Fundamentals of wholesale electricity prices

www. erranet.org

ERRA Tailor-made Training Course: Principles of Tariff Regulation

Implemented for: Oman Power & Water Procurement Company

December 2-4, 2018 • Muscat, Oman

Fundamentals of wholesale

electricity prices

David Williams

2ERRA Tailor-made Training Course: Principles of Tariff RegulationDecember 2-4, 2018 • Muscat, Oman

Contents

A. The difficulties of electricity markets

B. Build-up of costs and LCOE

C. Economic dispatch

D. Contracting and PPA pricing

E. Annual Revenue Requirement


Power supply and demand: what

makes electricity so difficult?

– Because demand is inelastic in

short-run, the demand schedule

is almost vertical.

– Market price, p*, and total

energy to be supplied, q*, is

determined by intersection of

supply and demand curves.

Demand side flaw 1:

Historically a lack of real-time demand elasticity: demand responds only minimally to price →System Operator must set price when clearing is not achieved

Demand side flaw 2:

Cannot control real-time flow to specific consumers enforcing bilateral contracts → requires System Operator to balance in real-time


Power supply and demand: what

makes electricity so difficult?

– Storage is about timing of

delivery.

– Storage is about frequency

and balancing.

– There is a value to

flexibility

Supply side flaw:

Electricity cannot be stored as electricity → batteries, fly wheels, pumped storage etc convert to other energy forms at cost

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£/M

Wh

MW

Half-hour

MW Price Imbalance price

Generate

Refill


Build-up of costs (retail)

Multiple tariffs

– Commercial and industrial

– Social

Multiple services

– Energy efficiency

– Purchase of transmission

services

But essentially a bundled service

– Metering and meter

reading

– Transmission, distribution

– Energy and energy profile

– Price management

Wholesale energy – bought

off generators and varies

depending on demand

shape

Subsidies

Distribution network costs

Transmission network

and services costs

Renewables costs and other

statutory charges and taxes

Supplier costs (incl hedging)

Supplier margin


Build-up of costs (wholesale)

Generation costs are

– Fuel

– Variable O&M

– Fixed O&M

– Investment (capital costs)

Hydro and many renewables

have negligible variable cost

– Valued at opportunity cost

Costs include:

– Risk (incl. balancing cost)

– Load profile (idle capacity)

Revenues from the market

– But also from alternative

markets such as ancillary

services

Generator fuel cost and

other variable cost

Generator investment

cost and profit margin

Generator fixed costs

Balancing cost

Transmission losses?

Ancillary services


Simple assessment of competitiveness:

levelised cost of electricity

Levelised cost of electricity (LCOE)

– LCOE is cited as a measure for the comparison of the costs of alternative

power plant technologies.

– LCOE are commonly used for power development planning (selecting the

least cost stack of generation).

– LCOE is a single $/kWh price representing the per unit costs for the energy

generation from power plants.


LCOE calculation

– The levelised cost of electricity (LCOE) is the present value of the total cost

of building and operating a power plant over its lifetime.

– 𝐿𝐶𝑂𝐸 =𝐾×𝐶𝑅𝐹+𝐹

𝐸+ 𝑉, where:

– NB: The function –PMT in excel can be used for the CRF

𝑉 =

𝐹 =

𝐸 =

Total value of variable O&M

costs

Total value of fixed O&M

costs

Total energy generated

𝐶𝑅𝐹 =

𝑖 =

𝑛 =

𝐾 =

𝑖 1+𝑖 𝑛

1+𝑖 𝑛−1is used to discount

Interest rate (discount factor)

Life expectancy of power plant

Total capital cost


Illustration of LCOE

– Botswana LCOE supply curve for 2020

– But is this the full story?


LCOE advantages and disadvantages

Advantages

– Provides a common basis for

the comparison of power

generating technologies

– Reflects time value of money

and inflation

– Relatively simple

Disadvantages

– It can not provide a reliable

comparison for scheduled vs

intermittent quantities

– It can be misleading in assets

with long vs short lifetime

– Does not capture the

suitability of power plants for

base vs peaking generation

– Does not show the financials

of the investment

– It is heavily based on the

assumption of the hours of

power generation


What gets dispatched? The Load

Duration Curve

Arranges load (demand) from largest to smallest, typically over a year


What gets dispatched? Merit order

and least-cost dispatch

Overlay on load for dispatch Sort available generators by their

variable costs and stack

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1 2 3 4 5 6 7 8

Hour

Ca

pa

city (

MW

)

Gen 1 Gen 2 Gen 3

Gen 4 Gen 5 Gen 6

Increasing variable cost


Economic dispatch, short-run value of

generation and pricing

Merit order model for least cost dispatch

– Lowest variable cost generation will be

dispatched first

– Models consider transmission and system

constraints (including must-run

conditions)

Infra-marginal rent

Peaking value

– Short-run scarcity

In a liberalised market

– Price is set at clearing for all generators

– infra-marginal rent and peaking value

cover fixed costs

In a regulated market like Oman costs are

typically disaggregated and defined per

generator

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h

Exports

Solar

Wind

Reservoir

RoR

Imported Coal

Lignite

Natural Gas


Reflection of costs in PPA (standard

approach)

Specific to each generator

– Maintain flexibility in portfolio establishment

– Ex Ante in nature

Commercial terms regarding timing of payments, application of interest,

independence of dispute resolution

Capacity Payments

– Capital to sustain the generation business

– May be linked to availability

Energy Transactions

– Flexibility to reflect generation type and demand need

– Based on expectation of short run marginal cost pricing


Contract options

Contract options include

– Varying periods (daily, weekly, monthly or even multi-year contracts)

– Varying quantities

– Optionality (calling rights, insurance-type products)


Beyond LCOE: Annual Revenue

Requirement

AR

R (

$/M

Wh)

– Generators must recover fixed

and variable costs – their annual

revenue requirement (ARR)

– Add variable costs to fixed

costs (capital costs converted to

annual MWh of de-rated

available capacity) to get ARR in

£/MWh

– A “screening curve” plots how

ARR changes with plant capacity

factor

– De-rated capacity to address

forced outages

– Translated to LDC this estimates

relative capacity needed from

each fuel source

Oil-fired capacity required

Coal fired capacity required


Applying to non-dispatchable

generation– But Solar PV and wind are not

dispatchable → adding to a

screening curve is problematic

– Using average capacity factor as

de-rated “availability” may

indicate relative economic

competitiveness at far right of

curve (see PV example, right)

– But this ignores need to sell all

generation when operating at

full capacity and any correlation

between load and output

– Cannot be used to assess

competitiveness

– Instead may use a chronological

load time-series and resource

pattern (for RE output)

computational model

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0% 20% 40% 60% 80% 100%Ave

rag

e co

st o

f ca

pac

ity

($/M

Wh

)

Capacity factor of plant (after de-rating)

Coal Oil Solar PV

XSolar PV capacity?

X

W

THANK YOU

FOR YOUR ATTENTION!

ERRA Tailor-made Training Course: Principles of Tariff RegulationDecember 2-4, 2018 • Muscat, Oman

David Williams

E-mail: [email protected]

Web: www.eca-uk.com

Fundamentals of wholesale electricity prices

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