Download FERC - Robert Blohm

Don’t Overemphasize Spot at the
Expense of Forward and Real
Time (Macro & Micro)
Federal Energy Regulatory Commission
February 26, 2002
Robert Blohm
Investment Banker & Economist
email: [email protected]
TOTAL
COST
CURVES
E V
T
A
E N
L
U
E
TOTAL
REVENUE
LINEAR : AR = MR
= MR
= AR
AC
=
T O
R
MC
=
TOTAL
COST
TOTAL
REVENUE
CURVES
LINEAR :
AC = MC
NON-LINEAR
NON-LINEAR
AC : AVERAGE COST
MC : MARGINAL COST
AR : AVERAGE REVENUE
MR : MARGINAL REVENUE
: SLOPE
: SLOPE
QUANTITY
SOLD
QUANTITY
SOLD
OUTSIDE THE PERFECTLY COMPETITIVE TEXTBOOK WORLD OF STRAIGHT LINES ,
CURVES ARE NON-LINEAR .
$ / UNIT
PERFECT COMPETITION
ONLY AT A HORIZONTAL SUPPLY AND DEMAND CURVE
WHERE MARGINAL EQUALS AVERAGE
MC: MARGINAL COST
AC: AVERAGE COST
AR: AVERAGE REVENUE
MR: MARGINAL REVENUE
p : PERFECTLY COMPETITIVE PRICE
pc
q : PERFECTLY COMPETITIVE QUANTITY
pc
: PERFECTLY COMPETITIVE
SUPPLY AND DEMAND CURVE
MC
SUPPLY CURVE
p
AC
p
pc
AR
DEMAND CURVE
VALUE CURVE
MR
q
q
pc
QUANTITY
IMPERFECT COMPETITORS PRODUCE THE PROFIT-MAXIMIZING
QUANTITY AND PRICE OFF THE AVERAGE REVENUE CURVE
IMPERFECT COMPETITION :
ONCE THE (PERCEIVED) DEMAND CURVE SLOPES ,
AVERAGE AND MARGINAL REVENUE DIVERGE
PERCEIVED AGGREGATE DEMAND CURVE STEEPENS AS THE INDUSTRY
COMPRISES FEWER STRATEGIC PLAYERS.
EACH PLAYER IS EFFECTIVELY A SMALL MONOPOLIST, LEAVING ONE-ANDTHE-SAME RESIDUAL PORTION OF DEMAND UNSERVED.
$ / UNIT
AR : AGGREGATE PERCEIVED AVERAGE REVENUE
MR : AGGREGATE PERCEIVED MARGINAL REVENUE
PERFECT
COMPETITION :
FLAT HORIZONTAL
SUPPLY AND DEMAND
CURVE
$ / UNIT
A QUINTOPOLY
ACTUAL DEMAND CURVE
1/3
p
p=c
1
q
$ / UNIT
Q
PERCEIVED DEMAND CURVE
AR
c
QUANTITY
MR 5/6
q
1 2/3
A QUADROPOLY
A TRIOPOLY
1/2
2/5
p
p
AR
MR
4/5
q
c
2/3
1 3/5 Q
AR
MR
c
3/4
q
1
p
AR
p
AR
c
ACTUAL AND PERCEIVED
DEMAND CURVE
MR
1 1/3
Q
A MONOPOLY
A DUOPOLY
MR
2/3
q
1 1/2
Q
c
1/2
1
q
QUANTITY
UNIT
PRICE
A MARKET'S OR AUCTION'S
PRICE-DETERMINING MECHANISM
AFFECTS
PRICE SIGNALLING .
IMPLICIT BILATERALIZATION OF POOLS .
SINGLE (MP) PRICE POOL HIDES (AP) PRICE PATH .
NET DEMAND-IMPATIENCE
S : SUPPLY
D : DEMAND
Q : TOTAL QUANTITY
BOUGHT / SOLD
MP : MARGINAL PRICE
AP : AVERAGE PRICE
: TRANSACTED PRICES
AP
S
VARIABLE-COST CURVE
MP
D
VALUE CURVE
QUANTITY
&
Q
TIME
SPLITTING THE DIFFERENCE WITH LESS PRICE-SENSITIVE BUYERS
GIVES SELLERS A HIGHER (AVERAGE) PRICE .
BILATERALIZATION MEANS MULTIPERIOD PRECOMMITMENT IN
MULTIPLE FORWARD MARKETS : PRICE-PATH REVELATION MEANS
SMOOTHER, MORE PREDICTABLE PRICE BEHAVIOR .
UNIT
PRICE
O : OFFER-PRICE CURVE
BID & OFFER CURVES
B : BID-PRICE CURVE
ARE
S : SUPPLY CURVE
NOT THE SAME AS
D : DEMAND CURVE
O
THE VALUE /
O
VARIABLE-COST
SUPPLY AND
DEMAND CURVES .
THE LESS PATIENT
TRADE FIRST AS THE
CURVES INTERSECT
S
ON THE PRICE PATH
FROM LEFT TO
RIGHT .
VARIABLE-COST CURVE
S
BID & OFFER
CURVES START
FROM
INVERTED
POSITIONS
IMPLICIT
D
VALUE CURVE
B
SEQUENCE OF
TRADE
FROM THE LEFT AS
BID CURVE RISES &
OFFER CURVE
LOWERS .
B
Q
D BILATERALIZATION
OF POOLS
RIGHTWARD SEQUENCE OF TRADE
AS BID & OFFER CURVES APPROACH VALUE CURVE & VARIABLE-COST CURVE FROM THE LEFT
UNIT
PRICE
O
O
S
S
B
D
B
D
O
S
B D
QUANTITY
&
TIME
UNIT
PRICE
A MARKET'S OR AUCTION'S
PRICE-DETERMINING
MECHANISM
AFFECTS
ALLOCATION OF SURPLUS .
NET DEMAND-IMPATIENCE .
SINGLE (MP) PRICE POOL
REALLOCATES TO BUYERS
THE EXTRA SURPLUS
OTHERWISE GOING TO SELLERS
MORE PRICE-SENSITIVE THAN BUYERS .
: SURPLUS TO SELLERS IN A
SINGLE (MP) PRICE POOL
AP
: EXTRA SURPLUS TO SELLERS IN
A BILATERALIZED EXCHANGE
AP : AVERAGE PRICE
MP : MARGINAL PRICE
S : SUPPLY
D : DEMAND
S
VARIABLE COST CURVE
MP
D
VALUE CURVE
Q
QUANTITY
&
TIME
UNIT
PRICE
NET SUPPLY-IMPATIENCE .
CALIFORNIA UTILITIES WANTED A PERMANENTLY
MANDATORY POOL TO BE ABLE TO CAPTURE EXTRA
SURPLUS ,
POST RETAIL ACCESS .
WHEN THEY FAILED TO GET IT , THEY
DIVESTED GENERATION TO BECOME
NET DEMANDERS .
: EXTRA SURPLUS TO BUYERS IN A BILATERALIZED EXCHANGE
S : SUPPLY
D : DEMAND
MP : MARGINAL PRICE
AP : AVERAGE PRICE
S
VARIABLE COST CURVE
MP
D
VALUE CURVE
AP
Q
QUANTITY
&
TIME
UNIT
PRICE
NET DEMAND-IMPATIENCE .
MARKET POWER OF SELLERS RELATIVE TO BUYERS .
BILATERALIZATION MEANS SELLERS PRICE OFF THE MARKET'S
AVERAGE (TRANSACTION) REVENUE CURVE .
ONE-(MARGINAL-)PRICE POOLS MASK PRICE SIGNALLING OF
MARKET POWER ; SO,
UNDER THE MYTH OF PERFECTLY-COMPETITIVE POOL PRICING ,
THEY MAY ENCOURAGE SELLERS TO REDUCE QUANTITY .
S : SUPPLY
D : DEMAND
AR : AVERAGE REVENUE
MR : MARGINAL REVENUE
MR : MARGINAL REVENUE AFTER SUPPLY
REDUCTION
AR
p
REDUCED SUPPLY CURVE IF
SINGLE-(VARIABLE-COST-)PRICED POOL
MR
S
MR
VARIABLE COST CURVE
D
VALUE CURVE
Q
REDUCED QUANTITY IF
SINGLE-(VARIABLECOST-)PRICED POOL
QUANTITY
&
TIME
Table 1
The physical energy price is the average price of the purchase portfolio.
The financial concept of "term structure" is closely linked to a "purchase portfolio",
which is a strongly physical concept.
bought at
t-n
consumed at
...
t-3
t-2
t-1
t-n
.
...
.
...
t-3
.
...
.
t-2
.
...
.
.
t-1
.
...
.
.
.
t
.
...
.
.
.
Column
t-n:
termstructure
of
purchases
made at
time t - n
t
. Row t: (pre)purchase portfolio for
consumption done at time t
2 Measures can hurt forward
markets
• Operation of spot market by a system operator
– Officially designed/operated spot market risks being
made the mandatory market for regulated supply by State
regulators
• Lack of physical transmission rights
– Hoarding of physical transmission rights is outdone by a
properly designed real-time market
• Financial rights can be hoarded too, and at much less cost
– Financial derivatives are always more expensive than the
real thing
A spot market is not a real-time
market for reliability
• It can be an economic optimization market
• The real time-market is the true end-point of the forward market
price path.
• Real time transactions cannot be done moment-by-moment
deterministically
– Time is too short
• Real time performance and value must be measured probabilistically
– Classical physics versus quantum mechanics
• Joint indeterminacy of position and momentum
• Joint indeterminacy of time and reliability-pricing
– reliability pricing as a time average
Tiered real-time market
• NERC’s Control Performance Standard
– targets error performance of Balancing Authorities
relative to system/frequency error performance
– individual error is assessed based on whether it hurts or
helps the system/frequency
Approximate CPS1
p : ProbabilityOn average
over the past year:
e : Annual standard
MW, or p
+
deviation of
DF
( )
Target
2
2
:
e
=
e
+
m
DF
RMS
m D F : Year's Mean of D F
DF :1-minute average of
Frequency error
Bi < 0:Control area i's bias -e
B-i <0:Bias for other than i
B < 0: System bias
( )
-
- 10 B i D F
:
DT-i ,CPS 2 = 16.5 e10 å-i B-i B
"No inadvertent allowed
in the direction of
Frequency error when
+e
DF ³ e "
-50
50
DF = ±
10 Bi e 2
16 .5e 10 å -i B-i B
DF
+(mHz)
10 B i D F
Control area i's maximum allowed 1-minute average total tie-line
flow (including response) in the direction of the frequency error:
:
æ e
ö
DTi = -10 Bi ç e
- DF ÷
è DF
ø
One-year target probability density of 1-minute
averages of frequency error, adjusted for deviation of
the mean from 0
Tiered real-time market (cont.d)
• Market made it necessary to price Balancing
Authorities’ inadvertent
– because they have have commercial interest
– must be done in a way compatible with tariffed
pricing of unscheduled energy of exclusively
commercial entities
Tiered real-time market (cont.d)
• Market made it necessary to price Balancing
Authorities inadvertent (cont.d)
– 3 components of inadvertent valuation
• Market value of the energy
• Transmission loading component
• Frequency control contribution (FCC)
– value of unscheduled is not just energy: it is also quickness of
response
» primary (response) and secondary (regulation/AGC, and
(operating & replacement/load-following reserves)
» primary is faster and more valuable than secondary
– value is the unscheduled energy’s good or bad contribution to the
frequency deviation relative to system/frequency error
performance
» compatible with CPS1
Balancing Authorityi 's
Frequency Control Contribution  i,h
is the slope of the regression line through
points relating DF h toI i sampled at different hoursh
+ DF h
=  i, h
Ii
- DF h
Dual pricing of unscheduled energy
Ambiguity along the diagonal
Revenue/Expense
Unscheduled
part   0
energy part U  0
sold
bought
good
bad
peU + p  
peU - p  
- peU + p  
- peU - p  
receive
pay
Primary Response Stabilizes Frequency
Secondary Response Restores Frequency
Hz
60
59.925
15
Seconds
Inadvertent Interchange and Primary and Secondary Response
Very simplified
Balancing
Authority
A
Balancing
Authority
B
100
100
Numbers in Mw
Load
75
25
50
50
Generation
Inadvertent
of 25
75
Primary response of
50 in load reduction,
25 each in A and B
75
75
50
25
50
Outage of 50
in
Balancing Authority B
100
75
100
25
50
50
Secondary
response
of 50
Replacement by 50 from Balancing Authority A
50
Tiered real-time market (cont.d)
• FCC does not target frequency
• Balancing Authorities must settle their FCC monthly
– Since inadvertents sum to zero by definition, Balancing
Authorities always clear
• Balancing Authorities must also comply with CPS
frequency targeting, acting as agents subject to
NERC penalty
– NERC CPS penalty will prompt Balancing Authorities to
trade their CPS rights the way DOE pollution penalties
prompted market for pollution rights.
• To meet their monthly CPS scores, Balancing Authorities will
trade their frequency control contributions as an alternative to
buying options on frequency support
Tiered real-time market (cont.d)
• FCC is open and scalable to a market below
Balancing Authorities
– Balancing Authorities can apply FCC to their
constituent entities to incent entities’ self-provision
and good performance, thereby minimizing the
Balancing Authority’s own local intervention.
• Three tiered market for frequency control
– NERC, Balancing Authorities, local entities.
• Frequency is a public good requiring an authority like
NERC to drive the frequency-control markets by the threat
of penalty.
– This meets both a reliability and a markets objective
Producing unscheduled energy versus producing frequency support (under contract):
Frequency support
Secondary
Producing without (option)
contract
j'
Affects producer
Producing under (option)
contract
's  ij '
j'
Not affects producer
's ij '
because "scheduled"; so, settled
Entitlement to payment for
j
Improves buyer

reversing some system
Primary
because
j'
part reversed & settled with
Affects producerj _
Entitlement to payment for part
of some entityj _
'sij
's  ij
_
's
 ij
_
Not affects buyerj
j
 ij
prepays part of
'sij
; rather
j_
to
4 market operations
Entities j may be indifferent, but BAsi
Paying out your  ij to anotheri * j,'
For increasing his
By settling
Paying anotheri *j ' ,
 ij (or i* )
 i* ,
By buying-  ij
 i*
of his
,  ij
_
or  ij '
 ij or
 ij
to reduce your
j, _
For increasing
_
primary by -  ij
-  ij of
his
, j_
are not indifferent, between
his  ij ' (or
 i*
By increasing
his scheduled
)
secondary by
-  ij
_
 ij'
No option
contract
Option contract
No option
contract
Option
contract
Operation 1:
Operation 2:
Operation 3:
Operation 1:
Operation 4:
Settlement payout of
Buy primary support
Trading
Settlement
Buy secondary
support
 ij
 ij
 ij
 ij
payout of
 ij
Ancillary services markets
• Ancillary services markets need to be
developed as robust options markets
– The option price is driven by volatility which is
another way to capture/express Frequency
Control Contribution
Possible portfolio of options

Price should arbitrage buyer's avoided cost
with supplier's opportunity cost
p
supply:
demand:
price:
q in order of size
of unscheduled
Puts on generation Calls on generation
Calls on loads
In a complete options market for frequency response
the optimal scheduling point minimizes the cost of unscheduled B + C
Period
Overscheduling
A
C
M
w
Optimally
Scheduling
B
D
Underscheduling
Order of size of unscheduled
A
Overscheduled
due to overscheduling
Unscheduled
B
C
Overscheduled + Underscheduled
due to optimally scheduling
D
Underscheduled
due to underscheduling
MinValue ( B + C )  Min[Value( A), Value( D )]
Conclusion
• True price revelation requires specifying spot
markets less in order to leave room for the forward
and real-time markets to mature
• FERC should not
– over-specify spot markets on the phony pretext that
those markets are delivering on their misnamed promise
of real-time transactions and reliability,
– nor prompt thereby the migration of transactions from
physical forward markets where they belong.
• Forward markets are in desperate need of liquidity
development
– Spot-opiented merchant generators are capital short