1. Pricing and Gaming in a Simple Electricity Market
Queen’s University Regulatory Economics Class Guest Lecture
November 16, 2017
November 14, 2017
Ontario Energy Board

2. David Brown Senior Advisor, Regulatory Policy David.brown@oeb.ca
November 14, 2017
Ontario Energy Board

3. Overview Deregulation in Electricity Concept of congestion in general
Potentially competitive sectors
Regulated natural monopoly sectors
Motives for restructuring
Concept of congestion in general
A simple electricity grid
Pricing, shadow prices, LMP
Ontario’s uniform pricing
Congestion side payments and gaming
November 14, 2017
Ontario Energy Board

4. Structure of the Electricity Sector
Demand bids
Dispatchable loads
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Ontario Energy Board

5. Deregulation in Electricity
Potentially competitive sectors
Natural monopoly regulated sectors
Motives for electricity deregulation: Official story
Transfer investment risk to private sector
Greater price and cost transparency
Benefits of competition
Motives for electricity deregulation: Real story
Political lobbying by industrial loads
November 14, 2017
Ontario Energy Board

6. Congestion Generally
Economic Activity takes place via infrastructure networks. Examples are: road systems, telephony, gas pipelines, electric grid, the banking system, air travel system.
Some networks are “hard” like the grid, gas pipelines, road system. Some are “soft” like common languages e.g.., English, common software packages e.g., Microsoft Windows.
Mostly networks are in the background when we think of the activity that uses them – we take them for granted.
Congestion: reaching the capacity of the network to transmit whatever it transmits.
On March 29 of this year the OEB formally completed its transition to a self-funded crown corporation, after having been part of Ontario’s Ministry of Energy
Our job is to regulate the gas and electricity sectors in Ontario
In Canada energy is largely in provincial jurisdiction
Many of the roles played by your Federal Energy Regulatory Commission in the U.S. are played by regulatory agencies like the OEB in Canada.
We regulate the energy industries in Ontario within a policy framework established by the government and the Minister of Energy
While the government sets the overall policy direction the OEB is playing an increasingly important role in the development of energy policy in Ontario
Among other responsibilities of the OEB is to promote:
Economic efficiency in generation, transmission, and distribution
Communication within the energy sector and with consumers
We expect even more responsibilities will be coming our way when the government unveils new legislation next month that begins to reshape Ontario’s energy market
November 14, 2017
Ontario Energy Board

7. Gardiner and Lakeshore
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8. Two Regions Trading November 14, 2017 Ontario Energy Board P
Region 1 Region 2 Aggregate
S1: P = Q S2: P = Q
D1: P = 30 – 0.5Q D2: P = 30 – 0.25Q S2 S1 D2 D1
November 14, 2017
Ontario Energy Board

9. Two Regions Trading Pre-trade Region 1 Region 2 Aggregate Price 17.5
23 1/3
Quantity 25
26 2/3
51 2/3
Exports -
Imports
Trade 21
Quantity Supplied 32 22 54
Quantity Demanded 18 36 14
Trade with congestion
19 1/4
22 1/6
28 1/2
24 1/3
52 5/6
21 1/2
31 1/3 7
November 14, 2017
Ontario Energy Board

10. Congestion Generally
When the infrastructure is uncongested production is at its highest and there are no “congestion costs”. The quantity is produced at its lowest possible cost.
When trade is restricted (to 7 units in the example) or not possible there is a re-dispatch of production from lower cost to higher cost producers. The total produced is lower. There is a price difference between the two regions.
Starting from the no trade / no infrastructure position a social decision must be made as to how much capacity to build.
November 14, 2017
Ontario Energy Board

11. Congestion Generally
This decision has that “one size must fit all” characteristic of many public goods.
Thus the decision will tend to be made in the political arena.
Who will oppose larger capacity and who will support it?
Suppliers
Demanders
Region 1
Support
Oppose
Region 2
November 14, 2017
Ontario Energy Board

12. Congestion Generally
These types of issues arise frequently in regulatory economics
There is at least one very big example of a congestion story happening right now in North America with big implications for Canada
What is it?
A second one, less dramatic but still important
November 14, 2017
Ontario Energy Board

13. A Three-Node Electricity Grid
Figure 1
A Three Node Grid
NW NE S
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Ontario Energy Board

14. A Three-Node Electricity Grid
Figure 2
Dispatch with no constraints
26 2/3 MW
NW NE G2 = $30
G1 = $20
Injection = 80
53 1/3 MW
S Load = 80
November 14, 2017
Ontario Energy Board

15. A Three-Node Electricity Grid
Figure 3
Injections at both nodes
33 1/ = 23 1/3 MW
NW NE G2 = $30
G1 = $ Injection = 30
Injection = 100
(Max capacity)
66 2/ = 76 2/3 MW
33 1/ = 53 1/3 MW
S Load = 130
November 14, 2017
Ontario Energy Board

16. A Three-Node Electricity Grid
The market price would be $30 given a demand of 130 MWh.
November 14, 2017
Ontario Energy Board

17. Shadow Prices November 14, 2017 Ontario Energy Board Figure 4
SNW = / = 23 1/3 MW SNE = 30
NW NE G2 = $30
G1 = $ Injection = 30
Injection = 100
66 2/ = 76 2/3 MW
33 1/ = 53 1/3 MW
S Load = 130
Ssouth = 30
November 14, 2017
Ontario Energy Board

18. Shadow Prices The Shadow Price
The Shadow Price at a node is the marginal cost of serving another MW of load at that node. In a system with no transmission constraints or line losses each node could be served by the generator that is at the margin in the merit order. Thus the shadow price at all nodes would be that generator’s offer price.
If transmission constraints are present then generation will have to be re- dispatched around the constraint – the merit order will have to be departed from. This will result in locational differences in shadow prices.
November 14, 2017
Ontario Energy Board

19. Transmission Constraints
Thermal Limit: exceed this limit and the line might melt
Security Limit: exceed this limit and the line would not be able to handle the extra surge that might occur under some other contingency. This type of limit will be more restrictive than a thermal limit.
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Ontario Energy Board

20. Transmission Constraints
Figure 5: A Transmission Constraint
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21. Re-dispatch Around the Constraint
Figure 6: Re-dispatch
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22. A Three-Node Electricity Grid
What will the shadow prices (SNW, SNE and Ssouth be with a corrected dispatch?
SNW and SNE are simple: 1 MWh of consumption at the NW and NE nodes can always be met with and extra MWh of production by the generators at those nodes
Ssouth is different: An extra MWh at South requires 2 more from NE and one less from NW.
November 14, 2017
Ontario Energy Board

23. Re-dispatch Around the Constraint
Figure 7: Re-dispatch
SNW = 20
SNE = 30
Ssouth = 40
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24. The Two Schedules Market Schedules and Dispatch Schedules
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25. The Two Schedules Market Schedules and Dispatch Schedules
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26. Ontario’s Uniform Price System
Although the intention at market opening in 2002 was to move to an LMP system, it never sat well with the Ontario government.
Also, it would have meant higher prices for consumers in southern Ontario – many of whom are politically influential.
November 14, 2017
Ontario Energy Board

27. Uniform Price System
It is actually referred to as the two-schedule, uniform price system
Market Schedule ignores congestion constraints – pretends we can operate as in Figure 2 here.
Dispatch schedule includes constraints – sets quantities for the generator but the price is set by market schedule. With load = 80, price = $20.
But what about G2 whose costs are $30?
November 14, 2017
Ontario Energy Board

28. Congestion Payments
G2 must be given a “constrained on” payment – pay the owner the profits he loses by not being able to actually carry out the market schedule:
G2’s market schedule is 0 output therefore 0 profit.
G2’s dispatch schedule is 10 MW. With MCP set at $20 in market schedule G2 loses $100.
Congestion payment is the operating profit he would make in market schedule minus the operating profit he makes in dispatch schedule
November 14, 2017
Ontario Energy Board

29. Uniform Prices and Two Schedules: Congestion Side Payments
Congestion payment = Operating Profit (Market Schedule) – Operating Profit (Dispatch Schedule)
Operating profit in the market schedule is defined as:
1) Operating profit(MS) = (MCP – Offer price) * Market Quantity = (20 – 30) * 0 = 0
Similarly operating profit in the dispatch schedule is defined as:
2) Operating profit(DS) = (MCP – Offer price) * Dispatch Quantity = (20 – 30) * 10 = -$100
Congestion payment = 1 – 2 = ) = $100.
More Generally Congestion payment = (MCP – Offer price) (Market Quantity – Dispatch Quantity)
November 14, 2017
Ontario Energy Board

30. Congestion Payment to G1
This payment is harder to understand
Because of congestion G1 can only produce 70 MW, not 80.
Pay G1 the difference between his market schedule profit and his dispatch schedule profit.
With Load = 80, MCP = 20 G1 gets no payment.
However if load was up at 130, then MCP = $30, and G1 will get a congestion payment.
November 14, 2017
Ontario Energy Board

31. Gaming of Congestion Payments
A big problem in this market is that generators can influence the size of the congestion payments they receive:
Congestion payment = (MCP – Offer price) (MQ – DQ)
If you are constrained on MQ < DQ. What can you do to increase the size of the payment?
If you are constrained off MQ > DQ. Same question…
November 14, 2017
Ontario Energy Board