Scarcity Pricing Background
Scarcity Pricing Forum
Prepared by the Electricity Authority
19 January 2011
663288-3
Scarcity Pricing Background
Contents
1.
Purpose of this paper
5
1.1
Introduction
5
1.2
Work to date
5
1.3
Legislative framework
6
2.
Problem Statement
7
2.1
Description
7
2.2
Problems with current practice
7
2.3
Potential consequence of current practice
10
3.
Solutions
12
3.1
Introduction
12
3.2
Floors, caps, collars and fixed prices
12
3.3
Pricing mechanisms
13
4.
Question for Forum members
15
4.1
Roundtable discussion
15
4.2
Discussion of the problem statement
15
4.3
Solutions
15
4.4
Follow Up
15
Appendix A
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Demand Curtailment
17
C
Scarcity Pricing Background
1.
Purpose of this paper
1.1
Introduction
1.1.1
The purpose of this paper is to provide background information to the Scarcity
Pricing Forum (SPF) on the definition of the problem related to suppressed price
signals in the spot electricity market during scarcity situations.
1.1.2
This paper covers:
(a)
the impact on prices during energy and capacity situations for both shortfall
and scarcity;
(b)
a range of potential solutions; and
(c)
a series of questions for forum members
1.1.3
The views presented in this paper are intended to stimulate discussion and do
not represent the views of the Electricity Authority (Authority). At this stage the
Authority does not have a firm proposal on the Scarcity Pricing Project (SPP) and
is open to suggestions provided the solutions progress the Electricity Authority
statutory objective. Feedback from the SPF may be used by the Authority to
progress the Scarcity Pricing project.
1.2
Work to date
1.2.1
The Electricity Commission (Commission) consulted with interested parties in
October 2009 on broad options to address issues around revenue adequacy for
voluntary demand side response and generation investment/operation. The
Electricity Commission Board (Commission Board) considered the submissions
and agreed to explore scarcity pricing as the preferred mechanism for ensuring
revenue adequacy. Furthermore the Commission Board also agreed that no
further work was to proceed on capacity contracting mechanisms at that time.
1.2.2
The Scarcity Pricing and Default Buy Back Technical Group (SPDBTG) was
subsequently established to provided technical advice to the Commission on the
development of the SPP. The SPDBTG has met on a number of occasions to
discuss aspects of scarcity pricing 1 (and the customer compensation scheme).
1.2.3
The Authority is preparing to consult on the specifics of a SPP design and
welcomes engagement with senior level electricity industry executives. The SPP
has the potential to change the risk profile for participants in the market due to
higher prices in times of scarcity. This may have a material impact on the market
risks organisations face and could necessitate a review on how market financial
risk is managed by participants.
1
The SPDBTG work can be found http://www.ea.govt.nz/our-work/advisory-working-groups/spdbtg/
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Scarcity Pricing Background
1.3
Legislative framework
1.3.1
The Electricity Industry Act 2010 (Act) provides a statutory objective for the
Authority to promote competition in, reliable supply by, and the efficient operation
of the electricity industry for the long term benefit of consumers.
1.3.2
The Act also requires the Authority to (by 1 November 2011), either amend the
Code to "impose a floor or floors on spot prices for electricity in the wholesale
market during supply emergencies (including public conservation campaigns)", or
to explain why not and suggest alternative methods for dealing with the issue and
the timeframe for doing so.
Scarcity Pricing Background
2.
Problem Statement
2.1
Description
2.1.1
The Authority is considering different forms of price intervention in the market to
address situations where the spot price does not reflect scarcity of supply
situations.
2.2
Problems with current practice
2.2.1
When supply is insufficient to meet demand, the economically efficient price is
the level that would ration demand to the amount of supply. However, in the
electricity spot market generator offers set prices, which means prices are below
efficient levels when forced outages are imposed. Consequently, investment in
generation and demand response may be inefficient, and response in real time
may be diluted.
2.2.2
Spot prices may be also inefficient when other non-market approaches are used
to reduce demand, such as when demand reductions are achieved with public
conservation campaigns (PCCs). Similarly, spot prices may be inefficient when
non-market approaches are used to increase energy supply, such as when
instantaneous reserve (IR) requirements are relaxed.
2.2.3
In summary four types of price suppression or “scarcity situations” are possible in
the market (these may occur in combination with one another).
(a)
2
Capacity Shortfall Scenario: In this situation the System Operator needs to
instruct demand reduction as the forecast amount of MW demanded is
greater than the forecast amount of MW supplied. Appendix one lists the
situations where the System Operator reduces demand 2 . Figure 1
illustrates the supply and demand curve for a capacity shortage scenario.
Note that the final pricing process uses the metered demand (equal to the
curtailed demand in figure 1). This scenario also includes the situation
where insufficient IR is procured to cover the extended contingent event
(ECE).
The System Operator works with network companies to actively manage demand during periods of tight supply.
Effectively demand is rationed by network company and each network company manages the load in their
respective area, they may use voluntary or involuntary cuts. It is possible that when the System Operator has
rationed demand that no demand cuts are implemented if actual demand levels are less than the System
Operators rationed demand levels. This creates an issue in that it can be hard to determine in some instances
if demand was actually shed involuntarily.
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Scarcity Pricing Background
Figure 1: Capacity - Shortfall Scenario
(b)
Energy Shortfall Scenario: In this situation the System Operator implements
targeted outages with notice (rolling outages) 3 to reduce the likelihood of
unplanned power cuts. It is possible that there is sufficient MW to meet real
time demand but power is rationed to mitigate against uncontrolled cuts in
the near future. This situation is demonstrated in figure 2. New Zealand
has not had widespread rolling outages since the formation of the electricity
market. Experience in Australia shows that prices become very volatile as
load blocks are taken in and out of the market. Prices move between the
intersections of the supply curve and the two demand curves.
Figure 2: Energy - Shortfall Scenario
(c)
3
Capacity Scarcity Scenario: At this time no shortfall of MW exists however
there is insufficient generation capacity and market based demand
response to meet the combined energy and IR needs of the market. This
increases the risk that an actual shortage may occur. The supply and
demand curve is shown in figure 3. In this scenario the System Operator
The rolling outages discussed here are in conjunction with the rolling outages are outlined in Part 9 of the Code.
That is the System Operator needs to consult with the Authority and make a supply shortage declaration.
Scarcity Pricing Background
currently procures all available IR to reduce system security risk. As
energy and IR are co-optimised in the market, suppressed IR prices can
also lead to a suppression of energy prices.
Figure 3: Capacity - Shortage Scenario
(d)
Energy Scarcity Scenario: This scenario is similar to the energy-shortage
situation with the exception that instead of rolling cuts a PCC 4 is
implemented. The key difference is that energy is conserved voluntarily by
consumers on a best endeavours basis. For completeness this is
illustrated in figure 4.
Figure 4: Energy - Scarcity Scenario
2.2.4
Of these four scenarios the key characteristics include;
(a)
4
Scarcity events are more frequent than shortfall events as scarcity is the
precursor to shortage;
Proposed code changes under the Customer Compensation Scheme will define an official conservation
campaign.
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Scarcity Pricing Background
(b)
The number of capacity events (several per year) are likely to be greater
than the number of energy events (1-2 per decade);
(c)
The duration of energy events (weeks) are longer than capacity events
(hours);
(d)
The System Operator determines the level of demand reduction for shortfall
events; and
(e)
The market determines the level of IR supplied in a capacity shortfall
scenario and the amount of energy conserved in a public conservation
campaign.
2.3
Potential consequence of current practice
2.3.1
On first glance, to a consumer of electricity, lower market prices may appear to
be a preferred market outcome. Low prices during scarcity or shortage
situations, however, tend to exacerbate the scarcity or shortfall.
2.3.2
In the short term the problem can be described as the unit commitment issue.
Some generation plant is slow starting and incurs a cost to be available, such as
the cost of fuel to maintain boiler heat (“commitment cost”). These types of plant
need to recover the commitment costs and running costs during the periods that
they are actually running to remain profitable. The unit commitment problem was
evident in 2009.
2.3.3
Another short term issue is the supply of IR, particularly the higher priced
interruptible load (IL) (other forms of IR may also be high priced). IL is important
in the capacity scarcity and shortage scenarios, as other forms of IR are cooptimised into the energy market. Reduction of prices in the IR market
disincentivises IL providers in the market to make their resource available in
times of scarcity.
2.3.4
Non-economic demand rationing occurs when the System Operator imposes
forced demand reductions. Parties that could respond to price signals may not
need to do so as the current practice will reduce their price exposure. Some
consumers who would choose to not forgo consumption have their power
reduced whereas others who would choose to not consume continue to consume
the scarce electricity resource. It is important to note that for a significant portion
of consumption in New Zealand the end-user does not see the price signal as
they are on fixed- price variable-volume tariffs.
2.3.5
In the long term the consequences of the current practice culminates into a
resource adequacy issue. This is about ensuring that sufficient resources are
available to meet the required level of system security. The trade-off is about the
cost of unserved energy (energy shortfalls) against the cost of electricity supply.
This trade-off is represented in figure 5.
Scarcity Pricing Background
Illustrative
$m/year
40000
Lowest
overall cost
30000
20000
10000
0
0.0120%
0.0060%
Cost of supply
0.0030%
0.0015%
0.0008%
0.0004%
0.0002%
Expected unserved energy as % demand
Cost of curtailment
Total cost
Figure 5: Cost of supply versus cost of curtailment
2.3.6
The investment decision can be further compounded by investment in the wrong
type of plant. Price suppression reduces price volatility and encourages
development of base load plant, whereas the most efficient solution could be
more peaking response.
2.3.7
A compounding issue for resource adequacy is the issue of price uncertainty.
Currently participants are uncertain as to what prices are likely to occur during
shortfall/scarcity situations, as these situations occur infrequently making it
difficult to assess participant behaviour in the future.
2.3.8
Ultimately all of these consequences lead to decreased operating of the
electricity system in a secure state. Through a combination of reduced
investment, reduced demand side participation, reduced unit commitment and
reduced supply of IR the inevitable outcome is an increasingly unreliable
electricity system.
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Scarcity Pricing Background
3.
Solutions
3.1
Introduction
3.1.1
This section discusses a range of solutions for the following scarcity/shortage
scenarios.
(a)
capacity scarcity situation - a shortage of instantaneous reserve;
(b)
capacity shortfall situation - a shortfall in energy requiring short term
demand reductions;
(c)
energy scarcity situation - public conservation campaigns; and
(d)
energy shortfall situation - rolling outages.
3.1.2
A key issue is how to determine when each of the above situations actually
exists, i.e. what is the trigger to commence a price intervention mechanism?
3.2
Floors, caps, collars and fixed prices
3.2.1
Price intervention can be in the form of a floor, a cap, a collar (a combined floor
and cap) or a fixed price, and could apply to either a price outcome from the
market (a market cap/floor) or a price constraint within the bid/offer process (an
offer cap/floor).
3.2.2
A floor price is a minimum price, and a cap price is a maximum price. In electricity
markets cap prices are used in two different contexts.
3.2.3
In many of the US markets (e.g. PJM, NE-ISO) a market cap is used to manage
market power issues by placing a relatively low price cap in the energy market to
produce outcomes consistent with short run marginal cost (SRMC) pricing 5 .
These markets also have capacity markets to provide the additional revenue to
allow generators to recover capital costs.
3.2.4
By contrast energy-only markets (Australia, Singapore and Texas) use “hockey
stick” 6 bidding is used to raise energy prices up to an energy cap. This produces
the high scarcity prices. It is during these periods of high prices that generators
recover capital costs.
3.2.5
A collar is a combination of a floor and a cap – that is, prices must be higher than
the floor but lower than the cap.
3.2.6
A fixed price can be considered a collar with the same price for the floor and cap.
5
Note that FERC have recently ruled that these caps can be over-ridden in scarcity events (usually a shortage in
IR).
6
Hockey stick bidding relies on a small number of high priced offers that are used to set market prices during
periods of scarcity, up to the level of the market cap.
Scarcity Pricing Background
3.3
Pricing mechanisms
3.3.1
Several mechanisms can be used to alter spot prices for scarcity and shortfall
situations.
3.3.2
One approach is to constrain inputs into the pricing process, say by introducing
bid/offer price cap/floor requirements. This places an obligation on participants to
construct bids and offers that produce certain outcomes. For example in Texas
scarcity pricing is implemented via “hockey stick” 7 bidding and an offer cap. An
issue arises around the use of market power and participants using hockey stick
bidding when scarcity is not an issue. To mitigate this Texas reduces the offer
cap once a pre-determined number of high price periods have occurred in any
one year.
3.3.3
Another approach is to amend the scheduling, pricing and dispatch (SPD) model
to produce high prices during scarcity situations. This could be done by
introducing a dummy bid or offer that is used to set prices when no intersection of
supply and demand exists. Other more general constraints can be used to
produce prices consistent with scarcity from within the model.
3.3.4
Finally, the outputs of SPD can be amended to reflect the required scarcity
situations. For example in Australia (not WA) a market price override mechanism
is used. In the case of a MW capacity shortage Australian Energy Market
Operator sets the market price for that dispatch interval equal to the market price
cap. When insufficient IR is procured the price for that dispatch interval is also
set to the market cap price. An additional mechanism is also used in Australia to
reduce the impact of extended periods of scarcity pricing.
7
Hockey stick bidding relies on a small number of high priced offers that are used to set market prices during
periods of scarcity, up to the level of the market cap.
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Scarcity Pricing Background
4.
Question for Forum members
4.1
Roundtable discussion
4.1.1
The primary objective of the SPF is a roundtable discussion amongst members to
discuss the following issues.
4.2
Discussion of the problem statement
Q1.
Does the scarcity situations described in the paper actually occur in New
Zealand? Are there other scarcity situations that need to be considered?
Q2.
Do the scarcity situations have an impact on the market? What is the
materiality of these impacts?
Q3.
What are participants’ experiences with these issues?
4.3
Solutions
Q4.
Is this an issue worthy of solving? Is the status quo acceptable?
Q5.
How should each scarcity price be triggered?
Q6.
What are the benefits/issues of floors, caps and fixed prices? What are the
benefits/issues with offer based solutions and price based solutions?
Q7.
How would different solutions impact on market risks for participants? Are
participants able to manage these risks?
Q8.
How would different solutions impact the viability of the market?
4.4
Follow Up
Q9.
If scarcity pricing was implemented how could it be transitioned into the
market?
Q10.
What other actions would the Authority need to take in conjunction with
Scarcity Pricing?
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Scarcity Pricing Background
Appendix A Demand Curtailment
Participants and the System Operator have the ability to curtail demand in a number of
situations. The table below lists the different scenarios currently outlined in the Code. More
information on how the System Operator uses demand management is outlined in the
System Operator policy statement clauses 72-74 (inclusive).
The process around how much demand is shed and where it is to be shed is identified in the
System Operator policy statement clauses 75-81 (inclusive). These clauses allocate
demand reduction according to pro-rated share of peak capacity or energy usage for either
peak capacity constraints or energy capacity constraints respectively.
Situation
Rule
Comment
Voluntary reduction in
demand by participant in
response to price.
The current bid rules may apply if
MW reduction is greater than
20MW or 10% (provided that this is
greater than 5MW).
(clause 13.17, Part 13)
Alternatively Participant may elect
to use the dispatchable demand
rules if they are implemented.
This scenario is not covered in
scarcity pricing project.
Demand response via
instruction from System
Operator
Part 8 Schedule 8.3 Technical
Code B - Grid Emergencies
System Operator can take a
range of actions including
1. reduce demand (clause
6.1, 6.2)
2. reconfigure grid (clause
clause 6.1 – Insufficient generation
and frequency regulating reserves
clause 6.2 Insufficient transmission
capacity
clause 6.3 Frequency outside of
normal band
clause 6.4 Minimum voltage limit
clause 6.5 Unexpected event
6.1)
3. disconnect demand
(clause 6.1,6.2,6.3, 6.4)
4. any other reasonable
action (clause 6.1,6.2,
6.5)
5. Request generators to
vary offer (clauses 6.1,
6.2)
6. assets owners to restore
assets (clauses 6.2)
Automatic Under
Frequency Load
Shedding
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Part 8 Schedule 8.3, Technical
Code B, clause 7
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Scarcity Pricing Background
Rolling Outages
Emergency Management Policy
This scenario is covered in
scarcity pricing project.
PCC
Emergency Management Policy
This scenario is covered in
scarcity pricing project.
IR Shortfall – insufficient
IR to cover a contingent
event
System Operator Policy Statement
clauses 33.1 – dispatch all
remaining offered IR
This scenario is covered in
scarcity pricing project.
IR shortfall – insufficient
IR plus AUFLS to cover
extended contingent
event
System Operator Policy Statement
clauses 33.1 and 33.2 – dispatch
all remaining offered IR and reduce
demand
This scenario is covered in
scarcity pricing project.
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