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Power Liberalization, CrossBorder Transactions, and Market Convergence Directive 5403

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Title: Power Liberalization, CrossBorder Transactions, and Market Convergence Directive 5403


1
Power Liberalization, Cross-Border Transactions,
and Market ConvergenceDirective 54/03
Regulation 1228/03/EC
Workshop on Implementing the Gas and Electricity
DirectivesEuropean Commission - DG Enlargement
TAIEX and the Ministry of Energy and Mining of
KosovoPristina - 24 March 2006

Carlo PozziDepartment of FinanceESSEC
Graduate School of Businessand Centre de
Géopolitique de lEnergie et des Matières
PremièresUniversité Paris DauphineEmail
pozzi_at_essec.fr / Mobile 33 6 7180 2717
2
FOCUS OF THE PRESENTATION
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Describing the specificities of electricity as a
commodity and the constrains that these impose on
the creation of an integrated electricity market
(IEM)Elucidating how an optimal market model
can lead to the creation of such IEM under
criteria of best economic and physical
efficiencyHighlighting how these concepts
inform the existing European regulation and favor
the convergence between different electricity
markets
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carlopozzi
3
ELECTRICITY A SPECIAL COMMODITY
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The electricity industry includes in its
boundaries one or more natural monopolies. Its
competition levels are therefore unstable.
Concentration tends to increase (horizontally
and vertically) and the industry tends to
collapse into an integrated monopoly.
Procurement
Generation
Transmission
Distribution
Sales and Billing
carlopozzi
4
ELECTRICITY A SPECIAL COMMODITY
?
An integrated monopoly is a monolithic form of
organization. Economic (cost and revenues) and
physical balances (transmission and distribution
loads) are internally achieved on the basis of a
technical program.
Procurement
Generation
Transmission
Distribution
Sales and Billing
carlopozzi
5
ELECTRICITY A SPECIAL COMMODITY
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Directive 54/03 envisions the creation of
competitive power markets by mandating the
unbundling of vertically integrated monopolies at
the national level (Art10)
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Generation
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Transmission
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Distribution
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Households Businesses
carlopozzi
6
ELECTRICITY A SPECIAL COMMODITY
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The separation of subsequent stages of the value
chain implies that exchanges formerly
administered on the basis of internal rules
(transfer pricing) can then be governed by
market prices.
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Generation
P
Transmission
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P
P
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Distribution
P
P
P
Households Businesses
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carlopozzi
7
ELECTRICITY A SPECIAL COMMODITY
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LiberalizationThe unbundling of electricity
sectors does not create inherently efficient
markets (factors may be less than optimally
allocated) because it cannot eliminate natural
monopoliesHence liberalization, in
order to achieve its goals, requires a strict
regulation of the activity of those subjects who
control monopolies
National Monopoly
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Transmission
Regional Monopoly
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Distribution
carlopozzi
8
ELECTRICITY A SPECIAL COMMODITY
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A crucial role to further the efficient success
of liberalizationis therefore to be performed by
Transmission System Operators (TSOs) who-
are to be independent subjects who administer the
survivingmonopolies- administer the
infrastructure aside from its owner(s)- ensure
its capacity and reliability- administer the
balanced flow of energy (dispatching)- provide
non discriminatory access to the system-
guarantee viable interconnection with other TSOs

carlopozzi
9
ELECTRICITY A SPECIAL COMMODITY
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In a transmission system it is possible to
measure only How much power generators load to
the grid How much power consumers use from the
gridbut not how much power specifically flows
from suppliers to the clients in bilateral
trades.Electricity is thus a standardized
merchandise (commodity) whose trades among
multiple agents need be coordinated in a
centralized fashion.And since transmission
lines can only bear a maximum amount of flow
load,not all trades can be performed as agents
would economically prefer. This gives
particular authority to each TSO in each market
and creates an information asymmetry.
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carlopozzi
10
ELECTRICITY A SPECIAL COMMODITY
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At the Continental level, transmission systems
and markets are many- They are highly
interconnected - They require complex
coordination
B/L
NL
DK/N/S/FI
IR
GB
CH
L/D
A
SL
F
P/E
GR
I
carlopozzi
11
ELECTRICITY A SPECIAL COMMODITY
?
B/L
NL
DK/N/S/FI
IR
GB
CH
L/D
A
SL
F
P/E
GR
I
Liberalization and integration by allowing free
access to suppliers and eligible demand to
consumers require a complex continental
organization in order to validate and
perform cross-border contracts coordinate
power flows by taking into account the physical
limits of the grid respect market efficiency
(best allocation) and non- discrimination allo
w the respect of regional specificities across
the continent.
carlopozzi
12
AN OPTIMAL MARKET MODEL
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Current Market Practices (Bilateral Contracts)

In administered markets agents tend to exchange
power through point-to-point bilateral trades at
an all-inclusive exchange price (over the counter
trade OTC)This is however non-optimal from
the economic and physical efficiency standpoint,
since over-the-counter bilateral trades may
ex-ante not adequately consider the cost and the
physical possibility of being performed over the
network need to be integrated and performed
in the transmission network on an ex-post basis,
hence they may be individually tracked and
potentially discriminated cannot be easily
sold (low liquidity), economically cleared
and/or physically netted out after their
agreement.
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carlopozzi
13
AN OPTIMAL MARKET MODEL
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Market Splitting vs. Market Coupling. The
Efficiency Value of Coordination. (1)
SplittingIf an OTC bilateral trade potentially
consumes more than the transmission capacity
which is available, TSO cannot perform it (both
internally or internationally)So a transaction
between regions or nations does not take place
and markets remain separatedIf one market
produces at a higher efficiency than another,
this higher efficiency cannot be used to satisfy
consumers in both markets
carlopozzi
14
AN OPTIMAL MARKET MODEL
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Market Splitting vs. Market Coupling. The
Efficiency Value of Coordination. (2)
Coupling- if market agents communicate ahead of
time their will to offer or to bid for power to
TSOs- and TSOs can coordinate all these offers
and bids by exchanging their information, markets
can be synchronized (coupling)Then available
interconnections (between regions or nations) can
be better used to maximize efficiency and the
most efficient production system touches the
highest number of consumers in two or more
bordering regions
carlopozzi
15
AN OPTIMAL MARKET MODEL
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Optimal market model (from TSOs standpoint)
Build a Physical Representation of the Network
(Constraints Bottlenecks)
Gather Ex-Ante Bids Offer
OptimizationMaximize Net Load Value (Under
Physical Constraints)
Dispatching
Administer Physical Flows
carlopozzi
16
AN OPTIMAL MARKET MODEL
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Power Exchanges Separation of Two-Sided
Exchange Contracts
?
To better achieve economic efficiency, OTC
bilateral contracts can be suitably split into
single-legged financial positions (bids and
offers) One-legged position trading can be
centralized in power exchanges and different
positions cleared against each-otherCentralized
trading enhances liquidity (finding
counterparties), convergent pricing (low bid-ask
spreads) and lowers performance risksAnd
favors the optimal economic use of the
transmission network by netting out bids and
offer and favoring dispatch optimization.
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carlopozzi
17
AN OPTIMAL MARKET MODEL
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Separation of two-sided exchange contracts
Supplier
Buyer
Traders
Traders
Traders
Suppliers
Buyers
ClearingAuthority(Marketplace)
SystemOperator(TSO)
carlopozzi
18
AN OPTIMAL MARKET MODEL
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Directionality and performance
The flow-direction of one-legged positions can
be identified, so one-sided trades furthering
the efficient use of the network (releasing
congestion) can be economically
privileged Market agents therefore may receive
an efficient signal on the utilization of scarce
transmission capacity And since the right to
use the network may also be separated from the
obligation to use it, overruns and under-runs of
the network can be better identified and
economically sanctioned.
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carlopozzi
19
AN OPTIMAL MARKET MODEL
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Market coordination (coupling)
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In an optimal organizational setup, power
positions can therefore be ex-ante bid or offered
by any continental market actorSingle
bid/offer can be stacked to form supply and
demand curves so that efficient clearing prices
can be found at their intersectionsDifferent
power exchanges can cover one or more regions of
the networkWithin the region(s) covered by a
single marketplace, preemptive disallowance of
non-performable trades (pro-rata capacity
allocation) or other control mechanisms like
market-splitting or counter trading allow for
making physically possible the best ex-ante
exchange programWhile across regions, share of
information, and auctioning coordination can
assure maximum economic efficiency to ex-ante
bid/offer programs
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carlopozzi
20
Market Opening
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TSO/DSO Market Design in New Member
StatesLegend OOwnership, LLegal, M
Management, A Accounts, N No unbundling
Third Benchmarking Report
carlopozzi
21
Market Opening
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Market Structure Firms Operating
Fourth Benchmarking Report
carlopozzi
22
Market Opening
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Market Structure Switching Statistics
carlopozzi
Fourth Benchmarking Report
23
Market Convergence
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Price History OMELSpain
carlopozzi
24
Market Convergence
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Price History PowernextFrance
carlopozzi
25
Market Convergence
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Are Price Differentials and Cross-Border
Transactionsbetween France and Spain Related?
carlopozzi
26
Market Convergence
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Strong Relationship (GARCH Modelling)Price
differentials significantly drive cross-border
exchanges between France and Spain
carlopozzi
27
Market Convergence
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Weaker Relationship Price differentials between
two single countries have less evident power on
cross-border exchanges where power can follow
multiple path between them.France and Germany
carlopozzi
28
Contact Information
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Carlo PozziDepartment of FinanceESSEC
Graduate School of Businessand Centre de
Géopolitique de lEnergie et des Matières
PremièresUniversité Paris DauphineEmail
pozzi_at_essec.fr / Mobile 33 6 7180 2717
carlopozzi
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