers’ bills.
But Wall Street banks and other investors have stepped in, siphoning off much of the money. In New York, DC Energy accounted for more than a quarter of the total $639 million in profits in the congestion markets between 2003 and 2013, The Times found. Some of DC Energy’s biggest paydays involved Port Jefferson, a village 60 miles east of Manhattan. Because of the geography of the grid, moving power from one point to another means demand often briefly outstrips supply here.
DC Energy — and its profits — are an unexpected result of the deregulation of the nation’s electric grid. The idea behind deregulation was to eliminate old monopolies and create robust, competitive markets that would encourage investment and ultimately lower costs for consumers. (
) But in most places, electricity bills have been rising, not falling. While fuel prices, taxes and fees have added directly to the costs, Wall Street-style traders have contributed in subtle ways by turning new markets, like the trading of congestion contracts, to their advantage, The Times analysis found.The contracts have attracted big money: More than $2 billion has been invested nationwide in the monthly auctions for contracts since 2011, according to Platts, a trade publication.
DC Energy had bet there would be trouble. That spring, its traders bought a number of congestion contracts at a monthly Nyiso (pronounced NIGH-so) auction. Those derivatives entitled the firm to collect the difference in power prices between multiple points on the Long Island grid, including between Port Jefferson and Northport, 20 miles to the west.l
On that May morning, transmission lines near a power plant in Northport were down for maintenance just as the heat arrived. The Northport area had plenty of electricity for itself but could not send more to communities like Port Jefferson. So while prices in Northport climbed to more than $129 a megawatt hour, prices in Port Jefferson jumped to $324 — a boon for DC Energy, which held congestion contracts tied to price differences between the two points.
The derivatives were not primarily devised for Wall Street. But in New York and elsewhere, many power companies are smaller players in the market compared to Wall Street banks like Goldman Sachs, and trading firms like DC Energy.
It is unclear how much the activity in the markets, particularly by the banks, is speculation versus hedging on behalf of clients. Still, many of the most active participants are investment firms.
The utilities and power companies suggest they cannot win against trading outfits that employ math specialists, often called “quants,” to spot lucrative opportunities. With transmission contracts, there are tens of thousands of tradable combinations.
“The financial players have the resources, the smart people that discovered there is a great opportunity to make money here,” said Hany A. Shawky, a professor of finance and economics at the University at Albany who has studied the electricity markets. “The utilities are sometimes missing opportunities to hedge because of the competition coming in from financial players.”
Trading firms like DC Energy say they ultimately benefit consumers by bearing financial risks and fostering competition. They argue that power companies can hedge only if someone else is willing to speculate. Market forces, they say, can also help power companies determine where to invest in the grid.
“We believe this type of activity should cause prices to better reflect true costs and thus create a more efficient electricity infrastructure that should better serve the retail customer,” Andrew J. Stevens, a co-founder of DC Energy, said in an email. DC Energy executives declined to be interviewed for this article but answered questions by email.
For DC Energy, the derivatives seem close to a sure thing. Former employees said the executives had told staff members that the firm lost money for two months in its decade-long history. DC Energy bought the same Northport-Port Jefferson contracts on Long Island 47 times since 2005, earning $2 million, The Times found.
Dr. Stevens said via email that the firm was involved in markets across the country. “We invest in hundreds of thousands of contracts across the marketplace,” Dr. Stevens said. “Any subset of these contracts in some subset of time will show gains, while another subset will show losses.”
Yet in places like upstate New York or Long Island, the market is so small, and the participants for certain contracts so few, that knowledgeable traders can collect rich rewards. Frank A. Wolak, an economics professor at Stanford who studies commodities, said the congestion markets created perverse incentives because profits rise when grid congestion becomes worse.
"If traders are making money, then consumers are paying more,” Mr. Wolak said. “The money that these guys are making has to come from somewhere.”
A major concern for federal regulators is that congestion contracts are one way to manipulate electricity prices. While trading by financial players is legal and DC Energy has not been accused of any wrongdoing, the Federal Energy Regulatory Commission has since 2012 proposed penalties or reached settlements with three large banks and several investment firms, accusing each of manipulation of some type.
In one of the cases, Louis Dreyfus Energy Services, an energy trading company, began buying contracts linked to the grid around Velva, N.D., where winds off the prairie spin the turbines of a wind farm, in spring 2009.
First, Xu Cheng, an employee at Louis Dreyfus Energy, which at the time was partly owned by a J. P. Morgan hedge fund, placed a bet that congestion would drive up electricity prices. Then, FERC later charged, Louis Dreyfus set out to make sure those bets would pay off. Trading in another corner of the electricity market, a second trader created the impression that congestion was hitting the Velva area, the commission concluded. Mr. Cheng had examined just such a situation in his doctoral dissertation at the University of Illinois at Urbana-Champaign, noting that traders could “make extra profit by creating nonreal congestion.”
The payoff for Louis Dreyfus was a quick $3.3 million in profits.
The commission smelled trouble and began to investigate. In February, Louis Dreyfus agreed to pay $7.4 million to settle allegations that it had manipulated prices. As is often the case in such settlements, the firm neither admitted nor denied wrongdoing.
The commission has been trying to crack down in the electricity market lately, but for years it has been outmaneuvered by the traders it is supposed to police.
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