GB Energy Market Structure

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GB Energy Market Structure
Imperial College London

• David Newbery
• DECC workshop
• London, 4th September 2014
• http//www.eprg.group.cam.ac.uk

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Outline
Imperial College London

• 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
Imperial College London

• short-term volume and price volatility gt need to
  contract
• very durable capital, high ratio of capital to
  variable cost gt confidence in future pricing
  and/or long-term PPA
• non-storable, subject to congestion gt LMP,
  complex transmission charges/contracts (FTRs,
  etc)
• QoS and SO value varies over space and by
  millisecond
• gt 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
• gt 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
Imperial College London

• Efficient pricing of electricity requires
• Prices varying in response to SD 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?

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GB incentives
Imperial College London

• Lack of pool encouraged vertical integration
• balancing mechanism opaque, poorly designed
• with energy-only market gt self-balance
• fairly sticky domestic customers provides
  quasi-LT hedge
• gt discourages merchant entry
• RES high gas prices discourage flexible CCGT
• CPS EPS discourage coal gt capacity crunch gt
  CRM
• ROCs volatile, wind exposed to imbalance
• contract with Big 6 or face high WACC gt CfDs
• Connect and manage uniform pricing
• gt locate in Scotlandgt congestiongt bootstraps
  2b

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Other possible structures
Imperial College London

• 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
  build
• ISO or SO? Energy-only, capacity markets or
  Pools?
• SB, PPAs or LT contracts? Extent of regulation?

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EU Standard Market Design?
Imperial College London

• Central dispatch in voluntary pool
• SO manages balancing, dispatch, wind forecasting
• LMP capacity payment LoLP(VoLL-LMP)
• Hedged with reliability option (RO)
• gt 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
Imperial College London

• Investment needs low WACC
• gt Predictable policies markets or long-term
  contracts?
• gt 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
Imperial College London

• Innovation gt competitive contracts for RDDD
• 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 gt lack of coherence,
  piecemeal policy

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Conclusions
Imperial College London

• 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

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GB Energy Market Structure
Imperial College London

• David Newbery
• DECC workshop
• London, 4th September 2014
• http//www.eprg.group.cam.ac.uk

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Acronyms

• BCoP Bidding Code of Practice to bid at
  short-run variable opportunity cost
• CCGT Combined cycle gas turbine CfD Contract
  for difference
• CRM capacity remuneration mechanism EMR Electrici
  ty Market Reform
• FiT Feed-in tariff FR Frequency Response
• FTR Financial Transmission Right ISO Independent
  System Operator
• LMP Locational marginal price or nodal price
• LoLP Loss of Load probability LSE Load Serving
  Entity retailer
• LT Long-term PPA Power Purchase Agreement
• QoS Quality of Supply RES Renewable energy
  supply
• RO (C) Reliability Option or Renewable Obligation
  (Certificate)
• SB Single Buyer
• SMD Standard Market Design (the US model)
• SEM Single Electricity Market (of island of
  Ireland)
• SO System Operator TEM Target Electricity
  Model
• WACC Weighted Average Cost of Capital VOLL Value
  of Lost Load

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