First Lecture: Part 2
Strategic Evolution of
Competitive Electricity
Markets
Derek W. Bunn
London Business School
The globalisation of energy markets is having an
effect on price convergence
• Global Markets for Fuels: Oil, Coal, LNG
• Global Energy Businesses replacing National Utilities
• International Capital Markets and Multinational Investors
• Market Liberalisations and Harmonisations
• Regional Interconnections
But rather less than we would expect…
EU Industry Prices still show substantial disparity…..
So, what do we now know about the evolution of
power markets?
1. Dynamic Evolution
Initial thoughts that global markets would be a strong
convergent driver have not been upheld:
Local Factors, Market Structure and
Strategic Behaviour may be more
important.
UK Monthly Forward Prices
18-Jun-03
28-May-03
7-May-03
16-Apr-03
26-Mar-03
5-Mar-03
12-Feb-03
22-Jan-03
31-Dec-02
6-Dec-02
15-Nov-02
25-Oct-02
4-Oct-02
12-Sep-02
21-Aug-02
31-Jul-02
10-Jul-02
20-Jun-02
28-May-02
7-May-02
15-Apr-02
21-Mar-02
28-Feb-02
7-Feb-02
Gas
17-Jan-02
24-Dec-01
3-Dec-01
12-Nov-01
Power
22-Oct-01
1-Oct-01
10-Sep-01
17-Aug-01
27-Jul-01
6-Jul-01
15-Jun-01
24-May-01
2-May-01
9-Apr-01
1-Oct-00
1-Jul-99
1-Apr-98
Local Fundamentals:
1. Link to fuels
£/MWh
45
40
35
30
Spread
25
20
15
10
5
0
-5
Local Fundamentals: The Supply Stack Links Fuels to
Prices
The “Stack” is produced from the Generators’ Offers to the
market…
But would the Generators’ offers be cost reflective?
120
January 20th 1997
100
Price
80
(£/MWh)
60
40
20
0
5000
10000
15000
20000
Capacity (MW)
25000
30000
35000
Notice the High Volatility During the “Price-Cap”
Period….
Time Weighted Average Monthly Pool Prices
£24 Average Price
Cap
£ 6 0 .0 0
PSP
£ 5 0 .0 0
P rice / M W h
PPP
£ 4 0 .0 0
SMP
£ 3 0 .0 0
£ 2 0 .0 0
£ 1 0 .0 0
£ 0 .0 0
A p r90
O c t90
A p r91
O c t91
A p r92
O c t92
A p r93
O c t93
A p r94
O c t94
M o n th
A p r95
O c t95
A p r96
O c t96
A p r97
O c t97
A p r98
O c t98
The Increase in Price Volatility……...
60000
50
50000
500
50000
40
40000
400
40000
30
30000
300
30000
20
20000
200
20000
10
10000
100
10000
Total Gross System Demand
Total Gross System Demand
4:00
2:30
1:00
23:30
22:00
20:30
19:00
17:30
16:00
14:30
13:00
11:30
10:00
8:30
0
7:00
0
5:30
4:00
2:30
1:00
23:30
22:00
20:30
19:00
17:30
16:00
14:30
13:00
11:30
8:30
10:00
0
7:00
0
£/MWh
600
MW
60000
5:30
£/MWh
60
MW
Pool prices for Wednesday 18th January 1995
Pool prices for Wednesday 19th January 1994
…. was achieved through changing the supply function….
80
70
60
£/MWh
50
40
30
20
10
0
0
10000
30000
50000
Cumulative MW
Wed 19 January 1994
Wed 18 January 1995
Local Fundamentals:
1. Link to Fuels
2. Supply and Demand Balance
Margin
35
30
25
20
15
10
5
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
20
02
20
03
20
04
0
Sensitivity of Prices to Reserve Margin
Prices and Reserve in Victoria
UK Margin (%) and Price (£/MWh)
45
35
40
30
35
25
30
20
Margin
25
prices
15
Price
20
%reserve
15
5
10
0
5
19
90
19
91
19
92
19
93
19
94
19
95
19
96
19
97
19
98
19
99
20
00
20
01
10
0
Years 1995- 2000
California Reserve Margin Declined Steadily….
Margin %
Deregulation
35%
30%
25%
20%
15%
10%
5%
0%
1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998
And at a critical point, spikes began to emerge…
CAL Hourly wholesale power prices ( $/MWh )
1600
1400
1200
1000
WSCC
800
600
400
200
Jan-01
Dec-00
Dec-00
Nov-00
Nov-00
Nov-00
Oct-00
Oct-00
Sep-00
Sep-00
Aug-00
Aug-00
Jul-00
Jul-00
Jun-00
Jun-00
Jun-00
0
Local Fundamentals:
Fundamental link to Fuels
Reserve Margin
Market Structure and Conduct
Yearly British Prices
2001/02
2000/01
1999/00
1998/99
1997/98
1996/97
1995/96
1994/95
1993/94
1992/93
1991/92
New Game
1990/91
30
28
26
24
22
20
18
16
14
12
10
A
90
pr
-9
O 1
ct
-9
A 1
pr
-9
O 2
ct
-9
A 2
pr
-9
O 3
ct
-9
A 3
pr
-9
O 4
ct
-9
A 4
pr
-9
O 5
ct
-9
A 5
pr
-9
O 6
ct
-9
A 6
pr
-9
O 7
ct
-9
A 7
pr
-9
O 8
ct
-9
A 8
pr
-9
O 9
ct
-9
A 9
pr
-0
O 0
ct
-0
A 0
pr
-0
O 1
ct
-0
1
ct
-
90
pr
-
O
A
Share of Coal Generation Capacity
Changing Ownership of Coal (ie price-setting) Plant
(Source: John Bower)
100%
National
Power
BEGL
80%
International
Power
Innogy
60%
AES
TXU/Eastern
EdF
40%
AEP
Edison
20%
PowerGen
Scottish
Power
ALCAN
0%
The Growth of Vertical Reintegration
%Energy Verticaly Integrated
80
70
60
50
%Energy
Verticaly
Integrated
40
30
20
10
0
1991
1997
1998
The effects of Over-capacity, Retail Liberalisation and a New
Market Structure on Wholesale and Retail Prices…
110.0
105.0
Residential
Price
100.0
Index
95.0
90.0
85.0
Full Retail
Opening
80.0
Wholesale
75.0
70.0
65.0
Jan-02
Nov-01
Sep-01
July-01
May-01
Mar-01
Jan-01
Nov-00
Sep-00
Jul-00
May-00
Mar-00
Jan-00
Nov-99
Sep-99
Jul-99
May-99
Mar-99
Jan-99
60.0
Neta
Vertical Integration Immunised against Wholesale Price…
Value moved to the Least Elastic part of the Supply
Chain
Prices Paid for Residential Assets (£/Domestic Customer)
500
400
300
200
100
0
Jul-98
Dec-99
Apr-01
Sep-02
Jan-04
May-05
With a Drop in Value of Generating Plant
900
800
700
600
500
400
300
200
100
0
Oct-95
Mar-97
Jul-98
Dec-99
Apr-01
Sep-02
Jan-04
CCGT Resale Prices £/kW
May-05
Re-Concentration follows distress…
Market Share of Top 3 Companies
70
60
%Market
50
40
Generators
30
Suppliers
20
10
0
2000
2001
2002
(U
K)
Np
ow
ED
er
F
En
er
Sc
Br
gy
ot
i
t
ish
t is
h
G
&
So as
ut
Br
he
itis
rn
h
En
Sc
At
er
ot
la
gy
t is
nt
ic
h
Po
El
ec
we
tr ic
r
&
G
az
G
as
de
Fr
an
Bi
ce
zz
Ec
En
on
er
om
gy
yP
ow
er
O
th
er
s
Eo
n
90% of Retail now delivered by Top 6
Suppliers
Supplier Market Shares 2004
0.25
0.2
0.15
0.1
0.05
0
Source: Power UK March 2005
65% of England and Wales Generation Produced
by Top 6 Suppliers
Market Share of Generation Feb 2005
25
20
15
10
5
Br
itis
h
En
er
gy
EO
N
Ed
F
SS
E
Dr
ax
RW
E
BN
In
te
Ce FL
rn
at
io ntri
n
Sc al ca
ot Po
w
t is
e
h
Po r
we
O r
th
er
s
0
Source: IPA Energy
Apr-04
Feb-04
Dec-03
Oct-03
Aug-03
Jun-03
Apr-03
Feb-03
Dec-02
Oct-02
Aug-02
Jun-02
Apr-02
Feb-02
Dec-01
Oct-01
Aug-01
Jun-01
Apr-01
Prices Moved Up…
Ofgem monthly reference prices, GBP/MWh
35
30
25
20
15
10
Large Generators Returned some Capacity
Margin
35
30
25
20
Margin
15
10
5
04
20
03
20
02
20
01
20
00
20
99
19
98
19
97
19
96
19
95
19
94
19
93
19
92
19
91
19
19
90
0
These Basic Divers Appear in Price Models
Fundamental link to Fuels
Reserve Margin
Market Structure and Conduct
Eg. Monthly Price Model (1990-2002) by Evans & Green
Price (Lerner) = a + b1 Herfindahl
+ b2 Herfindahl2
+ b3 Demand/Capacity
+ b4 Sept2000
(R2 = 67%)
And their effects are Cyclical…
What do we now know about the evolution of power
markets?
1. Dynamic Evolution
Initial thoughts that global markets for fuels would be
a strong convergent driver have not been upheld:
Local Factors, Market Structure and
Strategic Behaviour may be Pro-cyclical.
2. Value can migrate up and down the supply chain
Retail can capture value more effectively than
wholesale
What do we now know about the evolution of power
markets?
1. Dynamic Evolution
Initial thoughts that global markets for fuels would be
a strong convergent driver have not been upheld:
Local Factors, Market Structure and
Strategic Behaviour may be pro-cyclical.
2. Value can migrate up and down the supply chain
Retail can capture value more effectively than
wholesale
3. Governments are beginning to prefer imperfect markets
A few large, vertically integrated companies
provide security and can be “managed”.
…. and many countries explicitly pursue the ‘national
champion’ objective….
EU GENERATION CAPACITY CONCENTRATION RATIO (3 FIRM) 2001
100%
90%
70%
60%
50%
40%
30%
20%
10%
UK
Norway
Germany
Netherlands
Austria
Finland
Denmark
Sweden
Spain
Italy
Portugal
Belgium
Ireland
France
0%
Greece
Share of Total Net Supply (%)
80%
What do we now know about the evolution of power
markets?
1. Dynamic Evolution
Initial thoughts that global markets for fuels would be
a strong convergent driver have not been upheld:
Local Factors, Market Structure and
Strategic Behaviour may be pro-cyclical.
2. Value can migrate up and down the supply chain
Retail can capture value more effectively than
wholesale
3. Governments are beginning to prefer imperfect markets
A few large, vertically integrated companies
provide security and can be “managed”.
4. Imperfect Markets will exhibit Dynamic Strategic Behaviour
Prices will not stabilise at marginal costs
Even after 7 years of daily evolution, the supply
function was not stable….
120
January 20th 1997
100
Price
80
(£/MWh)
60
40
20
0
5000
10000
15000
20000
Capacity (MW)
25000
30000
35000
12th February
11th February
10th February
9th February
8th February
7th February
6th February
5th February
4th February
3rd February
29th January
28th January
27th January
26th January
25th January
24th January
23rd January
22nd January
21st January
Days
20th January
Price
(£/MWHr)
The following days continue to show dynamic learning
and gaming….
60
50
40
30
20
10
30500
0
23000
15500
8000
500
Capacity
(MW)
What do we now know about the evolution of power
markets?
1. Dynamic Evolution
Market Structure and Strategic Behaviour may be
Pro-cyclical.
2. Value can migrate up and down the supply chain
Retail can capture value more effectively than
wholesale
3. Governments are beginning to prefer imperfect markets
A few large, vertically integrated companies
provide security and can be “managed”.
4. Imperfect Markets will exhibit Dynamic Strategic Behaviour
Prices will not stabilise at marginal costs
5. Regulatory Risk is inevitable and substantial
Further Reading:
Sally Hunt
Making Competition Work in Electricity (Wiley, 2002)
Steven Stoft
Power System Economics (Wiley, 2002)
Alexander Eydlund and Krzysztof Wolyniec
Energy and Power Risk Management (Wiley, 2003)
Derek Bunn
Modelling Prices in Competitive Electricity Markets
(Wiley 2004)