Auctions and Trading in Energy Markets: an Economic Analysis David Newbery and Tanga McDaniel, University of Cambridge 8 th POWER Conference: Electricity industry restructuring - Berkeley, March

2 Auctions in energy markets Electricity: –NETA + BM replaces Pool -changes auction Gas: –auctions of entry capacity since Sept 1999 –long term auctions since Jan ( ) Electricity Interconnection –Germany/Netherlands –England/France

3 Criteria for successful liberalisation “deliver the lowest possible sustainable prices to all customers, for a supply that is reliable in the short and long run”  minimise entry and exit barriers  minimise transaction costs and avoidable risks  charges should be cost-reflective and paid by those causing cost

4 The case for NETA “The Pool is too transparent and discourages bilateral bargaining” “Making balancing market a poor guide to SMP will encourage contracting” “If there is no market of last resort then must-run stations have to accept lower bids”

critique The root problem is lack of competition If this is resolved the Pool may work better Pool replacement may then be unnecessary, costly and counterproductive. It will: –accelerate vertical integration –deter entry so equilibrium prices will rise –raise transaction costs and hence prices

6 Events from RETA to NETA Competition intensified –Jul 99 Edison buys 4GW $472/kW –raises load factor from 25% to 40+ % –AES buys Drax, then offers for sale  SMP falls 20-30% year-on-year –Oct 01 Edison Mission sells at $190/kW Interconnector raises UK gas prices –CCGT at margin –more dispersed ownership  more competition

7 Source: John Bower (Oxford Institute for Energy Studies)

8

9 Did NETA causes prices to fall? Fall before NETA, after increased competition –endgame or too many to collude? Was NETA needed to encourage plant sales? –Quid pro quo for attractive vertical integration? Did ending Pool cause (modest) overcontracting rather than (modest) undercontracting? If so, is this a Good Thing?

10

11

12 Critique of Balancing Mechanism volatile and risky SSP low, moderately predictable SBP unpredictable, can be very high each agent penalised for imbalance  incentive to over-contract, spill at SSP  excessive self-balancing, reserves

13

14

15 Rationalised defence of NETA dual cash-out prices  asym risk  over-contracting  spot price  over-contracting discourages market power spot market sets contract price then prices  inefficiencies small price for more competition?

16

17 UKPX reflects contract prices

18 Costs of NETA costly to implement: $1 billion and rising small genco costs up 16% wind power can be charged for selling –BM imbalance exceeds energy value self-insure with own spinning reserve –loss of system multiplexing Demand forecasting decentralised –system accuracy ~5%, individual ~ 15%

19 Incentives to over-contract and part-load Supplier forecast error  5- 15% Optimally over-contract x  : F(x  ) = (b-p)/(b-s): x = 0.1 to Cost approx 1-3% of purchase costs Part-loading a 500MW coal fired plant –thermal efficiency falls from 35 to 32% (net) –fuel cost increase 10% (~ £1/MWh) –0.5-1 million tonnes extra C, £40 million/year

20 Improving NETA Reform Balancing Mechanism: –only charge those who add to imbalance –re-instates statistical averaging –targets charges on those causing imbalance –single cash-out price: SSP or SBP Ofgem: may discourage contracting But competitive risky markets normally encourage contracts changes due March

21 NETA assessment NETA benefits large vertically-integrated (G+S) companies with smart traders excess reserves raise costs damages renewables, entry, small companies competition, not NETA, lowered prices NETA: a costly way to buy competition?

22 Auctions for network trading For gas entry to replace LRMC charge –increase transparency, reduce constraint costs –efficient allocation and rent capture For electricity interconnection –can reduce market power –single price better than pay-as-bid –but market integration potentially better still Unreliable for financing network investment

23 Monthly vs daily access prices: St. Fergus

24 Comparison of costs and returns to buying interconnection

25 Cost & profit of trading from France to England

26 Conclusions NETA- costly iteration towards a better system? Auctions assign property rights for access Auctions work best if –capacity fixed and well-defined –enough competitors, liquid spot markets –constraints otherwise costly to manage Good for gas entry, electricity over links Less good for meshed networks, investment

Auctions and Trading in Energy Markets: an Economic Analysis David Newbery and Tanga McDaniel, University of Cambridge 8 th POWER Conference: Electricity industry restructuring - Berkeley, March