economic markets for power

8/12/2019 Economic Markets for power

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RDT SD 126

ESD 126

ESD 126 Economic Markets forESD 126 Economic Markets forPowerPower

E


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RDT SD 126

ESD 126

Characteristics of ElectricCharacteristics of ElectricDemandDemand

E


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March 5, 2001 RDT ESD 126

ESD 126Electricity Demand inElectricity Demand in

HokkaidoHokkaido

FY '75 '80 '85 '90 '95 '02 '07FY '75 '80 '85 '90 '95 '02 '07 '12'12

11.7 16.3 17.6 20.5 24.4 29.2 31.511.7 16.3 17.6 20.5 24.4 29.2 31.5 33.933.9

%1 48 46 39 33 29 28 27%1 48 46 39 33 29 28 27 2626

%2 52 54 61 67 71 72 73%2 52 54 61 67 71 72 73 7474 ! !! !

OUTLOOKOUTLOOK ------------!!----------------!!

%1 = Industrial use %%1 = Industrial use %

%2 = Residential and commercial use %%2 = Residential and commercial use %

Estimated demand from 1975Estimated demand from 1975--20092009

Courtesy of Hokkaido Electric Power Co.,Inc; Used with Permission.


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RDT SD 126

ESD 126

Power System EconomicsPower System Economicsand Electric Marketsand Electric Markets

E


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RDT SD 126

ESD 126

Competitive ConditionsCompetitive Conditions

Price

Quantity

ConsumerSurplus

ProducerSurplus

Q*

P*

Supply

Demand

E


7/42

RDT SD 126

ESD 126

{

Conditions under TaxationConditions under Taxation

Price

Quantity

ConsumerSurplus

Producer

Surplus

Q*

P

Supply

Demand

GovernmentRevenues

Societal

Loss

Tax

Q

E


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RDT SD 126

ESD 126

Profit Maximizing FirmProfit Maximizing Firm

Price

Quantity

P*

Supplier is a

Price TakerP = D = MR

E


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RDT SD 126

ESD 126

Monopoly PricingMonopoly Pricing

Objective is to capture benefits of economies ofObjective is to capture benefits of economies ofscale and at the same time providing thosescale and at the same time providing thosebenefits to customers by charging as close tobenefits to customers by charging as close tomarginal cost as possible.marginal cost as possible.

Given that Marginal Cost < Average CostGiven that Marginal Cost < Average Costalternative pricing structures are usedalternative pricing structures are used Ramsey, or second best pricing

Provide form of marginal cost pricing while allowing firmsto recover costs

E


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RDT SD 126

ESD 126

Monopoly PricingMonopoly Pricing

Price

Quantity

Pm

Qm

Monopolist Restricts Outputto Achieve Greater Profits

(Monopoly Rent)

MC

MR D

Marginal Revenue falls fasterthan price as output increases

PC

QC

AddedConsumer Surp.

MonopolyRent

Marginal Costs fall fasterthan average costs thus if marginalcosts are used as price, firm looses money

E


11/42

RDT SD 126

ESD 126

Pricing StructuresPricing Structures

Short Run Marginal Cost (SRMC)Short Run Marginal Cost (SRMC) In general under recovers because MC < AC

Long Run Marginal Cost (LRMC)Long Run Marginal Cost (LRMC)

Average Cost PricingAverage Cost Pricing

Ramsey PricingRamsey Pricing Charge customers a price that is inversely proportional to

their elasticity of demand

Time of use (TOU) Real Time Pricing (RTP)

E


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RDT SD 126

ESD 126

Electric MarketsElectric Markets

MW

$

SupplyDemand

E


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RDT SD 126

ESD 126

0

20

40

60

80

100

120

Cumulative Hours

Mills /kWh

87601

Cost Duration Curve:

Sorted by Marginal Cost

E


14/42

RDT SD 126

ESD 126

Individual Unit EconomicsIndividual Unit Economics

0 8760

MarginalCost

p/kWh

Unit A

Unit B

Return on Capital is difference betweenUnit Marginal Cost and System MarginalCost on a Unit by Unit basis

System Marginal Cost

E


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RDT SD 126

ESD 126

What is a Market?What is a Market?

Rules for the ideal market:Rules for the ideal market:

A Homogeneous product Buyers and sellers can find one another

Perfect information is available

Entry and exit is free

Vocabulary of the imperfect marketVocabulary of the imperfect market Market power

Imperfect measure of the imperfect market = HHI

In general:In general: A place where an independent buyer and an

independent seller can exchange goods at an agreedupon PRICE

The Key:The Key:E

PRICE not COSTPRICE not COST


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RDT SD 126

ESD 126

PlayersPlayers

GeneratorsGenerators

TransmittersTransmitters

DistributorsDistributors

System Operator(s)System Operator(s) MarketsMarkets

BrokersBrokers

ConsumersConsumers

E


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RDT SD 126

ESD 126Players Roles:Players Roles:

GeneratorsGenerators

StrategiesStrategies Multiple facilities

Geographic dispersion Same fuel, same type units

Geographic contiguity Diverse fuel, diverse units

Single facility Niche supplier

Peaking ?

E


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RDT SD 126

ESD 126Players Roles:Players Roles:

Marketers / BrokersMarketers / Brokers

Market Maker (Grease)Market Maker (Grease) Identify spreads

Buy Low

Sell High

Reduce risk to buyers and sellers Buy forward to reduce producer risk and/or assure market

for future capacity

Sell forward to reduce (eliminate) price risk to consumer

Fuel Swap Gas for Electricity

Tolling

Brokers: Match Maker onlyBrokers: Match Maker onlyE


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RDT SD 126

ESD 126Products in the ElectricProducts in the Electric

MarketMarket

Capacity (short ===> long term)Capacity (short ===> long term)

Energy (time and location specific)Energy (time and location specific) Transportation (Transmission)Transportation (Transmission)

Ancillary ServicesAncillary Services

Loss Compensation

Constraint Mitigation

Spinning Reserves / Energy Imbalances

VAR Support

Black Start

System Protection

Energy ServicesEnergy Services

Cost packages

Value packages

The MCI and Sprint of Electricity

E


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RDT SD 126

ESD 126Products: Energy andProducts: Energy and

CapacityCapacity

EnergyEnergy

CapacityCapacity Installed (Long Term)

Operable (Short Term)

Reserve

SeparabilitySeparability and Timing are Critical Issuesand Timing are Critical Issues Multiple Products

Short time periods for trading and clearing Minimize the role of the ISO in the market

E


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RDT SD 126

ESD 126

Prices (Costs)Prices (Costs)

For Energy and CapacityFor Energy and Capacity Bilateral Market Based

Swaps (contracts for differences)

Spot Market Based

Ancillary ServicesAncillary Services ? Regulation because of localized monopoly conditions

Independent System Operator

Call Contracts Reservation

Strike

E


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RDT SD 126

ESD 126Markets and MarketMarkets and Market

InstrumentsInstruments Forward (Futures) MarketsForward (Futures) Markets

Price lock-in Information for future investments

Referent to Spot Market

Expectation of change

Spot MarketsSpot Markets High variability / uncertainty

Ancillary Services MarketAncillary Services Market Operating requirements

Clearing MarketsClearing Markets After the fact trading by buyers and suppliers

E


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RDT SD 126

ESD 126Markets and MarketMarkets and Market

InstrumentsInstruments

Forward (Futures) MarketsForward (Futures) Markets

Price lock-in Information for future investments

Referent to Spot Market

Expectation of change

Spot MarketsSpot Markets High variability / uncertainty

Ancillary Services MarketAncillary Services Market Operating requirements

Clearing MarketsClearing Markets After the fact trading by buyers and suppliers

E


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RDT SD 126

ESD 126Prices in the ElectricPrices in the Electric

Market: FunctionsMarket: Functions

Provides signals to buyersProvides signals to buyers Operations: how much to demand given value of end

product

Investment:

Fuels Efficiency

Provides signals to suppliersProvides signals to suppliers

Operations: Investment: when, what kind, and where

E

trade-off between

how much, when and where


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RDT SD 126

ESD 126Price Discovery MechanismsPrice Discovery Mechanisms

in the Electric Marketin the Electric Market

Regulated requirementRegulated requirement (Avoided Costs) PURPA in the US

Required bidding through regulated entityRequired bidding through regulated entity Mandatory Pool as in the UK

Coordinated BiddingCoordinated Bidding Voluntary PoolCo (Transactions may go around the

pool)

NordPool ? Open marketOpen market

Bilateral Contracts

E


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RDT SD 126

ESD 126How is price discovered inHow is price discovered in

a Competitive Market?a Competitive Market?

Supermarket and Auto MileSupermarket and Auto Mile

Industry knowledge / Word of MouthIndustry knowledge / Word of Mouth The Natural Gas Model

Henry Hub plus basis points

Brokers and MarketersBrokers and Marketers For complex markets / products

When information and contact failures occur

Electronic Bulletin Board (EBB)Electronic Bulletin Board (EBB)

E


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RDT SD 126

ESD 126Information Required byInformation Required by

the buyerthe buyer

Define the product neededDefine the product needed amount

delivery point

timing

reliability Prices of delivered energy available in the marketPrices of delivered energy available in the market

Who will sell (marketers and/or primary suppliers)Who will sell (marketers and/or primary suppliers)

Conditions of the offers to sellConditions of the offers to sell

Credibility of the suppliersCredibility of the suppliers

E


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RDT SD 126

ESD 126Information Required byInformation Required by

the Marketerthe Marketer

TheirTheir sources and conditions of supplysources and conditions of supply

Their costs of energyTheir costs of energy

Their costs of transmission (and distribution)Their costs of transmission (and distribution)

Their ability to reliably deliverTheir ability to reliably deliver Hedged in energy and or $

E


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RDT SD 126

ESD 126Contract is written againstContract is written against

specific terms:specific terms:

Cost of EnergyCost of Energy

Cost of TransmissionCost of Transmission

QuantityQuantity

DurationDuration

ReliabilityReliability

Delivery pointsDelivery points

ContingenciesContingencies

E


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RDT SD 126

ESD 126What institutions and / orWhat institutions and / or

functions are necessary?functions are necessary?

ISOISO Balancing

Responsible only for ISOs activities

BillingBilling handled on the basis of individual players.

Significant opportunity for additional specialization in themarket -- firms established to provide metering and billingservices as well as firms to do the actually billing

E


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RDT SD 126

ESD 126

SummarySummary

Financial Markets CriticalFinancial Markets Critical

Restructuring will bring about:Restructuring will bring about: Winners

Losers

New entities will emergeNew entities will emerge

New financial instruments will emergeNew financial instruments will emerge

New physical and service products will emergeNew physical and service products will emerge

E


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RDT SD 126

ESD 126What are the markets that willWhat are the markets that will

develop and what will bedevelop and what will besold?sold? Spot MarketSpot Market

EnergyAncillary Services?

Futures MarketFutures Market

Energy Capacity?

Reliability MarketReliability Market

Capacity Installed Operable

Reserve

Ancillary Services

}}}

Must be Closely

Related in theMarket

E


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RDT SD 126

ESD 126

SRMCSRMC

Operating Cost (Variable Cost) BasedOperating Cost (Variable Cost) Based Fuel, O&M ...

Spot Price / PIP or POPSpot Price / PIP or POP

Economically efficient operating rulesEconomically efficient operating rules

Best when operating costs dominateBest when operating costs dominate Electricity

E


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RDT SD 126

ESD 126

Hours

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

1

3

5

7

9

11

13

15

17

19

21

23

1

3

5

7

9

11

13

15

17

19

21

23

System Lambda

Mills /kWh

Two Days in January, 1993Hourly Marginal Costs

E


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RDT SD 126

ESD 126

0

20

40

60

80

100

120

Cumulative Hours

Mills /kWh

87601

Cost Duration Curve: Sorted by

Marginal Cost

E


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RDT SD 126

ESD 126Ramsey version of SRMCRamsey version of SRMC

Rate: RTP (US) or ...Rate: RTP (US) or ...MCMCGENGEN(t)(t) System Lambda (t) or SystemSystem Lambda (t) or System

Marginal CostsMarginal Costs++

Marginal Generation and Maintenance Cost (t)Marginal Generation and Maintenance Cost (t)

++

Marginal Cost of Reserves and Contingencies (t)Marginal Cost of Reserves and Contingencies (t)

++

Marginal Shortage Costs(t) (VOLL/LOLP or otherMarginal Shortage Costs(t) (VOLL/LOLP or other

approximation method)approximation method)

++

Revenue Recovery Adjustment (US)Revenue Recovery Adjustment (US)

E

==


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RDT SD 126

ESD 126

Individual Unit EconomicsIndividual Unit Economics

0 8760

MarginalCost

p/kWh

Unit A

Unit B

Return on Capital is difference betweenUnit Marginal Cost and System MarginalCost on a Unit by Unit basis

System Marginal Cost

E


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RDT SD 126

ESD 126

Revenue RecoveryRevenue Recovery

Objective: to match the financial calculation ofObjective: to match the financial calculation of

required revenues to the economic earnings ofrequired revenues to the economic earnings ofmarginal costsmarginal costs In general the earnings from MC < AC

In theory, when you include Capacity Shortage Costs,and are in equilibrium, sufficient revenue will begenerated with SRMC pricing.

Methods of recovery for difference between MC and AC

Adder (per kWh) Lump Sum (connection charge)

Multiplier (per kWh)

E


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RDT SD 126

ESD 126

LRMCLRMC

Forward looking to the nextForward looking to the next investmentinvestment

Includes expected operating costsIncludes expected operating costs

Saw toothed behaviorSaw toothed behavior

Best for infrastructure with little operating cost andBest for infrastructure with little operating cost andhigh capital costhigh capital cost Water and Sewer

E


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RDT SD 126

ESD 126

LRMCLRMC

$/kWh

Time -- years

E

Summary of Pricing Rules andSummary of Pricing Rules and


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RDT SD 126

ESD 126

Summary of Pricing Rules andSummary of Pricing Rules andRealities: The Devil is in theRealities: The Devil is in the

DetailsDetails

What role will the regulator play?What role will the regulator play?

How quickly will deep markets emerge?How quickly will deep markets emerge? Who will benefit and who will be hurt in the transition?Who will benefit and who will be hurt in the transition?

How many products are there?How many products are there?

Who will decide? How will the futures market develop to provide for hedges onHow will the futures market develop to provide for hedges on

price?price?

Can the regulator remain aloofCan the regulator remain aloof ---- in the UK the regulator hasin the UK the regulator has

stepped in because of poor initial rules?stepped in because of poor initial rules?

E


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S

ESD 126Swaps / Contracts forSwaps / Contracts for

DifferencesDifferences

Time

$/kWh

ContractPrice

Spot Price

economic markets for power

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