Main Lessons from the Electricity Markets of England & Wales, Norway and Spain

1. 27 June 2002 – Graham Shuttleworth, Director, NERA Main Lessons from the Electricity Markets of England & Wales, Norway and Spain

2. The study of England & Wales, Norway and Spain shows some features are inevitable, some not • Our study considers some common suggestions: • “No compulsory pool” • “Allow bilateral contracts” • “Pay generators the prices they bid” • “Abolish capacity payments” • “Create liquid markets” • We found that some of these suggestions are impossible to implement

3. The study covers three electricity sectors with different characteristics

4. In each country, a central market covers real-time trades, but not necessarily day-ahead trades

5. Every competitive electricity market must have a compulsory mechanism for pricing imbalances Network 110 MWh 120 MWh 120 MWh 10 MWh Market Operator 10 MWh

6. Some markets settle imbalances net of contract sales and purchases (a “net pool”)

7. A “gross” pool allows bilateral contracts, but treats all physical flows as if they were imbalances

8. Both “gross” and “net” pools allow bilateral contracts, but must have a compulsory system for settling imbalances.

9. Market Clearing Price 1 2 3 4 5 6 7 8 In Norway and Spain (and E&W until 2001), the central market sets market-clearing prices Price €/MWh

10. Pay-as-Bid Price(s) 1 2 3 4 5 6 7 8 “Pay-as-bid” markets do not produce systematically lower prices (except as mistakes) Price €/MWh

11. Reward for surplus is very low Penalty for deficit is very high The dual pricing of imbalances (E&W from 2001) penalises new entrants (generators and retailers) Volume (MWh) Contract sales Hours NB: England and Wales = thermal system, no day-ahead central despatch Norway – hydro system; Spain – Day-ahead market

12. In competitive markets, all prices settle around the “market-clearing level” Setting dual prices for imbalances harms small companies = new entrants

13. Generators must recover the cost of capacity in market prices or by other means (1 – Hydro)

14. Illustrative smoothing effect of a “LOLP.VOLL” system Generators must recover the cost of capacity in market prices or by other means (2 - thermal)

15. Electricity market designers can choose how to recover the costs of capacity: • Price spikes • Capacity payments • Capacity (contract) obligations

16. Prices in Ore/kWh / Norway “splits” its market into “areas”, each with a different price 10 11 12 13 13 14 15 16 100 MW Area Price = 12 Area Price = 15 @ 3

17. .. Prices in Ore/kWh @15 @13 @2 Holding Account Most markets (including England & Wales, Spain) have one price with “counter-trades” • NB: Spain uses the market price (14) for the counter-sale (instead of 13), but this policy has caused generators to distort offer prices and despatch 10 11 12 13 13 14 15 16 Price = 14 Counter-trade

18. Varying prices by region is more efficient in the short term, but it requires the tolerance of local politicians and investors

19. Some elements of electricity markets are inevitable, some are matters of choice • Inevitable elements: • A compulsory mechanism for pricing imbalances • Use of bilateral contracts to hedge prices • All prices tend towards the market-clearing level • Matters of choice • Centralise day-ahead markets for security of supply? • Set one market price for imbalances, or two penalties? • Pay for capacity in price spikes or more predictably? • Split the market or arrange counter-trades?