Your Competitive Edge In Energy

Designing Liquid, Transparent, Reliable Wholesale Markets Nigel Evans Executive Vice President Head of Global Energy Market Strategy

Competitive Wholesale Markets - Building Blocks Full separation of transmission/distribution (from generation and retail supply) Full retail supply competition Properly incentivised, for-profit SO Regulation of behaviour based on financial- markets best practice and application of competition laws And remember Markets are not “designed”

Establishing competitive wholesale markets - the Pool approach Establish a market at a specific time day-ahead Solicit offers and bids from generators and customers Offers designed to reflect generators’ costs (multi-part structure, start-up and no-load costs, minimum run-time, ramp rates and other technical parameters) Complex algorithms used to calculate a single (hourly or half-hourly) clearing price Examples: Australia, England & Wales Pool (1990), FERC standard wholesale market design

The day-ahead Pool approach does not work Repeated daily auction encourages leader-follower pricing strategies with few participants competing to set clearing prices The complexity of pricing algorithms frustrates transparency Encouraging significant demand-side participation can be problematic Straightforward to manipulate prices (problem if the Pool is compulsory, even worse if it’s not) Difficult to hedge price risk (the complexity of pricing algorithms and ability to manipulate prices discourages non-physical players from participating in market) Disconnection between day-ahead and real time markets

So what should you do? Enable all market participants to trade in whatever way they choose right up to real time Typically participants may trade: OTC via exchanges (cleared or otherwise) Tenors from years to hours (or less) Participants will decide terms on which they trade, but will typically use a “pay-as-bid” approach “ I offer to sell you 100 MWh at $21/MWh..Agreed”

So what should you do? Cont... Transactions take place because “Longs” will wish to sell “Shorts” will wish to buy and“Traders” will wish to trade Market prices emerge (via price reporters, exchanges, or even mandated reporting) on the basis of prices at which transactions take place Algorithms play no part in establishing market prices

Maintaining balance in real time SO (RTO) has responsibility to maintain balance in real time SO incentivised to balance economically using a broad range of forwards, options and real time actions SO market power curtailed through: -separation (and ownership) -collars on incentive revenues/losses -market information disclosure obligations

Maintaining balance in real time. Cont.. Out of balance market participants cashed out based on costs of balancing actions (excluding constraint/frequency response action) Need for on-going surveillance for exercise of locational/temporal market power

How does this work in practice? New Electricity Trading Arrangements (NETA) replaced England & Wales Pool in March 2001 Power exchanges/brokers have emerged Price reporting has developed Liquidity has increased Volumes bought/sold in the (real-time) balancing mechanism have remained low (2% of physical) (and in the over-supplied market wholesale prices have fallen)

Trading Period BM IS T-3 ½ hrsT-One DayT-One MonthT-One Year Bulk OTC Trading Standardised Products Option Contracts Other Financial Products PX Trades The New Electricity Trading Arrangements (NETA)

Exchange Liquidity

Presented to the National Energy Marketers Association Annual Conference June 21, 2002 Washington, DC © 2002 Caminus Corporation