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Main Principles of Electricity and Capacity Market Functioning

Main Principles of Electricity and Capacity Market Functioning. The Importance of the Electricity Industry and the Interrelation of Markets within the Fuel and Energy Complex. 2. The Importance of the Electricity Industry in the Russian Economy.

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Main Principles of Electricity and Capacity Market Functioning

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  1. Main Principles of Electricity and Capacity Market Functioning

  2. The Importance of the Electricity Industry and the Interrelation of Markets within the Fuel and Energy Complex 2

  3. The Importance of the Electricity Industry in the Russian Economy 0,5% – 1,5%* construction, engineering, agriculture;coke, oil products and nuclear materials production 2,0% – 2,6%* transport and communications;gas, water and steam production and distribution; mining operations 4,9% – 6,1%* chemical industry, metallurgy 17,8%* electricity industry * Electricity cost in the final product 3

  4. Planned Electricity Consumption Europe and Urals Planned electricity consumption is the entire planned volume of customer purchase determined as a result of competitive day-ahead bid selection • Reduction of electricity consumption results from economic slowdown in Russia. • 2009 electricity consumption equals that of 2006 4

  5. Planned Electricity Consumption Siberia Planned electricity consumption is the entire planned volume of customer purchase determined as a result of competitive day-ahead bid selection • Reduction of electricity consumption results from the economic slowdown in Russia. • 2009 electricity consumption equals that of 2006 5

  6. Markets of the Fuel and Energy Complex By 2011,all electricity shall be sold at non-regulated prices, except for electricity sold to the population (at regulated tariffs until 2014) From July 1 till December 31 2009, 50 % of electricity from the FTS balance and consumption volumefor 2007 shall be sold at non-regulated prices Increasing marginal gas prices in order to ensure equal profitability of domestic and external markets by 2011 (domestic market gas price = gas price on the European market less logistics and export duties) 6

  7. Synchronous Liberalization of Electricity and Gas Markets Supplies at non-regulated prices 80% 100% ELECTRICITY 60% 50% 30% 25% 15 % 10 % 5 % European market price 100% 92% 79% GAS 66% 53% 40% 15% 7

  8. The Electricity and Capacity Market Model 8

  9. Market Model: a Two-level System Wholesale Market Retail Market Suppliers:generating companies of the wholesale market, electricity importers Suppliers:energy supply companies andsuppliers of last resort,generating companies of the retail market Buyers:large consumers (total connected capacity of at least 20 MVAand at least 2 MVA in each delivery point cluster), including partial participants (over 85% of planned consumptionpurchased on the retail market), energy supply companies andsuppliers of last resort, electricity exporters Buyers:retail customers, partial participants Electricity and capacity are sold separately Each participant may act both as a seller and a buyer Electricity and capacity may be sold both separately or as a single product (electricityinclusive of capacity) 9

  10. Wholesale Market Model: Entities and Infrastructure Technological Commercial Market infrastructure NP “Market Council” TSA, OJSC CFS, CJSC System Operator Distribution companies Consumers and retail companies Generation Kontsern Energoatom, OJSC Consumers – market entities Market entities RusHydro, OJSC Suppliers of last resort 7 WGCs, 14 TGCs Other generating companies Energy supply companies 10

  11. Wholesale Market Model: Regulation NON-STATE STATE Contract relations Regulatory Connection Agreement (NP “Market Council”) Tariff (FTS of Russia) Antimonopoly (FAMS of Russia) WECM rules (NP “Market Council”) 11

  12. Wholesale Market Areas ■NON-PRICE AREAS (areas with a regulated wholesale market) –Kaliningrad and Arkhangelsk Regions, Komi Republic, the Far East ■■PRICE AREAS (areas with a liberalized wholesale market) – European Russia and Urals + Siberia ■ISOLATED REGIONS 12

  13. Wholesale Market Model: Sectors Capacity Market Electricity Market • Regulated Contracts (RCs) • Electricity and/or capacity sale and purchase contracts between suppliers and buyerswhere the prices are set according to electricity and/or capacity tariffs set by the FTS • Non-regulated Bilateral Contracts (NRBCs) • Electricity sale and purchase contracts between suppliers and buyerswherethe terms and conditions, including prices, are agreed upon by the parties • Day-Ahead Market (DAM) • System of relations within price areas of the wholesale electricity market between wholesale market participants and FGC UES, which involves supply/consumption of electricity in volumes determined based on the results of competitive selection of day-ahead price bids • Balancing Market (BM) • Sector for the trade of deviations from planned volumesof electricity supply determined as a result of competitive selection of price bids for system balancing and (or) determined by actual generation/consumption of electricity based on metering data 13

  14. Wholesale Market Model: Sectors Electricity Market Capacity Market • Regulated Contracts (RCs), including: • Capacity contracts for generating equipment of nuclear and hydro power plants (CBCs) • Sale and Purchase and Agency Contracts • Sales of excessive electricity or capacity by the buyer or purchase of deficient electricity or capacity by the supplier under agency or sale and purchase contracts • Non-regulated Electricity and Capacity Sale and Purchase Contracts (NRECCs), including: • Stock-ExchangeNRECCs • Non-regulated sale and purchase electricity and capacity contracts concluded during trading on the exchange organized according to Russian Federation legislation on commodity exchanges and exchange trade, by a commodity exchange, the rules for exchange trade of which contain a procedure for conclusion of non-regulated electricity and capacity sale and purchase contracts through trading on the exchange and determination of prices in such contracts, and other termsfor arranging stock-exchange auctions that correspond to the requirements of the Agreement on connection to the trading system of the wholesale market • Over-the-CounterNRECCs • Non-regulated electricity and capacity sale and purchase contracts concludedin accordance with theAgreement on connection to the trading system of the wholesale marketor concluded for volumes of generating equipment capacity not included in the forecast balance for 2007 14

  15. Wholesale Market Performance(Price Areas) Electricity Market Turnover, 2009 Capacity Market Turnover, 2009 15

  16. Pricing on the Wholesale Electricity and Capacity Market 16

  17. Regulated Contracts Formation of the buyer’s regulated contracts package Terms of the regulated contracts (prices, volumes, counterparts binding) are defined by the Federal Tariff Service (the FTS ofRussia) and the commercial operator (TSA, OJSC) so that the average price of regulated contracts does not exceed the electricity tariff set by the FTS for the relevant region The share of regulated contracts in the electricity generation/consumption balance approved by the FTS for 2007 is gradually decreasing; by 2011 RCs shall cease to exist 17

  18. Operation of the Competitive Sector of the Wholesale Electricity Market Operation day (X) Trading day (X-1) Payment upon delivery Day X-7 Suppliers Trading results (prices, volumes) Bids Bids Supply Payment UC results DAM (competitive selection) Price bid auction Balancing market Collection of metering data Payment upon delivery UC (unit commitment) Reserve formation Bids Consumption Trading results (prices, volumes) Payments Customers 18

  19. Unit Commitment Procedure Based on indicative price bids (for start-ups and electricity generation) of suppliers for all units and “regime” generating units System Operator conducts a Unit Commitment Procedure (UCP) according to electricity generation cost minimization criteria Generating Equipment at theWECM Units (non-block sections), the state of which in the UC optimization calculation is always predetermined Units (non-block sections) of TPPs, the state of which may be determined based on the results of the UC optimization calculation • NPPs • HPPs • TPPs: units (non-block sections), ICof at least 150 MWh Forced modes State determined based on bids “Regime” generators On/off state is fixedbeforethe optimization calculation Onstate is fixedbeforethe optimization calculation on other grounds (e.g., generation of thermal power, equipment condition) Onstate is fixedbeforethe optimization calculationin order to ensure system reliability On/off state determined based on results of the optimization calculation 19

  20. Day-Ahead Market • The Day-Ahead Market (DAM) is based on a competitive selection (auction) conducted by TSA (OJSC) of price bids of suppliers and buyers with deliveryon the day following the day of the auction • Electricity losses and system constraints are consideredduring competitive selection • Based on DAM results the following are determinedfor each node of the computed model for every hour of the next day: • Plannedhourly consumption • Plannedhourly generation • Equilibrium electricity prices • At the DAMmarginal pricing is used – the price is determined based on the most expensive electricity supply bidsatisfied 20

  21. DAM: Marginal Pricing Price Demand (buyers’ bids) Supply (suppliers’ bids) Equilibrium price Volume Equilibrium volume 21

  22. DAM: Preventing Manipulation • To reduce the risk of price manipulation, the participants are incited to bid competitively – the lowest price bids are satisfied first • Administrative measures aimed at manipulation prevention • State • Corporate procedures for naturally monopolistic entities where the controlling stake belongs to the State • Introducing price regulation for specific market entities • Introducing bidding constraints • Mandatory separation of dominating market entities • Infrastructure organizations • Deprivation of WECM entity status • Terminating admission to the trading system • Applying BM imbalance distribution coefficients for metering and billing violations • Reducing the value of the generating equipment availability factor • Applying penalties 22

  23. DAM: Price Volatility Equilibrium electricity price index dynamics in Siberia (January – October 2009), rub/MWh • The DAM prices are characterized by: • Cyclical fluctuations (daily, weekly, annual) • Price fluctuations caused by unforecastable changes in the demand or supply side • High volatility • The participant risks: • Lower competition as a result of a monopolistic power of a consumer or the generator in some regions • Lower system reliability as a result of planning difficulties On March 29, 2009, against the background of demand reduction, a flow increase over the controlled connection between the Europe and Siberia price areas towards Siberia was observed. A price reduction in the price bids of suppliers was also observed. As a result the auctions accepted the lowest price bids. On June 3, 2009, in Siberia a sharp decline of the equilibrium price index, owing to a decrease of electricity demand, was observed. As a result the low price bids of generating companies were the closing bids. Nonzero prices were established in Omsk and Altai, but in the rest of Siberia, the price was approaching minimum. On September 13, 2009, impacted by the decrease of electricity consumption due to the absence of an electricity purchase bid from a large customer, the equilibrium price index in Siberia decreased. 23

  24. Non-regulated Bilateral Contracts • Non-regulated Bilateral Contractsfor Electricity Sale and Purchase (NRBCs) are concluded between the supplier and the buyer under the terms and conditions agreed by the parties • The NRBCs allow the participants: • to carry out long-term business planning • to fix the electricity purchase/sale prices • to hedge the risks of performing obligations under regulated contracts • to determine the terms and procedure of payments for electricity • Non-regulated contracts allow the participants to reduce financial risks resulting from high volatility of electricity prices on the day-ahead market 24

  25. Balancing Market • The Balancing Market (BM) is designed to cover the deviations of the actual electricity generation and consumption from those planned • At the BM trading is conducted by the System Operator as a competitive selection of the suppliers' bids in conditions of short-term planning of generation and consumption (3 hours ahead) and real-time • At the Balancing Marketmarginal pricing is used with account of losses and system constraints 25

  26. Balancing Market: Competitive Selection Price Consumption growth BM indicator DAM price Volume DAM planned consumption 26

  27. Capacity Market • Competitive Capacity Selection (CCS) for operation the following year: • Is performed by System Operator on the basis of generators’ bids • The bid price is set no higher than the FTS tariff Capacity sales at the tariffs of Regulated Contracts: The share – according to the electricity market liberalization process Non-regulated Bilateral Electricity and Capacity Contracts (NRECCs) Stock-exchange The participants sell/buy standard electricity and capacity contracts at the exchange Over-the-counter To replace the RCs For new generation The remaining capacity is sold by the generators at the CCS bid price 27

  28. Capacity Market: Mechanisms of Determining the Purchase Price The capacity purchase price as a result of the CCS is determined as follows The payment for capacity is conducted as follows 28

  29. Capacity Market: Non-regulated Contracts • Non-regulated Electricity and Capacity Sale and Purchase Contracts (NRECCs) assume simultaneous supply of electricity and capacity • NRECCs are traded on certified stock-exchanges (currently, the MEEX)in the form of contracts standardized by terms, types and volumes of electricity and capacity . • In organized NRECC trade, marginal pricing is used. • Over-the-counter NRECCs are concluded between suppliers and consumers under the terms agreed upon by the parties. • Under agency and sale-and-purchase contracts the following is sold: • excess energyresulting from purchase under RCs (including CBCs), sold at the weighted average RC price • excess energy resulting from purchase under non-regulated contracts, sold at the price equal to the weighted average price of the bids for all selected capacity • Trade in capacity agency and sale-and-purchase contracts is performed through CFS (CJSC) (a subsidiary of Market Council and TSA) 29

  30. Capacity Market: CSCs • Capacity Supply Contracts (CSCs): an obligation of the generator to introduce new capacity with specified characteristics within a set period with guaranteed payment for the commissioned capacity for a specified period • New system of capacity supply contracts has been designed. • These contracts: • provide supply of capacity via generating facilities • are included in investment programs of generating companies • provide payment for such capacity, in general, within 7 years of the facility commissioning date • These contracts provide, among other things,  the mechanism of control over fulfillment of the investment programs, and the responsibility of the parties for failure to fulfill their obligations 30

  31. Capacity Market: Transition to the Target Model Transition Model Long-term Capacity Market • Payment for all existing capacity • No competition between suppliers • No motivation to decrease the costs • The customer pays for excess capacity • Competition between suppliers for payment of capacity– partial payment for capacity • Motivation to reduce costs • Only the capacity needed in the system is paid for – move away from excess capacity • Accurate price signals reflecting sufficiency (deficiency) of capacity in the regions • Separate pricing for two related products • Marginal revenue from the electricity marketdoes not reduce the cost of the supplier’s capacity– overstating the aggregate cost for the customer • Interrelation of the capacity and electricity markets • Motivation to reduce aggregate electricity and capacity costs • Long-term relations • Long-term guarantee of payment for capacity in the future (after its commissioning) • Possibility of bilateral relations • Long-term regional price signals for industrial growth • No long-term relations • No long-term conditions for investments • No long-term signals for the customer 31

  32. Retail Electricity Market 32

  33. Retail Market: Main Principles of Operation • Electricity and capacity purchased by suppliers of last resort and retail companies at the wholesale market are sold to end customers • Each supplier of last resort (SLR) operates in its special area of operation. One area – one SLR • The supplier of last resort concludes a contract with each customer according to the contract form approved by the government • The SLRtranslates the non-regulated wholesale market prices to retail customers: • Sells the volumes purchased under the RCs at a regulated tariff to retail • Sells the volumes purchased at non-regulated prices to the end customers also at non-regulated prices • The population buys electricity from the SLRonly at regulated prices • An energy supply company has the right to conclude a contract with a customer under any terms and conditions, as well asto refuse to conclude a contract 33

  34. Retail Market: Wholesale Market Price Translation Wholesale Market Supply under regulated contracts (tariffs) Liberalized portion Wholesale market non-regulated price Wholesale market regulated price Retail Market Supplier of last resort Energy supply company Population Customers on the retail market 34

  35. Retail Market: Pricing 2009 Retail Price Structure • The main factor influencing the price for the end customer is the cost of electricity and capacity purchased at the wholesale market • Changes of electricity and capacity cost purchased on the wholesale marketmay be due to: • Price changes under the influence of supply and demand • Change of regulated tariffs • Change of the share of liberalized volumes • Change of electricity and/or capacity consumption volumes _____ * regulatedprices 35

  36. Information Disclosure 36

  37. Information Disclosure • Government Order #24 of 21.01.2004 established information disclosure standards • For all entities of the electricity market • Financial (accounting) reporting • Tariffs • For network organizations • Contract terms and conditions • Return on investment (forRAB) • Asset flow • Capital investment • Network losses and grid state • Number of applications for technological connection • For System Operator • Contract terms and conditions • Market simulation model • Electricity quality and electricity supply reliability • Dispatcher orders and reasons for deviation from the planned schedule • Generation and consumption plans (day, month, 1 year, 5 years) • Repair, hydroregime and system constraints forecasts and schedules 37

  38. Information Disclosure • Government Order #24 of 21.01.2004 established information disclosure standards • For generating companies • Hazardous emissions • Hydrologic system use mode and its state (for HPPs) • For the commercial operator • List of wholesale market entities • Terms and conditions of the connection agreement and of participation in wholesale market trading • Membership fee for market participants • Aggregated wholesale market operation results (without detailing transactions of specific participants) • List of system generators • Reports on the results of control over System operator actions • Information disclosure: • via mass-media • via web-sites of disclosing organizations • at the request of a market participant 38

  39. DERIVATIVES MARKET DERIVATIVES MARKET IN POWER SECTOR

  40. INSTRUMENTS • «MEEX» has built up a work group from energy companies representatives, Russian and foreign brokers, «RTS» clearing center professionals, that analyzed foreign experience of electric power trades, technology of commodity assets trading in Russian exchanges. • Contract specification is developed. Month futures contract is selected, based on the average price of electric power index in Center and Ural hubs of the Price zone 1 and Kuzbass hub of the Price zone 2 during certain delivery hours (base-load hoursand peak hours). • The trading technology is similar to the EEX exchange technology that makes the trading mechanism multipurpose for the Russian and foreign participants.

  41. TRADE ORGANIZATION BROKER client client client client client client

  42. PRICE FORMATION A METHOD OF PRICE FORMATION – CONTINIOUS TWO WAY AUCTION SUBMISSION OF ORDERS TO THE EXCHANGE SYSTEM. ANONIMOUS ORDERS MARKET PRICE. FIXED PRICE. ADDRESS LIMIT ORDERS: FIXED PRICE. TRADING HOURS 10:30-23:50 (MOSCOW TIME) CLEARING – SYSTEM OF THE PARTIES’ OBLIGATIONS DEFINITION UNDER TRANSACTIONS: CLEARING TIME: 14-00, 18-45. VARIATION MARGIN RECALCULATION. SETTLEMENT PRICE DETERMINATION (TWICE A DAY).

  43. Thank you for your attention! 39

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