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Colombian Firm Energy Market: Discussion and Simulation

Colombian Firm Energy Market: Discussion and Simulation. Peter Cramton (joint with Steven Stoft and Jeffrey West) 9 August 2006. Outline. Discussion of issues Simulation of market Purpose Model 1 Historical prices Simulated units Outline of Model 2 Historical prices and output

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Colombian Firm Energy Market: Discussion and Simulation

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  1. Colombian Firm Energy Market: Discussion and Simulation Peter Cramton(joint with Steven Stoft and Jeffrey West) 9 August 2006

  2. Outline • Discussion of issues • Simulation of market • Purpose • Model 1 • Historical prices • Simulated units • Outline of Model 2 • Historical prices and output • Actual units • Outline of Model 3 • Full simulation of auction and investment decision • Conclusion

  3. Issues

  4. Issues • Reducing risk in early auction years • Further protection from insufficient competition • Long lead-time projects • Why not have a higher strike price? • Repowering bids

  5. Reducing risk in early years • Early years of auction • Ceiling and floor on firm energy payment to existing suppliers • Spread between ceiling and floor expand each year • Spread starts at 0 (transition years) • Increases to • Ceiling = 2 CONE • Floor = .5 CONE

  6. Insufficient competition rule • Add additional requirement to assure competition from non-dominant players • At qualification, quantity of new projects from small players (less than 15% firm-energy market share) > 50% of required new firm energy • Otherwise insufficient competition: • Auction held • New entry paid clearing price • Existing capacity paid 1.1 CONE

  7. Long lead-time projects • 4-year planning period may be too short for large hydro projects (6-8 years to build) • Allow large hydro projects to lock in auction price from 4-year ahead auction seven years (or less) ahead • Large hydro project is price taker • Decides after auction a fraction of its firm energy to lock in at 4-year ahead auction price • Total quantity of firm energy in years > 4 that load purchases is limited by a percent of new firm energy required in that year based on planning projections: Years ahead: 7 6 5 Percent limit: 40 50 60

  8. Strike price • Why not have a very high strike price?(US$250 or more) • Benefits of call option are largely lost • Load hedge • Mitigation of market power in spot energy market • No reason to set strike price higher than marginal cost of an expensive thermal unit

  9. Repowering bids • Easily accommodated in auction • Two types: • Quick switchovers (down time less than 1 year) • Repower bid is a new entry bid and a conditional retirement • Extended down time (more than 1 year) • Retirement followed by new entry bid 1 or more years later

  10. Simulation

  11. Purpose

  12. Purpose • Assess supplier risk • Consider variations of market design • Evaluate alternative auction parameters

  13. Model 1

  14. Model 1Historical prices, simulated units • Sample: October 1995 through May 2006 • Scarcity hours: spot price > strike price • One long dry period: thirteen months • 30 Mar 1997 to 21 Apr 1998 • One short period of high prices(start of market) • 21 Nov 1995 to 24 Dec 1995

  15. Scarcity hours by year

  16. Scarcity hours by month and year Almost every hour is a scarcity hour in long dry periods.

  17. Thermal percent of load Thermal share of load much higher in dry periods.Hydro share is still large in long dry periods.

  18. Model 1: Thermal unit • Random time until failure • Random time to repair • Both exponentially distributed • Long-run availability: 70% and 95% • Mean time to repair: 10 hours and 40 hours • 1000 simulations over entire time period • Calculate distribution of net firm energy payment

  19. Firm energy payment • All amounts in January 2006 US dollars • Auction not modeled so assume payment • Firm energy payment = $10.86/MWh • Should be $13.045 • Exact value not relevant

  20. Net firm energy payment • Net firm energy payment = Firm energy payment + reward for over performance− penalty for under performance • In hours where spot price > strike price,Reward or penalty = (Qactual – Qobligation)(Pspot – Pstrike) • Qobligation = supplier’s share of load

  21. Energy rents Call option (FEM) Peak energy rent Strike price Energy rent Forward energy contract Unit’s marginal cost Unit does not operate $0

  22. Model 1 results: thermal • Net firm energy payment roughly constant • Some variation in dry periods • Standard deviation is small compared to mean • Variation greatest for unreliable units with long mean repair times • Slight reduction in dry periods (about 10%) • Thermals under perform on average • Over perform in low-load conditions • Under perform in high-load conditions • Small positive correlation between price and load

  23. Alternative obligation:Thermal constant • Idea: Make obligation more consistent with unit’s actual dispatch • Give thermal a constant obligation during scarcity hours (obligation = LR availability) • Hydro follows residual demand(load minus thermal obligation) • Can still treat as one product • Load following is not scare • Service is priced at zero in competitive market

  24. Model 1: Hydro unit • Actual quantity of firm energy in dry period is a random variable (normal distribution) • Unit sells its mean firm energy in dry period (mean availability = 30% or 50%) • Actual firm energy has standard deviation(sd = 10% or 15%) • Note: Probably too high. Will rerun with empirically fitted distribution from hydrology data from 1950s.

  25. Thermal-constant alternative • No impact on risk • Thermal: Higher mean in dry period • Hydro: Lower mean in dry period • Obligation better matches actual dispatch • Units enter spot market with balanced position • No incentive to exercise market power • With load-following approach: • Hydro increases slope of supply curve (increasing price in high-load hours) • Thermal bids higher (increasing low-load price)

  26. Model 2

  27. Model 2Historical prices, output; Actual units • Assume each unit sells its firm energy certification(either reference or maximum for hydro) • Calculate net firm energy payment for each unit in each hour • Aggregate over month • Aggregate over year • Aggregate over company’s portfolio • Provides some insight on supplier risk

  28. Model 3

  29. Model 3Full simulation of auction and investment • Can ask new questions • How does acquired firm energy differ from firm energy target? • What is the impact of increasing the slope of the demand curve around the target? • Stationary model • Three project types: baseload, peaker, hydro • Baseload and peaker: Capacity, FC, VC • Hydro: Capacity, FC, Firm Energy

  30. Conclusion

  31. Conclusion • Call option reduces market risk • Load is hedged from high spot prices • Hedge is not too costly for suppliers to offer • Physical asset covers obligation • Call option reduces supplier risk • Get nearly constant payment, rather than highly variable peak energy rents • Call option improves spot market • Mitigates market power problem during scarcity • Better spot market improves forward energy market • Spot energy prices are more stable and predictable • Thermal-constant obligation is better than load-following obligation

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