Capacity Mechanisms: management of Interconnectors and cross-border effects

Capacity Mechanisms: management of Interconnectors and cross-border

effects

David Newbery

University of Cambridge

Cambridge Spring Research Seminar16th May 2014

http://www.eprg.group.cam.ac.uk

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Outline

• What is the problem?• Energy-only markets and capacity payments: theory

– policy failures, price caps

• Proposed EMR capacity auction– defended by missing money (VOLL > max energy price)

– complications: risk, market coupling rules

• Interconnectors: problems

Energy PolicyResearch Group

What is the problem?Ofgem’s derated capacity margin

Source: DECC IA

System Operator’sproblem

First Capacity Auction delivery

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Interconnectors by 2018IFA to France 2 GWBritned to NL 1 GWMoyle to NI 0.5 GW (or 0.25?)EWIC to RoI 0.5 GWNEMO to Belgium 1 GWEclink to France 1 GW

Total 6 GW• potential swing 12 GW = 20% peak demand• emergency SO actions cannot reverse IC flow

Key question - what contributon to derated capacity?Poyry (2012): 50-80% depending on margins abroad


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Energy-only markets• If generators can (and are allowed to) bid

scarcity prices no problem?– France (de facto monopoly) bids high peak prices– GB has adequate capacity and flat prices

• Wind, PV, cheap coal, low C prices drive clean spark spreads negative (in DE especially)– electricity prices affected by policy

=> policy uncertainty undermines peaking investments neededCapacity contracts to address policy failure


France much peakier than GBEuropean power exchanges 2012

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Capacity payments: theoryEfficient price = SMC + CP

SMC = system marginal cost, CP = capacity payment

CP = LoLP*(VoLL - SMC)LoLP = Loss of Load Probability in each hour

LOLE = LoLP over year (Loss of Load Expectation) set at 3 hrs in GB

=> VoLL = Value of Lost Load = £17,000/MWh• Max price in Euphemia day-ahead = €3,000/MWh

– Max price in France = €3,000/MWh

– Max price in SEM (Ireland) = €1,000/MWh

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Experience in the Pool and BETTA

• The Pool (1990-2001) had an explicit CP at LoLP*(VoLL-SMP), VoLL = £(2013)5,000/MWh – (but SMP is as bid, not SMC)

• NETA/BETTA was an energy-only market with a Balancing Mechanism, System Buy and Sell prices– reformed many times, long side defaults to prompt price

– initially pay-as-bid, then average of last N MW

– consulting on Significant Code Review to deal with 2015/16

How well did they signal scarcity?


Pool prices were peakier than spot market as they had a capacity payment

UK price duration curves 2012 and Pool Purchase price 1998-9

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N2EX 2011-12

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PPP 1998-9 at RPI

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CP in the Pool - 50% revenue in 1.8% (158) hoursPPP-SMP 1998-9 at 2012 RPI prices

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Pool prices 1998-9 and System Buy Price 2008Price duration curves Pool 1998-99 and Balancing 2008 at 2013 CPI prices

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Balancing prices peakier than Pool

Imbalance prices not adequately marginal?Price duration of System Buy Price 2013-4

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GB Balancing Market

• Ofgem conducts Significant Code Review of BM• Proposes:

– single marginal price

– load shedding bids at proxy Value of Lost Load• pVOLL = £3,000 rising to £6,000/MWh by 2018

• DECC sets VOLL at £17,000/MWh

– STOR bids in at f(pVOLL,LoLP)

BM price has never hit even £3,000/MWh

Missing money: 3hrs*(£17,000-6,000)/MWh


Capacity to be replaced

Source: DECC IA

Seems small - can it be covered by interconnectors?

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GB Capacity Auction

• Pay-as-clear descending clock auction in 2014 for delivery 2018/19– max energy price assumed £6/kWh– LOLE = 3 hrs => VOLL = £17/kWh– => missing money = 3 hrs*(17-6)/kWh = £33/kW

• new build gets 15 yr contract at auction price– existing plant: 1 yr contract unless major refurbish

• must be price taker unless good cause, entrants set price• existing plant can delay until later auction (2017)

• DSR auctioned from 2016: 1 yr contracts


Illustrative auction demand curve

Source: DECC IA

New plant sets high price for all

No new plant and price is low

£75/kW year

Net benefit is difference between large producer surplus and large consumer loss

Initially adverse

GB coupledto NWE 4/2/14

SWE coupled toNWE 13/5/14

SEM not until 2016

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Issues with interconnectors

• Interconnectors increase security of supply– provided they are free to respond to scarcity

=> they should have a positive derated capacity– Poyry estimates 50-80%

• Efficient pricing benefits trading country– if partner mis-prices they lose

=> efficient pricing drives out inefficient pricing

• But Euphemia imposes €3,000/MWh cap


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Cross-border capacity procurement

• EU wants any capacity market to be EU-wide• What contract can deliver capacity from abroad?

– How does specific foreign plant guarantee to export to GB in stress hours?

• PTR defaults to FTR on the day, but GB price may not signal true scarcity (and there is a price cap)

– Would it not likely do so anyway without a CP?

• Why not have a contract with the SO for imports over the interconnector in stress hours?– Devolve to SO securing supply

– or SO auctions for capacity over IC?


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Investment in interconnectors

• The economics of investment look good anyway– and get better with more wind, PV, carbon price floor

• recognising contribution to security increases value– DC interconnectors are controllable

– GB Interconnectors are logical suppliers of capacity

• problem: TO’s cannot contract for generation – but SO (abroad) could run auction for capacity and access

=> rent collected by ICs

EU open access to CP needs firm access to ICs

and penalties for non-delivery


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Conclusions

• Theory of scarcity pricing clear– leads to CP = LoLP*(VoLL-SMC)– energy-only markets could do this in theory

• and hedge with reliability options

• main failures: policy uncertainty and price caps– and lack of credible distant futures markets

• Capacity markets can address these– but potentially large transfers from consumers

And need much higher Euphemia price cap


Appendix Capacity Mechanisms: management of Interconnectors and cross-border effects

David Newbery

University of Cambridge

Cambridge Spring Research Seminar16th May 2014

http://www.eprg.group.cam.ac.uk

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AcronymsBM Balancing mechanism (or market)CONE Cost of new entry (net = net of revenue from selling power)CP, CM Capacity payment, capacity marketDSR demand side responseEMR (UK) Electricity Market ReformF(P)TR Financial (physical) transmission rightIC InterconnectorLOLE Loss of load expectation = LoLP over yearLoLP Loss of Load probabilityPV Photo voltaicSEM Single Electricity Market for IrelandSMC(P) System marginal cost (price)SO system operatorSRMC short-run marginal costSTOR short-term operating reserveTEM Target Electricity MarketTO transmission ownerVOLL Value of Lost Load (£17,000/MWh in GB)

Energy PlicyResearch Group

References

• DECC (2102) Electricity Market Reform – Capacity Market Impact Assessment at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/252743/Capacity_Market_Impact_Assessment_Oct_2013.pdf •Poyry (2012) Poyry (2012) Impact Of EMR On Interconnection: A report to DECC at https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/252744/Poyry_Report_on_Impact_of_CM_on_Interconnection.pd?

1

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Capacity payments in Irish SEM

• Bidding Code of Practice requires generation to bid into Pool at SRMC

=> missing money => CP based on VoLL & LoLP• generators get ex post system MC (SMC) + CP• VoLL scaled to deliver adequate payment for new

entry, paid part on ex ante LoLP, part on ex post– stabilises revenue, reduces volatility

• paid on imports, charged to exports

ex post pricing incompatible with TEM


Average €7/MWh

SEM Capacity Payments 2012 and 2013

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Base case: each country matches average production to consumptionarbitrages over coupled IC’s, no shared balancing or reserves

Source: DG ENER (2013)

Benefits of market integration for EU 27+2 relative to base case

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Capacity Mechanisms: management of Interconnectors and cross-border effects

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