The Key Issues in the Korean Electric System Kwang-In Kim, Ph.D Korea Power Exchange kikim@kpx.or.kr Tel : 02-3456-1710

Introduction KPX : The Electricity Market and System Operator of Korea Korea Power Exchange (KPX) was established for operating Electricity Market and Power System according to Korea Electricity Business Act (April 2, 2001). Cost Based Pool (CBP) is operating now, but the market was originally designed to be operated temporarily before transition to the Two-Way Bidding Pool (TWBP) CBP has been operated well so far and it proved the efficiency improvement in generation sector . Changes in Environment of Electricity Market Operation Since the inception of CBP in 2001, the market environment has changed a lot. Market members increased and various stakeholders for market operation was formed. Changes in fuel price was faster than response of the supply side by proper fuel mix. Need for Prolonged CBP Operation Because of the government’s decision to suspend splitting distribution sector of Korea Electric Power Co.(KEPCO), we expect CBP to last longer than expected before. Need for solving cumulative inefficiency and for system improvement to operate CBP over the long run.

Structure of Electricity Industry Electricity Market (KPX) Genco (Public) Genco (Private) Bidding Bidding Electricity Market (KPX) KEPCO(T&D) CES General Customers Large Customers

Market Structure of Korea Load Forecast Cost Based Bid Curve Day-ahead Market · Price · Schedule Payments + Energy · Scheduled · CON/COFF - Real Time System Operation Generation Capacity Bid Capacity Prices Capacity 지금부터는 한국 전력산업 구조개편 추진 현황을 소개하겠습니다. A / S Bid A/S Prices A / S

Features of Electricity Market Generation Competition Market - The competition in the market was introduced to the generation sector . - KEPCO is the single buyer and plays a role as a price taker. CBP (Cost Based Pool) Market - Supply Curve is decided by real fuel cost rather than supplier’s price bidding. - Market Price is set to the short-run marginal cost, which is called to SMP. - Capacity Payments are decided by long-run marginal fixed cost. * The exercise of market power is mitigated because of supplier’s real cost bidding and the market is stabilized by small volatility of the price, but there is small competition therein. Competition Structure of Market - Only Day-ahead market is operated, and as for output difference between day-ahead market and real time operation, which is Constrained-on(CON) and Constrained-off(COFF) generation, the opportunity cost is compensated in the market also. - Uniform Pricing is adopted in the market, and the price is set at the measuring point. The transmission costs are charged to KEPCO which is single buyer / transmission company. - Ancillary services (A/S) are compensated by a designated price to their contribution.

Features of Electricity Market(2) Risk Management Tool of Electricity Market No bilateral contract for risk hedge in the single buyer structure. Price risk of demand side(buyer) is much bigger than supply side in the CBP. Base-load market, a form of vesting contract, is operated for management of buyer’s risk. Characteristics of Base-load Market All the base load generators(nuclear and coal power plants) which are owned by the subsidiaries of KEPCO must participate in the base load market. The base-load market price is set by marginal cost of the market. The capacity payments is set by long run marginal fixed cost of the market The main mission of the base load market is balancing of rate of return between KEPCO, single buyer and its subsidiaries(6 large generation companies).

Market Segmentation Generation Schedule 80% Base-load Generators 20% Price Stability Profit Balance 20% Non base-load Generators External Variables (Fuel Cost, Exchange Rate, etc)

Market Operation Process KPX Generators Prod. Cost Evaluation Fixed : Yearly Construction Cost Demand Forecast Var. : Monthly Fuel Cost Submit Day ahead Offer Available Cap. Scheduling SMP Commitment Gen. Ready Notify Trading day Historical data Weather data Dispatch Instruction Real-time Dispatch 지금부터는 한국 전력산업 구조개편 추진 현황을 소개하겠습니다. Gen. Operation After 26 days Invoice Notification Settlement Payment

Growth of the Market Number of members Trading Volume The market started as 7 members when the market opened in April 2001, but it increased and reached to 74 members now, as many small generators such as renewable generators entered the market. Trading volume and amount also increased continuously. Number of members Trading Volume (Now: 74 members) 16 Volume: TWh 339 32 Amount:Trillion Won 318 299 281 65 15.6 17.3 56 지금부터는 한국 전력산업 구조개편 추진 현황을 소개하겠습니다. 14.5 49 199 13.3 9.5 01 02 03 04 05 01 02 03 04 05yr

Actual Demand and Demand Forecast Actual Demand vs. Demand Forecast 60000 10 forecast Actual Error 9 55000 8 7 50000 6 MW 45000 % 5 4 40000 3 2 35000 1 30000 2001 2002 2003 2004 2005

Fuel Mix and Reserve Margin MW

Change of the Fuel Costs Fuel Costs (Won/Gcal) Won/Gcal 50,000 45,000 40,000 35,000 30,000 Nuclear 25,000 Coal 20,000 Oil LNG 15,000 10,000 5,000 - 2001 2002 2003 2004 2005 2006

The Market Prices Market Price(SMP) vs. Pool Selling Price(PSP) Won/kWh 80 Unit : Won/kWh 60 01 02 03 04 05 06 Market Price(SMP) 50 SMP 48.8 47.3 50.4 55.8 61.9 81.1 Pool Selling Price (PSP) PSP 47.8 47.2 48.6 49.2 51.1 55.1 01 02 03 04 05 06 SMP has been stable, fluctuating between 50 and 60 Won/kWh, but it rose to 81 due to the increase of oil price in the first half of 2006. However, average Pool Selling Price(PSP) has been stable due to the operation of base-load market.

Cost Efficiency of CBP Cost Efficiency Elements of Generation Competition Market Reduction of periods and costs needed for Power Plant Construction and Maintenance Decrease of Peaker’s generation due to the increase of Base-load Generation Yearly Cost Reduction : About 800 billion Won/yr(2005) Generation Cost Reduction : About 560 billion Won/yr Construction Cost Reduction : About 240 billion Won/yr Consumer Retail Price vs. Electricity Tariff 114.7 Index : 2000 yr = 100 99.9 100 Consumer Price 지금부터는 한국 전력산업 구조개편 추진 현황을 소개하겠습니다. 80 Electricity Tariff 1995 1997 1999 2001 2003 2004

Suggestion from Operation of CBP Successful Operation of CBP Market price has been stable due to the successful mitigation of market power. New investment from private sector was made due to price mechanism of the market. Cost reduction in the generation sector was high resulting from competition. Need to Improve Market to Face Changes in Market Environment Reserve rate is very low because power demand was higher than expectation over the last few years and it is likely that market price will rise. Recently market price increased a lot due to the global increase of fuel cost. Low reserve rate and high fuel cost are threatening the limit of current risk management mechanism by market segmentation. There is the need to improve market in order to solve problems and enhance efficiency because current CBP is expected to last over the long run though it was meant to last 2-3 years.

Background of Market Improvement Background and Purpose of CBP Temporary operation in the transition to the TWBP which was the second phase of restructuring in the government’s basic plan As a limited competition market, it started 2001. Experience accumulation of competitive market, Market price stability Prolonged CBP as Government suspended the split of distribution/ sales sector of KEPCO Monopoly of distribution sector by KEPCO will be continued for some long time and transition to TWBP is unclear. KEPCO will play a role of single buyer continuously. Limitation as a Temporary Trading System Lack of detailed market design ☞ Need to solve problems and enhance efficiency in order to operate CBP over the long run

Direction of Market Improvement Sustenance of the Basic Frame of CBP Only Day-ahead market and constrained on-off compensation will be sustained. Supply curves for market price setting are decided based on real variable cost Sustenance of established procedures of bidding, demand forecast, scheduling, dispatch, metering, settlement, etc. Settlement of Problems of CBP Find and amend the problems of current market system. Solve cumulative inefficiency resulting from changes of market environment. Improvement of Market Efficiency Development of new competition elements. Development of new system for long-term efficiency.

Key Issues of Market Improvement(1) Transformation into single market frame - Artificial segmentation of market leads to price discrimination for the same product and weakening of the price signal to construct base load generators. - Limitation in proper allocation or balancing of profit among KEPCO and its subsidiaries when big changes of reserve margin and/or fuel prices were occurred in the market. - Introducing vesting contract(VC) is a alternative to substitute the market segmentation to solve the problem of risk management and profit allocation. - Before VC, price cap for a base-load generators will be introduced temporarily. Introducing Locational Signal - Current CBP is lack of locational signal for new investment due to uniform pricing, which is not designed because of temporary operation. - We plan to introduce marginal loss factor first and then zonal/nodal pricing.

Key Issues of Market Improvement(2) Workability of Investment Signal - In CBP, investment signal is provided through infra-marginal rent and capacity payment - Signals for Private Gencos(IPPs) to enter into the market is properly working, but signals for exit is not. - As for KEPCO’s subsidiaries, out-of-market signal is bigger than market signal. ☞ A-J effect as public companies; industry structure problems Propriety of Marginal Pricing - Cost based bid curve is decided by Cost Evaluation Committee through verification and evaluation of generators’ fuel cost - Propriety problems of cost evaluation method and element are occurred. - Propriety question of marginal price elements (incremental, no-load, start-up cost) - Disparity between marginal price and real marginal cost due to unconstrained generation scheduling in price setting. ☞ Need to decide market price reflecting many constraints by ex-post pricing

Key Issues of Market Improvement(3) Propriety of Market Governance - Possibility of KEPCO’s influencing its subsidiaries in the decision making process - Prominent position of KEPCO in the governance of KPX Customer Price and Demand Response - No pass-through of wholesale price to customer price - Discrepancy between electricity market and demand management due to the distortion of customer price structure(tariff). - Impediment of the stability of market price due to the lack of demand response. Need for Capacity Market, A/S Market, etc. - Need to substitute the government’s long-term power development plan for capacity market or call option, etc. - Need to substitute the A/S obligation for a A/S market - Need to complement CON/COFF compensation through ex-post price setting.

Concluding Remarks CBP was worked properly as a temporary market. Operation costs in generation sector was remarkably reduced after the market opened. Market prices were stabilized and market power was controlled well. Many IPPs entered the market according to the price signal. Current CBP needed to improve to operate for long run As the limitation in proper profit allocation when big changes of reserve margin and/or fuel prices were occurred, existing artificial market segmentation is substitute for new VC. Reflection of accurate marginal cost to the price will be performed by improving the cost evaluation process and ex-post price setting. Introducing the locational signals by applying marginal loss factor and congestion allocation will provide proper investment signal.

The End Thank you!