Market design and market power in wholesale electricy

Market design and market power in wholesale electricy markets Guido Cervigni IEFE-Bocconi University, Milan CEEM – Summer School on Economics of electricity markets Ghent University, Faculty of Economics and Business Administration 1 September 2015

Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Product standardisation: time dimension 0 1/2 1 Time 1/2 0 1 1/2 1 -10 - 10 MW 0 -20 MW § During the same hour all consumers withdraw 10 MWh § Should they be buying the same product?

Product standardisation: geographic dimension Zone 1 Maximum transfer capacity 1 ->2 = 200 MW Zone 2 Supply: unlimited @30 €/MWh unlimited@50€/MWh Demand: 300 MW @any price 250 MW @ any price § Should a consumer in Zone 1 and a consumer in Zone 2 with identical consumption buy the same product?

Product standardisation: Remark - 1 § In the «real time» , injections must match withdrawals MW Injections by seller of 10 MWh in hour t 10 0 1/2 1 Time Withdrawals by buyer of 10 MWh in hour t -20 Balance ( «system» position) in hour t Half-hour with net surplus (SO sells) Half-hour with net deficit (SO buys)

Product standardisation: Remark - 2 § In the real time network constraints must be met Zone 1 Supply: Maximum transfer capacity 1 ->2 = 200 MW Zone 2 unlimited @30 €/MWh unlimited@50€/MWh 300 MW @any price 250 MW @ any price Demand: Market equilibrium sales with standard product: 550 MW@30 €/MWh Power flow 1 ->2 @ market equilibrium: 0 MW 250 MW (above transfer capacity) SO actions to address network constraint: Sell 50 MW in zone 1 Buy 50 MW in zone 2

Product standardisation: wrap-up § Some product standardisation is necessary to make electricity trading possible § Product standardisation requires socialisation of some costs § We are still left with many products to trade

Agenda 1. Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Injections and withdrawal commitments - 1 § Normal products: o o Seller does not deliver … buyer does not consume Consumer wants more … additional purchase Seller overdelivers … extra is returned or disposed of Consumer does not receive …goods go back or disposed § Consequences of any over/under delivery issues are borne by (only) the parties to the transaction

Injections and withdrawal commitments - 2 § Electricity is different: over/under delivery – if not addressed – causes a black-out, affecting all consumers and producers § How is this feature addressed? o o The SO takes care of system balance at all times Injections and withdrawal commitments are enforced financially

Example MWh 50 Market participant G 50 MWh 25 MWh Imbalance G (bought by G from SO) 0 MWh Net physical position at gate closure (Program) 50 Real time actual net injections 0 Market participant C 0 -50 MWh -33 MWh 17 MWh -50 Imbalance C (sold by C to SO) System Imbalance +17 MWh 8 MWh -25 MWh Bought by SO in the Balancing market

Balancing market, balancing perimeter and imbalance charges § The SO procures/disposes of any deficit/surplus of electricity in the «balancing market» § Alternative settlement systems differ in: o o The balancing perimeter Imbalance prices

Delivery and settlement: wrap-up § Electricity delivery commitments can be enforced only financially § An imbalance is a difference between an injection/withdrawal commitment (the program) and actual injection/withdrawals § Issues with standardisation of imbalance prices

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o o Market power in wholesale electricity market Market power mitigation mechanisms

Electricity is traded on multiple timeframes Electricity market transactions Long term transactions Gate closure 1 day before delivery Days before delivery Day-ahead market Real time Intraday market Time System Operations Reserve procurement, Congestion management, Balancing • From multi-year to week ahead • Basaload/peak products • Decentralised trading and organised venues • Daily • Hourly products • Non discriminatory auctions • Implicit allocation of transmission rights • Power exchanges • Daily • Hourly products • Non discriminatory auctions or continuous trading • Power exchanges Imbalance settlement • SO is counterparty to all transactions • Different arrangements across Europe

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

The standard approach to assessing competition applied to the wholesale electricity generation Industry structure Relevant Market Degree of competition

Non storability & network contraints: a different competitive assessment in each hour? 14% 17% 14% 29% 17% 57% 30% of the time 70% 10% of the time 60% of the time

Does market power depend on market shares? €/MWh Profit P. Mkt Pwr Profit P. Comp MW A small generators woith much market power MW

Does market power depend on market shares? €/MWh P. Comp P. Mkt Pwr MW High concentration with no market power MW

Market power assessment based on pivotality Bid curve Ppivot § A possible index of market power in electricity generation is the ability to corner the market - or Pivotality profits § Generator i is Pivotal in hour t, in an hour, if in that hour: Market_demand– Capacity_but_i’s > 0 ↓ Assess market power based on the Number of hours in which the generator is Pivotal Demand § Market power: ability and incentive to set prices higher than the competitive level Variable cost Pcomp Capacity of competitors and imports Generator’s capacity Generator’s pivotal capacity

Adjusted Pivotality indicators Pivotal Capacity (MW) - Ability to cross the market Ability & Incentive to exercise market power Inflexible output = 0 Incentive to cross the market Hedged load = 0 Pivotal capacity (MW) - Incentives § Hourly pivotality adjustments § § Ability measure: Pivotal Capacity – Inflexible generators Incentive measure: Pivotal capacity – Hedged load

Examples Pivotal Capacity (MW) - Ability Inflexible output = 0 MW Hedged load = 0 Pivotal capacity (MW) - Incentives Many hours with incentives and ability to corner the market Few hours with incentives and ability to corner the market ↓ ↓ Market power issues No market power issues

Agenda 1. Wholesale electricity markets o o o Product standardisation Delivery and the settlement system Electricity trading 2. Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

Market power mitigation: capacity divestiture - 1 €/MWh D post div D pre div MC post div MC pre div Source: Federico and Lopez 2009 Divested quantity MW § Divestiture lowers and flattens the firm’s residual demand …

Market power mitigation: capacity divestiture - 2 €/MWh P pre div P post div MR pre div MW § Reducing the profit maximising price … MW

Market power mitigation: long term contracting €/MWh P pre contr MC MC P post contr D D MR pre contr MW Contracted quantity MR post contr MW § The long-term contract makes part of the firm’s revenues independent of the spot market price

Comparison § Advantages of contracting over divestitures: o Politically easier o No impact on scale economies § Drawbacks o Incentives to sustain spot prices above profit max level to support future long term negotiations o Less effective (given the volume)

Market power mitigation: price cap €/MWh Demand Supply net of withholdng Supply €/MWh Demand Supply Price increase Withheld capacity MWh § With-holding as the largest impact on prices when the system is tight § An overall price cap (below VOLL) mitigates market power but … § Results in «missing money»

Market power mitigation: bid mitigation § The generator’s bid in the spot market is constrained every time the generator’s is assessed to enjoy «great» market power Phase 1: Screening Phase 2: Mitigation Example: (PJM) any three generators pivotal to solve a constraint in a 15 min period? Cost-based bids enforced on the three jointly pivotal generators

• You may want to take a look at: The economics of electricity markets, Pippo Ranci and Guido Cervigni Eds, Elgar, 2013 • I can be reached at: guido. cervigni@gmail. com