Topics Deregulation and Privatization of the Electricity Market

Topics • Deregulation and Privatization of the Electricity Market • Reasons for it • Features of the Electricity Market • Auction Theory and Electricity Market • Uniform vs Discriminatory Auctions • The problem of Interconnections • The Italian Case

Deregulation and Privatization • The 1990 s featured a wave of deregulation and privatization of electricity industries in several Nations: Finland (1997); U. K. and Germany (1998); Sweden (1999); Austria (2001); Spain (2003) … France, Italy and many others (2007). • In Italy this process begins in 1999 (privatization of ENEL) up to 2007 (creation of the free Electricity Market)

Why? Competition in the production and sale has become focal in policy discussion related to electricity (Hunt 2002) and changes in the electricity arrangements would: 1. Best meet the needs of customers with respect to price, choice, quality and security of supply. 2. Enable costs and risks to be reduced and shared efficiently. 3. Provide transparency. 4. Enable demand to be met efficiently.

Why? 5. Respond flexibly to unexpected circumstances. 6. Promote competition in electricity markets, facilitating entry and exit from such markets. 7. Avoid discriminations against particular energy sources. 8. To be compatible with government polices.

Why? The overall objective was that: “trading arrangements should deliver the lowest possible sustainable prices to all customers, for a supply that is reliable in both the short and the long run” (Electricity Pool, U. K. , 1998).

Features of the Market In general sale electricity markets are organized as multi-unit procurement uniform price auctions, run daily by Indipendent System Operators (ISOs). Typically there are two systems: Day. Ahead auctions, run daily for each hour of the following day, and real-time (adjustment) auctions, run every five minutes during the day. Generators participate in these auctions by submitting offer curves consisting of generation levels and energy prices (and other technical constraints).

Features of the Market The ISO collects these offers and combines them with energy bids from load serving entities to construct the aggregate supply and demand curves it uses to clear the market in a (Offer)Cost-Minimizing Way (typically by using an optimization algorithm). Alternatively a Payment cost minimization can be adopted, Luh et al. (2005) show that Payment cost minimization problem returns procurement costs relatively lower than those obtained under (Offer) cost minimization. A complete analysis of these problems in Shunda (2005).

Uniform vs Discriminatory Auctions The Auction mechanism at work in these markets has two components, one related to the method of final payment and one to the allocation of energy contracts among generators. The methods of final payment most considered in literature are: Uniform prices (pay market clearing price) vs Discriminatory Prices (pay the offer price). The British regulatory authorities believed that uniform auctions are more subject to strategic manipulation (following Klemperer opinion). California Power Exchange goes in the opposite directions (according to Kahn, Cramton, Porter and Tabors). It is well known among auction theorists that discriminatory auctions are not generally superior to uniform auctions. In multi unit settings the comparison is even more complex. Other Auction methods such as Vickery auctions, in such markets, have received little attention. BUT…. .

…BUT • A huge literature shows extensive evidence on the existence of generators’ unilateral market power and resultant pricing above marginal cost (Borenstein (2002), Puller (2005), Patrick (2001), Puller (2005), Wolak (2003)…). • Simple auctions, such as uniform or discriminatory auctions, are not in general optimal in terms of productive efficiency (Leutier 2001). • Are more complex auctions methods the right answer?

The Key-Point • The key-point is: without competition in production, expected prices will equal the reserve price (related to the previous regulated price), in this case auctions are unnecessary and costly and also the design of more complex auctions methods (as Ausubel (1998)) for discouraging collusion is useless.

The Market Players • Producers • Suppliers • Traders They are not mutually exclusive, as a result, the producer may also supply electricity to final consumers. The Italian Case…

Market Players MINISTERO ECONOMIA FINANZE TERNA ENEL ENI

Cheap Fonts in Production Activity (percentage)

How production depends on Oil (Percentage) Peso percentuale sulla produzione di energia elettrica complessiva dei derivati del petrolio e del gas naturale

Customers • More than 98% of families has not changed provider. • Only 62% of families knows that electricity market has been deregulated. • What about prices?

Prices Souce: GME; prices of: 24 Sept 2008

Price in EU Electricity Markets (Source: Thomson Reuters)

Interconnections A related (less studied) issue is the regulation of exchange of electricity among countries. It is a significant barrier to efficient electricity market formation. Transmission activity across markets has become increasingly important in all industrial countries. The European Electricity Market looks like a juxtaposition of individual markets rather than an integrated commodity market (Finon 2001). The Florence Forum recommends to use the implicit auction method for managing cross-border congestion. However the “Use it or lose it” principle seems to have been widely adopted. In Italy…the import of electricity is about 70%

Rete di trasmissione nazionale