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Wholesale Electricity Markets: Design and Market Power

This article explores the design of wholesale electricity markets, including product standardization, delivery and settlement systems, electricity trading, competition policy, market power, and mitigation mechanisms.

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Wholesale Electricity Markets: Design and Market Power

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  1. Market design and market power in wholesaleelectricymarketsGuido CervigniIEFE-Bocconi University, Milan CEEM – Summer School on Economics of electricitymarketsGhentUniversity, Faculty of Economics and Business Administration 1 September 2015

  2. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in wholesaleelectricity market • Market powermitigationmechanisms

  3. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in wholesaleelectricity market • Market powermitigationmechanisms

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

  5. Product standardisation: geographic dimension Maximum transfer capacity 1->2 = 200 MW Zone 2 Zone 1 Supply: unlimited @30 €/MWhunlimited@50€/MWh Demand: 300 MW @anyprice250 MW @ anyprice • Should a consumer in Zone 1 and a consumer in Zone 2 with identicalconsumptionbuy the sameproduct?

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

  7. Product standardisation: Remark - 2 • In the real time network constraints must be met Maximum transfer capacity 1->2 = 200 MW Zone 2 Zone 1 Supply: unlimited @30 €/MWhunlimited@50€/MWh Demand: 300 MW @anyprice250 MW @ anyprice Market equilibrium sales with standard product: 550 MW@30 €/MWh 0 MW Power flow 1->2 @ market equilibrium:250 MW (above transfer capacity) SO actions to address network constraint: Sell 50 MW in zone 1 Buy 50 MW in zone 2

  8. Product standardisation: wrap-up • Some productstandardisationisnecessary to makeelectricity trading possible • Product standardisationrequiressocialisation of some costs • We are stillleft with manyproducts to trade

  9. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in wholesaleelectricity market • Market powermitigationmechanisms

  10. Injections and withdrawal commitments - 1 • Normalproducts: • Seller doesnotdeliver … buyer doesnotconsume • Consumer wants more … additionalpurchase • Seller overdelivers … extra isreturned or disposed of • Consumer doesnotreceive …goods go back or disposed • Consequences of any over/under delivery issues are borne by (only) the parties to the transaction

  11. Injections and withdrawal commitments - 2 • Electricityisdifferent: over/under delivery – ifnotaddressed – causes a black-out, affectingall consumers and producers • How isthisfeatureaddressed? • The SO takes care of system balance atalltimes • Injections and withdrawalcommitments are enforcedfinancially

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

  13. Balancing market, balancing perimeter and imbalance charges • The SO procures/disposes of any deficit/surplus of electricity in the «balancing market» • Alternative settlementsystemsdiffer in: • The balancingperimeter • Imbalanceprices

  14. Delivery and settlement: wrap-up • Electricity delivery commitments can be enforcedonlyfinancially • An imbalanceis a differencebetween an injection/withdrawalcommitment (the program) and actualinjection/withdrawals • Issues with standardisation of imbalanceprices

  15. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in wholesaleelectricity market • Market powermitigationmechanisms

  16. Electricity is traded on multiple timeframes Electricity market transactions Gate closure Real time 1 daybefore delivery Days before delivery Long termtransactions Day-ahead market Intraday market System Operations Reserveprocurement, Congestion management, Balancing Imbalance settlement Time • SO iscounterparty to alltransactions • Differentarrangementsacross Europe • Daily • Hourlyproducts • Non discriminatoryauctions or continuous trading • Powerexchanges • Daily • Hourlyproducts • Non discriminatoryauctions • Implicitallocation of transmissionrights • Powerexchanges • From multi-year to week ahead • Basaload/peakproducts • Decentralised trading and organisedvenues

  17. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in the wholesaleelectricity market • Market powermitigationmechanisms

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

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

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

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

  22. Market power assessment based on pivotality Bid curve • Market power: ability and incentive to set prices higher than the competitive level • A possible index of market power in electricity generation is the ability to corner the market - or Pivotality • 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 Ppivot Pivotality profits Demand Variable cost Pcomp Generator’s capacity Capacity of competitors and imports Generator’s pivotal capacity

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

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

  25. Agenda • Wholesaleelectricitymarkets • Product standardisation • Delivery and the settlementsystem • Electricity trading • Competition policy in wholesalepowermarkets • Market power in the wholesaleelectricity market • Market powermitigationmechanisms

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

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

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

  29. Comparison • Advantages of contracting over divestitures: • Politicallyeasier • No impact on scale economies • Drawbacks • Incentives to sustain spot pricesabove profit maxlevel to support future long termnegotiations • Lesseffective (given the volume)

  30. Market power mitigation: price cap €/MWh €/MWh Supply net of withholdng Demand Supply Supply Demand Price increase Price increase Withheldcapacity Withheldcapacity MWh 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»

  31. 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 2: Mitigation Cost-basedbidsenforced on the threejointlypivotalgenerators Phase 1: Screening Example: (PJM) anythreegeneratorspivotal to solve a constraint in a 15 minperiod?

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

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