Energy Economics and Policy
Spring 2012
Instructors: Chu Xiaodong , Zhang Wen
Email：[email protected],
[email protected]
Office Tel.: 81696127
Overview
•
•
•
•
•
•
Deregulation of electricity markets
Elements of wholesale electricity market designs
Market design flaws
Market power
Capacity adequacy
Market monitoring
Deregulation of Electricity Markets
• Under regulation both short-run decisions regarding
the operation of power plants and long-run decisions
on investment in generating capacity were made by
vertically integrated utilities
• The transition to a deregulated environment has
changed the incentives faced by private generating
companies
• Electricity market is a number of submarkets in
energy, operating reserves, transmission congestion
management, and ancillary services
Elements of Wholesale Electricity Market
Designs
• Most conventional markets do not require any
special organization
– Buyers and sellers find each other with little centralized
coordination
• Electricity markets need organization to ensure that
supply matches demand with high precision
– Electricity cannot be economically stored in large
quantities
– Mismatches between supply and demand of electricity can
be very costly, even resulting in wide-scope blackouts
Elements of Wholesale Electricity Market
Designs
• At the moment of operation, there is no time to
schedule generation on the market base to match
the demand
• Forward trades take place hours and minutes before
the operation to pre-schedule the generation to
meet the demand
– Day-ahead markets are of particular importance,
determining which set of generating units should be
scheduled and dispatched to meet demand in every hour
of the following day in the most economic way
Elements of Wholesale Electricity Market
Designs
• Principal organization schemes: How should the dayahead electricity market be organized?
• Three broad categories of the organization schemes:
bilateral, exchanges and pools
– In a bilateral electricity market, buyers and sellers trade
directly, in which the transmission operator collect trade
data from market participants to ensure that the physical
dispatch will not overload any transmission equipments
Elements of Wholesale Electricity Market
Designs
• Three broad categories of the organization schemes:
bilateral, exchanges and pools (cont’d)
– An exchange is an entity that collects price-quantity
demand bids and supply offers during each hour of the
following day, then intersects the demand and supply
curves to determine the market-clearing quantity
• The single market-clearing price at the intersection point is paid by
all cleared bids to all cleared offers
Elements of Wholesale Electricity Market
Designs
• Three broad categories of the organization schemes:
bilateral, exchanges and pools (cont’d)
– Pools are similar to exchanges but accept more complex
bids from generators, which may include start-up costs,
no-load costs, ramp rates, and minimum run times
• The pool schedules generation to meet the demand to minimize
the total cost, setting the price at the last accepted bid price
• The clearing price may not enough to cover the start-up and noload costs of some units and these units are paid by the pool
through ‘bid production cost guarantees’
• Please compare these three schemes and be clear
about their advantages and disadvantages
Elements of Wholesale Electricity Market
Designs
Bilateral Markets
Exchanges
GB (formerly a pool
until 2001)
France
Germany
Italy
Netherlands
Nordic countries
Pools
US
Spain
Australia
New Zealand
Elements of Wholesale Electricity Market
Designs
• Relationships between day-ahead and real-time
balancing markets
– In day-ahead markets, power plants are scheduled to meet
the forecast load on the following day
– Actual demand and the generator’s availability may change
and adjustments to the day-ahead schedules may be
required, which is made in the real-time balancing markets
Elements of Wholesale Electricity Market
Designs
• Ancillary services
– Generators perform certain services to counter the minute
to minute fluctuations in demand or supply (regulation)
and to offset outages of generating or transmission
facilities (operating reserves)
– Regulation and operating reserves are usually provided by
partially loaded generators, but demand response has the
potential to supplement the reserves
Elements of Wholesale Electricity Market
Designs
• Transmission congestion management
– Transmission congestion occurs when generation and
demand schedules cleared in a market result in an
infeasible set of power flows
– The congestion is alleviated by re-dispatch
• Pools often manage the transmission congestion simultaneously
with clearing the energy markets, resulting in the locational price
• Congestion in single-price markets is managed through re-dispatch
payments, i.e., the TSO re-dispatches generation capacity to
resolve transmission constraints, paying generators for deviations
from their planned output level
Market Design Flaws
• Arbitrage opportunities
– Market rules may impose certain restrictions that allow
temporal or locational arbitrage opportunities to persist,
which may induce market participants to shift the bulk of
market operations towards the most profitable submarket
and away from other submarkets
– The market operator has to resort to means to match
supply and demand, resulting in decreased reliability of
electricity supply
Case 8.1: PJM Market
• When the Pennsylvania-New Jersey-Maryland
Interconnection (PJM) began market operations as a
structured pool in 1997, market designers did not
expect much congestion, so the design of the pool
used a strict single-price structure
• When congestion arose in the PJM system, the
market design created adverse incentives, resulting
from the arbitrage opportunity created by the
system
Case 8.1: PJM Market
• Generators in export-constrained areas the expected
to be turned off due to the congestion quickly
arranged bilateral trades alongside the pool, with
price lower than the clearing price to attract loads
• These bilateral schedules just restored the
congestion and PJM had to turn to other controllable
generators to reduce output, which in turn moved
their supply into the bilateral market
• PJM quickly ran out of controllable generators and
had to restrict bilateral transactions and resort to
administrative measures
Market Design Flaws
• Opportunity costs
– Generators believe that if they offer their capacity in a
market at variable cost and are dispatched based on
competitive bidding, they would wish they had bid
differently upon observing the market outcome
– Generators incorporate the opportunity costs into their
energy bids in addition to the variable cost of energy
generation
– Price that are based opportunity-cost bidding do not
reflect the marginal cost of energy and may result in
increase of the overall cost of the energy provision and
incorrect long-term investment signals
Case 8.2: Unit Commitment Cost Pricing
• Unit commitment costs are not explicitly addressed
in some markets
• Generators bidding into such a market may expect
that if they are dispatched based solely on their
energy bid, the market-clearing price of energy will
not be sufficient to cover their total costs
Case 8.2: Commitment Cost Pricing
• The generators may incorporate some of the unit
commitment costs into their energy bids in addition
to the energy variable costs, e.g., start-up costs,
minimum load costs, minimum run-time constraints
and ramping constraints
• Incorporation of the commitment costs into the
energy costs involves making predictions of energy
prices over the following day, resulting in an
inefficient dispatch with a high probability of
incorrect predictions
Market Power
• Market power of generators is the consequence of
certain properties of demand and supply of
electricity
– The demand for electricity is inelastic in the short run;
consumption does not significantly decrease in response
to price increases
– Generators cannot increase their output beyond their
capacity limits and the power from remote generators
often cannot be imported due to transmission constraints
• For example, if demand in an electric system cannot be met
without dispatching the capacity of a given generator, that
generator essentially has infinite market power
Market Power
• As in other markets, generators may exercise market
power by restricting output in order to derive
additional profits from selling a reduced quantity at a
higher price
– Physical withholding by reducing the physical availability of
generating capacity, e.g., declaring unit outages
– Economic withholding by bidding higher than a
competitive price, being priced out of the market
Market Power
• The electricity markets may be prone not only to
unilateral market power but also to collective
dominance
– Electricity is a homogeneous product traded in rather
transparent markets that usually do not exhibit much
growth
– Generating companies have similar cost structures and
interact frequently
Market Power
• Locational market power: The market power
problem is exacerbated by the presence of
transmission constraints
– Binding transmission constraints within a single
coordinated market result in fragmented geographic
submarkets, in which market concentration is often higher
than at the broader market level
• When transmission constraints are binding in the direction of a
large load center, this center becomes a separate relevant market,
a load pocket
Market Power
• Methods of measuring market power
– Structural measures: These measures are used to assess
the potential of exercise of market power before an entity
actually attempts to exercise market power
• Many conventional measures of market structure are misleading
when applied to electricity markets, e.g., HHI (HerfindahlHirschman index)
• Structural measures that are more relevant for electricity markets
are generally based some measure of residual demand faced by
particular generators, e.g., PSI (pivotal supplier index) and RSI
(residual supply index)
Market Power
• Methods of measuring market power (cont’d)
– Behavioural measures: These measure are devised for
detecting actual exercise of market power
• Many studies analysing generators’ behaviour compare actual
prices with the estimates of competitive prices based on variable
production costs
• The bids of generators that are suspected of market power
exercise can be compared with similar bids that are known a priori
to be competitive
Market Power
• Market power is mainly dealt with by not allowing
markets to become too concentrated
– Investigation of market abuse practices and their
mitigations are often carried out by authorities ex post
upon receiving complaints from market participants or
customer groups
– Electricity markets also apply ex ante mitigation
procedures aimed at limiting the ability of market
participants to exercise their market power by increasing
prices or capacity withholding
Resource Adequacy
• Revenues earned by generators should be sufficient
for them to invest and maintain the amount of
capacity necessary for meeting peak demand and
keeping the capacity margins for reliability purposes
• A revenue stream has to be arranged to complement
the revenues from energy markets through capacity
mechanisms
– Capacity payments
– Capacity markets
– Energy-only markets
Resource Adequacy
• Capacity payments: The most straightforward way to
ensure a revenue stream for generating capacity is to
give a per-MW payment to all generators whose
capacity is available
• These mechanisms have many short-comings
– Small errors in establishing the capacity price may result in
a large error in capacity investment
– Adverse incentives may be created when available capacity
is determined based on past or current dispatch
Resource Adequacy
• Capacity markets: The markets determine the
equilibrium capacity payment based on the capacity
requirement
• To address the problems of early capacity markets,
the advanced capacity markets feature locational
capacity requirements accounting for local
deliverability problems, and administratively set
capacity demand curves to reduce price volatility and
mitigate market power
Resource Adequacy
• Energy-only markets: These markets can only work if
price spikes are allowed under actual capacity
shortage conditions while controlling for the possible
exercise of generator market power
• A workable model of an energy-only market may be
based on an administratively set decreasing demand
for operating reserves and joint clearing of markets
of energy and operating reserves
– Since the markets clear simultaneously, the high price of
reserves during the shortage will also result in a high
energy price, reflecting arbitrage between production of
energy and providing operating reserves
Market Monitoring
• Electricity markets are susceptible to the creation of
unexpected pricing incentives, price manipulation,
and insufficient investment incentives
• The organization and operation of wholesale
electricity markets should be closely monitored
– The main role of market monitors is to act preventively by
continuously detecting and correcting incentives that may
exist for generators to exercise market power
– Market monitors also analyse and correct flaws in market
rules that may cause efficiency losses
Market Monitoring
• Independence of the market monitor is critical in
order for its analysis not to be distorted in favour of
any of the stakeholders and market participants
• Independent market monitors test elements of
market design that can potentially create adverse
incentives, and perform a continuous surveillance of
the competitiveness of electricity markets
Next Lecture
• The main topic will be Market Failures and Energy
Policy
• You are encouraged to read in advance Chapter 5 of
[McConnell, Brue & Flynn, 2012]