Power exchange prevents energy prices from spiking.

During this summer's killer heat wave in the Midwest, prices for electricity jumped to $7,000 a megawatt-hour, more than 200 times the average cost. That caused a panic among electric utilities as they rushed to secure power supplies.

But during last week's California heat wave, when more power was used than at any other time in state history, the cost of electricity only rose to $170 a megawatt-hour, and there was no panic among local utilities.

How has California managed to escape the price spikes that plagued the Midwest?

Part of that answer lies with the 5-month-old California Power Exchange Corp. in Alhambra. a statewide electricity trading market and the largest such market in the nation.

The Power Exchange, or PX as it is called, has acted as a stabilizer for electricity prices. It was designed to ease the transition to a deregulated market, in which prices fluctuate with supply and demand.

About 40 power providers trade electricity on the PX, with the bulk of trading done by the state's three largest electricity providers: Edison International, Pacific Gas & Electric. and Sempra Energy. Under the deregulation package enacted in 1996, all three investor-owned utilities are required to conduct their electricity transactions through the PX. at least until full deregulation arrives in 2002. That means up to 80 percent of all electricity traded in California is handled through the PX, making it the nation's largest electricity-trading entity.

But unlike the market for soybeans or pork bellies. individual buyers and sellers do not come together on a price at the PX. Rather, the exchange receives dozens of bids to buy and sell. averages those bids and sets a single market price for all buyers and sellers. If there are more bids to buy than to sell, the average buy bid is given a correspondingly heavier weight in determining the "market clearing" price.

By averaging the bids and fixing the price. the PX has been able to avoid the panic seen in the Midwest, where prices spiraled with each trade between individual buyers and sellers.

"Our mission is the operation of a smooth market for the pricing of electricity," said PX Chief Executive George Sladoje.

The PX actually got off to a rocky start. A series of problems with the computer system that linked it with the Independent System Operator (the entity set up by the state to ensure that all the electricity gets to where it's needed) forced a three-month delay in its launch. The PX finally opened for business on March 31.

At the heart of the Power Exchange operation is a bank of computers that receive and process incoming bids from power sellers like out-of-state utilities with excess power and buyers, like in-state urban utilities. These bids are submitted between 5 a.m. and 7 a.m. every day, as buyers project what they are going to need that day and sellers project how much they can sell. The day's market clearing price is posted by 7:30 a.m.

Edison has a team of 50 people whose main job is to determine how much electricity' the company needs to buy on any given day to augment the electricity produced by its own power plants.

Edison's energy supply manager Kevin Cini said the company submits a series of bids to the PX each morning - each bid pegged to a specific projected price.

"We take all the bids that come in and average them out," said Becky Kilbourne. director of market services for the California Power Exchange. "We see where the cumulative price for the bids to buy and the cumulative price for the bids to sell intersect. That point is what we call the market-clearing price: it is the price for power for that day."

After the price is set, the PX makes power allocations. which must then be cleared with the Independent System Operator to ensure there is enough power to go around.

While the PX bid process tends to prevent huge price spikes, it has a downside: it also raises the lowest bids. That allows for independent power marketers - such as Los Angeles-based New Energy Ventures - to purchase power directly from other power suppliers at a price slightly lower than the PX.

Some buyers and sellers prefer dealing with marketers because it allows them to enter into longer-term contracts at prices pegged to a particular percentage below the PX price.

The price difference is negligible lot individual residences, but for a major corporate customer like a supermarket chain or aerospace manufacturer, a dollar or two oil each megawatt of energy can add up to millions of dollars a year in savings.

Partly to be more competitive with these other marketers, the PX last month instituted "hour-ahead" trading, where prices are set three to four hours in advance of a given hour rather than just once each morning. This allows more flexibility to ever-changing weather conditions that can add to or reduce demand.

"There was often a big discrepancy between what everyone thought they would need the day before and what they would actually need," said Arthur O'Donnell, editor and associate publisher of California Energy Market. a Bay Area-based industry newsletter. "With this hour-ahead market, the Power Exchange has proven it is an elastic institution.