POWER MARKET ECONOMICS Deregulation Socio-economical and Technical Issues

POWER MARKET ECONOMICS Deregulation: Socio-economical and Technical Issues Inés Romero Navarro January 2004 Lund University, SWEDEN Inés Romero Navarro, IEA. LTH INDUSTRIAL ELECTRICAL ENGINEERING AND AUTOMATION

Outline • • • Introduction Engineers vs. Economists Market Architecture Market Design Conclusions Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

Introduction II • Power Systems and Power Markets – lack of reliability (elasticity of demand 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 today’s networks Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

Market Architecture (MA) • • Regulated and Deregulated services Bilateral and Centralized Markets Forward and Real Time Markets Customer Response Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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) Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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) Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 power’s marginal value – TSOs exercise it by withholding interruptible load or controlling imports/exports Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

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) Inés Romero Navarro, IEA. LTH

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) Inés Romero Navarro, IEA. LTH

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 Inés Romero Navarro, IEA. LTH

Conclusions • The famous break down in California market 2000 – Market characterized by low profits and lack of an investment policy – 1990 s 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 Inés Romero Navarro, IEA. LTH

Questions ? Inés Romero Navarro, IEA. LTH