Energy Management

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Competitive electricity markets

Md. Mizanur Rahman School of Mechanical Engineering Universiti Teknologi Malaysia Office: C23-228, UTM, JB Cell: 0176480491 Email: mizanur@mail.fkm.utm.my

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o No freedom of choice

o Inefficiency

o Poor service quality

o High operation costs

o High losses (10-40%)

o Lack of competition

o Minor role in electricity and emissions trading.

State monopoly

Highly subsidize prices, distortion of markets.

The state budgetary support is the main sources of funding.

State plays a dominant role as policy maker, regulator, owner, operator.

Private generation to a small extent.

Vertically integrated operation in

electricity market organization.

• Electricity utility companies, state or privately owned are natural monopolies

• Are regulated by legislative measures.

• Naturally only one physical connection from supply to an electricity user.

• It prevents competition in the energy market

• In recent years many governments around the world have begun alternative solutions which introduce competition into their respective electricity and gas supply industries.

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• The commodity component of electricity is similar to many other commodities but -

• It has some special features-

– Electricity demand fluctuates in the various time horizons (in a day, a year, or in the business cycle) both randomly and non-randomly.

– Electricity cannot be easily stored.

– Generation (and transmission) capacity needed to cope with peak demand

– Capacity is partly unused in periods of lower demand

– Reserve capacity may be required to cope with random demand fluctuations or generation shortfalls

– A diversified portfolio of electricity generating technologies is needed to provide the different loads of electricity at least cost.

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Case 1:

Consider an organization uses fuel oil to run its factory.

– The organization will have a choice of competing fuel suppliers from whom to purchase oil.

– The organization can negotiate a bilateral supply contract with any one of the suppliers (or dealers).

– If one supplier becomes expensive, the organization can simply switch to another supplier.

– If demand for fuel oil is high, the suppliers will be able to raise their prices.

– If demand is low then the price of oil will also be low.

– Thus a competitive market in fuel oil exists which reflects the demand for oil at any moment in time.

– Like any other commodity, the oil price will vary because customers have the ability to switch between suppliers.

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Case 2:

Now consider the same organization purchasing electricity from a utility

company. Since the electricity is supplied through cables owned by the utility

company, the customer has no choice but purchase electricity from this utility

company.

• As a consequence:

– No competition exists: The customer is in a weak position since electricity prices

and services are fixed by the utility company.

– No market exists: Under a tariff, electricity prices are fixed, prices do not reflect the

fluctuations in demand for electricity. (Although many tariffs do have reduced ‘off-

peak’ elements, these are at best only a crude indicator of market demand.)

– The potential for cross-subsidy exists: The utility company may offer lower

electricity prices to its large industrial customers, and recoup some of its lost

income by increasing the prices of its smaller domestic and commercial customers.

This is termed as ‘cross-subsidy. 6

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• The electricity businesses are in a position where artificially set

electricity prices are existed.

• Lack of competition ultimately leads to:

– Utility companies becoming over manned and inefficient.

– Industry paying a high price for energy, the unit cost of

production increases and the industry becomes less competitive.

– Many countries are reviewing the monopolistic position of their

respective utility companies.

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• In order to promote competition in the electricity supply industry it is necessary to

create a market for the commodity which is flexible and yet still robust enough to

cope with wide fluctuations in demand

• The market should:

– Allow various electricity supply companies and generators to compete with each other to sell

electricity direct to customers.

– Allow customers to negotiate electricity supply contracts with various suppliers.

– Be transparent, so that generators, suppliers and customers can see that the market is fair and

equitable.

– Create a ‘spot market’ which accurately reflects both demand for energy and cost of production.

This spot market then becomes the market indicator of the real cost of production at any given

point in time.

– Facilitate a future’s market in electricity trading.

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• The above points are relatively easy to achieve in a normal

commodity, but not for the case of electricity

• Because

– Electricity cannot be stored and must be generated only when it can be

consumed.

– Physical constraints of an electricity supply system.

As a result a truly competitive market in electricity is likely to be much more

complex than a normal commodities market.

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• It is impossible to achieve a competitive market with a vertically integrated electricity supply industry.

• Instead a horizontally integrated structure is required. • Horizontally integrated electricity supply industry, in which the generation,

transmission and distribution roles are all split up from each other.

• By splitting up the roles it is possible to create competition between generators who then have to bid in a ‘spot market’ for the right to supply electricity to the transmission grid.

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• Transmission system acts in a fair

and independent manner

• Possible for new ‘independent power

producers’ to enter the market to

compete with existing generators.

• This should result in a reduced cost

to the customer for each unit of

electrical energy produced.

• Customer must be allowed to negotiate supply contracts with individual

energy generator or supplier.

• Customer purchases electricity from competing supply companies, who pay a

fee to the relevant distribution companies for the use of their ‘wires’.

• This ‘line rental’ fee is then passed on to the customer and included in the unit

price paid for the electricity.

• In order to ensure that true competition takes place, the ‘line rental’ fees

should be transparent and equal for all potential electricity suppliers.

• These fees are usually fixed by some form of statutory regulatory mechanism

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Example of competitive electricity market

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Producers (private or government,

national or international, large

or small)

Whole sale market End-users (large or

small industries, services,

agriculture, transports, households

Retail market

Brings competitiveness

Direct purchase

Competitive selling and buying

Transmission/distribution service is regulated as these are natural monopoly

Distribution is separate activity from electricity trade

• Producers: companies generate electric power.

• Supplier: A supplier buys power either directly from a producer, or through

markets. In general, a supplier resells it to small and medium-sized companies and

households.

• Trader: represents the entity which owns the power while the trading process is

taking place. For example, the trader may buy power from a producer and sell it to

a retailer, or the trader may choose to buy power from one retailer and sell it to

another retailer. There are many routes from the producer to the end-user.

• Brokers: play the same role in the power market as estate agents do in the property

market. A broker does not own power, but instead acts as an intermediary. A retailer

may, for example, ask the broker to find a producer who will sell a given amount of

power at a given time.

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Market players

• Distributor: Distributor is granted a permit giving him the exclusive right

and obligation to build a distribution network in a certain geographical

area. The authorities define levels of maximum profit which ensures that

stable and reasonable prices are maintained. A distributor might also have

the role of a supplier, but is obliged to distribute electrical energy from any

other supplier under the same terms.

• End-user : Either a company or a private household. Every end-user pays

for the power consumed to the supplier, he pays for the power transmission

to the distributor and he pays taxes. An end-user can choose among a big

range of suppliers while he has only one choice with regard to the

transmission operator or distributor. Every geographical area has one

distributor responsible for the network transmission.

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System operator (SO) is responsible for an area to be electrically stable, and

for the security of supply in his area. A system operator has to be a non-

commercial organization, neutral and independent with regard to the market

members (usually government body).

The system operators have the responsibility for both the security of supply

and the high-voltage grid (the transmission grid).

Regardless of the market framework (monopoly or competitive),

system operation always remains a monopoly.

The Nordic transmission system operators (TSO) are Statnett SF (Norway) Svenska Kraftnät (Sweden) Fingrid (Finland) Energinet.dk (Denmark). Elering (Estonia) Litgrid (Lithuanian) AST (Latvia) Mizanur@fkm.utm.my 15

• The distribution company is primarily interested in procuring enough

electrical energy from generators in order to meet demand on its grid.

It is not particularly interested in any individual supply contracts.

• Conversely, customers, suppliers and generators are primarily

interested in negotiating contracts which ensure their desired price

and are not interested in the distribution company’s need to meet

instantaneous demand.

• Satisfying these conflicting needs requires the setting-up of complex

bidding, pricing and settlement mechanisms. It is the specific nature

of these mechanisms and the efficiency with which they are applied

which will ultimately determine the success or failure of any

electricity market.

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Number of countries in the world, including the USA, EU (UK, Sweden, Norway, Denmark etc.) have deregulated (at least in part) their electricity supply industries and are developing new energy-trading markets.

Five electricity spot markets ‘pools’ have so far been created in Europe-

i. UK electricity spot market (i.e. the electricity pool)

ii. Nord-pool in Scandinavia (covering Norway, Denmark, Sweden, Finland, Estonia, Latvia, Lithuania, Germany and the UK)

iii. Amsterdam Power Exchange (covering The Netherlands, Belgium and Germany)

iv. Spanish Pool

v. Swiss Pool and 17

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