POWER MARKET ECONOMICS

1
POWER MARKET ECONOMICS  Deregulation
Socio-economical and Technical Issues
Inés Romero Navarro January 2004 Lund
University, SWEDEN
INDUSTRIAL ELECTRICAL ENGINEERING AND AUTOMATION
2
Outline

• Introduction
• Engineers vs. Economists
• Market Architecture
• Market Design
• Conclusions

3
Introduction I

• Last century-power structure was constituted by
  large utilities, governed by market monopolies
• Today - competitive markets, deregulation or
  re-estructuring
• Electricity objective Ensure delivery of energy
  to customers with high reliability and high
  quality contain, but optimizing the use of
  available resources
• Reliability is today a popular term!
• Reliability levels
• The influence of the re-estructuring process on
  reliability levels
• Investments in generation and transmission
• Enough installed capacity

4
Introduction II

• Power Systems and Power Markets
• lack of reliability (elasticity of demand and
  investments)
• lack of sufficient capability (investments)
• lack of coordination and communication
• Deregulation has increased the complexity to
  design and manage the power system ...
• but It is not the main cause of the low
  reliability levels in todays networks

5
Engineering vs. Economics I

• Power Market combines power system and market
  economic fields. Optimal power market performance
  requires experts in both fields
• Experiences show lack of cooperation Failure in
  the Market Design
• Economists look at power as a common tradable
  good
• main challenge maximize profit for both buyers
  and sellers
• Engineers focus on technical aspects
  (reliability, quality)
• forget about the competitive nature of product
  traded in the stock market
• Engineers economic advise
• Wrong assumption Power is comparable to other
  common transaction
• Failure Maximize market profit without
  considering the main constraints that threat
  power delivery
• California Summer 2000 opens a discussion about
  Ethics

6
Market Architecture (MA)

• Regulated and Deregulated services
• Bilateral and Centralized Markets
• Forward and Real Time Markets
• Customer Response

7
Re/deregulated Services

• Ancillary Services (AS) and System Operator (SO)
• SO responsible to maintain system balanced
  supply equal demand
• frequency and voltage control
• monopoly on the reactive power market
• AS are fully regulated, coordinated by SO, and
  benefit to the entire market
• Unit Commitment (UC) and Congestion Management
  (CM)
• UC is handled by the generation side
• CM is handled by SO (Revenues)
• Risk Management and Forward Markets (FM)
• Transmission and Distribution
• Natural monopolies
• New line decision from either SO or a private
  company
• Retail Competition
• Retailing services are related to financial
  transactions and sending out bills
• Green power, reliability level - benefit of
  retail competition

8
Cen/decentralized Design

• Bilateral vs. centralized exchanges and pools
• Define the role of SO
• Small role market power from private parties
  (bilateral exchanges)
• Large Role inefficiency of non-profit
  organizations
• Bilateral markets are slow.
• Problems to handle Unit Commitment and Congestion
  Management
• Lack of transparent information
• Exchanges vs. pools
• Exchanges are inefficient. Lack of reliability
  and coordination
• Pools induces gaming and inefficiencies caused by
  side payments
• Locational Pricing
• Energy prices differ by location (congestion
  limits) locational pricing
• They are competitive and unique, (supply and
  demand)

9
Forward and RT Markets

• Trading power involves a sequence of overlapping
  markets, forward and real time markets
• Forward markets are settled by long-term
  contracts
• Sold up to 1-2 years
• Covering from several years to the day before
  real time
• Financial markets
• The SO is responsible for the DA- and RT- markets
• DA-market is handled in the form of exchanges or
  pools
• The market is operated as auctions

10
Customer Response

• Electricity marginal cost of production highly
  fluctuates and so does the delivery cost
• Real-time metering to measure fluctuations is
  limited at residential, commercial and industrial
  levels
• Customers lack information on continuous
  real-time prices. Low customer response to prices
  Lack of demand elasticity
• Lack o demand elasticity supply and demand
  curves may fail to intersect. SO is forced to set
  the price
• Today, all the markets operate in this way
•  

11
Power Market Design (MD)

• Congestion Pricing
• Refunds and Taxing
• Ancillary Services
• Market for Operating Reserves
• Market Power and Gaming
• Reliability and Investment Policy
• Requirements for Installed Capacity

12
Congestion Pricing

• Power limits protect the lines and stability of
  the system, by constraining the maximum capacity
  that can be transfer through the lines
• The result Competitive locational energy prices
  (CLPs)
• Minimize the production costs
• Least cost dispatch in a competitive market
• Computed in the DA market by a centralized market
  (SO)
• When handled centrally No TR are issued

13
Refunds and Taxing

• SO charges for various services and uses of the
  system
• PRICES- to encourage the efficient use of system
  facilities
• TAXES- to raise funds to pay for the facilities
  and various services
• Efficiency charging - efficient pricing for as
  many services and externalities as possible
  (lines, losses, reactive power, generator
  ramping)
• Prices determined by competition or by the system
  operator
• Energy taxes are regulators to motivate/reduce
  the consumption of a specific type of energy
• renewable energies, clean and green energies
• Customers response (ecological food market)

14
Ancillary Services

• Frequency and Voltage Support
• Frequency stability and power balancing -
  provided by regulation and frequency response
  services
• Market for trading reactive power (SO)
• Black-start Capability
• extreme failures, full or partial blackouts
• Re-start the system requires generators with
  black-start capability
• Transmission Security
• keep the grid operating- SO (transmission
  rights or energy bids in the DA)
• Re-scheduling differences between the DA and RT
  markets
• Economic Dispatch
• use of generators to minimize the cost of
  production
• DA and RT markets are important in order to
  dispatch economically
• Trading Enforcement
• metering of power flows between all trades and
  the common grid and
• setting accounts with traders who deviate- SO

15
Market for Operating Reserves

• Spinning reserve (SR)
• increase in the output that a generator/load can
  provide in ten minutes (load)
• Regulation, 30 minutes non-spinning reserves, and
  ten-minute reserves (gas turbines)
• Expensive
• Total SR largest amount of power that can be
  lost under a single contingency
• total cost of SR depends on cost of the energy
  provided when the reserves are called on, and
  chance to be called
• Capacity-bid scoring is efficient
• Non optimal bids inefficient dispatch (market
  estimates)
• Gaming

16
Market Power I - Introduction

• Ability to affect the market price, resulting in
  a profitable action for the supplier/s, and in a
  market price away from the competitive levels
• Monopoly Power benefits from the market power
  are for the sellers /suppliers Prices higher
  than the competitive ones
• A supplier withholds power higher prices and an
  inefficient market
• Profit to the actor but also other suppliers.
  Wealth Transfer
• Problem supply curves are often vertical or
  almost vertical Measure the Markup
• Market protection to ensure that the bid that
  raises the price may not set the price
• Monopsony Power benefits from the market power
  are for the customers
• Holding out the demand/bidding a price that is
  lower than the powers marginal value
• TSOs exercise it by withholding interruptible
  load or controlling imports/exports

17
Market Power II - Gaming

• Market power is exercised in RT. Never in forward
  markets
• However, any exercise of market power in the RT
  market will be reflected in the future forward
  markets since their price is directly derived
  from the RT price GAMING
• High spot prices motivate more suppliers to act
  in the market
• regulators will start taking restriction actions
  Threat of Entry
• restrictions hold down prices and participation
  

18
Market Power III - Solutions

• Competition, monitoring and enforcement of the
  market are necessary to control the exercise of
  market power
• High demand elasticity and low supplier
  concentration is desired
• Access to RT prices 
• If the demand of elasticity is failing, which
  other factors are maintaining the competitive
  response of the market?
• forward contracts and obligation of suppliers
  (controlled by policy)
• uncertainty of the demand which causes
  supply-curve bidding

19
Reliability Investment Policy I

• Reliability refers to security to deliver power
  to customers
• Importance at all levels
• Incentive investments- establishing new policies
  and rewarding
• Reliability market for customers (elasticity of
  demand)
• Motivate renewable and green investments
• Reliability, price spikes and investments
  determined by regulatory policies
• If supply not equal to demand, the market cannot
  determine a price
• Traditional markets - enough installed generation
  capacity - high costs Gen.
• Today shedding load or by fixing a high price
• Best solution increase demand elasticity
• The minimal price intervention that would produce
  a reasonable level of reliability is known as
  value-of-lost-load (VOLL) pricing (Regulator)

20
Reliability Investment Policy II

• Profit is the key to encourage investment
• High prices induce investments increase
  Installed Capacity
• Short-run competitive prices induce right level
  of investment and reliability
• Side effects of the reliability policy
• Infrequent high price peaks -risk for investors
  (Risk Premium)
• Extremely high prices facilitate the exercise of
  market power. 
• Long-run investments
• Generators sell in FM. Suppliers/customers buy in
  FM or RT
• Preference forward market -lock a price and
  avoid the volatility of the spot market-
• long-term and spot prices must be close to each
  other
• High spot prices will influence long-term prices
  (investment long-term market)
• Low spot prices will influence long-term prices
  (investment RT market)

21
Requirements for Installed Capacity

• Optimal level of installed capacity (Icap)
• acceptable number of hours of load shedding
  around one day every ten years, reliability of
  the generators, and variations of the load,
• spare capacity - neighborhood of 118 of expected
  peak load
• Individual requirements for installed capacity
• The Individual requirements are met by either
  purchasing generation or by contracting for its
  use. Penalties
• To any load-serving utility that fails to own or
  contract for the required capacity
• To generators that fail the contract

22
Conclusions

• The famous break down in California market 2000
• Market characterized by low profits and lack of
  an investment policy
• 1990s increase of load in the Western region
• Compromised available capacity
• Results
• Extremely high prices (172 /MWh in August 2000
  vs. 58/MWh in May)
• Lack of price control - lack of customer response
  
• Exercise of market power
• Shortages - lack of reliability
• Bankruptcy or insolvency of large companies
• Losses for investors,
• Unemployment
• High costs for customers

23
Questions
?