2. Basic Elements of Electricity Market Design dr. Péter Kaderják Director, REKK Workshop on Regulatory Monitoring of the Electricity Sector January 31 - February 2, 2006, Almaty, Kazakhstan

3. 2 ELECTRICITY MARKETS: BUILDING BLOCKS Unbundling of the ‘essential facility’ from competitive activities Networks Regulated and non-discriminatory access to the networks Establishing independent regulator Enforce competition in generation and supply

4. 3 QUESTIONS How generation is dispatched in the different models? How generators can recover the costs of their operations? What kind of contracts and markets characterize the different models?

5. 4 VERTICAL INTEGRATION

6. 5 Central dispatch of generation (technical optimisation) IPPs can not sell to anyone Costs are recovered at the utility level and revenue is redistributed Investment decisions are made through a central planning process Risks of investments are passed through to consumers by a cost-of-service regulation MODEL CHARACTERISTICS

7. 6 SINGLE BUYER

8. 7 Main purpose is to introduce elements of competition in generation Dispatch of generation is done by the transmission company / Single Buyer Cost is recovered by the typical contract: a long term power purchase agreement (PPA) Rules for access to transmission for IPPs should be laid down MODEL CHARACTERISTICS

9. 8 SB purchases an option to run a generation plant Ensures availability and provide security of supply Ensures investor security – quasi state guarantee Consists separate payments for separate products provided under PPA: capacity, energy and ancillary services Crucial element is the sharing of risks Has a major effect on potential stranded cost issues Might seriously object supply side competition in the short and middle run PPA – WHAT IS IT ABOUT?

10. 9 IPP ImportsExports MVM state single buyer System Operator Transmission grid Utility wholesaler Baseload nuclear plant Secondary reserve plants DisCo PPA Former Strucrure of the Hungarian Industry

11. 10 Security Investor security Security of supply at minimum wholesale price risk Availability if proper incentives are present Moderate political risk (e.g. coal mines) Can offset short-run market power Removes incentives to hold back capacity Can deal with peak load periods efficiently POTENTIAL BENEFITS OF PPAs

12. 11 Costs Financial / stranded costs (too expensive contracts) Political costs associated with renegotiations Conserve inefficient capacities Impede market liberalization Block domestic supply Block the development of system- and ancilliary services’ market Dispute boils down to the trade-off between security of supply and economic efficiency in supply POTENTIAL DRAWBACKS OF PPAs

13. 12 PPAs can be used in order to tackle security of supply and market power issues if applied in a limited scale Implicit state guarantees should be restricted behind PPAs Incentives for availability should be structured properly Limit contracts in time and scope in order to arrive at fair risk sharing between partners In the context of privatization, short-run fiscal needs might be detrimental to meet the above mentioned requirements SOME LESSONS

14. 13 WHOLESALE COMPETITION

15. 14 RETAIL COMPETITION

16. 15 Moves the „purchasing agency” down to low voltage level Multiple products sold for multiple buyers/markets Various contractual arrangements Dispatch is based on (scheduled) contracts Condition: Open access to the grid MODEL CHARACTERISTICS

17. 16 MARKETS FOR GENERATORS Product of GeneratorPotential BuyerContract Energy (base-load, peak- load) EX, Pool, traders, DisCos, consumers Bilateral, standard, futures, etc. Balancing energyTSO/ISOBilateral CapacityEX, Pool, TSO/ISOBilateral, standard, futures, etc. Reserve capacityTSO/ISOBilateral Ancillary services (black start, reactive power) TSO/ISOBilateral

18. 17 Different markets might develop for different products Bulk electricity: Pool, Exchange, Bilateral / OTC Balancing electricity market Reserve and ancillary services markets Capacity markets Time / quantity differentiated products are traded on these markets Real-time, day-ahead, futures MARKETS FOR GENERATORS

19. 18 Obligatory participation for sellers and buyers Organization of market transactions and dispatch is centralized and integrated Bids - market clearing price determination – schedule – least-cost dispatch Liquidity, transparency, market power ORGANIZED MARKETS: THE POOL

20. 19 ORGANIZED MARKETS: THE POOL P Q P clearing MR Dispatched bids Non-dispatched bids

21. 20 DISPATCH IN THE ABSENCE OF A POOL Balance Group TSO Scheduling Dispatch Balancing market SCHEDULING G G G G C C C C

22. 21 Voluntary marketplaces for bulk power Can be considered as a specific Balancing Group Popular in Europe: British, Spanish, French, Dutch, German, NordPool, Austrian, Polish, Czech, Slovenia Standardized contracts and products Provide liquidity and transparency to the market players ORGANIZED MARKETS: ENERGY EXCHANGES

23. 22 „Public good”, centralized Balancing - „Real time” market Covers the differences of aggregate schedules and actual load Normal case: 1-2% of energy is traded here If more, there might be a problem with pricing (California, Poland) Major problems: market power, lack of free capacity on „normal” markets ORGANIZED MARKETS: BALANCING MARKET

24. 23 A fear that generators are not fully compensated from other revenues for having their capacity available – security problem Special capacity markets are created British Pool, OMEL, PJM, California? Discussion on whether Europe needs such markets ORGANIZED MARKETS: CAPACITY MARKETS

25. 24 MAJOR OBSTACLES TO EFFICIENT COMPETITION 1.Restrictions on free choice of consumers or generators 2.Restrictions on efficient import competition 3.Cross subsidisation between regulated and market activities 4.Collusion, excercise of market power of a small number of players on a market 5.Safeguards against competition for certain market players 6.Distortions in fairly priced and non-discriminatory network access 7.Lack of important market institutions DEFINE AREAS FOR MARKET MONITORING