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Market design and market power in wholesale electricy markets Guido Cervigni IEFE-Bocconi University, Milan Market design and market power in wholesale electricy markets Guido Cervigni IEFE-Bocconi University, Milan CEEM – Summer School on Economics of electricity markets Ghent University, Faculty of Economics and Business Administration 1 September 2015

Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Product standardisation: time dimension 0 1/2 1 Time 1/2 0 1 1/2 1 -10 Product standardisation: time dimension 0 1/2 1 Time 1/2 0 1 1/2 1 -10 - 10 MW 0 -20 MW § During the same hour all consumers withdraw 10 MWh § Should they be buying the same product?

Product standardisation: geographic dimension Zone 1 Maximum transfer capacity 1 ->2 = 200 MW Product standardisation: geographic dimension Zone 1 Maximum transfer capacity 1 ->2 = 200 MW Zone 2 Supply: unlimited @30 €/MWh [email protected]€/MWh Demand: 300 MW @any price 250 MW @ any price § Should a consumer in Zone 1 and a consumer in Zone 2 with identical consumption buy the same product?

Product standardisation: Remark - 1 § In the «real time» , injections must match Product standardisation: Remark - 1 § In the «real time» , injections must match withdrawals MW Injections by seller of 10 MWh in hour t 10 0 1/2 1 Time Withdrawals by buyer of 10 MWh in hour t -20 Balance ( «system» position) in hour t Half-hour with net surplus (SO sells) Half-hour with net deficit (SO buys)

Product standardisation: Remark - 2 § In the real time network constraints must be Product standardisation: Remark - 2 § In the real time network constraints must be met Zone 1 Supply: Maximum transfer capacity 1 ->2 = 200 MW Zone 2 unlimited @30 €/MWh [email protected]€/MWh 300 MW @any price 250 MW @ any price Demand: Market equilibrium sales with standard product: 550 [email protected] €/MWh Power flow 1 ->2 @ market equilibrium: 0 MW 250 MW (above transfer capacity) SO actions to address network constraint: Sell 50 MW in zone 1 Buy 50 MW in zone 2

Product standardisation: wrap-up § Some product standardisation is necessary to make electricity trading possible Product standardisation: wrap-up § Some product standardisation is necessary to make electricity trading possible § Product standardisation requires socialisation of some costs § We are still left with many products to trade

Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Injections and withdrawal commitments - 1 § Normal products: o o Seller does not Injections and withdrawal commitments - 1 § Normal products: o o Seller does not deliver … buyer does not consume Consumer wants more … additional purchase Seller overdelivers … extra is returned or disposed of Consumer does not receive …goods go back or disposed § Consequences of any over/under delivery issues are borne by (only) the parties to the transaction

Injections and withdrawal commitments - 2 § Electricity is different: over/under delivery – if Injections and withdrawal commitments - 2 § Electricity is different: over/under delivery – if not addressed – causes a black-out, affecting all consumers and producers § How is this feature addressed? o o The SO takes care of system balance at all times Injections and withdrawal commitments are enforced financially

Example MWh 50 Market participant G 50 MWh 25 MWh Imbalance G (bought by Example MWh 50 Market participant G 50 MWh 25 MWh Imbalance G (bought by G from SO) 0 MWh Net physical position at gate closure (Program) 50 Real time actual net injections 0 Market participant C 0 -50 MWh -33 MWh 17 MWh -50 Imbalance C (sold by C to SO) System Imbalance +17 MWh 8 MWh -25 MWh Bought by SO in the Balancing market

Balancing market, balancing perimeter and imbalance charges § The SO procures/disposes of any deficit/surplus Balancing market, balancing perimeter and imbalance charges § The SO procures/disposes of any deficit/surplus of electricity in the «balancing market» § Alternative settlement systems differ in: o o The balancing perimeter Imbalance prices

Delivery and settlement: wrap-up § Electricity delivery commitments can be enforced only financially § Delivery and settlement: wrap-up § Electricity delivery commitments can be enforced only financially § An imbalance is a difference between an injection/withdrawal commitment (the program) and actual injection/withdrawals § Issues with standardisation of imbalance prices

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Electricity is traded on multiple timeframes Electricity market transactions Long term transactions Gate closure Electricity is traded on multiple timeframes Electricity market transactions Long term transactions Gate closure 1 day before delivery Days before delivery Day-ahead market Real time Intraday market Time System Operations Reserve procurement, Congestion management, Balancing • From multi-year to week ahead • Basaload/peak products • Decentralised trading and organised venues • Daily • Hourly products • Non discriminatory auctions • Implicit allocation of transmission rights • Power exchanges • Daily • Hourly products • Non discriminatory auctions or continuous trading • Power exchanges Imbalance settlement • SO is counterparty to all transactions • Different arrangements across Europe

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

The standard approach to assessing competition applied to the wholesale electricity generation Industry structure The standard approach to assessing competition applied to the wholesale electricity generation Industry structure Relevant Market Degree of competition

Non storability & network contraints: a different competitive assessment in each hour? 14% 17% Non storability & network contraints: a different competitive assessment in each hour? 14% 17% 14% 29% 17% 57% 30% of the time 70% 10% of the time 60% of the time

Does market power depend on market shares? €/MWh Profit P. Mkt Pwr Profit P. Does market power depend on market shares? €/MWh Profit P. Mkt Pwr Profit P. Comp MW A small generators woith much market power MW

Does market power depend on market shares? €/MWh P. Comp P. Mkt Pwr MW Does market power depend on market shares? €/MWh P. Comp P. Mkt Pwr MW High concentration with no market power MW

Market power assessment based on pivotality Bid curve Ppivot § A possible index of Market power assessment based on pivotality Bid curve Ppivot § A possible index of market power in electricity generation is the ability to corner the market - or Pivotality profits § Generator i is Pivotal in hour t, in an hour, if in that hour: Market_demand– Capacity_but_i’s > 0 ↓ Assess market power based on the Number of hours in which the generator is Pivotal Demand § Market power: ability and incentive to set prices higher than the competitive level Variable cost Pcomp Capacity of competitors and imports Generator’s capacity Generator’s pivotal capacity

Adjusted Pivotality indicators Pivotal Capacity (MW) - Ability to cross the market Ability & Adjusted Pivotality indicators Pivotal Capacity (MW) - Ability to cross the market Ability & Incentive to exercise market power Inflexible output = 0 Incentive to cross the market Hedged load = 0 Pivotal capacity (MW) - Incentives § Hourly pivotality adjustments § § Ability measure: Pivotal Capacity – Inflexible generators Incentive measure: Pivotal capacity – Hedged load

Examples Pivotal Capacity (MW) - Ability Inflexible output = 0 MW Hedged load = Examples Pivotal Capacity (MW) - Ability Inflexible output = 0 MW Hedged load = 0 Pivotal capacity (MW) - Incentives Many hours with incentives and ability to corner the market Few hours with incentives and ability to corner the market ↓ ↓ Market power issues No market power issues

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

Market power mitigation: capacity divestiture - 1 €/MWh D post div D pre div Market power mitigation: capacity divestiture - 1 €/MWh D post div D pre div MC post div MC pre div Source: Federico and Lopez 2009 Divested quantity MW § Divestiture lowers and flattens the firm’s residual demand …

Market power mitigation: capacity divestiture - 2 €/MWh P pre div P post div Market power mitigation: capacity divestiture - 2 €/MWh P pre div P post div MR pre div MW § Reducing the profit maximising price … MW

Market power mitigation: long term contracting €/MWh P pre contr MC MC P post Market power mitigation: long term contracting €/MWh P pre contr MC MC P post contr D D MR pre contr MW Contracted quantity MR post contr MW § The long-term contract makes part of the firm’s revenues independent of the spot market price

Comparison § Advantages of contracting over divestitures: o Politically easier o No impact on Comparison § Advantages of contracting over divestitures: o Politically easier o No impact on scale economies § Drawbacks o Incentives to sustain spot prices above profit max level to support future long term negotiations o Less effective (given the volume)

Market power mitigation: price cap €/MWh Demand Supply net of withholdng Supply €/MWh Demand Market power mitigation: price cap €/MWh Demand Supply net of withholdng Supply €/MWh Demand Supply Price increase Withheld capacity MWh § With-holding as the largest impact on prices when the system is tight § An overall price cap (below VOLL) mitigates market power but … § Results in «missing money»

Market power mitigation: bid mitigation § The generator’s bid in the spot market is Market power mitigation: bid mitigation § The generator’s bid in the spot market is constrained every time the generator’s is assessed to enjoy «great» market power Phase 1: Screening Phase 2: Mitigation Example: (PJM) any three generators pivotal to solve a constraint in a 15 min period? Cost-based bids enforced on the three jointly pivotal generators

 • You may want to take a look at: The economics of electricity • You may want to take a look at: The economics of electricity markets, Pippo Ranci and Guido Cervigni Eds, Elgar, 2013 • I can be reached at: guido. [email protected] com