An electricity
market in
transition
1
content
Foreword
A changin electricity market 3
World class research 3
FLEXIBLE ELECTRICITY USE
Reducing load by flexible electricity use 4
Risk for increased volatility with demand flexibility 5
Time differentiated tariffs may control the development 6
The role of the power exchanges
The market integration takes important steps
– what is the future role of power exchanges? 7
The power exchanges need new bidding formats 8
The market makes the decisions
– the choice of reference prices and hedging products 9
The internal electricity market
Network codes for a common market
10
Capacity mechanisms and the need for capacity
Is now the time to start trading capacity?
11
The Russian capacity market disturbs cross-border trade
12
The role of networks in the electricity market
The Baltic states increasingly integrated with the Nordics and EU
13
Trading with regulating power across borders
– Challenges and opportunities
The distribution network regulation is socioeconomically suboptimal
14
15
www.marketdesign.se
production: Krem AB texts: Tomas Wall, Lars Magnell graphic design: Gabriella Lindgren TRANSLATION: Mats Nilsson
2
An electricity market
in transition
Today’s electricity markets are becoming increasingly
complex. The main causes are political decisions
changing the underlying conditions for electricity
generation as well as for electricity retail. Facing this
change means that the markets must develop and
adjust, none the least to handle large volumes of
wind and solar power. The power system and trade
need to become more responsive and efficient. For
example, we have to create systems allowing the renewable energy sources to cooperate optimally with
conventional power sources.
New knowledge about the existing institutional
lacunae in electricity market, and the possibilities to
develop the market, has been brought to the industry, authorities and other decision makers through
Elforsk’s research program Market Design. The overarching vision is that the knowledge gained can be
used as an input to the design of market rules.
The fourth and last phase of the program, active
2010–2014, has focused on the fast introduction of
renewable electricity generation, and its impact on
the market conditions. The reports from this phase
highlights the way forward in the grand European
electricity market scheme without threatening existing Nordic well-functioning electricity institutions1.
This pamphlet consists of a synthesis of the reports
and their conclusions. It is our hope that it is accessible and gives the reader good insights into the
current state of the art of knowledge in this field.
Additionally, it should describe the future challenges Europe’s electricity market experts and decision
makers face.
Enjoy your reading!
Lars Magnell, Krem
Tomas Wall, Desiderate
World class research
After this fourth phase Elforsk has decided to
approach the electricity market research from a
new angle. In a planned future program this will
continued by even more focus on the coming market issues. Our ambition is to approach concerns
on the future electricity market with a more open
mind and an innovative stance. The goal is that
the new program will encompass several academic
environments and increase the cooperation between different stakeholders and decision makers.
The vision is that the new program offers a “camp
1
fire”, where the participants together define the
research problem, follow the projects and in the
end interpret and use the results. Building on the
internationally acknowledged platform built by the
Market Design program in its 15 years of existence
there are good preconditions to meet the target of
a Swedish and Nordic electricity market research of
world class standard.
Stefan Montin, Program manager Elforsk
[email protected]
We use the word institution in its social science meaning, i.e. the norms, rules and regulations surrounding some human activity.
3
FLEXIBLE ELECTRICITY USE
Reducing load by flexible electricity use
The 1996 electricity market reform gave the customers the possibility to lower
their costs by actively choosing a suitable contract among competing retailers.
The next big step to add value may be found in the possibility for the consumers
to adapt their electricity use to prices.
There are about 1.2 million detached houses heated with
electricity in Sweden. Demand flexibility, flexible electricity
use, is achieved by controlling the heat production in housing with waterborne heating systems. There is a theoretical
potential of moving 2000 MW (the Swedish peak is roughly
25000 MW) of electricity over the day. This is of roughly the
same order (in 2013) as the Swedish strategic reserve, handled by the Swedish Transmission System Operator, Svenska
Kraftnät
The field experiment calculates the total customer benefit to
2200-2600 SEK/year.
The project report highlights some non-pecuniary benefits.
According to several households the more even indoor temperature increased the comfort level. Other household noted
that the control of the heating system also benefits the environment. Several household also appreciated that they through
the service provider got access to a fact based and competent
energy advisor.
Field experiments in Vallentuna
Several obstacles
In a field experiment sponsored by Market Design, a study
of the consequences of smart control of heat pumps in residential housing in Vallentuna, a Stockholm suburb, was conducted. The control of the heat pumps was exercised as a
temporary automatic shut-off. The consumers’ participation
was limited to deciding on the comfort level (indoor temperature and the temperature variability) and their sensitivity
to prices.
The study shows that up to 15 kWh/household of heat load
can be automatically moved within a day without any disturbances to consumer comfort. Since heat load is inert, i.e. it
takes time to notice change; the consumers will not notice
them immediately.
There are several obstacles to a large scale development of
automatic heat control for residential customers.
If the control of the electricity use if heat pumps increased
in scale (in Sweden to about 100000 residential users) the
demand flexibility must be an integral part of the price formation, or else the consequences could be disruptive. The
moving of load could create price peaks instead of shaving
them. To develop the spot market for electricity the business
model dealing with demand flexibility has to become more
complex.
The current distribution network regulation lacks incentives
for the distribution companies to have tariffs that encourage
flexible energy use. The network regulation disregards this
in spite of the fact that a more even load and less network
losses are clearly beneficial.
Yet another obstacle is the diversity of heating systems and
houses in the market. It is thus difficult to create a standardized, simple and robust technical mass market solution.
Given the above mentioned limitations further investigations should be conducted, assuming an institutional setting
accommodating demand flexibility.
Cost minimization
The Vallentuna experiment verified several benefits of the automatic control of heat loads if it is linked to an hourly price
settlement. Perhaps the clearest benefits from a customer
view is the possibility to move load to low price hours thus
lowering the overall electricity bill, both the retail and the distribution network component. Calculations showed savings
between 500-2350 Swedish SEK/year. The assumption is that
the electricity price reflects spot price variations combined
with network time differentiated tariffs (low price weekdays
22-06 and weekends) based on 2010 and 2011 prices..
Other benefits
•
•
•
•
4
Reduced heat use by approximately 10-15%
(in isolation the largest benefit)
Less variations in indoor temperature
Increased efficiency in the heating system
Less peak load use by a temperature more adapted to actual needs
Elforsk reports
11:66 Norra Djurgårdsstaden – Nya marknadsmodeller för engagerade
kunder – October 2011 (Swedish only)
12:48 Pilotstudie i Vallentuna – Reflexioner rörande affärsmodeller för
förbrukarflexibilitet och självlärande prognosstyrning för kundanpassad
effektreglering – June 2012 (Swedish only)
13:95 Efterfrågeflexibilitet på en energy-only marknad: budgivning,
nättariffer och avtal – December 2013 (Swedish only)
The reports can be downloaded free of charge from www.elforsk.se
FLEXIBLE ELECTRICITY USE
Risk for increased
volatility with demand
flexibility
Demand flexibility has to be an integrated part of the spot market price formation to avoid
disruptions. This is shown by simulations of the electricity use of houses heated by electricity.
Without the link between this group of consumers and the spot market the automatic
controls of heat pumps (i.e. more flexible electricity use) threatens to create price peaks
instead of shaving them.
A conventional assumption is that a more flexible load, demand flexibility, can be created without involving the power
exchange. The idea is that customers could delay or advance
their electricity consumption given the prices the next day.
Simulations done as part of a Market Design-project now indicate that this is unlikely to happen.
Demand flexibility without active participation in the price
formation only works to some extent. At 100000 active customers the benefits for society and the customers may be large.
However, at 700000 a tipping point is reached and rather than
smoothing out the price patterns there are new price peaks
created at different times. For example, the morning peak may
move to another time of the day.
mation they inherently smooth out the price variations.
“Thus the incentives to the individual consumer to adapt
her electricity use to hourly prices decrease. There are no longer any economic incentives to move from peak to low-peak
hours”, says Björn Berg who continues, “We need to create
other incentives for the customers to move their load. Active
customers must be rewarded even if the price is constant if the
system gains”.
Other parts of the market could utilize so called cooperative
demand flexibility. Examples are the balancing markets, the distribution networks, and to some extent the regulating markets.
“The actor who pays the most for this potential in flexibility
is the one who is getting rights to use it” says Björn Berg.
Creating instability
Thus the purpose of the whole exercise of creating more demand flexibility is jeopardized. The consequences are to make
the price formation less predictable instead more stable and
less volatile. “Another concern may be that the trust in the
spot exchange Nord Pool may decrease which can have serious
impact”, says Björn Berg, a co-author of the report.
“A lot of the trade and the decision making will move closer
to real time, which would hamper planning and lead to a bigger need for regulating resources”, he adds.
But the study provides some evidence that demand flexibility
can add benefits if it becomes part of the bidding procedure
that is part of the day-ahead price formation at the Nord Pool
spot exchange. Alas, even this contains a caveat. When a large
group of consumers become active and part of the price for-
Elforsk report
13:95 Efterfrågeflexibilitet på en energy-only marknad: budgivning,
nättariffer och avtal – December 2013 (Swedish only)
The report can be downloaded free of charge from www.elforsk.se
FLEXIBLE ELECTRICITY USE
TRADE AT NORD POOL
In energy only electricity markets, as the Nordic, there are normally
low incentives to limit the electricity use during peak hours. For end
consumers, the spot price has only marginal effects on the cost per
kWh. Since a market for capacity does not exist there is a theoretical
chance that supply fail to meet demand. To solve this problem extra
capacity can be kept in the system or deals can be made with customers to abstain from using electricity when demand is peaking.
The trade at Nord Pool is divided into a dayahead and an intraday market. Trading at the
spot exchange occurs through an auction with sell
and buy bids for each separate bidding area.
5
FLEXIBLE ELECTRICITY USE
Time differentiated
tariffs may control
the development
Demand flexibility can be useful for the power system in its entirety, and for the local
distribution network. In most case the benefits for these different levels coincide. The
flexibility can contribute to a more efficient price formation by equalizing variations and
at the same time help the distribution network to a more efficient use.
Time differentiated network tariffs, making it profitable for
customers to move their use away from peak load hours can
realize significant savings. In addition, time differentiated tariffs provides the customers with a predictable value of the use
of being active. With a correct design of the tariffs, the value
to the distribution network is a better use of the existing resources. At present time differentiated tariffs are allowed and
used by many distribution companies. However, the legislation
lack incentives to make the use of time differentiated tariffs
more general. The future electricity law dictates that network
tariffs should incentivize better use of the network, and the
regulated revenue cap should consider the overall efficiency
of the network use. Such a change could be foreseen with
the implementation of the EU energy efficiency directive, to be
implemented from 1st July 2014.
Providing predictability
From the above elaborations, we deduce a hypothesis that demand flexibility in a large scale should be enforced through
time differentiated local grid tariffs.
The network tariffs can give the customer the predictability
they need to invest in control equipment (e.g. for heat pumps)
already today. Additionally, this opens up for energy service
providers to help the customers to better control their loads.
6
The active customers investing in electricity demand control
systems are likely to benefit from energy efficiencies directly
increasing the monetary value of the investment.
Time differentiated tariffs probable supports the overall
power system. In the long run there is nothing preventing market offers to control load according to spot prices when the
time and place is ripe for this.
In the meantime larger users, e.g. industrial demand, will in a
more volatile market develop their demand response activities.
Elforsk reports
12:48 Pilotstudie i Vallentuna – Reflexioner rörande affärsmodeller för
förbrukarflexibilitet och självlärande prognosstyrning för kundanpassad
effektreglering – June 2012 (Swedish only)
12:73 Övergripande drivkrafter för efterfrågeflexibilitet – hinder,
möjligheter och alternativa utvecklingsvägar – May 2013 (Swedish only)
13:95 Efterfrågeflexibilitet på en energy-only marknad: budgivning, nättariffer och avtal – December 2013 (Swedish only)
14:23 Further development of Elspot – May 2014
The reports can be downloaded free of charge from www.elforsk.se
The role of the power exchanges
The market integration
takes important steps
– what is the future role of power exchanges?
In February 2014 the different power exchanges in Northwestern Europe2 was
linked together. Thus the Nordic electricity market has been integrated with
large parts of the continent. But what is the future for the power exchanges in
merged markets that in the end should end up as one single electricity market
The power exchanges have a key role in cross border trade,
and they are strongly connected to the system operators’ activities. A Market Design project has elaborated on likely and
desirable development paths.
One of the studied scenarios leaves the power exchanges
as national or regional power exchanges and let the market
integration procedures to one or more dedicated system operators. They would be regulated monopolies dealing with
trade cross national and bidding area borders in Europe. The
power exchanges would continue their work in competition
as is the current case.
A different, so called decentralized case, the assumption
of the power exchanges remains. But in this case they are in
charge of the market integration in a decentralized process.
The EU Network Codes will regulate technical and commercial aspects of the market integration within EU (and
Norway and to some extent Switzerland) but it will not in
an exact manner assign roles and responsibilities among the
involved participants.
With the development during 2014 with the Northwestern
European electricity markets linked through decentralized
decision making this model seems to have been given a head
start. Seemingly, this would be the quickest and most flexible
way achieve more market integration. However, this hinges
on the assumption that the national or EU-level authorities
abstain from intervening in the processes.
It is not obvious that an EU-wide independent system operator, or an EU-wide power exchange is needed to achieve
the target. These suggested entities seems both to unlikely
and complex to be realized. However, due to increased competition we should expect some economies of scale and thus
consolidation among the power exchanges in Europe.
Elforsk report
13:57 The Increasing Scope and Authority for Power Exchanges – June 2013
The report can be downloaded free of charge from www.elforsk.se
2
The linkage is between the electricity markets Germany, Austria, France, Belgium, Netherland, Luxembourg, Great Britain, Denmark, Sweden, Finland,
Norway, Estonia, Lithuania, Latvia and Poland. It consists of four power exchanges and 13 Transmission system operators in Northwestern Europe.
7
The role of the power exchanges
The power exchanges
need new bidding
formats
New models for bidding into the Nord Pool spot
auctions would relatively easy open for a future market
that more efficiently deals with flexible supply and
demand resources.
The Nord Pool spot auction is not fully conducive to a power
market with large amount of intermittent power production.
For example, as wind power cannot be controlled (at least not
upwards) and is difficult to forecast, putting a bid noon dayahead involves some challenges. This has led to a study, within
the framework of Market Design, of alternatives to today’s bidding procedures. The study assesses the possibilities to change
trade to accommodate more flexibility, and thus open for a
market with a larger share of intermittent electricity production. The Northwestern European markets have been linked
through a new spot price calculation algorithm (Euphemia).
The new algorithm has opened up for the possibility to try
bidding procedures up until now only used in the Continent as
they are now compatible with the existing Nordic procedures.
Some of the existing procedures, and additionally some hypothetic, that allows for increased flexibility has been investigated. Common for all the models is their purpose to increase the
resource use of available flexible capacity in the system, thus
smoothening price formation and make it more efficient. The
focus of the study is the day-ahead trade which currently dominates Nord Pool spot. It is on day-ahead the pass- through of
more flexibility would have the largest financial impact.
Demand flexibility in a new light
The users’ flexible heat loads such as heat pumps, refrigerating
and freezing systems are in general not sensitive to the timing of when they run. The load (in MW) represented by these
user segments can be advanced or delayed in time without
any large discomfort to the users. A more dynamic bidding
procedure on Nord Pool spot could accommodate new ways
of exploiting this resource, e.g. by an automated bidding procedure where the optimal user profile is calculated, and the
result is fed back to the bidder.
Another possibility would be to let industries offer a capacity
reduction. The electricity market would be offered a “flexible
hour” where demand could be reduced, and the algorithm
would calculate whether an hour exist day-ahead where this
8
offer would make sense for the bidder. This procedure could
be developed to include several “flexible hours” in the enhanced algorithm.
Thermal electricity generation
Thermal electricity production, e.g. gas powered thermal plants
can also be used as flexible resources. These power plants have
high startup costs but when running they run at a given per hour
cost as many hours as needed to cover the fuel and startup costs.
In many cases they can offer up and down regulation.
With a bidding procedure including a specification of the power plants actual cost profile, and conditions for up- and downregulation the spot market algorithm can include this information. It is then possible to optimize the generation, calculating
hour for hour whether the power plant should run or not, and
when it runs the hourly variation of the output. From a technical
viewpoint such procedure would lead to a more efficient use of
the flexibility in the system than is currently the case.
It is worth mentioning that the Market Design program also
has studied the possibilities to decrease the forecast errors, and
consequently the higher balancing costs, from wind power by
moving gate closure towards real time. Intraday, Elbas, would
then be the dominating market place. On Elbas trade is closer
to the actual hour of delivery and this makes it possible for actors to get balanced before the delivery hour. However, wind
power forecasts do not really improve until three hours ahead
of delivery thus model does not seem to solve the problems
for wind power.
These are examples of possible development of the Nord Pool
spot market place, as well as a market with large volumes of
wind power.
Elforsk report
14:23 Further development of Elspot – May 2014
The report can be downloaded free of charge from www.elforsk.se
The role of the power exchanges
The market
makes the decisions
– the choice of reference prices and hedging products
The Nordic electricity market system price may soon have served its purpose as a
reference for price formation of financial hedging instruments. At least in Southern
Sweden and Denmark, the German market may become a natural reference both for
forward contracts and price area risks.
The actors in the electricity market use different kind of financial
instruments to hedge themselves against price volatility. The trade
is based on the system price calculated on the power exchange
Nord Pool spot. The reference price (the System price) is calculated for the 15 bidding zones in the Nordic area as if there was
no congestion within the Nord Pool spot area. The trade is done
stepwise. In the first step forwards are bought ensuring future
deliveries at a certain price. The price of the forward usually differs
from the system price at the delivery day. This is the future price
risk which the hedging protects against. The actor can also take a
second precaution, this time against price area risks. This is done
by buying/selling an EPAD (electricity price area differentials, formerly called CfDs, contracts for difference). This is instrument that
hedges against a price difference between the system price and
the area price. If you own the combination of the forward and the
EPAD, you are fully hedged from variations in the area price.
This system works well but is not without glitches. Bidding
zone 4 in Sweden (the counties of Skåne, Halland and southern part of Småland) is sometimes disconnected from the rest
of Sweden due to bottlenecks in the transmission system between bidding zones 3 and 4 in Sweden. As bidding zone 4
is a deficit area, price volatility and thus hedging costs has a
potential to become large. Thus if a retailer sells a fixed contract for one year ahead to a customer in bidding zone four,
the markup due to hedging costs could be very different from
a retailer contract in e.g. bidding zone 3.
A financial instrument with a potential to improve the hedging possibilities would be to trade so transmission rights. This is
an instrument that the EU-commission advocates and it is part
of the European Network code package, a set of regulations
aiming for an integrated European electricity market, to be implemented the coming years. The trade with Financial Transmission Rights (FTRs) can be exercised by a regime in which the
system operator auctions expected congestion rents between
for example bidding zone 3 and 4 in Sweden. As with the other
instruments the time period and also in this case the direction
of the congestion would have to be decided in the deal. When
there is an hour of congestion, the value of the transmission
right is the price difference times the MW that hour.
There is no consensus whether this is the correct path for the
Nordic market to take. The coming Network codes include an
exemption for the Nordic market from the demand to introduce
FTRs if the concerned markets can be proven to be liquid. Studies within the Market Design program point in different directions. Seemingly there is a consensus that trading with transmission rights can increase the hedging liquidity in bidding zones
with generation deficit and steeply sloped supply curves. That is
a fair description of the Southern Swedish and Danish situation.
However, a questionnaire sent to the participants in the market
showed little interest in the introduction of FTRs. Additionally,
this would mean that more regulation would have to be introduced which would be time consuming.
The market meets the need
Concluding, the studies made within the market design framework emphasize that future risk hedging in the Nordic market
does not have to have a one size fits all model. The increased
integration means more interaction with continental actors.
This could decrease the importance of the Nord Pool spot area
as a region for trade. For southern Sweden and Denmark this
could result in increased compatibility with German prices, and
thus more interest in using the German price as a reference,
both for forwards and bidding zone risks.
The choice of reference prices for hedging is mainly driven
by market needs. The structure of generation, demand side
activities, and the development of transmission infrastructure
are strong determinants of what future hedging instruments
that will turn up efficient.
Elforsk reports
11:16 FTRs in the Nordic electricity market – April 2011
12:69 Reference price for hedging products – October 2012
The reports can be downloaded free of charge from www.elforsk.se
9
The internal electricity market
Network codes for a common market
EU aim to improve the preconditions for a common market by the future implementation
of common network regulation (Network codes). Among other things this package
of regulation defines the rules for cross border trade, and how security of supply is
maintained in a common electricity market.
The aim of the network codes is to create an infrastructural
foundation for a common electricity market on a path towards
secure energy supply with a minimal impact on the climate.
The vast process of developing the network codes is currently ongoing. However, the end dates are somewhat uncertain. The nine most important codes should be implemented
at the end of 2014 and during 2015. However, this timeline
seems optimistic.
There is a cautious optimism among Swedish market participants that the network codes will improve the market. However, there is also a fair amount of criticism. On a larger scale the
issue seems to be the pressure from the EU Commission and
the European transmission system operator association, ENTSOe, to push for standardized rules across Europe. The Swedish
market participants fear that this kind of one size fits all may
not be optimal. In addition, the significance of the amount of
detailed instructions in the code is difficult to overview.
For the market actors the overall consequences of combined
network codes is difficult to predict. Seemingly, the code will
have far reaching consequences. None the least as they are
replacing the current national institutional setting
Elforsk reports
14:18 Network code development in the EU – January 2014
12:32 Elmarknadsreformen – behöver den reformeras? – June 2012
(Swedish only)
The reports can be downloaded free of charge from www.elforsk.se
The network codes fundamentally changes the electricity market
The network codes cover most aspects of the power system,
and it has a potential to change almost all rules in the present
Nordic market. It concerns market functions as well as how the
technical system should cooperate, both concerning the demand and the supply side. The codes are divided into three different areas but they are internally dependent on each other:
1.
2.
3.
Network access – generation, demand, systems for high voltage direct current (HVDC)
System codes – security of supply, system operations,
system planning, frequency control and reserves,
procedures for disturbances
Market – transmission capacity allocation, congestion management, balancing, etc.
Transnational rules
The network codes will be EU regulations and as such should
be directly implemented as law in all EU countries. This means
that there will no national adaptions to the rules. The will also
overrule national legislation in cases of conflict.
Unclear consequences
From a Nordic perspective there are several questions about
the consequences of the Network codes:
Who pays?
The network codes may upset the roles and responsibilities in
the Nordic market and thus change who pays for what. Some
choices of solutions are more socioeconomic efficient than
10
others and means that the design of the final codes will affect
the level on the total system costs which ends up on the end
customers’ bills.
Heavy versus light-handed regulation
The Nordic regulatory tradition is based on less detailed laws
and regulations, developed in cooperation and agreements.
How can Nordic market participants, including Nordic authorities, manage judicial processes and detailed regulation? Is
there any threat to the historically dynamic cooperation processes signifying the Nordic electricity system?
Rules set in stone
To work to develop the Network codes has been time consuming, and partially very difficult. Some of the detailed network
regulations has taken 5-10 years to develop and they are yet
to be approved. There is a risk that when the regulation is approved it may be very difficult to amend within the current EU
bureaucratic procedures.
How should conflict be resolved?
There is an ongoing struggle of jurisdiction between EU legislation and member state legislation. What powers does the EU
regulator ACER have in comparison to the national regulatory
agencies? What legal status does ENTSOe have compared
to national transmission system operators? Is it possible for
national rules and support systems to erode the efficiency of
the Network codes?
Capacity mechanisms and the need for capacity
Is now the time
to start trading
capacity?
Large volumes of renewable electricity
generation change the conditions to own and
run conventional power plants. Less expected
operational hours could decrease profitability and
increase the financial risks. How should the market
rules be designed to ensure that we have enough
power supply when we need it? Is the European
market ripe for capacity markets?
The issue on capacity markets and mechanisms in the European markets is important none the least because the target
market model for EU is an energy only market. That is, the
profits earned by selling electricity should cover both variable
and fixed costs. If individual member states decide to have
payments for capacity in addition to the energy payments, this
distorts the incentives to invest in generation and transmission
capacity between countries. Thus the choice of a pure energy
only, or some kind of capacity market is an important crossroad for European electricity policy.
Strategic reserves
An alternative to large all-encompassing capacity mechanisms, is
the strategic reserves presently (2014) used in Sweden and Finland.
The system operator is tasked with tendering and command a strategic reserve. The accepted participants in the tender get a fixed
remuneration and are paid at variable costs when the reserve is
used. The reserve in Sweden consists of both production units and
demand reduction. The strategic reserve is only used in extreme
situations, and is not meant to deal with normal variability in for
example wind power production.
Reliability options
Another possibility investigated within the Market Design-program is the creation of a capacity market designed in a similar way as the current green certificate system. A mandatory
market for capacity certificates, or reliability options as they
are commonly called, reduces the risk for investors in capacity
and the likelihood of conventional power plants to stay in the
market increases.
The idea is to create incentives for the producers to build
and maintain capacity corresponding to the market needs, as
defined by some authority. The instrument, the reliability option, gives the buyer a guarantee that a certain amount of capacity is available. The suggestion is that balancing responsible
parties is assigned the obligation to secure the decided level of
capacity. The producers can sell these options corresponding
to the provided capacity.
When the market price is higher than the option strike price
the buyer is compensated buy the seller for the price difference. In reality this would ensure that if the producer is generating capacity as promised, the market will provide her with
the difference. Through its construction the reliability options
also protects the customers from price spikes.
A variety of problems
The choice between having a strategic reserve or a system with
some kind of capacity mechanism is determined by the underlying structure of the market, but also what problems that
the mechanism should solve. A strategic reserve may solve a
short run capacity shortage but can’t replace long run investment incentives. A strategic reserve is not well suited to deal
with problems of price volatility or recurring price spikes. These
problems may be better handled through a reliability option
scheme. However, the complexity of introducing reliability options is non-trivial. It would require a large and detailed regulatory framework.
Still a hot topic
Germany is preparing to have a temporary strategic reserve
from 2016 to avoid the decommissioning of power plants
that are crucial for the system security. Great Britain and
France are other countries where different kind of capacity
schemes have a prominent place to secure supply. In the long
run, a more flexible demand side and increased development
of cross border capacity would decrease the impact of intermittent electricity generation, and thus the importance of
future capacity markets.
Elforsk report
11:30 A Raw Model for a North European Capacity Market – June 2011
The report can be downloaded free of charge from www.elforsk.se
11
Capacity mechanisms and the need for capacity
The Russian capacity
market disturbs
cross-border trade
When a country unilaterally establishes a capacity market, disregarding trade
with surrounding countries, the negative consequences can be large. The trade
between Russia and Finland is one example of this. The flow from Russia to
Finland has decreased substantially due to the market rules with respect to the
Russian capacity market.
In a capacity market, the generators get paid for the capacity
kept available to the market and the energy produced. The capacity payments are meant to ensure that enough capacity is
held in the system to deal with “all” contingencies. An efficient
capacity mechanism should cover more than one country.
Dramatic difference
A good case illustrating this point is the cross border trade between Finland and Russia. The Russian electricity market was
liberalized 2008. To ensure enough capacity in the system a
capacity mechanism was put in place during 2011. The capacity mechanism works through long run contracts on capacity
between the Russian state and the electricity generators. The
cost for these contracts is covered by a high fee charged to
the customers using the system peak load hours. Export of
electricity is treated the same as all other demand, thus it also
pays the capacity fee.
In the case of Finland this means that the cost to import
Russian electricity has gone up by approximately 20 Euros per
MWh during peak load hours. This has had a dramatic impact
on trade which has dropped by two thirds (from 12 TWh to
4 TWh annually). The capacity fee has at times rendered export non-profitable even if the energy prices on the Russian
and Finnish markets tell a different story. When the fee is not
charged, the trade continues as usual.
Lessons learned
The Finnish-Russian clearly show that policies that affect price
formation can have widespread impact on cross-border trade,
which may have long run implication for the power system in a
region. Capacity mechanisms, depending on their design, can
also lead to high costs and inefficiency in the market where
they are implemented. In a common European market a coordinated market mechanism is thus desirable.
Elforsk reports
14:05 Linking together electricity markets with different market designs:
case study of the future use of the Finnish–Russian interconnection –
January 2014
14:22 Analysis of Capacity Remunerative Mechanisms (CRMs) in Europe
from the Internal Electricity Market Point of View – March 2014
14:28 Designing individual capacity mechanisms in a non-distortive
manner – June 2014
The reports can be downloaded free of charge from www.elforsk.se
The following may be the consequences of unilaterally establishing capacity mechanisms:
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• The excess capacity leads lack of price peaks. A dampened price on one side of a border can have a negative impact on price formation on the other side of the border
• It has distributional consequences. The customers in the area with the capacity mechanism ends up paying for the supply of capacity to the neighboring country
•
•
Investment in production is affected. Investment may be concentrated to the system with the capacity mechanism. This affects the cost of supply and the price formation in the whole area
Investment in infrastructure is affected. With the added risk of incorrect price formation it may become harder to correctly assess the value of increased transmission interconnectors
The role of networks in the electricity market
The Baltic states
increasingly integrated
with the Nordics and EU
The integration of the Estonian,
Lithuanian and Latvian markets is
continuing almost according to plan.
With the new transmission link to
Sweden the tie between the Baltics and
the Nordic area becomes even tighter.
Still, obstacles exist and there is a large
need for investment.
The Baltic Energy Market Interconnection Plan (BEMIP) is an
action plan concerning the Baltic energy markets. It consists
of investments in cross border connections as well as reforming the electricity and gas markets. The plan, created 2008,
is a result from the general overseeing of EU:s second energy
policy, in which the integration of the Baltic Sea states were
given highest priority.
Market Design has superficially mapped the progress made
and analyzed the remaining challenges that needs to be tackled before the goal of an efficient Baltic electricity market, fully
integrated with EU can be fulfilled.
Large investments
A key determinant to the market integration is the development of new and improved transmission interconnectors.
There are projects for new interconnectors to Poland, Finland
and Sweden. Additionally there are ongoing reinforcements
internally in each state and between the Baltic States. These
infrastructural changes are a condition for an efficient electricity market and the creation of more variety of electricity
supply. The following transmission projects are mentioned in
the plan:
• Estonia-Finland, Estlink II (650 MW, ready 2014). Running. Increased integration with Finnish market
• Lithuania-Sweden. NordBalt (700 MW, ready 2015-16). Project ongoing
• Lithuania-Poland, LitPol Link (500 + 500 MW ready 2015 and 2020) Project ongoing.
Market structure development
To enable market integration the Baltic States need to develop
their markets. A decision has been made to adopt many of the
Nordic institutional settings. Actions to fulfil this are taken in and
between the countries. The plan is to stepwise introduce the
rules and regulations, and the overall market structure aligned
with the development in the Nordic countries.
Depending on local conditions in the three countries their
implementation of the new set of rules are at different stages.
The early successes in Estonia has been boosted by the cross
border interconnector, Estlink 1, and a strong wish to be part
of Nord Pool spot which has become the market place for the
Baltic sea (“exemptions” are Russia and Germany). Nord Pool
Spot is now the market place for both day-ahead and intraday
in the area. The same forces to integrate are present at Lithuania
who will soon be connected to Sweden and Poland. Latvia has
no plans of any interconnectors outside the Baltic States but has
to trust that development will be driven by the development in
its neighboring countries
Remaining challenges
To create well-functioning markets and to secure supply, there
are needs for investment in both grids and generation. The
grids are old, and basically built to strongly integrate the Baltic
States with Russia (or Soviet Union at the time). If no new
production is built the Baltic States will remain a deficit area
since the nuclear power station at Ignalina and some other old
plants have been decommissioned.
Each country’s electricity market is characterized by a high
concentration of owners, so there are some worries about low
competitive pressure. This is especially important as the interconnections are currently fairly small.
There are also continuing concerns about the conditions for
trade with Russia, amongst other things the transit of electricity to Kaliningrad through the Baltic States.
The Baltic States’ market integration must be seen as a success for EU’s ability to achieve competition, environmental goals,
and secure supply, even though some challenges still remain.
Elforsk report
12:17 Nordic & Baltic Power Market, challenges in market Integration
– May 2012
The report can be downloaded free of charge from www.elforsk.se
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The role of networks in the electricity market
Trading with regulating
power across borders
– Challenges and opportunities
In the integrated European electricity market one option may be to trade regulating
power cross border, for example between Sweden and Germany. But trade with
regulating power cross border is challenging.
During the last phase of the Market Design-program the issue
of transmission system operators reserving capacity for the
purpose of ancillary services actions was elaborated upon. Is
it socioeconomic beneficial to set aside interconnector capacity to trade regulating resources across borders?
In theory, there are several advantages to cross border
trade with regulating resources. The security of supply may
increase, and the competition in the balancing markets increases. But cross border trade with regulating resources
demands that any resources traded are physically available
where it is needed at the time when it is needed. To enable
this capacity must be available on the cross border interconnectors. However, most interconnectors are getting fully used
by day-ahead trading. Thus the reservation of interconnector
capacity will encroach on the day-ahead trade. The negative impact on the day-ahead trade must be smaller than the
gains in ancillary services market efficiency. The advantages
of cross border interconnector reservation for ancillary service
use may therefore be challenged.
However, some of the analysis done in the Market Design
program indicates that cross border trade with regulating
power may be socioeconomic beneficial in certain cases for
example in trade between Sweden and Germany.
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The issue is very controversial and has been dealt with on
EU-level. The European regulator ACER is negative to reservation of interconnector capacity while ENTSOe, the European transmission system operators’ trade association has
been more positive. The two organizations have agreed on a
compromise which is now being processed by the EU-Commission. Briefly, the proposal is that the transmission system
operators in certain conditions should be able to reserve capacity. They are obliged to submit cost/benefit analysis “proving” the socioeconomic value of the proposal.
Currently the proposal is processed in the EU-commission.
After due process the right to reserve capacity on interconnectors can be included in the Network Codes, and as such
become binding EU-wide legislation.
Elforsk reports
13:48 Reserving inteconnector capacity for balancing exchange
– Mach 2013
14:08 Reservation of cross-zonal capacity for balancing services
– February 2014
The reports can be downloaded free of charge from www.elforsk.se
The role of networks in the electricity market
The distribution network
regulation is socioeconomically suboptimal
The current regulation of quality of the Swedish distribution grids should from
a socioeconomic perspective change to become more efficient and appropriate.
This conclusion is drawn in a Market Design-study where possible changes in
regulation to achieve higher socioeconomic is outlined.
Starting 2012, the Swedish regulator, Energimarknadsinspektionen, reviews the fairness of the distribution tariffs. This ex ante
review decides the total revenues allowed for the coming four
years. The revenue cap imposed should consider the quality of
service provided by the distribution network companies. This
consideration could increase or decrease the revenue cap.
However, the current quality measures seems suboptimal
from a socioeconomic view, shows a number of case studies in local distribution networks. The study proposes several
changes (see below).
balance short run efficiency with measures securing long run
security of delivery.
During March 2014 the regulator has proposed a change
in regulation including the vintage of the capital assets. This
would highlight the need for continuous upgrading of the
assets. However, how this proposal will impact the quality
component of the regulation is premature to conclude. This
change will be the target of further studies.
The Swedish regulator propose changes in
the regulation model
Elforsk report
The intent is that the regulation of distribution networks should
The report can be downloaded free of charge from www.elforsk.se
13:71 The impact of regulation on network investments – October 2013
Market Design’s proposal
The measures proposed to increase the socioeconomic
benefits for the next regulatory period, 2016-2019 can be
summarized:
1. The level of the quality indicators are at present set
with the historical outage statistics for each company.
These should be set as a benchmark between the companies. If the knowledge of who performs best is the norm
this incentivizes all companies.
2. The amount of the revenue cap depending on the
quality level is currently calculated as a deviation from
the norm.3 The idea is that the amount calculated should
correspond to the costs for the customers of blackouts.
A more detailed model should better capture the actual
costs to customers. The present model is far too imprecise.
3. The economic result of the present quality adjustment mechanism is that half is given to the customers
and half is given to the distribution network companies. The factor 0.5 ought to be changed so all the
benefits accrues to the distribution company. As long
as this is not done the socioeconomic value will differ
from the companies’ valuation of activities to increase
the quality. The proposed changes assume customer
surveys determining the value to the customers of
blackouts. It is urgent to increase the knowledge of
the distribution of costs between different customers
segments, and how the time for the outage affects the
costs etc.
3
The model is explained in the report EI R2010:08 kvalitetsbe-
dömning av elnät vid förhandsreglering
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www.marketdesign.se
Elforsk AB
Olof Palmes gata 31
101 53 Stockholm, Sweden
www.elforsk.se
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