IG Meeting Flow-based Coordinated Auction Allocation Scheme for the CEE – Region Report WG – CA Christian Todem 18 th IG Meeting, Vienna April 30 th 2008

2 Detailed description of social welfare algorithm Revenue distribution keys for testing phase Agenda

3 NRA’s have demanded from CEE TSOs’ an explanation regarding the allocation algorithm (social welfare criteria). On April 23rd that explanation has been submitted to CEE NRA’s. Content:  General remarks  Methodology  Determination of clearing prices  Simplified example Detailed description of social welfare algorithm I/VIII

4 Detailed description of social welfare algorithm II/VIII General remarks FBA in principle is the process of searching for an optimum distribution pattern of the limited resources (represented by capacities of the transmission elements) which will:  be market oriented and will give efficient economic signals to market participants and TSOs,  ensure that the physical power flows resulting from the (intra-) regional transactions comply with network security standards. That description leads to an optimization problem to be solved by standardised mathematical solutions, also known from other areas of human or technical transactions (as production or transportation of goods, investment strategies etc).

5 Detailed description of social welfare algorithm III/VIII Methodology It is inherent to flow based coordinated allocation (FBA) that the results are subject to a trade-off between:  the total amount of allocated capacity,  the total welfare gain and  the security of the network. Reflecting the main intention of the European Commission behind the establishment of the IEM is to reach a higher social welfare for all market participants and stakeholders. In this context social welfare related criteria for flow based methods has to be inherently taken into account in determining the most appropriate and reflective allocation of cost/benefits associated with transmission network and cross border capacity access.

6 Detailed description of social welfare algorithm IV/VIII Methodology In principle the application of this objective to an individual border leads to an equal amount of allocated capacity as in currently applied bilateral solutions (the same bids would be accepted). The welfare is generally defined as the supplier surplus + consumer surplus + auction revenue and in case of explicit auction of transmission rights it can be expressed as the total of the bid price and the bid amount for all allocated (accepted) bids.

7 Detailed description of social welfare algorithm V/VIII Determination of clearing prices When applying the default objective function, the clearing prices are derived from the dual values of the binding constraints called Shadow Prices (SP). Shadow prices represent the increase in value of the objective function (i.e. market value) connected with marginal increase of the maximum allowed flow. This approach ensures that  Bidder pays either its bid price or less.  There is no rejected bid on a source-sink pair for which the bid price is higher than the bid price of any accepted bid on the same source-sink pair.  The ratio of any pair of clearing prices reflects the ratio of congested branch usage by the respective bids - the clearing prices are consistent throughout the region.

8 Detailed description of social welfare algorithm VI/VIII Determination of clearing prices  The clearing prices for different paths between one pair of source and sink are equal (e.g. clearing price for A  B plus B  C is equal to price for A  D plus D  C), i.e. network users will not be influenced by different contract paths.  The auction results give correct investment signals, since high Shadow prices represent the most critical points in the network where investments are most necessary. Thus, the individual planned project/investments could be evaluated with respect to how they would enable the decrease of Shadow price values.

9 “Area of operation” Detailed description of social welfare algorithm VII/VIII Simplified example Technical Limit 1 Technical Limit 2 Technical Limit 3  The technical limits (i.e. grid constraints) simply define the technical limits for “secure” operation.  Only within that “area of operation” a secure operation is possible!  The welfare objective criteria finally is seeking the economically best “point” in that area (based on economic input made by Traders = bids).  Usually such optimal solution lays on the edge of that “area of operation”! Vector of objective function Optimal Solution

10 Flow based modelling maximises the security domain allowing for more cross-border trade opportunities. flow-based Security domain bilateral ATC assessment max(A=>B+A=>C) Coordinated ATC assessment B A C * According to ETSO: Mini Forum Central Western REM, 20. June Detailed description of social welfare algorithm VIII/VIII Simplified example

11 NRA’s have demanded from CEE TSOs’ an explanation regarding the auction income sharing keys for the testing phase. (social welfare criteria). On April 3rd that explanation has been submitted to CEE NRA’s. Content:  General remarks  Criteria for the evaluation of auction income sharing keys  Selected auction income sharing keys  Current results Revenue distribution keys for testing phase I/IX

12 Revenue distribution keys for testing phase II/IX General remarks With the implementation of coordinated flow-based allocation method, the issue of how to share commonly generated auction income amongst CEE TSOs comes into question. In the current NTC-based explicit auctions, where the cross-border capacity is allocated only for transactions between two bordering TSOs, it is natural to distribute the auction income between the two concerned TSOs according to a 50:50 split principle. In case of flow-based allocation individual technical parameters (AMFs - Available Maximum Flows) of all network elements of the entire region are taken into account simultaneously. Additionally the auction income is generated as a lump-sum settlement and due to this, the allocation income sharing has been studied carefully and with the view of several important criteria – such as legal requirements, economic requirements etc.

13 Revenue distribution keys for testing phase III/IX Criteria for the evaluation of auction income sharing keys In compliance with legal requirements No distortion of allocation process in favor of any [market] party. Incentive for TSOs to maintain and increase interconnection capacity. In compliance with TSOs’ requirements Past investment of TSOs (in interconnection capacity) is rewarded. Commercial value of allocated capacity is considered. Transparent (auditable) determination of the key. No possibility of multiple reimbursement of not allocated capacity. Stability of auction income for TSOs (limitation of the income sharing sensitivity to small variations of flow-based allocation parameters). Continuity of auction income for TSOs (compared with existing principles). Qualitative evaluation Qualitative evaluation

14 Revenue distribution keys for testing phase IV/IX Selected auction income sharing keys In principle, each auction sharing key could be sorted into one of the following groups:  static auction income sharing key and  dynamic auction income sharing key. Integral version of sharing keys:  Integral key definitions auction income sharing keys means, that border TSOs will be remunerated for the flows they host on their borders which have not direct link to the CEE region (e.g. ELES will be compensated for flows from CEE on ELES-HEP border).

15 Revenue distribution keys for testing phase V/IX Selected auction income sharing keys Static auction income sharing key: The static income sharing key combines relative stability of auction results over time with appropriate continuity of effective income sharing in the past. To achieve both of these objectives, a multi-year moving average of past revenue sharing could be defined as a static key. Taking into account substantial revenue fluctuations occurred particularly in the previous years the number of considered years should be chosen in a appropriate way, i.e. as much years as possible/reasonable for a fair consideration. At the beginning of the process, a dominant share of the auction revenue could be distributed with a static key, whereas only a minor share could be distributed according to a more dynamic key. If the transition to the coordinated auction is successfully managed, this weighting could be shifted towards a higher influence of the dynamic income sharing key over time.

16 Revenue distribution keys for testing phase VI/IX Selected auction income sharing keys Dynamic auction income sharing key: The dynamic keys are, at least partially, based on the effective usage of the grid and therefore acknowledge that hosted cross-border flows should be remunerated by a certain share of the auction income. This implicitly means that any TSO, as he will open his grid for flows due to exchanges in the region, should get a significant portion of the revenue. Moreover, the selected keys mostly have in common that they allocate the auction income in a way which reflects the price differences between market areas and the traded volume. Auction income is allocated to borders in a first step and, after that, it is distributed by a share of 50% to the TSOs on both sides of the border. Borders within joint market areas are not considered for revenue sharing.

17 Revenue distribution keys for testing phase VII/IX Selected auction income sharing keys Modified Absolute Usage Key – MAU: MAU reflects the grid usage and the value of flows. MAU allocates the auction income resulting from accepted bids of each source-sink combination according to the ratio of the respective cross- border flow resulting from these accepted bids and the sum of all cross- border flows resulting from these accepted bids. This key does not consider the total revenue during the income sharing process but individually distributes the income for each source sink pair. Hence the MAU key remunerates any TSO, that will open his grid for flows due to exchanges in the region and therefore gives a right signal to TSOs. Integral version possible and selected.

18 Revenue distribution keys for testing phase VIII/IX Selected auction income sharing keys Absolute Usage Weighted with the Clearing Price Version 2 - AU_CP2 : AU_CP2 reflects the border flows and the border clearing prices. AU_CP2 allocates the auction income according to the ratio of the weighted AU (product of absolute usage and clearing price of border where flow occurs) of respective border and the sum of all weighted AUs. Currently no integral version of that key is available.

19 Revenue distribution keys for testing phase IX/IX Selected auction income sharing keys Absolute Usage Weighted with the Clearing Price Version 2 - AU_CP2 : AU_CP2 reflects the border flows and the border clearing prices. AU_CP2 allocates the auction income according to the ratio of the weighted AU (product of absolute usage and clearing price of border where flow occurs) of respective border and the sum of all weighted AUs. Currently no integral version of that key is available. Dynamic key reflecting clearing prices: bilateral sharing based on source-sink pairs The auction income resulting from each accepted bid is shared between the source and the sink TSO 50:50. No integral version possible; try’s to mimic the current bilateral principles.

20 Thanks for attention!