Ron CoutuS T R A T E G I C M A R K E T A D V I S O R ( N O T A N E N G I N E E R )

From the Computer Scientist’s perspective of the Economist view of the Market

Wholesale Electricity Markets Made Easy

This slide is representative of this presentation

Professor William Hogan is Research Director of the Harvard Electricity Policy Group (HEPG), who is one of the “fathers” of current Market design in the United States

From

To

Me - Computer Scientist originally trained in COBOL (This is the original COBOL team, I am not there) You: Very smart

engineers like Tesla

3

Today’s Objective

• To introduction and explain the ISO New England’s Energy Markets

• In these auction-based markets, customers buy and sell$6 to $12 billion of electricity annually

• Everyone who lives in New England is implicitly part of this market since almost every MW produced and consumed flows through the market

4

Power System Components

• Generators (Make power)

• Transformers

• Transmission lines

• Distribution lines

• Loads (Use Power)

.

Many Different Perspectives

PERSPECTIVES CAN SHAPE YOUR VIEWS

5

How many of these are spinning?

Which table is longer? Which is wider?

A B

LET’S TALK ABOUT MARKETSFrom an Economic Perspective

(put your engineering thoughts on hold)

8

9

Topics Covered

Wholesale Energy Markets:

• Market Auctions: How do they work?

• Economic Incentives: Why do they work?

• Do they work?: Competitive markets versus traditional utility regulation

10

Is an Electricity Market like a Grocery Store?

Dramatic Shift in Energy ProductionRegion has seen shift from oil to natural gas

1990 2000 2010 20130%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

6%15%

46% 46%34%22%

<1% <1%

36%

31%

30% 33%

16%

18%

11% 6%

2%

2% 1%1%

7%13% 12% 13%

Hydro & other renewables

Pumped storage

Coal

Nuclear

Oil

Natural gas

Capacity (MW)

11

12

Natural Gas & Wholesale Electricity Prices LinkedBecause of New England’s heavy reliance on natural gas as a fuel source, natural gas typically sets the price for wholesale electricity

Elec

tric

Ene

rgy

$/M

Wh

Fuel $/MM

Btu

January

2005

July

2005

January

2006

July

2006

January

2007

July

2007

January

2008

July

2008

January

2009

July

2009

January

2010

July

2010

January

2011

July

2011

January

2012

July

2012

January

2013

July

2013

January

2014$0

$20

$40

$60

$80

$100

$120

$140

$160

$180

$0

$5

$10

$15

$20

$25

$30

Wholesale Electricity at New England Hub (Real-Time LMP) Natural Gas

13

Electricity Auctions: Background

• Daily auctions for electric power

• Determine wholesale electricity prices

• Buyers and sellers are:– Large energy users (buyers)– Load Aggregators (buyers)

(serving homes & businesses)– Power plant owners (sellers)– Financial traders (buy and sell)

14

A Simple Example: Auction Bids and Offers

Buyer ID

Quantity (MWh)

Price ($/MWh)

K 100 $59

L 100 $58

M 250 $57

N 200 $55

O 150 $54

P 200 $53

Q 150 $51

R 200 $50

S 200 $49

T 125 $47

Seller ID

Quantity (MWh)

Price ($/MWh)

A 100 $46B 190 $47C 150 $48 D 210 $49E 200 $51F 250 $52 G 200 $54H 275 $55I 150 $56 J 100 $57

What is the Market Clearing Price?

Supply: Offers to Sell Demand: Bids to Buy

15

0 500 1,000 1,500 2,000 $45

$47

$49

$51

$53

$55

$57

$59

Clearing the Market: Price and Quantity

Price = $52

Quantity

Supply

Demand

16

What Clears? What Offer Sets Price?

ID Quantity Price

K 100 $59

L 100 $58

M 250 $57

N 200 $55

O 150 $54

P 200 $53

Q 150 $51

R 200 $50

S 200 $49

T 125 $47

ID Quantity Price

A 100 $46B 190 $47C 150 $48 D 210 $49E 200 $51F 250 $52 G 200 $54H 275 $55I 150 $56 J 100 $57

Offer F Sets the Market Price = $52

Offers to Sell Bids to Buy

Marginal Seller

Marginal Buyer

150

17

Market Settlement: Who Gets Paid What?

Seller ID

OfferQuantity

Offer Price

Cleared Quantity

Market Price

SellerCredit ($)

A 100 $46 100 $52 $5,200

B 190 $47 190 $52 $9,880

C 150 $48 150 $52 $7,800

D 210 $49 210 $52 $10,920

E 200 $51 200 $52 $10,400

F 250 $52 150 $52 $7,800

G 200 $54 0 $52 $0

H 275 $55 0 $52 $0

I 150 $56 0 $52 $0

J 100 $57 0 $52 $0

Total Payments to Sellers $52,000

Supply Side: Cleared Offers to Sell

18

Market Settlement: Demand Side

ID Bid Quantity

BidPrice

Cleared Quantity

MarketPrice

BuyerCharge ($)

K 100 $59 100 $52 $5,200L 100 $58 100 $52 $5,200M 250 $57 250 $52 $13,000N 200 $55 200 $52 $10,400O 150 $54 150 $52 $7,800P 200 $53 200 $52 $10,400Q 150 $51 0 $52 $0R 200 $50 0 $52 $0S 200 $49 0 $52 $0T 125 $47 0 $52 $0

Total Payments by Buyers $52,000

Demand: Cleared Bids to Buy

19

About Clearing the Markets

• Timing:

– Every hour has a different market price, quantity (24×7)

– Auction is held on a Day-Ahead basis

– Today’s prices…

• Published on http://isoexpress.iso-ne.com

• ISO to Go - iPhone and Android APP

• What happens the next day?

1. Sellers are assured payment at the market clearing price

2. Buyers are assured physical delivery by the market operator

Assuring Delivery the Next Day

• ISO New England operates:• Electricity auction markets for New England region; and• Electric power grid to assure deliveries in the region.

21

Energy Markets Timelines Real-Time (Spot) Market

Day-Ahead Forward Market

―00

:00

―13

:30

DA Forward Market results published by

13:30

RT (Spot) Market opens

14:0

0―

Re-Offer Period closes by 14:00 for the next day’s

Real-Time (Spot) Market

Continue to execute the Real-Time (Spot) Market during the delivery

(operating) day

―10

:00

DA Forward Market

bids and offers due 10AM

DELIVERY DAY – REAL TIME MARKET CLEARSDAY-AHEAD FORWARD MARKET CLEARS

―10

:00

―13

:30

Next DAY-AHEAD FORWARD MARKET CLEARS

Next DELIVERY DAY

―00

:00

22

Forward Markets and Spot Markets

• Time for a Reality Check:– Suppose buyers (retailers/utilities) purchased a certain amount of

electricity in the Day-Ahead Market auction

– What if actual demand turns out to be higher the next day?

• Do we need:– Another auction?

– New prices?

– How and when do we deal with this?

23

Forward Markets and Spot Markets

• There’s also a spot (“real-time”) electricity auction

– Intersecting supply offers and actual demand new price!– That means there are two prices:

1. A forward price set in the Day-Ahead Auction; and2. A spot price set in real-time, based on actual supply and demand

• Who gets paid what, then?

– Principle: The price is established when the offer is accepted

• Forward price applies to bids and offers cleared in the forward market;• Spot price applies bids and offers cleared in the spot market

24

0 500 1,000 1,500 2,000 $45

$47

$49

$51

$53

$55

$57

$59

Example: What if Actual Demand is Higher?

Day-AheadQuantity

Spot Price = $55

Day-Ahead Price = $52

Real-TimeDemand

25

Who Gets Paid What?

ID Quantity Price

A 100 $46B 190 $47C 150 $48 D 210 $49E 200 $51F 250 $52 G 200 $54H 275 $55I 150 $56 J 100 $57

Incremental offers are cleared to meet incremental demand in the spot (real-time) market

Offers to Sell

Previously Cleared at Forward Market Price = $52

Now Clear at Spot Market Price = $55200

26

Spot Market Settlement: At Real-Time PriceSellers F, G, H deliver 500 MW more than they sold in Day-Ahead auction

ID OfferQuantity

Offer Price

DeliveredMWh

Day -Ahead Sale MWh

Spot Market

Sale MWh

Spot Market

Price

Spot Market Credit $

A 100 $46 100 100 0 $55 $0

B 190 $47 190 190 0 $55 $0

C 150 $48 150 150 0 $55 $0

D 210 $49 210 210 0 $55 $0

E 200 $51 200 200 0 $55 $0

F 250 $52 250 150 +100 $55 $5,500

G 200 $54 200 0 +200 $55 $11,000

H 275 $55 200 0 +200 $55 $11,000

I 150 $56 0 0 0 $55 $0

J 100 $57 0 0 0 $55 $0

Total Payments for Spot Market Sales: $27,500

27

Real-Time Market Settlement: Demand SideAssume highlighted buyers demand more in RT than purchased DA

IDReal-Time Demand

MWh

Day –AheadPurchase

MWh

Spot Market Purchase

MWh

Spot Market

PriceSpot Market

Charge $

K 150 100 +50 $55 $2,750

L 200 100 +100 $55 $5,500

M 250 250 0 $55 $0

N 300 200 +100 $55 $5,500

O 200 150 +50 $55 $2,750

P 200 200 0 $55 $0

Q 200 0 +200 $55 $11,000

R, S, T 0 0 0 $55 $0

Total Payments for Spot Market Purchases: $27,500

28

Test Your Auction Intuition

What if demand turns out to be lower the next day?

– Then: Spot price < forward price

– In real-time: Market operator instructs sellers with offers above the spot price to not produce, even if they cleared in DA forward market

– In spot market settlement: These sellers are charged the spot price

• By not producing, these sellers incur no (variable) costs

Question: Are they happy about this?Or: Would they rather be producing?

29

0 500 1,000 1,500 2,000 $45

$47

$49

$51

$53

$55

$57

$59

Example: Actual Demand is Lower in Real Time

Day-AheadQuantity

Spot Price = $49

Real-TimeDemand

Day-Ahead Price = $52

Seller EOffer: 200 @ $51

30

Scenario 1: Seller E’s payoff if it produces to cover its Day-Ahead cleared position

• Consider its Day-Ahead auction position:– Offered: 200 MW at offer price $51 each– Cleared: 200 MW at market price of $52 each– Revenue: $52 × 200 MW = $10,400 – Costs: No (variable) costs yet; production occurs tomorrow.

• Real-time Scenario 1: Produce the 200 MW

Revenue $10,400 From DA Market (above)

Production cost ($10,200) $51 x 200 MW delivered

Profit $200

31

Scenario 2: Charging the seller to not produce

• Real-time Scenario 2: Don’t produce the 200 MW– Seller E will be charged the spot price to ‘buy out’ of its delivery

• Yes! Seller E is better off paying to not produce in real-time.– Same applies for Seller F. Why? – What about lower-cost sellers with offers below the spot price of $49,

such as Sellers A, B, and C? What would they rather do?– What would happen if the buy-out cost (spot price) is less than $49?

Revenue $10,400 From DA Market

‘Buy out’ cost ($9,800) 200 x $49 spot market price

Profit $600

32

How does this influence consumer’s bills?

• So in the previous examples the wholesale load server was getting charged as much as $55/MWh

• How does this translate into retail bills?

• Someone is buying the energy on your behalf, perhaps at the very volatile prices (prices can range from $0 overnight to $400/MWh on a single day at times)

• This gets passed on through a charged which is usually reflective of the expected average prices over a longer period of time

33

How Do These Markets Affect Homeowners’ Electric Bills?

Wholesale market prices impact “Generation” component of an electric bill

($77.15 / MWh = $0.07715 /kWh)

34

B. Auctions, Costs, and Incentives

• In the Day Ahead market example, the clearing price = $52.– Cheap seller A: Offered $46

– Marginal seller F: Offered $52

– Expensive seller J: Offered $57

• Who made a profit? Why?

• Implications. What incentives does this create for:

– Short term: A seller’s operating costs and offer prices?

– Long term: Incentives to minimize costs when building power plants?

35

Competitive Markets and Traditional Regulation

• In many other, non-ISO Market parts of the United States, there are traditional utilities that:– Own power plants, and build new ones, when power demand grows– Regulated power prices are set by PUC’s, passing costs onto consumers

• Concerns motivating competitive markets: High costs, incentives to over-build, and operational inefficiencies

• Why use a market-based system to price power competitively?– Economics says: To improve efficiency! Auction-based markets create

strong incentives to reduce production costs and offer prices.– And: who bears the risk of if a new plant comes in with high costs?

36

Wait! There are more ISO auction markets!

• The energy market auction prices vary by location– Thus: Locational Marginal Prices (LMP) – How many different locational prices? Hundreds.

In the spot market, they can vary every few minutes. – Why? Because at times the cheapest sets of offers cannot service all of the load

in the system due to transmission system limitations

• Other ISO Markets:– Capacity market: Long-term forward sales (covers some fixed costs)– Reserves and ancillary services: Special markets for real-time control

• All the ISO’s markets employ auctions, and follow the similar principles to those we’ve explored in this introductory module

– NYISO, PJM, MISO, ERCOT, SPP and California ISO

37

Topic Review

• ISO New England’s Energy Markets

– How the auction markets work

– Economic Incentives: Why they work

– Big Picture: Competitive markets instead of traditional regulation

YOU MAY NOW RETURN TO VIEWING THE WORLD FROM AN ENGINEER’S POINT OF VIEW

38