Market design and market power in

wholesale electricy markets

Guido Cervigni

IEFE-Bocconi University, Milan

CEEM – Summer School on Economics of electricity markets Ghent University, Faculty of Economics and Business Administration

1 September 2015

Agenda

1. Wholesale electricity marketso Product standardisationo Delivery and the settlement systemo Electricity trading

2. Competition policy in wholesale power marketso Market power in wholesale electricity marketo Market power mitigation mechanisms

Agenda

1. Wholesale electricity marketso Product standardisationo Delivery and the settlement systemDelivery and the settlement systemo Electricity tradingElectricity trading

2.2. Competition policy in wholesale power marketsCompetition policy in wholesale power marketso Market power in wholesale electricity marketMarket power in wholesale electricity marketo Market power mitigation mechanisms Market power mitigation mechanisms

Product standardisation: time dimension

During the same hour all consumers withdraw 10 MWh

Should they be buying the same product?

MW

Time1/2 1

- 10

0

MW

1/2 10

-20

1/2 1

-10

0

-20MW

Should a consumer in Zone 1 and a consumer in Zone 2

with identical consumption buy the same product?

Product standardisation: geographic dimension

Maximum transfer capacity 1->2 = 200 MW

Supply: unlimited @30 €/MWh unlimited@50€/MWh

Demand: 300 MW @any price 250 MW @ any price

Zone 1 Zone 2

In the «real time», injections must match withdrawals

Product standardisation: Remark - 1

MW

Time1/2 10

10

Withdrawals by buyer of 10 MWh in hour t

Injections by seller of 10 MWh in hour t

-20

Balance («system» position) in hour t Half-hour with net

deficit (SO buys)

Half-hour with net surplus (SO sells)

In the real time network constraints must be met

Product standardisation: Remark - 2

Maximum transfer capacity 1->2 = 200 MW

Supply: unlimited @30 €/MWh unlimited@50€/MWh

Demand: 300 MW @any price 250 MW @ any price

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

Zone 1 Zone 2

Some product standardisation is necessary to make

electricity trading possible

Product standardisation requires socialisation of

some costs

We are still left with many products to trade

Product standardisation: wrap-up

Agenda

1. Wholesale electricity marketso Product standardisationProduct standardisationo Delivery and the settlement systemo Electricity tradingElectricity trading

2.2. Competition policy in wholesale power marketsCompetition policy in wholesale power marketso Market power in wholesale electricity marketMarket power in wholesale electricity marketo Market power mitigation mechanisms Market power mitigation mechanisms

Normal products: o Seller does not deliver … buyer does not consumeo Consumer wants more … additional purchaseo Seller overdelivers … extra is returned or disposed ofo Consumer does not receive …goods go back or disposed

Consequences of any over/under delivery issues are

borne by (only) the parties to the transaction

Injections and withdrawal commitments - 1

Electricity is different: over/under delivery – if not

addressed – causes a black-out, affecting all

consumers and producers

How is this feature addressed?o The SO takes care of system balance at all timeso Injections and withdrawal commitments are enforced

financially

Injections and withdrawal commitments - 2

Example

MWh

0

Net physical position at gate

closure (Program)

50

25 MWh

Real time actual net injections

25 MWh Imbalance G(bought by G from SO)

50 MWh

Market participant G

MWh

0

-50

-33 MWh

17 MWhImbalance C(sold by C to

SO)

-50 MWh

Market participant C

-25 MWh

MWh

0

-50

50 System Imbalance

+17 MWh 8 MWh

Bought by SO in the Balancing

market

The SO procures/disposes of any deficit/surplus of

electricity in the «balancing market»

Alternative settlement systems differ in:o The balancing perimetero Imbalance prices

Balancing market, balancing perimeter and imbalance charges

Electricity delivery commitments can be enforced

only financially

An imbalance is a difference between an

injection/withdrawal commitment (the program) and

actual injection/withdrawals

Issues with standardisation of imbalance prices

Delivery and settlement: wrap-up

Agenda

1. Wholesale electricity marketso Product standardisationProduct standardisationo Delivery and the settlement systemDelivery and the settlement systemo Electricity trading

2.2. Competition policy in wholesale power marketsCompetition policy in wholesale power marketso Market power in wholesale electricity marketMarket power in wholesale electricity marketo Market power mitigation mechanisms Market power mitigation mechanisms

Electricity is traded on multiple timeframes

• Daily• Hourly products• Non

discriminatory auctions or continuous trading

• Power exchanges

• Daily• Hourly products• Non

discriminatory auctions

• Implicit allocation of transmission rights

• Power exchanges

• From multi-year to week ahead

• Basaload/peak products

• Decentralised trading and organised venues

Long term transactions

Gate closure

Real time

Time

1 day before delivery

Day-ahead market

Intraday market

Days before deliveryElectricity market

transactions

Reserve procurement, Congestion management, Balancing Imbalance settlement

System Operations

• SO is counterparty to all transactions

• Different arrangements across Europe

Agenda

1.1. Wholesale electricity marketsWholesale electricity marketso Product standardisationProduct standardisationo Delivery and the settlement systemDelivery and the settlement systemo Electricity tradingElectricity trading

2. Competition policy in wholesale power marketso Market power in the wholesale electricity marketo Market power mitigation mechanisms Market power mitigation mechanisms

14%

57%

29%

Industry structure

The standard approach to assessing competition applied to the wholesale electricity generation

Degree of competitionRelevant Market

Non storability & network contraints: a different competitive assessment in each hour?

57%

29%14%

30% of the time

14% 14%

70%

10% of the time

17%60%

17%

60% of the time

Does market power depend on market shares?

A small generators woith much market power

€/MWh

MW

P. Comp

Pro

fit

Pro

fit

MW

€/MWh

P. Mkt Pwr

Does market power depend on market shares?

High concentration with no market power

MW

€/MWh

P. Comp

€/MWh

MW

P. Mkt Pwr

Market power assessment based on pivotality

Pivotality profits

Generator’s pivotal capacity

Ppivot

Bid curve

Pcomp

Dem

and

Capacity of competitors and imports

Generator’s capacity

Variable cost

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

Adjusted Pivotality indicators

Pivotal capacity (MW) - Incentives

Pivotal Capacity (MW) - Ability

Inflexible output = 0

Hedged load = 0

Ability to cross the market

Incentive to cross the market

Hourly pivotality adjustments Ability measure: Pivotal Capacity – Inflexible generators Incentive measure: Pivotal capacity – Hedged load

Ability & Incentive to exercise market

power

Examples

Pivotal Capacity (MW) - Ability

Pivotal capacity (MW) - Incentives

Hedged load = 0

Inflexible output = 0 MW

Pivotal Capacity (MW) - Ability

Pivotal capacity (MW) - Incentives

Hedged load = 0

Inflexible output = 0 MW

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

Agenda

1.1. Wholesale electricity marketsWholesale electricity marketso Product standardisationProduct standardisationo Delivery and the settlement systemDelivery and the settlement systemo Electricity tradingElectricity trading

2. Competition policy in wholesale power marketso Market power in the wholesale electricity marketMarket power in the wholesale electricity marketo Market power mitigation mechanisms

Divestiture lowers and flattens the firm’s residual demand

…

Market power mitigation: capacity divestiture - 1

€/MWh

Divested quantityMW

D pre divMC pre div

D post divMC post div

Source: Federico and Lopez 2009

Reducing the profit maximising price …

Market power mitigation: capacity divestiture - 2

€/MWh

MW

MR post div

P post div

MR pre div

P pre div

€/MWh

MW

The long-term contract makes part of the firm’s revenues

independent of the spot market price

Market power mitigation: long term contracting

€/MWh

Contracted quantity

MW

D

MR pre contr

P pre contr

MC

€/MWh

MW

D

MR post contr

P post contr

MC

Advantages of contracting over divestitures:o Politically easiero No impact on scale economies

Drawbackso Incentives to sustain spot prices above profit max level to

support future long term negotiationso Less effective (given the volume)

Comparison

Market power mitigation: price cap

€/MWh

DemandSupply

Price increase

€/MWh

MWh

Demand SupplySupply net of withholdng

Price increase

MWhWithheld capacity

Withheld capacity

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»

The generator’s bid in the spot market is constrained

every time the generator’s is assessed to enjoy

«great» market power

Market power mitigation: bid mitigation

Phase 1: Screening

Example: (PJM) any

three generators pivotal

to solve a constraint in a

15 min period?

Phase 2: Mitigation

Cost-based bids enforced

on the three jointly pivotal

generators

• You may want to take a look at:

The economics of electricity markets, Pippo Ranci

and Guido Cervigni Eds, Elgar, 2013

• I can be reached at: guido.cervigni@gmail.com