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POWER MARKET ECONOMICS
Deregulation: Socio-economical and Technical
Issues
Inés Romero Navarro
January 2004
Lund University, SWEDEN
INDUSTRIAL ELECTRICAL ENGINEERING AND AUTOMATION
Outline
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Introduction
Engineers vs. Economists
Market Architecture
Market Design
Conclusions
Inés Romero Navarro, IEA. LTH
Introduction I
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Last century-power structure was constituted by large utilities, governed by
market monopolies
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Today - competitive markets, deregulation or re-estructuring
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Electricity objective: ’Ensure delivery of energy to customers with high reliability
and high quality contain, but optimizing the use of available resources’
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Reliability is today a popular term!
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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
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Power Systems and Power Markets
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lack of reliability (elasticity of demand and investments)
lack of sufficient capability (investments)
lack of coordination and communication
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Deregulation has increased the complexity to design and manage the
power system ...
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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
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Power Market combines power system and market economic fields. Optimal
power market performance requires experts in both fields
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Experiences show lack of cooperation = Failure in the Market Design
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Engineers + economic advise
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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
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)
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Regulated and Deregulated services
Bilateral and Centralized Markets
Forward and Real Time Markets
Customer Response
Inés Romero Navarro, IEA. LTH
Re/deregulated Services
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Ancillary Services (AS) and System Operator (SO)
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SO responsible to maintain system balanced: supply equal demand
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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)
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UC is handled by the generation side
CM is handled by SO (Revenues)
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Risk Management and Forward Markets (FM)
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Transmission and Distribution
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Natural monopolies
New line – decision from either SO or a private company
Retail Competition
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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
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Bilateral vs. centralized exchanges and pools
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Define the role of SO
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Bilateral markets are slow.
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Small role = market power from private parties (bilateral exchanges)
Large Role = inefficiency of non-profit organizations
Problems to handle Unit Commitment and Congestion Management
Lack of transparent information
Exchanges vs. pools
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Exchanges are inefficient. Lack of reliability and coordination
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Pools induces gaming and inefficiencies caused by side payments
Locational Pricing
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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
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Trading power involves a sequence of overlapping markets, forward and
real time markets
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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
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DA-market is handled in the form of exchanges or pools
The market is operated as auctions
Inés Romero Navarro, IEA. LTH
Customer Response
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Electricity marginal cost of production highly fluctuates and so does the delivery
cost
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Real-time metering to measure fluctuations is limited at residential, commercial
and industrial levels
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Customers lack information on continuous real-time prices. Low customer
response to prices = Lack of demand elasticity
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Lack o demand elasticity = supply and demand curves may fail to intersect. SO
is forced to set the price
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Today, all the markets operate in this way
Inés Romero Navarro, IEA. LTH
Power Market Design (MD)
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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
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Power limits protect the lines and stability of the system, by constraining the
maximum capacity that can be transfer through the lines
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The result: Competitive locational energy prices (CLPs)
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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
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SO charges for various services and uses of the system
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PRICES- to encourage the efficient use of system facilities
TAXES- to raise funds to pay for the facilities and various services
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Efficiency charging - efficient pricing for as many services and externalities as
possible (lines, losses, reactive power, generator ramping)
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Prices determined by competition or by the system operator
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Energy taxes are regulators to motivate/reduce the consumption of a specific
type of energy
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renewable energies, clean and green energies
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Customers response (ecological food market)
Inés Romero Navarro, IEA. LTH
Ancillary Services
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Frequency and Voltage Support
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Black-start Capability
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‘keep the grid operating’- SO (transmission rights or energy bids in the DA)
Re-scheduling differences between the DA and RT markets
Economic Dispatch
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extreme failures, full or partial blackouts
Re-start the system requires generators with black-start capability
Transmission Security
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Frequency stability and power balancing - provided by regulation and frequency
response services;
Market for trading reactive power (SO)
‘use of generators to minimize the cost of production’
DA and RT markets are important in order to dispatch economically
Trading Enforcement
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‘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
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Spinning reserve (SR)
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Expensive
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‘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)
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
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(market estimates)
Gaming
Inés Romero Navarro, IEA. LTH
Market Power I - Introduction
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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
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Monopoly Power: benefits from the market power are for the sellers
/suppliers = Prices higher than the competitive ones
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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
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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
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Market power is exercised in RT. Never in forward markets
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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
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High spot prices motivate more suppliers to act in the market
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regulators will start taking restriction actions = Threat of Entry
restrictions hold down prices and participation
Inés Romero Navarro, IEA. LTH
Market Power III - Solutions
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Competition, monitoring and enforcement of the market are necessary to
control the exercise of market power
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High demand elasticity and low supplier concentration is desired
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Access to RT prices
If the demand of elasticity is failing, which other factors are maintaining the
competitive response of the market?
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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
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Reliability refers to security to deliver power to customers
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Importance at all levels
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Reliability, price spikes and investments determined by regulatory policies
If supply not equal to demand, the market cannot determine a price
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Incentive investments- establishing new policies and rewarding
Reliability market for customers (elasticity of demand)
Motivate renewable and green investments
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
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Profit is the key to encourage investment
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High prices induce investments = increase Installed Capacity
Short-run competitive prices induce right level of investment and reliability
Side effects of the reliability policy:
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Infrequent high price peaks -risk for investors (Risk Premium)
Extremely high prices facilitate the exercise of market power.
Long-run investments
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Generators sell in FM. Suppliers/customers buy in FM or RT
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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
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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
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Optimal level of installed capacity (Icap)
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acceptable number of hours of load shedding around one day every ten years,
reliability of the generators, and variations of the load,
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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:
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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
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The famous break down in California market 2000
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Market characterized by low profits and lack of an investment policy
1990s increase of load in the Western region
Compromised available capacity
Results
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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