Market design and market power in wholesale electricy markets Guido Cervigni IEFE-Bocconi University, Milan CEEM – Summer School on Economics of electricity markets Ghent University, Faculty of Economics and Business Administration 1 September 2015

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in wholesale electricity market o Market power mitigation mechanisms

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in wholesale electricity market o Market power mitigation mechanisms

Product standardisation: time dimension  During the same hour all consumers withdraw 10 MWh  Should they be buying the same product? MW Time 1/ MW 1/ / MW

 Should a consumer in Zone 1 and a consumer in Zone 2 with identical consumption buy the same product? Product standardisation: geographic dimension Maximum transfer capacity 1->2 = 200 MW Supply: Demand: 300 price250 any price Zone 1 Zone 2

 In the «real time», injections must match withdrawals Product standardisation: Remark - 1 MW Time 1/ Withdrawals by buyer of 10 MWh in hour t Injections by seller of 10 MWh in hour t -20 Balance («system» position) in hour t Half-hour with net deficit (SO buys) Half-hour with net surplus (SO sells)

 In the real time network constraints must be met Product standardisation: Remark - 2 Maximum transfer capacity 1->2 = 200 MW Supply: €/MWh Demand: 300 price 250 any price Market equilibrium sales with standard product: 550 €/MWh 0 MW Power flow market equilibrium: 250 MW (above transfer capacity) SO actions to address network constraint: Sell 50 MW in zone 1 Buy 50 MW in zone 2 Zone 1 Zone 2

 Some product standardisation is necessary to make electricity trading possible  Product standardisation requires socialisation of some costs  We are still left with many products to trade Product standardisation: wrap-up

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in wholesale electricity market o Market power mitigation mechanisms

 Normal products: o Seller does not deliver … buyer does not consume o Consumer wants more … additional purchase o Seller overdelivers … extra is returned or disposed of o Consumer does not receive …goods go back or disposed  Consequences of any over/under delivery issues are borne by (only) the parties to the transaction Injections and withdrawal commitments - 1

 Electricity is different: over/under delivery – if not addressed – causes a black-out, affecting all consumers and producers  How is this feature addressed? o The SO takes care of system balance at all times o Injections and withdrawal commitments are enforced financially Injections and withdrawal commitments - 2

Example MWh 0 Net physical position at gate closure (Program) MWh Real time actual net injections 25 MWh Imbalance G (bought by G from SO) 50 MWh Market participant G MWh MWh 17 MWh Imbalance C (sold by C to SO) -50 MWh Market participant C -25 MWh MWh System Imbalance +17 MWh 8 MWh Bought by SO in the Balancing market

 The SO procures/disposes of any deficit/surplus of electricity in the «balancing market»  Alternative settlement systems differ in: o The balancing perimeter o Imbalance prices Balancing market, balancing perimeter and imbalance charges

 Electricity delivery commitments can be enforced only financially  An imbalance is a difference between an injection/withdrawal commitment (the program) and actual injection/withdrawals  Issues with standardisation of imbalance prices Delivery and settlement: wrap-up

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in wholesale electricity market o Market power mitigation mechanisms

Electricity is traded on multiple timeframes Daily Hourly products Non discriminatory auctions or continuous trading Power exchanges Daily Hourly products Non discriminatory auctions Implicit allocation of transmission rights Power exchanges From multi-year to week ahead Basaload/peak products Decentralised trading and organised venues Long term transactions Gate closure Real time Time 1 day before delivery Day-ahead market Intraday market Days before delivery Electricity market transactions Reserve procurement, Congestion management, Balancing Imbalance settlement System Operations SO is counterparty to all transactions Different arrangements across Europe

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

Industry structure The standard approach to assessing competition applied to the wholesale electricity generation Degree of competition Relevant Market

Non storability & network contraints: a different competitive assessment in each hour? 57% 29% 14% 30% of the time 14% 70% 10% of the time 17% 60% 17% 60% of the time

Does market power depend on market shares? A small generators woith much market power €/MWh MW P. Comp Profit MW €/MWh P. Mkt Pwr

Does market power depend on market shares? High concentration with no market power MW €/MWh P. Comp €/MWh MW P. Mkt Pwr

Market power assessment based on pivotality Pivotality profits Generator’s pivotal capacity Ppivot Bid curve Pcomp Demand Capacity of competitors and imports Generator’s capacity Variable cost  Market power: ability and incentive to set prices higher than the competitive level  A possible index of market power in electricity generation is the ability to corner the market - or Pivotality  Generator i is Pivotal in hour t, in an hour, if in that hour: Market_demand– Capacity_but_i’s > 0 ↓ Assess market power based on the Number of hours in which the generator is Pivotal

Adjusted Pivotality indicators Pivotal capacity (MW) - Incentives Pivotal Capacity (MW) - Ability Inflexible output = 0 Hedged load = 0 Ability to cross the market Incentive to cross the market  Hourly pivotality adjustments  Ability measure: Pivotal Capacity – Inflexible generators  Incentive measure: Pivotal capacity – Hedged load Ability & Incentive to exercise market power

Examples Pivotal Capacity (MW) - Ability Pivotal capacity (MW) - Incentives Hedged load = 0 Inflexible output = 0 MW Pivotal Capacity (MW) - Ability Pivotal capacity (MW) - Incentives Hedged load = 0 Inflexible output = 0 MW Many hours with incentives and ability to corner the market ↓ Market power issues Few hours with incentives and ability to corner the market ↓ No market power issues

Agenda 1.Wholesale electricity markets o Product standardisation o Delivery and the settlement system o Electricity trading 2.Competition policy in wholesale power markets o Market power in the wholesale electricity market o Market power mitigation mechanisms

 Divestiture lowers and flattens the firm’s residual demand … Market power mitigation: capacity divestiture - 1 €/MWh Divested quantity MW D pre div MC pre div D post div MC post div Source: Federico and Lopez 2009

 Reducing the profit maximising price … Market power mitigation: capacity divestiture - 2 €/MWh MW MR post div P post div MR pre div P pre div €/MWh MW

 The long-term contract makes part of the firm’s revenues independent of the spot market price Market power mitigation: long term contracting €/MWh Contracted quantity MW D MR pre contr P pre contr MC €/MWh MW D MR post contr P post contr MC

 Advantages of contracting over divestitures: o Politically easier o No impact on scale economies  Drawbacks o Incentives to sustain spot prices above profit max level to support future long term negotiations o Less effective (given the volume) Comparison

Market power mitigation: price cap €/MWh Demand Supply Price increase €/MWh MWh Demand Supply Supply net of withholdng Price increase MWh Withheld capacity  With-holding as the largest impact on prices when the system is tight  An overall price cap (below VOLL) mitigates market power but …  Results in «missing money»

 The generator’s bid in the spot market is constrained every time the generator’s is assessed to enjoy «great» market power Market power mitigation: bid mitigation Phase 1: Screening Example: (PJM) any three generators pivotal to solve a constraint in a 15 min period? Phase 2: Mitigation Cost-based bids enforced on the three jointly pivotal generators

You may want to take a look at: The economics of electricity markets, Pippo Ranci and Guido Cervigni Eds, Elgar, 2013 I can be reached at: