1
Is the prevailing wholesale market design in
Europe and North America comparable?
Leonardo Meeus, Ronnie Belmans
Abstract— The contribution of this paper is to compare the
North American and European prevailing wholesale market
design focusing on day-ahead auction participation and the
treatment of network constraints and non-convexities. It is
argued that the prevailing designs are not as different as they
might seem at first sight. For the moment, the most relevant
difference is the treatment of network constraints. Europe has a
less efficient design in dealing with the network, but is deploying
this design on a more efficient scale.
Index Terms-- Pricing, market equilibrium, power system
economics
I. INTRODUCTION
T
here is no wholesale market in North America. Only
some states have introduced competition in generation.
North America is a patchwork of regions with developing and
more matured markets, but mainly with regions that did not
yet implement a market system.
Despite this patchwork, there clearly is a prevailing market
design. This is basically the market initially designed for
Pennsylvania, New Jersey and Maryland (PJM), which is also
the standard market design advocated by the Federal Energy
Regulatory Commission (FERC). PJM is often considered the
most successful market in North America, although it also has
still to deserve its merits in terms of investment in generation
capacity.
The North American wholesale market design is based on a
mandatory auction that runs one day ahead of delivery.
Typically, all network constraints are already taken into
account at the day-ahead stage by the so-called power pools.
Note that local authorities often got involved in designing
these power pools.
This kind of public involvement has been less common in
Europe where both European and most national authorities
refrained from designing the detailed rules and procedures of
the market. Although there is legislation on the European
level, these so-called Directives only lay down the general
conditions that should allow competition between generators
and suppliers.
While no European standard market design has been
L. Meeus is with the Electrical Engineering Department, KULeuven,
Leuven, Belgium (phone: ++32-(0)16/321722; fax: ++32-(0)16/321985; email: [email protected]).
R. Belmans is with the Electrical Engineering Department, KULeuven,
Belgium, Leuven (e-mail: [email protected]).
advocated, it is possible to advance a prevailing wholesale
market design. Trading arrangements are mainly bilateral
instead of pool based, but most markets do have a voluntary
day-ahead auction. The so-called power exchanges that
organize these auctions often do not (have to) take into
account network constraints at all or only partly, i.e. zonal
instead of nodal approach.
As will be discussed in this paper, also the treatment of
non-convexities such as generator start-up costs in Europe is
different from North America. Whereas power pools allow
generators to submit their non-convex costs and constraints
directly, this is not possible on power exchanges.
The contribution of this paper is to compare the North
American and European design focusing on day-ahead auction
participation and the treatment of network constraints and
non-convexities. It is argued that the prevailing designs are
not as different as they might seem at first sight.
Section II elaborates on the different role of day-ahead
auctions in European and North American electricity markets.
Section III then discusses the differences in design that
resulted from the different role.
II.
DIFFERENT ROLE
Power pools have always existed. Vertically integrated
utilities minimized their generation costs via power pools.
Also the market version of a pool determines which
generation units will run when during the following day,
taking into account the variable costs, start-up costs, ramping
constraints, etc. The main difference is that the parameters
generators submit have now become strategic. Because the
pool also determines the market prices, generators can have an
interest in not submitting their actual costs and constraints.
In other words, the North American day-ahead auctions
largely determine the generation schedule for the next day.
Intra-day and real time trading arrangements make deviations
from this schedule possible, but there is a strong link between
the day-ahead commitment and the actual delivery.
In Europe, trading arrangements are mainly bilateral. Most
wholesale trade is in so-called over the counter (OTC)
markets, often supplemented with day-ahead auction trade.
The transaction cost advantage of the exchanges that organize
these auctions is that they use simple rules to settle contracts
at a point of time where it is not worth getting into time
consuming negotiations. Exchanges are also counter-party for
all transactions so that trade is anonymous and traders do not
have to worry about counter-party risk. Most European
2
countries therefore have an exchange often as a result of
private initiative.
An important difference with North America is that the
European day-ahead auctions do not determine the generation
schedule for the next day. The day-ahead commitments are
only weakly linked with actual deliveries. At the day-ahead
stage, portfolios are fine-tuned as every MWh that will
eventually be delivered has already been physically traded
several times. Generators themselves determine their
generation schedule, taking into account the commitments
from trading in a variety of markets. At some point in time,
called gate closure, they submit their intentions to the system
operator.
III. DIFFERENT DESIGN
Given the different role discussed in the previous Section,
it should come as no surprise that the auctions are somewhat
differently designed. Table I illustrates the differences
between the typical North American power pool (PJM) and
the power exchanges of Germany (EEX), the Netherlands
(APX), France (Powernext), Belgium (Belpex) and the
Scandinavian countries (Nord Pool).
As illustrated in Figure 1, there are also other exchanges in
Europe. Some of them have a very specific design, especially
the Spanish OMEL and the Italian GME [1]. Therefore, these
exchanges are not considered in this paper.
Table I compares the day-ahead auctions based on the
treatment of network constraints, day-ahead auction
participation and dealing with non-convexities, which is
respectively discussed in the next paragraphs.
A. Network constraints
North America is physically interconnected. There is an
integrated transmission network, even though it does not
operate as one synchronous zone. The same counts for
Europe. Even before the liberalization process, these
integrated networks were used to transfer electric energy. In
most cases this was to mutually assist each other in case of
emergencies, but sometimes also because of economical
reasons.
Since the liberalization process, cross-border transfers have
increased substantially. On most borders in Europe (Figure 2)
separate markets for transfer capacity have been set-up to
guarantee non-discriminatory access. Note that as of July
2004 this is legally required for all Member States of the
European Union (Regulation 1228/2003). As a result,
European wholesale markets are linked. Prices co-relate,
although they are far from being at the same level. There are
several reasons. Firstly, cross-border network capacity is still
scarce. Secondly, in most cases borders already close at the
day-ahead stage, meaning that intra-day and real time markets
are only accessible for domestic players. Finally, the
capacities on most borders are allocated in separate markets
and largely uncoordinatedly.
Implicit auctioning
Explicit auctioning
DK
NL
PL
B
CZ
SK
F
A
H
CH
SLO HR
BIH
P
P
I
CS
Fig. 1: European power exchanges
Fig. 2: Cross-border transfer capacity markets in Europe end of 2006
3
TABLE I: MAIN DESIGN CHARACTERISTICS ELECTRIC ENERGY AUCTIONS
Participation
Network constraints
Mandatory?
Separate network
capacity market?
No
Non-convexities
Nodal pricing?
Non-convex
order?
Nonlinear
pricing?
Yes
No
Yes1
No
No2
Yes3
No
Yes1
No
Nord Pool (Scandinavia)
No4
No
No5
Yes1
No
PJM (US)
Yes
Yes
Yes
Yes
Yes
EEX (Germany)
APX (Netherlands)
Powernext (France)
Belpex (Belgium)
1 Only block orders: quantity that is offered or requested in multiple hours with a fill-or-kill constraint; traded jointly with the hourly orders
2 Mandatory for day-ahead international trade
3 Yearly and Monthly transfer capacities on the French-Belgian and Belgian-Dutch border are still auctioned separately/explicitly
4 Mandatory for all international trade
5 Norway is split up in 3 price zones
However, the tendency in Europe is the so-called coupling
of markets, starting with the day-ahead auctions. Exchanges
are increasingly allowed to use the capacities on the borders to
optimize the clearing of their orders, i.e. market coupling.
Nord Pool can use the full capacities available on the internal
borders of the Scandinavian countries (and a part of
Germany). More recently APX, Belpex and Powernext are the
first exchanges to jointly allocate the day-ahead capacities on
their internal borders. Furthermore, steps are also taken
towards opening intra-day and real time markets to foreign
players.
The North American wholesale markets on the contrary are
more weakly linked, if it al all. Note that for instance between
MISO and PJM there is a common market initiative [2].
However, the North American power pools do deal with intrazonal network constraints. Already at the day-ahead stage,
trade is constrained by the internal network. This means that
in case the network constraints are binding, every node can
have a different price, i.e. nodal pricing.
In Europe, internal network constraints are not taken into
account in the wholesale trading arrangements. These
constraints are dealt with in real time and the occasional
redispatch cost is socialized among grid users. Most European
countries are therefore single priced zones. Even Germany,
which has 4 control zones, only has one price zone.
Exceptions are Norway, which has three price zones, and
Italy, which can be split in several price zones, although a
single price for demand is retained.
Several authors have analyzed the difference in design
between a zonal and a nodal system, e.g.:
• Stoft [3] presents a game theoretic analysis of the zonal
design. He considers strategic behavior of market players
who take unanticipated advantage of market rules. The
author explains and illustrates how generators with high
costs can get paid not to generate in a zonal system. As
also discussed by Hogan [4], generators in a zonal system
have incentives to cause intra-zonal congestion to get
paid for redispatching their plants. This will raise the
short-run cost to loads and will encourage inefficient
entry of new generation.
• Bjorndal et al. [5] and Glachant and Pignon [6], referring
to the zonal Scandinavian market, argue that by overconstraining inter-zonal transfers, TSOs can hide the need
for intra-zonal network investments.
The treatment of network constraints in North America and
Europe therefore seems to be significantly different at first
sight. With nodal pricing generally considered better than
zonal pricing, it could be concluded that the North American
design is superior to the European. However, it is important to
underline that the European market is much larger than the
North American markets. The European continent alone
(UCTE area) has a peak load of 390GW [7]. Note that the
peak loads of countries like Germany (81GW) and France
(82GW) on their own are even not much smaller than peak
load in PJM (135GW) and MISO (112GW) [2] and [7].
To sum up, in Europe a less efficient design is being
deployed on a more efficient scale. The larger scale is thanks
to common European legislation but can also be partly
explained by the simpler design that is prevailing in Europe.
Arguably, it is also more difficult to couple the North
American markets because they apply (a different
implementation of) nodal pricing internally. The reason is that
it is politically difficult to harmonize the treatment of network
constraints and especially if the treatment is already fine
tuned, which is less the case in Europe.
Note finally that in dealing with the network, the European
zonal design can easily be improved by splitting up zones. It
may even not be sensible to have as many prices as the
number of physical nodes in a network, i.e. full nodal. The
argument against full nodal is that the market is illiquid if
there are few agents at each node.
4
B. Participation
In power pool based markets, trade is settled in the same
market at the same prices, while in a market with mainly
bilateral trade there is physical trade in a variety of markets
where it is settled at different prices. Therefore, the difference
has been compared with the difference between a uniform and
a discriminatory priced auction.
For instance, several authors have analyzed the 2001
reforms in the UK as a shift from a uniform to a pay-as-bid
(discriminatory) priced auction. In 2001, the regulator in the
UK replaced the Pool (England and Wales) by a market
system based on bilateral trade (NETA later on BETTA), as in
the rest of Europe, e.g.:
• Wolfram [8] argues against the reforms, saying that
switching to discriminatory pricing is unlikely to solve
the problem of high prices in the UK given the market
structure, which is dominated by a small number of
generating companies.
• Bower and Bun [9]-[10] even suggest that the reforms
would actually increase prices. Their results are based on
an agent-based simulation model. The reason, they argue,
is that market prices are not publicly available and agents
with a large market share gain a significant informational
advantage in a discriminatory auction, thereby facing less
competitive pressure.
• The results in Fabra et al. [11] are based on a multi-unit
auction model. They present an analysis inline with the
view of the regulator.
In other words, there is no consensus on which is best. Both
discriminatory and uniformly priced auctions have advantages
and disadvantages. Furthermore, the difference between a
pool and bilateral based market is clearly more complex. Note
also that Europe is moving towards a system in which crossborder trade is increasingly organized by power exchanges.
This means exchanges will be mandatory for cross-border
trade, as is already the case in the Scandinavian region and
partly also between Belgium, France and the Netherlands. To
sum up, the difference in terms of day-ahead auction
participation between North America and Europe is fading.
C. Non-convexities
In this paragraph, order formats are discussed respectively
from the perspective of the generator and auctioneer.
1) Incentive compatibility
North American power pools allow generators to explicitly
express their non-convex costs and constraints. Therefore,
generators can easily tell the truth about these costs and
constraints. If faced with adequate competitive or regulatory
pressure, they will also tell the truth. This so-called incentive
compatible design allows an efficient unit commitment, which
is the role of power pools in North America.
European power exchanges on the contrary do not allow
generators to explicitly express their costs and constraints.
Exchanges have simple rules, procedures and products to keep
transaction costs low. The design is therefore not suited for
unit commitment. This is not necessarily a problem as
generators can trade in many consecutive markets in Europe.
However, the previous paragraph discussed that exchanges are
becoming mandatory for cross-border trade. This means that
the exchanges are also becoming more important for unit
commitment, while the order formats are not designed for that.
In fact, exchanges in Europe have already started to introduce
new order formats or products in their day-ahead auctions or
are at least studying it.
For the moment on most exchanges, generators can only
submit hourly orders and block orders to the day-ahead
auctions. Blocks can for instance help generators in dealing
with start-up costs. To illustrate this, consider a 2MW power
plant with a fixed start-up cost of 1€ and a variable fuel cost
of 1€/MWh. The generator could submit an hourly order of
2MWh in every hour. In the worst case, the result would be
that he is only allowed to supply 1MWh during one hour at a
cost of 2€ (1€+1MWh*1€/MWh). Therefore, only if the
generator submits the hourly orders each at a price limit of
2€/MWh, he is sure of always recuperating his start-up costs.
Alternatively, the generator could for instance submit a
2MWh/h block order spanning hour 1 and 2. A block is a
multiple period order with a fill-or-kill constraint, meaning
that the order has to be accepted completely or not at all. The
average cost of this block being accepted is therefore
1.25€/MWh (1€/MWh+1€/(2MWh/h*2h)). Therefore, the
generator can submit the block at this price limit, which is
lower as the one of the hourly orders. In other words, blocks
allow generators to express that they can offer more at a lower
per unit price.
The problem is that generators have different operating
points and can operate in several combinations of hours, while
many of these production alternatives are mutually exclusive.
In the above illustration the generator that wants to implicitly
express his start-up costs has several alternative ways of doing
that but has to self-restrict to submitting one of the possible
orders.
Therefore, the conclusion could be that the day-ahead
auctions in North American offer more flexibility to
generators. This is not completely true because in Europe
blocks can also be submitted at the demand side of the dayahead auctions. This way they are also used by generators to
de-commit power plants that were scheduled at the day-ahead
stage as a result of trade commitments. Note that they are for
instance also used to schedule large energy consuming
industrial processes with start-up costs, Power pools, on the
contrary, are designed for unit commitment so that there is
only simple hourly bidding at the demand side or no demand
side participation at all day-ahead.
2) Non-convex orders and pricing
Both the North American and the European day-ahead
auctions with blocks are non-convex. This implies that the
auctions do not necessarily have a set of market clearing
prices, i.e. a set of hourly prices at which demand equals
supply in every hour [1]. Most literature prescribes nonlinear
pricing to deal with this. Nonlinear pricing means that the
traded volumes (q, MWh) are settled at hourly prices (p,
€/MWh), which are the same for all orders, in combination
5
with side payments (A, €) which can be different for all
orders: pxq + A. Note that pay-as bid (p=0) is a special case of
nonlinear pricing.
North
American
power
pools
apply
different
implementations of nonlinear pricing. As discussed in [12],
exchanges have a plausible alternative approach. They do not
use side payments to clear the market (A=0), i.e. linear
pricing. Instead, they equalize demand and supply at hourly
prices by rejecting block orders that are in the money, i.e. that
want to trade at the determined prices. Although the European
approach is perhaps less efficient, a clear advantage is its
(perceived) simplicity.
To sum up, the order formats of the day-ahead auctions in
Europe are less suited for unit commitment of generators, but
this is not necessarily a problem as long as exchanges are
voluntary. The applied pricing approach in dealing with nonconvexities is simpler in Europe than in North America.
Arguably, it is more difficult to couple the North American
markets because they apply (a different implementation of)
nonlinear pricing internally. The reason is that it is politically
difficult to harmonize the treatment of non-convexities and
especially if the treatment is already fine tuned, which is less
the case in Europe.
[2]
[3]
[4]
[5]
[6]
[7]
[8]
[9]
[10]
[11]
[12]
IV. CONCLUSIONS
It is increasingly recognized that electricity markets are too
complex to be modeled adequately so that there will never be
closure on best design [13]. Still, a badly designed market can
make it easier for market players to misbehave or can even
make it impossible for them to behave perfectly competitive.
For instance, the treatment of network constraints in Europe is
often cited to be inferior to the nodal pricing approach in
North America. Indeed, in Europe, generators have more
opportunities to abuse the fact that internal network
constraints are only dealt with in real time.
However, as underlined in this paper, the European design
is being deployed on a more efficient scale. This is thanks to
European legislation but can also be partly explained by the
simpler design that is prevailing in Europe. It has been argued
that the more fine tuned North American markets are more
difficult to couple.
Finally, the tendencies in Europe are such that the
differences with the prevailing North American design will
continue to fade. In conclusion, the prevailing designs in
Europe and North America are clearly more comparable than
they might seem at first sight.
An interesting extension to this paper would be to discuss
the differences in design in terms of investment incentives.
This paper rather focuses on the rules and procedures that
have an impact on the behavior of market players in the short
run.
REFERENCES
[1]
L. Meeus, "Power exchange auction trading platform design," PhD
dissertation K.U.Leuven, ESAT-ELECTA, Advisors: R. Belmans & S.
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available at http://hdl.handle.net/1979/338..
[13]
MISO-PJM. FERC-filed Joint and Common Market Reports, 2006,
http://www.jointandcommon.com/documents/downloads/20061026er04-375-017.pdf
S. Stoft, Using Game Theory to Study Market Power in Simple
Networks. In H. Singh, ed., Game Theory Tutorial, IEEE Power
Engineering Society, Parsippany, NJ, 1999.
W.W. Hogan. Transmission congestion: the nodal-zonal debate
revisited,
Harvard
University,
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available
at:
http://ksghome.harvard.edu/~.whogan.cbg.ksg.
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C. Wolfram. Electricity Markets: Should the Rest of the World Adopt
the UK Reforms? Regulation, vol. 22, 1999, pp 48-53.
J. Bower, and D. Bunn. Experimental analysis of the efficiency of
uniform-price versus discriminatory auctions in the England and Wales
electricity market. Journal of Economic Dynamics and Control, vol. 25,
2000, pp561-592.
J. Bower and D. Bunn. Model-based comparison of pool and bilateral
markets for electricity. The Energy Journal, 21(3), 2001.
N. Fabra, N-H. von der Fehr and D. Harbord. Designing electricity
auctions. CSEM WP 122, University of California Energy Institute
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L. Meeus, K. Verhaegen, R. Belmans, “Should exchanges with nonconvex orders apply nonlinear pricing” pending at IEEE Transactions on
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Systems,
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http://homes.esat.kuleuven.be/~leonardo/
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Leonardo Meeus received the M.S. degree in
commercial engineering in 2002 and the Ph.D.
degree in electrical engineering in 2006, both from
the KULeuven, Belgium. Currently, he is a senior
researcher of the KULeuven Electric Energy
Research Group ELECTA. His research interests
include power systems and markets and energy
policy issues. He is also the scientific coordinator of
the KULeuven Energy Institute and the European
Energy Institute (EEI). Since 2006, he is the
chairman of the CIGRE Task Force C5-7.1 on power
system investment incentives in a market environment.
Ronnie Belmans received the M.S. degree in
electrical engineering in 1979, the Ph.D. in 1984, and
the Special Doctorate in 1989 from the K.U.Leuven,
Belgium and the Habilitierung from the RWTH,
Aachen, Germany, in 1993. Currently, he is full
professor with K.U.Leuven, teaching electrical
machines and variable speed drives. He is appointed
visiting professor at Imperial College in London. He
is also President of UIE. He was with the Laboratory
for Electrical Machines of the RWTH, Aachen,
Germany (Von Humboldt Fellow, Oct.’88-Sept.’89). Oct.’89-Sept.’90, he was
visiting associate professor at Mc Master University, Hamilton, Ont., Canada.
During the academic year 1995-1996 he occupied the Chair at the London
University, offered by the Anglo-Belgian Society. Dr. Belmans is a fellow of
the IEEE and the IEE (United Kingdom). He is the chairman of the board of
Elia, the Belgian transmission grid operator.