11 GB Energy Market Structure David Newbery DECC workshop London, 4 th September 2014 Imperial College London

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GB Energy Market Structure

David Newbery

DECC workshop

London, 4th September 2014http://www.eprg.group.cam.ac.uk

Imperial CollegeLondon

Newbery 2014 22

Outline

• Drivers of business models• Benefits and costs of different business models

– Justification and criticisms

• Future drivers of change– Security, affordability, sustainability and the EU

How to allocate risk and incentivize investment?


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Drivers for electricity• short-term volume and price volatility => need to contract • very durable capital, high ratio of capital to variable cost =>

confidence in future pricing and/or long-term PPA • non-storable, subject to congestion => LMP, complex

transmission charges/contracts (FTRs, etc) • QoS and SO: value varies over space and by millisecond

=> specify contracts for inertia, fast FR, various reserves (1,2,3, up/down), reactive power, ramping constraints, black start, ...

• Other objectives: carbon, renewable targets not commercial => long-term contracts, undermine credibility of future spot prices

• Interconnectors part of TEM but countries acting as autarkies Future policy uncertainty, inefficient pricing, turbulent policies


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Theory and reality

Efficient pricing of electricity requires•Prices varying in response to S&D each second

– Australia has 5 minute pricing in real-time market

– Frequency response needed in 1-5 seconds

– Tender auctions may be cheaper than spot markets for some services

– Contracts needed to hedge risk and incentivise responses

•Investment needs forward prices for 15-20+ years– Or ability to predict confidently and hedge

•Investment needed is either capital-intensive (low-C) or has low capacity factors for balancing intermittency = risky

How to allocate risk to incentivise and reduce cost?


Newbery 2014 55

GB incentives• Lack of pool encouraged vertical integration

– balancing mechanism opaque, poorly designed – with energy-only market => self-balance– fairly sticky domestic customers provides quasi-LT hedge=> discourages merchant entry

• RES + high gas prices discourage flexible CCGT– CPS + EPS discourage coal => capacity crunch => CRM

• ROCs volatile, wind exposed to imbalance contract with Big 6 or face high WACC => CfDs

• Connect and manage + uniform pricing => locate in Scotland=> congestion=> bootstraps £2b


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Other possible structures

• SMD in the US – has LMP, ISOs + unit commitment with central dispatch,

capacity auctions with obligations placed on LSEs, ISO involved in transmission planning

• Other states keep to regulated cost-of-service utility model to minimise cost of new build

• SEM is trying to adapt gross pool + unit commitment and central dispatch subject to BCoP + CRM with TEM

• LA has moved to LT capacity auctions for new buildISO or SO? Energy-only, capacity markets or Pools?

SB, PPAs or LT contracts? Extent of regulation?


D Newbery 2014 7

EU Standard Market Design?• Central dispatch in voluntary pool

– SO manages balancing, dispatch, wind forecasting– LMP + capacity payment =LoLP*(VoLL-LMP)– Hedged with reliability option (RO)=> reference prices for CfDs, FTRs, balancing, trading

• Auction/tender LT contracts for low-C generation – Financed from state investment bank

• Credible counterparty to LT contract, low interest rate– CfDs when controllable, FiTs when not, or– Capacity availability payment plus energy payment

• Counterparty receives LMP, pays contract

• Free entry of fossil generation, can bid for LT RO– To address policy/market failures


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Costs and benefits

• Investment needs low WACC=> Predictable policies & markets or long-term contracts?=> efficient risk allocation and management

• Who can control imbalance risk? Not wind–But need incentives to offer ancillary services

• Efficient location and congestion management–Can this be left to TNUoS and redispatch or is LMP needed?

• Trading on Euphemia –3-part or “complex” bids?• Retail supply – why not a regulated default supplier?

Markets incentivise but challenging to get prices right


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Future drivers of change

• Innovation => competitive contracts for RDD&D – LCNF & NICs OK but SET-Plan needs dedicated funding– CCS as demo – but is the funding well targeted?– Hinkley Point – to learn how to do nuclear – but pricey!

• EMR: why fix strike prices and not auction? – Why over-procure capacity before learning about supply?

• Smart meters – why universal? Why so complex and costly?

• Low-C policies (ROs, CfDs, FiTs, CERT etc) – why charged to electricity consumers? Why not raise VAT?

Unclear objectives => lack of coherence, piecemeal policy


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Conclusions

• Low-C investment is durable and capital intensive– needs stable credible future prices to invest– or guaranteed contracts for cheap finance

• EU policy is a messy 27-state compromise– neither stable nor credible

• Each country searching for best solution– some mix of contracts and capacity markets

• Gains from cross-border trading higher with RES– share reserves, renewables to reduce investment

rapidly evolving environment for utilities


1111

GB Energy Market Structure

David Newbery

DECC workshop

London, 4th September 2014http://www.eprg.group.cam.ac.uk


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Acronyms

BCoP Bidding Code of Practice – to bid at short-run variable opportunity costCCGT Combined cycle gas turbine; CfD Contract for differenceCRM capacity remuneration mechanism; EMR Electricity Market ReformFiT Feed-in tariff FR Frequency ResponseFTR Financial Transmission Right ISO Independent System

OperatorLMP Locational marginal price or nodal priceLoLP Loss of Load probability LSE Load Serving Entity =

retailerLT Long-term PPA Power Purchase AgreementQoS Quality of Supply RES Renewable energy supplyRO(C) Reliability Option or Renewable Obligation (Certificate)SB Single BuyerSMD Standard Market Design (the US model)SEM Single Electricity Market (of island of Ireland)SO System Operator TEM Target Electricity ModelWACC Weighted Average Cost of Capital VOLL Value of Lost Load

Documents

11 GB Energy Market Structure David Newbery DECC workshop London, 4 th September 2014 Imperial College London