shmuel oren pricing
TRANSCRIPT
-
7/24/2019 Shmuel Oren Pricing
1/20
Capacity Payments and Supply Adequacy
in a Competitive Electricity Market
Shmuel OrenUniversity of California at Berkeley
VII SEPOPE, Curitiba-Parana Brazil
May 21-26, 2000
-
7/24/2019 Shmuel Oren Pricing
2/20
What is Reliability NERC (National Electric Reliability Council) defines
reliability as: the degree to which the performance of theelements of the electrical system results in power being
delivered to consumers within accepted standards and in theamount desired
Reliability encompasses two concepts:
Security: the ability of the system to withstand sudden disturbances.
This aspect concerns short-term operations and is addressed byancillary serviceswhich include:Voltage support, Congestion relief,
Regulation (AGC) capacity, Spinning reserves, Nonspinning reserves,
Replacement reserves.
Adequacy: the ability of the system to supply the aggregate electricpower and energy requirements of the consumers at all times. This
aspect concerns planning and investment and is addressed by Planning
reserves, Installed capacity, Operable capacity or Available capacity.
-
7/24/2019 Shmuel Oren Pricing
3/20
Markets and Reliability Security and Adequacy are both compliments and substitutes.
Security is apublic goodwhile Adequacy is mostly aprivate
good. Security can be provided through competitive procurement of
ancillary services. However, decisions concerning required
amounts, dispatch and cost allocation need be centralized due to
externalities and free rider effects.
Generation adequacy decisions can be decentralized and left to
the market. Inadequate supply will result in high prices which in
turn encourage new capacity. Customers should be allowed todecide how much they want to pay for and suppliers should
decide how much to invest. These are individual economic and
risk management decisions.
-
7/24/2019 Shmuel Oren Pricing
4/20
Alternative Approaches to Ensuring
Generation Adequacy
Rely on energy markets. Consumers and suppliers interact through
unrestricted energy spot markets. Energy spot and future energy prices
provide price signals and compensation for capacity investment. Technology
mix and generation capacity are determined by entry and exit of suppliers and
by customer choice of desired price risk. (California, Nordpool)
Central agency (ISO or Regulator) specifies requirements for planning
reserves based on traditional planning tools. Capacity market allow supplier
to trade reserves and efficiently reallocate the reserves requirements but the
capacity market and energy market may not be in equilibrium (PJM, New
York, New England)
Generators receive capacity payments based on availability, technology,
VOLL, LOLP to incent investment and availability. (old UK system,
Argentina, Spain)
-
7/24/2019 Shmuel Oren Pricing
5/20
Short-Term Vs. Long-Term Efficiency
Savings from improved dispatch under restructuring not likely
to be high (system operated quite efficiently).
Most efficiency gains from restructuring will be long-term
resulting from better investment decisions (technology choice,
location and generation capacity) and from demand side
response to price signals. The economic process that leads to long-term efficiency
involves entry and exit in response to energy price signals,
and customer choice of desired supply certainty and price risk.
Centrally determined installed capacity requirements orcapacity payments interfere with this economic process.
-
7/24/2019 Shmuel Oren Pricing
6/20
The Theoretical Foundation of Capacity
Payments Capacity payments originate in the theory of peak load pricing
(Boiteux)
Basic Idea: There are two commodities, energy and capacity. Theobjective of pricing is to recover cost while minimizing distortion of
efficient consumption. Peak load users are responsible for capacity
requirements while off peak user only consume energy. Hence, efficient
pricing must charge MC off-peak and MC+Capacity charge on-peak.
Peak Demand
Off-peak Demand
MC MC+CAP
MW
Peak Offpeak
-
7/24/2019 Shmuel Oren Pricing
7/20
Theoretical Foundation of Capacity Payments:
Extensions
Effect of Uncertainty
Basic Idea:The two commodities are energy and reliability
of supply. Additional capacity increases reliability (reduces
LOLP) on and off peak hence capacity cost should be
allocated over all time periods so as to reflect the value of
improved reliability Effect of Multiple Technologies
Basic idea:Recover production cost with optimal
technology mix through a nonlinear price structure basedon load factor (Wright tariff) or equivalently through a
combination of time of use MC- based energy rate and a
demand charge.
-
7/24/2019 Shmuel Oren Pricing
8/20
Cost Recovery Through a Combination of
Marginal Costs and Capacity Payment
M W
TIM ET 1 T 2 T 3
1 M W
$/M W H M A RG I NA L CO S T( P RI CE DURA T I O N CURV E )
C 1
C 2
C 3
TIM E
EN ER GY R EVEN UE
CAPAC ITY PAYMEN T PER M W= F1
M W
TIMET 1 T 2 T 3
G N 1
G N 2
G N 3
1 M W
C 1C 2
F 1
F 2
F 3
F3+C3*(T1+T2+T3)
C3*T 3C2*T 2
C1*T 1
F 1
T I M E
$/M W
F3+C3*(T1+T2+T3)=F1+C1*T1+C2*T2+C3*T3
CO S TFUNCTION
C 3
-
7/24/2019 Shmuel Oren Pricing
9/20
Capacity Payments Covered by Raising Energy
Prices to VOLL During Shortage PeriodsMW
TIMET1 T2 T3
1 MW
$/MWH MARGINAL COST(PRICE DURA TION CURV E)
C1
C2
C3
TIME
ENERGY REVENUE
MW
TIMET2 T3
GN 1
GN 2
GN 3
1 MW
C1C2
F1
F2
F3
F3+C3*(T0+T1+T2+T3)
C3*T3C2*T2
C1*T1
TIME
$/MW
F3+C3*(T0+T1+T2+T3)=VOLL*T0+C1*T1+C2*T2+C3*T3
COSTFUNCTION
C3
T1
CURTA ILED LOA DDEMA ND REDUCTION
T1
NO CA PACITY PAYMENT ( F1~VOLL*T0)
VOLL*T0
~
-
7/24/2019 Shmuel Oren Pricing
10/20
Demand Side Bidding Provides a Market Based
Alternative to Administratively set VOLLM W
T I M ET1 T2 T3
1 M W
$ / M W H M A R G IN A L C O S T(PRICE DURA TION CURV E)
C1
C2
C3
T I M E
E N ER G Y R E V E N U E
M W
T I M ET2 T3
G N1
G N2
G N3
1 MW
C1C2
F1
F2
F3
F3+C3*(T0+T1+T2+T3)
C3*T3C2*T2
C1*T1
T I M E
$ /MW
F3+C3*(T0+T1+T2+ T3) = +C1*T1+C2*T2+C3*T3
C O S TFUNCTION
C3
T1
CURTAIL ED L OA DDEMA ND REDUCTION
NO CAPACITY PAY MENT
D E M A N DBIDDINGC U R V E
c T dT T
( )0
0
c T dT T
( )0
0
-
7/24/2019 Shmuel Oren Pricing
11/20
MW
EnergyPrice
($/MWh) Price at7:00-8:00 p.m. without Capacity payment
Price at9:00 -10:00 a.m.
Price at2:00 -3:00 a.m.
GEN 1
Demand at2:00 - 3:00 a.m.
Q1 Q2 OptimalCapacity
GEN 2 GEN 3 GEN 4GEN 5
Demand at 7:00 - 8:00 p.m.
Demand at
9:00 - 10:00 a.m.
Energy Market With and Without Capacity
Market
GEN 6
Capacitywithcapacitypayments
Price at7:00-8:00 p.m. with Capacity payment
-
7/24/2019 Shmuel Oren Pricing
12/20
Example of Long Run Equilibrium in Energy
Only Markets
Supply: Two types of generators
G1: N=50 G2: N=100
Capacity=80MW Capacity=60MW
FC=$926,400/Month FC=$288,000/Month
MC=$15/MWh MC=$25/MWh
Demand: Two demand functions
Off-Peak: 420 Hrs./Month Peak: 300Hrs./Month
P=30-Q/1000 P=50-Q/1000
(This example is due to Severin Bornstein)
-
7/24/2019 Shmuel Oren Pricing
13/20
Example of Long Run Equilibrium in Energy
Only Markets (contd)
Peak price: $40/MWh Off-Peak price: $25/MWhFixed cost recovery:
G1: 80*[(40-15)*300+(25-15)*420)] - 926,400 = $9,600/Month (excess
profit)
G2: 60*(40-25)*300 - 288,000 = ($18,000/Month)(deficit)
0 4000 5000 10000 MW
MC $/Mwh
15
25
50
30
40
-
7/24/2019 Shmuel Oren Pricing
14/20
Example of Long Run Equilibrium in Energy
Only Markets (contd)
Long Run Equilibrium: Entry of 2000MW G1 capacity, Exit of 3000MW G2 capacity
Peak price $41/MWh Off-Peak price $24/MWh
G1: $926,400926,400= 80*[(41-15)*300+(24-15)*420] G2: $288,000288,000=60*(41-25)*420
0 4000 5000 6000 9000 10000 MW
MC $/Mwh
15
24
50
30
41 Peak
Off-Peak
-
7/24/2019 Shmuel Oren Pricing
15/20
Supply and Demand Uncertainty Cause High
Price Volatility in Energy Only Price Systems
Price volatility is an inherent aspect of electricity due to its
nonstorability and the steep supply curve.
$0
$10
$20
$30
$40
$50
$60
$70
$80
$90
$100
0 20000 40000 60000 80000 10000 0
Demand (MW )
Marginal Cost
($/MW h)Marginal Cost
Resource stack includes:Hydro units;
Nuclear plants;Coal units;
Natural gas units;Mi sc .
WSCC Generation Resource Stack Electricity On-Peak Spot Price
$0.0
$20.0
$40.0
$60.0
$80.0
$100.0
$120.0
$140.0
$160.0
12/1/95 3/10/96 6/18/96 9/26/96 1/4/97 4/14/97 7/23/97 10/31/97 2/8/98 5/19/98
Time
Spot Price
$0.00
$10.00
$20.00
$30.00
$40.00
$50.00
$60.00
$70.00
$80.00
ERCOT on-peak
COB on-peak
Electricity On-peak Spot Prices
-
7/24/2019 Shmuel Oren Pricing
16/20
Some Fundamental Aspects of Competitive
Electricity Markets
Obligation to serve replaced by Obligation to serve at a
price.
Prices determined by supply and demand and consist of
marginal production cost + scarcity rent.
Customers and suppliers are free to choose level of
exposure to price risk through risk management andcontractual agreements.
Reserve generation capacity beyond security needs is just a
hedge against high prices. Forward markets and hedging instruments provide a
competitive market alternative to capacity payments.
-
7/24/2019 Shmuel Oren Pricing
17/20
How it Can Be Done
Buyers decides how much they want to pay for capacity
according to the price risk they are willing to assume or price
level at which they are willing to be curtailed (buyer is
responsible for providing curtailment technology ordemonstrating ability to incur financial risk).
Generators diversify investment risk through forward supply
contracts that systematically link capacity payments to an
obligation to supply energy at a pre-specified strike price
(generator is liable to supply contracted energy or compensate the
buyer at VOLL).
Generators that do not receive capacity payments (uncontracted)are entitled to sell their energy at free market prices which can go
as high as VOLL.
Generation gets built if market value of capacity (as reflected by
contract markets) exceeds cost of new generation.
-
7/24/2019 Shmuel Oren Pricing
18/20
Demand can participate in mitigation of price risk by avoidingcapacity payments (not contracting) and subjecting their loadto curtailment (or self-curtailing) during high price periods.
VOLL can be set administratively or replaced by demand sideresponse to price signals. VOLL serves both as a price cap foruncontracted energy and as a penalty for contracted but notdelivered energy.
The role of regulatory agencies is reduced to ensuring that loadserving entities and generators have the resources (financial orphysical) to meet their obligations. Public risk exposure maybe regulated by imposing requirement for forward contracting
on load serving entities. Theoretical probabilistic models for calculating LLOP are
replaced by stochastic price models underlying the pricing offorward contracts but pricing is left to the market participants.
How it Can Be Done (cond)
-
7/24/2019 Shmuel Oren Pricing
19/20
Alternative Price Behavior Models Produce
Different Capacity Values
$0
$1 0
$2 0
$3 0
$4 0
$5 0
$6 0
$7 0
$8 0
$9 0
$100
0 0.5 1 1.5 2 2 .5 3
2 regime (Reg ime swi tching)
2 factor (Determ. Vol . Jump-Di f fus ion)
3 factor (Stoch. Vol . Jump -Di f fus ion)
Alternative Price Behavior Models
Spark Sp read Cal l und er Di fferent Models(Heat Rate: 9.5MMB tu/MWh, rf = 4%)
$0.0
$5.0
$10.0
$15.0
$20.0
$25.0
0 0 .5 1 1 .5 2 2.5 3
Matur i ty Tim e (yrs)
Spark Spread C a l l
Mode l 1a (De term. Vo l . Jump-Di f fus ion)
Mode l 2a (Re g ime s wi tch ing)
Mode l 3a (S toch . Vo l . Jump-Di f fus ion)
G B M
Value of Spark-Spread Call Options
Under Alternative Models
The role of models is to forecast prices but not to set them.
The market figures the right price.
-
7/24/2019 Shmuel Oren Pricing
20/20
Conclusions Capacity Payments undermine the potential gains of deregulation by
leading to over-investment, wrong technology choices, and foreclosure ofdemand-side options.
Regulation should focus on facilitating decentralization, trading, customerchoice and demand side responses (foster metering communication andEC technologies)
The role of capacity payments in ensuring adequacy of supply can befulfilled by risk management approaches and hedging instruments that
permit diverse choices and promote demand side participation. The valueof capacity as a hedge for price risk should be determined by the market.
If capacity payment are intended to correct failures of capital markets thenregulatory intervention should address directly the availability and cost of
long-term financing for capacity expansion secured by short-termcontracts (e.g., through loan guarantees) and focus on promoting marketconfidence and rules that facilitate liquid markets for energy futures andother risk management instruments.