UPTEC ES08 003
Examensarbete 20 p Februari 2008
Market Designs
A Survey and Analysis of Methods to Ensure Peak Capacity
Erik Gullberg
Teknisk- naturvetenskaplig fakultet UTH-enheten
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Ångströmlaboratoriet Lägerhyddsvägen 1 Hus 4, Plan 0
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Box 536 751 21 Uppsala
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018 – 471 30 03
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http://www.teknat.uu.se/student
Abstract
Market Designs: A Survey and Analysis of Methods to Ensure Peak Capacity
Erik Gullberg
The production and consumption of electricity must be in balance in order to maintain the frequency in an electrical grid. During peak loads this may be
troublesome to achieve due to lack of adequate production capabilities. Competitive electricity markets with price caps have a problem - insufficient revenues for peak production units which lead to mothballing or decommissioning of power plants.
Inadequate production capability is solved through design of the electricity markets which renders in incentives to operate these power plants.
This report analyzes the most common market designs with the Nordic countries of Finland, Norway, and Sweden in mind. The Nordic situation is used as the background for an evaluation of the impact of the chosen designs. The question of finding a market solution of the peak load problem is yet a prerequisite.
The conclusions are that a clear definition of what a market solution is, is needed in order to determine which design to prefer. The view on what to address as the problem makes a difference - treating the symptoms or the root causes leads to usage of different market designs as solutions. The Nordic countries may be better off by waiting to see the effects of the full penetration of the Automatic Meter Reading systems, which may reduce the peak loads by increasing the demand responsiveness.
The current market designs in the Nordic countries may also be sufficient while developing the market's demand response, and thereby not call for implementations of other market designs.
Sponsor: Fortum Generation AB ISSN: 1650-8300, UPTEC ES08 003 Examinator: Ulla Tengblad
Ämnesgranskare: Urban Lundin Handledare: Johan Linnarsson
Sammanfattning
I ett synkront elnät måste produktion och konsumtion vara i balans för att nätfrekvensen ska kunna behållas vid sitt riktvärde. I det nordiska elnätet är frekvensen 50 Hz. Om konsumtionen överstiger produktionen minskar nätfrekvensen och vice versa.
En topplastsituation är ett tillfälle då konsumtionen når väldigt höga nivåer. I Norden sker detta vintertid, oftast i januari. I det nordiska fallet beror topplaster till stor del på
uppvärmningsbehov, men kan i andra delar av världen istället bero på ett kylbehov och då sommartid. Topplastsituationer brukar vanligtvis kopplas till så kallade statistiska tioårsvintrar med väldigt låga utomhustemperaturer. En sådan situation kan i ett nordiskt fall röra sig om tiotals timmar upp till ett par dygn. Topplastkapacitet är således
produktionskapacitet som är avsedd för topplastsituationer. Detta innebär, i jämförelse med normala förhållanden, ett fåtal timmar i drift och höga omkostnader för den produktion som är avsedd att hantera detta topplastbehov.
Dagens nordiska elmarknad är konkurrensutsatt och produktionsoptimerad. Den avreglering som skedde under 1990-talet i Norden medförde att delar av
produktionskapaciteten lades i malpåse eller försvann helt. Tidigare fanns en viss överkapacitet som man delvis ville trimma bort genom denna liberalisering. Problemet som uppstår på liberaliserade elmarknader är helt enkelt att produktionskapacitet kan saknas vid extrema situationer. Detta kommer sig av att elproducenter inte finner det lönsamt att ha produktionskapacitet som kanske används ett fåtal timmar var tionde år.
Konkurrensen driver producenter att göra sig av med dessa kraftverk.
Den nordiska elen säljs till stor del på en spotmarknad, där elhandelsbolag köper och producenter säljer. Mindre konsumenter köper normalt sett sin el med avtalade priser.
Detta gör att en stor del av elkonsumtionen inte är känslig för prisspikar på
spotmarknaden. En följd av detta är att konsumtionen förblir hög trots extremt höga priser på spotmarknaden vid bristsituationer och därmed bidrar till svårigheterna att balansera produktion och konsumtion.
Syftet med elmarknadsdesign är att utforma elmarknaden på sådant sätt att man minskar eller eliminerar risken för t.ex. brist på produktionskapacitet vid topplastsituationer. Det handlar alltså om att reglera elproduktionen och elmarknaden på olika sätt så att kapacitet finns vid behov.
Denna rapport analyserar marknadsdesigner för att utröna fördelar och nackdelar ur ett nordiskt perspektiv vid en eventuell implementering. Idag förs diskussioner om hur topplastproblem skall lösas i framtiden i det nordiska elnätet, där dessa designer utgör möjliga lösningar. Marknadsdesigner som används runtom i världen skiljer sig åt inte bara vad gäller implementeringsrelaterade parametrar utan även i fundamentala avseenden. I rapporten genomförs en kvalitativ analys där olika effektmarknader,
kapacitetsbetalningar, en ren energimarknad (med fungerande efterfrågerespons), samt de nuvarande åtgärder som finns implementerade i Finland, Norge och Sverige jämförs med varandra.
Resultatet visar att de nordiska länderna har relativt sett okomplicerade och adekvata system implementerade för att handskas med topplastsituationer. Om man dessutom har en ren marknadslösning som mål kan det vara vettigare att fortsätta med nuvarande implementeringar istället för att införa en annan och mer komplicerad marknadsdesign.
Detta på grund av att vi eventuellt låser oss in i ett system som kan vara svårt och dyrt att ta sig ut ur. En stor anledning till att problem med topplastsituationer existerar är
avsaknaden av efterfrågerespons vid prisspikar. Kommande installationer av fjärravlästa mätare i Norden kan spela roll i detta fall då dessa mätare tekniskt sett kan möjliggöra efterfrågerespons och därmed en ren energimarknad som marknadslösning. Om en marknadslösning eftersträvas utgör definitionen av detta en viktig del för ens val av marknadsdesign. Olika designer har olika stor inverkan på marknader i fråga om till exempel grad av reglering. Även synen på vad som utgör själva problemet har betydelse för valet av marknadsdesign. Ser man till bakomliggande orsaker till effektbrist som problemet, istället för enbart effektbrist i sig självt, blir valet av design annorlunda.
Table of Contents
Page1 INTRODUCTION_____________________________________________________ 1 1.1 Deregulated markets and peak load capacity _________________________________ 1 1.2 The Nordic situation _____________________________________________________ 2
2 PURPOSE AND PROBLEM FORMULATION _____________________________ 4 2.1 Purpose ________________________________________________________________ 4 2.2 Problem formulation _____________________________________________________ 4 2.3 Delimitations____________________________________________________________ 4 3 METHOD ___________________________________________________________ 5
3.1 A Qualitative Analysis ____________________________________________________ 5
4. BACKGROUND AND THEORY ________________________________________ 6 4.1 Power and energy________________________________________________________ 6 4.1.1 Power Generation ______________________________________________________ 6 4.1.2 The varying need for power ____________________________________________________ 8 4.1.3 Frequency, energy and power consumption ________________________________________ 9 4.2 Peak Loads and Peak Load Capacity_______________________________________ 10 4.2.1 Extreme situations - When supply cannot meet demand______________________________ 10 4.2.2 Definitions of Operational Reserves and Peak Load Reserves _________________________ 11 4.3 Market Places __________________________________________________________ 13 4.3.1 Nord Pool _________________________________________________________________ 13 4.3.2 The Regulating Market _______________________________________________________ 14 4.4 The problem of Missing Money ___________________________________________ 15
5 MARKET DESIGNS _________________________________________________ 19 5.1 Demand Response - An essential part ______________________________________ 19
5.1.1 Demand Side Management and Demand Response _________________________________ 19 5.1.2 Automatic Meter Management and Automatic Meter Readings________________________ 22 5.2 Proposed Market Designs ________________________________________________ 23 5.2.1 The Energy Only-model ______________________________________________________ 23 5.2.2 Capacity Payments __________________________________________________________ 26 5.2.3 Energy Call Options _________________________________________________________ 28 5.2.4 Capacity Markets - ICAP and Succeeding Approaches ______________________________ 31 5.2.5 Forward Capacity Markets ____________________________________________________ 36 5.2.6 Capacity Subscriptions _______________________________________________________ 39 5.3 The Nordic Market Designs ______________________________________________ 41 5.3.1 Finland ___________________________________________________________________ 41 5.3.2 Norway ___________________________________________________________________ 45 5.3.3 Sweden ___________________________________________________________________ 47
6 ANALYSIS _________________________________________________________ 51 6.1 Analysis Criterions______________________________________________________ 51 6.2 Designs________________________________________________________________ 54
6.2.1 Energy Only _______________________________________________________________ 54 6.2.2 Capacity Payments __________________________________________________________ 55 6.2.3 Energy Call Options _________________________________________________________ 57 6.2.4 Capacity Markets - ICAP/LICAP/RPM __________________________________________ 58 6.2.5 Forward Capacity Market _____________________________________________________ 60 6.2.6 Capacity Subscriptions _______________________________________________________ 61 6.2.7 The Finnish Capacity Reserve _________________________________________________ 62 6.2.8 The Norwegian RKOM_______________________________________________________ 64 6.2.9 The Swedish Capacity Reserve_________________________________________________ 65 6.3 Demand Response as an alternative? _______________________________________ 67
7 DISCUSSION _______________________________________________________ 70 7.1 Analysis approach ______________________________________________________ 70 7.2 Problem formulation ____________________________________________________ 70 7.3 Analysis Criterions______________________________________________________ 71 7.4 Further studies _________________________________________________________ 72
8 CONCLUSIONS _____________________________________________________ 73 9 ACKNOWLEDGEMENTS_____________________________________________ 76 10 LIST OF REFERENCES_____________________________________________ 77 APPENDICES ________________________________________________________ 82 Appendix I - Glossary over words and abbreviations used in the report. ____________ 82 Appendix II – Simplified Matrix of results _____________________________________ 84 Appendix III – Summarizing Matrix of results__________________________________ 85
1 INTRODUCTION
1.1 Deregulated markets and peak load capacity
Electricity markets and systems have historically had a strong coupling to
governmental regulation, but during the last decade we have seen a change. Most countries have initiated a process of deregulating their electricity markets. Some are relatively mature markets; others are still struggling with problems. The general trend though, is a development towards more market inspired liberalized solutions.
The development towards liberalized markets has generated critical issues that were not apparent before deregulation. The level of installed capacity in highly regulated systems was in general too high, which resulted in high costs. The market economy, or more specifically competition, drives market actors to rationalize their production in order to lower the costs. The effect of liberalization of electricity markets has driven the actors to reduce installed capacity to better suit the overall needs during normal demand. All in all, this has rendered in more adequate price levels and removed de facto subsidizes, but it has also generated a potential danger.
In the light of this, the problem with deregulated markets is connected to the electricity demand, which varies, and can vary a lot depending on mainly outdoor temperature and time of day, but also on production related problems. A serious situation arises when demand exceeds supply, since electricity can not be stored and net frequency has to be maintained. Given that the margins for having an adequate amount of installed power at all time to meet demand is lower in a deregulated market, this becomes an essential question to handle. The part of the installed and available power intended to handle these extreme situations is called peak load capacity.
The liberalized electricity markets around the world addresses this problem using different strategies. There are a number of existing market designs in use, some in combination with another or slightly modified.
1.2 The Nordic situation
The Nordic countries are today interconnected with each other to such an extent that large cross-border power flows are a daily occurrence. This coupled with the fact of a shared electricity market place - Nord Pool - makes it relevant to speak of a Nordic electricity market instead of several separated national markets.
The Nordic electricity market is one of the most liberalized and mature. The transformation began with the Norwegian liberalization in 1991, following with Sweden in 1992, Finland in 1995, and Denmark in 1998.
The power generation in the Nordic countries should be viewed as a whole instead of each country by itself in separation, due to the shared market. The installed capacity is approximately 56% hydropower, 23% nuclear, 9 % coal and a smaller amount of bio, gas and wind.1
The Nordic countries have relied on imports as well, mainly from Russia, but also from Poland and Germany. The availability of imports and exports is used
extensively, and is a stabilizing factor for the overall security of supply.
Nordel is the collaboration organization of all Nordic national Transmission System Operators (TSO). This organization (among others) makes regular forecasts for energy and power consumption in the various countries, and as well as the Nordic area as a whole.
In one of their latest forecasts2 (see table) we can see figures for an average winter in year 2010/2011 as well as for a so called ten year-winter. The figures may look
1 Nordel - annual statistics 2006
2 Nordel, Power and Energy Balances 2010-2011
promising, but transmission constraints between the Nordic countries and eventualities regarding large units tripping are still issues not to be forgotten.
2010/2011 Normal 10-year Maximum
available production
(MWh/h) 78300 78300
Peak Demand
(MWh/h) 70400 74000
Margin 7900 4300
Tab1e 1: Forecasted aggregated peak demand and maximum available production in the Nordic countries for the winter of 2010/2011. Source: Nordel annual statistics.
2 PURPOSE AND PROBLEM FORMULATION
2.1 Purpose
The purpose of this report is to survey and analyze market designs aimed to ensure peak load capacity and point out factors, which could have substantial influence on the system, from a Nordic point of view, and thereby help to clarify and identify available options for the Nordic market.
2.2 Problem formulation
• Which market designs, both already in use and pure theoretical, for ensuring peak load capacity exists, and what are their properties?
• Is there a need to make a distinction between different market designs, regarding the results of what an implementation would do?
• How is the problem of ensuring peak load capacity addressed outside the Nordic market?
• Is there an alternative in not having a specific market design?
• Are there market designs which are more suitable for the Nordic electrical system than others given our current situation?
2.3 Delimitations
This report will focus on the Finnish, Norwegian and Swedish systems, and thus not take Denmark or Iceland into consideration. The main reason for this is that Denmark and Iceland do not have the same kind of problems that Norway, Sweden and Finland have.
They are also not synchronously connected to the rest of the Nordic countries. When referring to The Nordic Countries later on in this report, it will in most cases (regarding actual market designs) only include Finland, Norway and Sweden. In instances of transmissions, grids and overall condition of the Nordic system, Denmark is implicitly included, but not further elaborated.
A quantitative analysis (of energy prices or alike) has not been conducted, mainly due to the difficulty of building a relevant model.
3 METHOD
3.1 A Qualitative Analysis
This work is a desk job primarily based on written reports on market designs. Information has also been collected through attendance in Elforsk Market Design Conference 2007, along with several interviews. The approach of the thesis has been a qualitative analysis in all sections.
4. BACKGROUND AND THEORY
4.1 Power and energy
4.1.1 Power Generation
The Norwegian production is essentially only hydro based, whereas the Swedish production is a, near equal, mix of hydro and nuclear with elements of other kinds of thermal power plants3. The Finnish production is also a mix of hydro, nuclear and other thermal power, but is more evenly distributed. Denmark's production mix is mainly three quarters of thermal and one quarter wind power.
MW
Nordic capacity structure
0 5 000 10 000 15 000 20 000 25 000 30 000 35 000
Denmark Norway Sweden Finland
Wind power Gas turbines, etc.
Condensing power CHP, district heating CHP, industry Nuclear power Hydro power
Source: Nordel
Total Nordic capacity 92 300 MW (31 Dec 2006)
Figure 1: Nordic capacity structure.
3 Mostly bio-fuelled CHP.
The generation capacity in the Nordic countries has been adjusted by the effects of the market liberalization process. The amount of installed capacity4 decreased after the liberalization took place, to better match the demand. This rendered in both
decommissioning and mothballing of mainly oil-fuelled power plants (which can be seen in year 1998 in the figure below). The Swedish decommissioning of the nuclear reactor Barsebäck 1, in 1999, is a factor which can explain the dip in the graph below for year 19995. In 2005 also Barsebäck 2 was decommissioned.
Installed Power, Available Power and Peak Loads
0 5 000 10 000 15 000 20 000 25 000 30 000 35 000 40 000
1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Finland Norw ay Sw eden
[MW]
Installed Pow er Peak Load Available
Figure 2: Installed capacity, available capacity and Peak Loads in Finland, Norway and Sweden. Source: Nordel.
4 There is a difference between available capacity and installed capacity. The latter corresponds to the theoretical maximum power production in a producing unit, where the former is basically the amount of this installed capacity that can be used for production at a specific time.
5 Stenungsund, Karlshamn, Aros G3 and Marviken (total of 1931 MW) was decommissioned in 1998,.
Barsebäck 1 and 2 was 600 MW each. Source: Nordel statistics 1998
0 20 40 60 80 100 120 140 160
Denmark Norway Sweden Finland
Wind
Gas turbines, etc.
Condensing CHP, district heating CHP, industry Nuclear Hydro
TWh/a
Power generation in the Nordic region in 2006
Source: Nordel
Total Nordic generation 384 TWh in 2006
Figure 3: Nordic Power Generation.
4.1.2 The varying need for power
The consumption of electricity is not static but constantly fluctuating. One can see typical oscillations of demand and supply in a graph over longer periods where peaks occur per day, week, month and year.
A normal year in Norway is shown in the figure below. The behavior is the same for Sweden and Finland, with slight variations. The underlying causes of variations in consumption are varying outdoor temperature and social behavior. Peak loads in the Nordic countries occur wintertime when the need for warm indoor climate is higher.
The same behavior can be seen in regions with extremely hot weather during summertime and mild winters, where the peaks instead are found summertime. Peak loads are in this case mainly connected to a widespread use of air conditioning.
Figure 4: One year of production and consumption in Norway. Blue:
production, brown: consumption6. Scale is in MW. Source: Statnett
As a general trend, maximum power consumption as well as total energy consumption increases every year.
4.1.3 Frequency, energy and power consumption
When a sudden change in available generation or consumption occurs the first thing that happens is that the reduction or increase of need for power will affect the rotational masses in the system, which contains stored energy and thus functions as a battery.
Depending on if the load in the grid increases or decreases the rotational masses either slow down or rotate faster. This will lead to a change in the frequency, which is
monitored and incorporated into a regulating system that adjusts the mechanical power accordingly. This procedure is called primary regulation. The amount of available primary regulating resources in the Nordic system is 600 MW7. This figure is derived from the pre-agreed regulating stability in the Nordic system, which is 6000 MW/Hz and the predefined limit of deviation of 0.1 Hz during normal operation. The responsibility for these 600 MW is shared between the Nordic countries.
6 Statnett, Production and Consumption.
7 Fingrid, Maintenance of frequency.
When the primary regulation has reinstated balance in consumption and generation, the frequency has to be restored. This is achieved with secondary regulation, which is a manual activation of generation capacity in order to restore frequency.
Maintaining the frequency of 50 Hz8 in the grid is crucial. This has to do with how synchronous engines and generators operate. If the frequency deviates too much they will stop working. When a large deviation occurs it might render in a collapse of the whole electrical system.
4.2 Peak Loads and Peak Load Capacity
4.2.1 Extreme situations - When supply cannot meet demand As we have seen, the power production and consumption have to be close to equal in each instant. It is almost impossible to control the consumption today due to the lack of both technological and social reasons. This means, since generation capacity is a scarcity, that situations where supply cannot meet demand is possible if we for example are
experiencing a very cold winter or if a sudden shortfall occurs in a larger power plant.
The overall aim is to maintain grid stability, i.e. maintaining frequency and voltage in order to prevent a collapse of the electrical system. As discussed earlier, large electrical engines are sensitive to changes in frequency due to design, and they will stop
functioning if not fed with high quality9 electricity. Failure of electrical engines may result in a chain reaction which will further spur a system wide collapse, with a possible end result of a blackout. Fortunately there are several technical solutions to prevent this from happening. However, history has shown us that large blackouts can occur. The (partial) blackout in Sweden in 23rd of September 2003 is an example of this
8 This depends on design. E.g. in North America the frequency is set to be 60 Hz.
9 High quality electricity may be defined as electricity that is both within range of predefined limits for frequency and voltage levels, but also the level of reliability of deliverance.
phenomenon and shows that unlucky circumstances can generate severe problems even in a relatively well maintained grid with adequate technical safe guards10.
System operators are constantly monitoring frequency and voltage in the electrical grid.
They are also estimating near-future consumption and generation. If a TSO's estimation raises alert to a potential situation of power shortage, the TSO can invoke several countermeasures. If generation cannot be adjusted to match demand so-called rolling blackouts or load shedding 11 can be used as a last resort.
4.2.2 Definitions of Operational Reserves and Peak Load Reserves Regarding power generation reserves, one has to be aware of the existence of several definitions. Therefore what is included in a definition may vary.The definition used in the Nordic countries separates Peak Load Reserves completely from the "normal" operational reserves.
The operational reserves are divided into:
1) Automatically activated primary reserves for frequency regulation and momentary disturbance regulation.
2) Manually activated secondary reserves which are used for fast disturbance regulations, forecast errors and congestion management.
Peak Load Reserves are defined separately as reserves designated for times when demand is near exceeding the available production capacity. Operational reserves are not designated for handling Peak Loads at all in the Nordic system, and are supposed to be in place even at peak load times.
10It is not fair to compare Nordic grids to, e.g. North American grids since they are not in par with each other regarding technical standards. The US and Canada has experienced blackouts which have been given a lot of attention and this has a lot to do with the quality of their infrastructure.
11 The TSO orders disconnection from the grid for an area during a period of time to reduce the total load.
There is no real practical difference between these two, other than usage of names depending on how much
"panic" is involved in the decision to invoke it.
The European association of continental TSOs -Union for the Co-ordination of Transmission of Electricity, UCTE, defines reserves in a slightly different way12. There are three levels of operational reserves by their definition.
1) Primary control reserves.
2) Secondary control reserves.
3) Tertiary control reserves.
The first two levels, primary and secondary reserves, basically fill the same purpose as the equivalents of Nordel's definition13. The "primary control reserve" is used as an automatic response to frequency deviations and to cover for momentary disturbances.
The "secondary control reserve" is used as frequency restoration, to maintain power flow between control areas and to compensate for loss of generation. There is a third "tertiary control reserve" which, automatically or manually activated, will be used mainly as a means of securing an adequate level of secondary control reserves (whenever they are or have been used).
The difference between the two ways of defining reserves is that Peak Loads are
specifically made an issue of in Nordel's definitions14. In UCTE's definition peak loads of course occur, but not as a specific event in themselves, and they are regarded as normal elements of the daily load and assumed to be taken cared of within the three levels of operational reserves alone.
The background for the use of different definitions of reserves is based on the difference between the shape of the Nordic and the continental power consumptions. The Nordic countries are, both due to seasonal changes, exposed to larger variations in outdoor temperatures than continental countries are, but also due to larger usage of electrical heating. This means that situations can occur where power consumption rises to relatively much higher levels than compared to the continental variations. The continental systems experience peaks at a daily basis instead, and this is taken cared of within the range of their definition of reserves.
12 UCTE, Operation Handbook Glossary
13 Nordel, Nordic Grid Code,
14Nordel, Nordic Grid Code
4.3 Market Places
4.3.1 Nord Pool
In 1993, after the liberalization process took place in Norway, the Norwegian system operator Statnett established a market exchange for electricity trading - Nord Pool. It has since then grown, and is now the common market place for all Nordic countries, except Iceland. The number of members at Nord Pool has reached 374 at the time of writing this report.
The market place consists of a spot market - Elspot, an after spot market - Elbas and a market for financial derivates. Nord Pool also offers a clearing service for bilateral deals made between market players.
Spot market
The physical spot market has the highest liquidity of all electricity markets in the world.
It had a turnover of 251 TWh in 2006, which is about 61% of total consumption. The turnover on the financial market was 766 TWh the same year.
Trading is conducted through offers which render in supply and demand curves which clear a market price. There is a gate closure at 12.00 hours for bids applying to each hour of the day after. Based on all bids, supply and demand curves are calculated and the market clears at a price set for each hour, which is then valid for the following day.
Elspot generates a system wide price, as well as specific Elspot area prices. The current Elspot price areas are: Sweden, Finland, Norway -1, 2, 3, and Denmark -1, 2. There have lately been discussions on whether Sweden should be divided into more price areas or not15.
Elbas
If changes in production or consumption either have happened or are likely to happen after the spot price has been set, market players have the option of correcting the
15 Energimarknadsinspektionen, et al. POMPE.
difference between the later (and more accurate) estimation and the initial bid by trading on Elbas market. Elbas can of course be used primarily for making profit, instead of only trying to avoid having imbalances. Trading, for each relevant hour the following day, begins at 15.00 hours the day before and is available up to one hour before delivery hour.
Only Sweden, Finland and East Denmark operate at Elbas at the moment. The Norwegian market players will however soon be allowed to trade on Elbas. The opening is planned to the first half of 2008 by Statnett16
Financial market
Nord Pool features a financial market as mentioned. On this particular market financial derivates like forwards, futures and options are traded. This market is mainly used for hedging purposes by market players. Nord Pool also provides an OTC-market where bilateral contracts can be made.
4.3.2 The Regulating Market
The system operators have some options for maintaining an acceptable frequency.
Depending on the outcome of the preceding trading on Elspot and Elbas together with other variations in consumption and production, it may be necessary to adjust the frequency by activating or deactivating power production. This procedure is called up- and down-regulation, and is a part of the secondary regulation which makes use of secondary reserves described earlier. Power generating utilities usually participate in these markets17 and provide their respective TSO with bids for available regulating power for each hour.
Svenska Kraftnät (SvK), Fingrid and Energinet.dk18 use a pricing system which has two different prices; one price for up-regulation and another for down-regulation. Norwegian
16 Nord Pool exchange information, No 33/2007.
17 The regulating markets are provided by each national TSO for its own country. Trading between countries is maintained by the TSOs themselves.
18 The Nordic TSOs.
TSO Statnett uses a single price for both up- and down-regulation. The Nordic system operators are also buying regulating power amongst themselves when they need power.
The market for primary regulation differs a bit between the Nordic countries. In Sweden producers provide bids for the market to the TSO both on a weekly basis and at hourly basis, whereas in Finland it is yearly contracts instead. Nordel has proposed a common system for the regulating market, and a harmonization is to take place by 1 January 200919.
Day before delivery Day of delivery Day after delivery
Adjustment Elspot
12:00 15:00
Balance adjustment Elbas
Delivery hour
Regulation power 12:00
Figure 5: Time scale for buying and selling at the electricity markets on Nordpool
4.4 The problem of Missing Money
Why does not the market supply an adequate level of peak load capacity by itself? This question is natural to ask after the initial problems are presented and defined. The trivial answer is that generators do not receive large enough revenues to find it profitable to operate peak load units. But why is this case?
The problem originates in the nature of peak load itself. Due to how peaks are distributed over time, these power spikes when peak load units are needed, may only amount to a
19 Nordel, News release 2007-02-14.
few hours each ten years or so. It is during these few hours generators are supposed to collect revenues to finance the peak load unit in use.
Generators on a liberalized electricity market do not provide electricity as a pro bono service. The problem of insufficient revenues must be seen from a long run-perspective that takes both fixed and variable costs into consideration. It is not sufficient to only look at having variable costs covered in the short run. Production of electricity has to be conducted in such a manner that profit can be made, or otherwise there would be no reason to produce in the first place, at least from a strictly economical point of view20. In order to collect necessary revenues to cover both fixed and variable costs - for a specific peaking unit - the price will have to rise to a level considerably higher than variable cost. The revenues from this higher cost are usually referred to as scarcity revenues and are a necessity to get a peak load unit economically sound. It can be exemplified in an equation:
urs NumberOfHo ice
Spot VarCost
FixCost
TotalCost = + ≤ Pr *
This must be valid in the long run if a power plant is to be kept from being
decommissioned or mothballed, or being built in the first place. A side note is that the fixed costs for peak load capacity are usually minimized by being moved into variable costs due to natural reasons, i.e. competition drives generators to install typical peak load units, with lower fixed costs, instead of having base load units with extremely high fixed costs21, dedicated to peak load production22. There is a connection between the amount of production hours and the cost distribution of capacity in a competitive market.
20 A power utility can of course produce electricity with a non-economical unit due to reason like e.g.
goodwill, but a discussion around such issues are not within the scope here.
21 That is, these hypothetically high prices should act as incentives for competitors to install capacity with higher variable cost but with a much lower fixed cost and thus being able to compete in a long run - which the "base load"-peak producer would not be
22 Having a base load unit producing only in peak load situations would mean that the revenues needed to be collected would be much higher than compared to operating, e.g. a gas turbine.
Fixed Costs
Peak Load Capacity Base load
capacity
Variable costs
Figure 6: A simplified and generalized relationship for Base Load and Peak Load in regard to fixed and variable costs. Linearity is only for show in the graph, and not to be assumed in real cases.
The problem we started with in this section arises when these scarcity revenues are not allowed to be collected. The perhaps most obvious cause to this is politically enforced price caps, which are intended as protection for consumers against extreme prices.
Another important factor is offer caps intended to reduce market power abuse by
producers. There are other market power mitigation mechanisms that also add to this (as well), but the aim here is only to point out why the problem arises.
It is probably safe to say that market altering mechanisms that suppress prices (either direct or indirect) without affecting demand contribute to the missing money problem.
Energy Price
Base load and Normal Revenues Peak Load with both
Normal and Scarcity Revenues
Lost income / Missing money
8760 Hours Price
cap
Figure 7: Spot price as a function of time. This shows an approximate distribution of how the revenues are connected to the time of operation at varying prices.
The issue of missing money is not only a problem to existing production units, which normally are mothballed when the revenue stream decreases. Seen from an investors' point of view, it is rather the expectation of missing money that reduces the will to invest in peak load units - risk-aversive behavior in other words.
As we shall see, not all market designs address this problem. Those that do, do it with different approaches.
5 MARKET DESIGNS
A market, normally defined by economists, is something that emerges on its own and is not in need of construction. The electricity markets are however different. Due to the physical constraints in the form of instantaneous production and usage, natural
monopolies, large entry barriers for new generators, etc, electricity markets are "created"
in a way. Most people in the sector agree on the prerequisites of governmentally
regulation as a fundament for this kind of markets. Whether it is possible or not to see a complete free-market solution, is not a part of this thesis. It is however of interest to evaluate the existing market designs with market solutions in mind. Many market players agree on that a market solution (and thereby absence of governmental regulation) is to be preferred wherever it is possible.
5.1 Demand Response - An essential part
This section presents the crucial part of consumers' responsiveness to price variation. It is seen as a future solution to peak load problems if it can be enabled on a larger scale.
5.1.1 Demand Side Management and Demand Response
Elasticity, in economical terms, can be described as a property of change due to another change. The concept of demand response is partly about this. When talking of lack of demand response what is meant is that consumers do not react to price variations. The demand is inelastic. This leads to situations with more volatile prices. That is, if demand increases and generation capacity cannot be provided, prices will naturally soar on the spot market. The problem here is that end consumers will not care about price volatility since they are usually not exposed to it, and will consequently not lower their
consumption. Hence, the price mechanisms of the market, which signal shortages and surpluses, do not operate quite properly in this aspect of the electricity markets.
In the wholesale market electricity is traded in fixed volumes. The market players
operating in the wholesale market are price responsive but have little choice other than to buy electricity at the current price levels in order to provide end users with electricity.
This is a problematic issue of risk taking for smaller players, which usually have low liquidity.
The underlying reasons for end users' lack of responsiveness to varying prices on a spot market are several. One specific reason is the general usage of long term contracts which function as a hedging mechanism for consumers. This kind of typical contracts does not include explicit restrictions on volumes of energy. The fact that technical solutions which enable end users' responsiveness have not been available in large scale is a key matter to this problem. The question of whether an end user cares about price variations or not is also relevant and has to asked. If the spot price is not high enough, for an adequate time period, then customers may not care at all. The economical incentives may not exist if the savings are in the order of only a few euros during a system critical period.
In order to enable Demand Response, i.e. to enable price mechanisms to reach end users, obstacles like those mentioned above have to be overcome.
Another important aspect is Demand Side Management, which can be described as means to control consumers consumption through e.g. direct load control. It has been tested, but has not been readily available in large scale until recently. At the same time various tariff-based price control systems have been evaluated and tested. Today we can see new smart technology in the form of metering boxes, which are remotely accessible and have the capability of sending measure points of consumption at a high resolution.
Demand Response has been an issue for quite a while now. Several countries have taken part in an IEA-project23 about Demand Response. The Nordic countries are among these.
The Swedish organization Elforsk has conducted a number of demonstration projects in order to test feasibility of various business models and technical solutions. Direct load control as well as using varying prices as "control mechanism" has been evaluated in preliminary tests. Elforsk estimates the technical potential for load control of direct
23 International Energy Agency, IEA-Task XIII or Demand Side Management - DSM.
electrical heating in Swedish family homes to somewhere around 1500 MW24. Possible load control in the Swedish industrial environment amounts to somewhere between 100 and 300 MW, depending on assumptions on future installations of equipment. This can be compared to the total amount of the Swedish Peak Load Capacity Reserve of 2000 MW.
Elforsk identified some problems with direct load control in family homes. First of all, returning loads, which means that the disconnected load will render in a lower indoor (or water) temperature and thereby a higher load when the load control is deactivated again.
A possible solution would be to rotate load reductions between several groups of participants in order to reduce this effect of returning loads. The second identified problem had to do with lack of knowledge concerning the developing load in advance.
There are a number of already existing business models which have potential to enable demand side response. One kind of tariff which has been used in Norway by Trondheim Energiverk is called Fastpris med returrätt, which is a contract that essentially consists of a predefined volume of energy at a fixed price, and where the variations around this volume is bought (and sold) by the end user at spot prices.
Another interesting tariff is Dynamical time tariffs. The tariff consists of a fixed price for most hours of consumption, but not all. At peak time periods, when consumption is estimated to reach critical levels, the customers are to receive information about a
"critical period" under which the price will be increased to a much higher level and thereby act as an incentive for the customer to reduce his load.25
Elforsk has also discussed aggregation of existing reserve power units, like those found in hospitals, and estimates this to a potential of 1000 MW of available power.
Aggregation of power could be handled in a model where Aggregators take the role as the link (in the form of a market player) between the system operators, end consumers and reserve power owners, and offering available aggregated power as a resource for reduction when called for. Variants of this approach can be found in markets in USA, and
24 Elforsk report 06:40, Lindskoug, Stefan, Consumer reactions to peak prices, p. 3.
25 Elforsk report 06:61, Market Design, p. 35-36.
they seem to function well. The problem with this system might be to find economical incentives to make it work.
The utility Göteborg Energi has also conducted tests26 of load control with interesting results. Based on their theoretical calculation they estimate that their model, if used on a national level in Sweden, could enable approximately 2800 MW of power consumption to be used as resources for peak load reductions.
5.1.2 Automatic Meter Management and Automatic Meter Readings There is an ongoing process in Sweden of installing Automatic Meter Readers (AMR) to all consumers. All Swedish households, with fuses of less than 63 Ampere, must have monthly readings by 1July 2009. In reality this means that AMR-devices will be used.
Fortum has an agreement with Telenor Cinclus to use their technical solution. This means that Fortum will have approximately 835 000 AMR-boxes installed by that date.
Vattenfall and EON have similar solutions, as do the rest of the utilities, who are responsible to install these units.
The metering boxes Fortum will have installed are capable of handling several different tariffs which enables the customer to control electric heating or other installed devices as he wishes. An AMR-box will be connected to a data central via IP over GPRS or through regular broadband connections. It also contains a remotely controllable relay, which can be used to shape each customers electric load. This effectively means that distributors can control the load in their distribution grid in a whole new way than before. This
technology offers not only individual loads to be shaped, but also loads in larger areas. 27
All distribution grid owners will install metering boxes that will have remote readings capabilities, but also worth mentioning is that the majority of these boxes will most likely have capabilities similar to Fortum's choice of AMM-box regarding usage of different tariffs and resolution of measurements. This means that one technological obstacle for
26 Elforsk report 06:61, Market Design.
27 Telenor Cinclus
introducing price responsiveness to end consumers may very well be on its way to vanish.
The Norwegian Water Resources and Energy Directorate aims to have AMR-units installed before 201328. When Norway has installed their AMR-units, we might see an even larger market for Demand Response and Demand Management. There is also an ongoing discussion in Finland about AMR.
At least Fortum and Vattenfall have the aim to install these AMR-units throughout their customer base in Norway, Sweden and Finland29.
5.2 Proposed Market Designs
Here is a presentation of the core ideas which are often proposed as solutions. Some have been implemented, others have not.
5.2.1 The Energy Only-model
The Energy Only-design is not really a design. It is merely system with a market where only energy is traded and where energy prices will suffice as signals for both investors and consumers. Energy Only is often regarded as a preferred system when discussing market solutions of peak load capacity-problems. The idea is to let high energy prices guide market players in their decisions, and thereby create a self-adjusting market system.
This means that price caps have to be set high or be absent in first place. It is also necessary that consumers are price responsive.
Using Energy Only as a name for a market design might be somewhat confusing since it is depending on how it is defined. What the name implies should maybe in its purest form be interpreted as "An energy market without additional specific measures taken to ensure capacity". Another way to present it might be to say that signals of need for new capacity are only to be provided through energy prices, and not by capacity markets.
28 NVE, Toveiskommunikasjon.
29 Malte Windle - Fortum AMM-project.
In a pure hypothetical perfect electricity market without flaws, customers would, simply put, pay the "correct" price for energy and thereby provide the revenues needed.
The adequate level of capacity would be automatically adjusted by consumers' actions.30 When considering flawed markets, one has to take into account that supply may not always match demand, and that price dampening measures might have been taken. Thus, no matter how one defines Energy Only, the problem of missing money and the typical cause of it must be addressed if the goal of adequacy is to be reached. The question of market power must also be handled. Using Energy Only as model approach therefore implies something in addition to only having an energy market.
A theoretical approach proposed by Hogan31 discusses a method of restoring missing money by using an administratively set reserve target, which is added to the demand curve with the result of sufficiently high prices to receive needed revenues.
Apart from determining the necessary capacity (which is added to the demand curve) the administrator somehow has to estimate Value Of Lost Load (VOLL), which is the flat part in the figure.
P=10 000$
Pnatural
Pnew Added reserves
Price
Demand
Supply
Quantity
30 I.e. price responsiveness and remote disconnection is present here. In short: Stoft's two demand side flaws do not exist.
31 Hogan, William, 2005: On an Energy Only Electricity Market Design for Resource Adequacy.
Figure 8: Demand, consisting of both elastic and inelastic load, with a calculated necessary increased reserve part on the demand curve; resulting in a higher spot price on the market.
A real-world example of an energy-only approach is the Electricity Reliability Council of Texas (ERCOT) -market in Texas, USA. By relying only on high spot prices to induce investments, this market will manage without a separate capacity market. The Public Utility Commission of Texas (PUCT) approved in 2006 a three-step increase of the offer cap in the ERCOT market. Raising the offer cap from $1000 to $3000 per MWh32 will give the market sufficiently high spot prices according to proponents. The need for increased demand response has been acknowledged within PUCT. Consideration about requirements of AMR for smaller consumers has been raised. PUCT has also required that ERCOT in the future shall include controllable loads as a resource in the ancillary markets of regulation, as opposed to how it is today.
The ERCOT market has also seen a need to make information, which can affect the market, more rapidly available to the market as the prices (or rather offer caps) are
reaching higher levels. Information of quantities and prices of both bids and offers will be disclosed after two days33
In order to prevent too large revenues, the offer cap-level will not be held static if peaking units are receiving too much. The offer cap will be decreased to better match an estimated need. This method called the scarcity pricing mechanism (SPM) is supposed to happen in annual cycles, where each cycle begins with the highest possible offer cap and thereafter decreased for the rest of the year, if deemed necessary.
The ERCOT market will tackle market power by disallowing producers with a share of production that exceeds 5 percent to act completely free34. They also have the so called
32 This will be done in steps of 1000 -> 1500 -> 2250 -> 3000 with one year in between each raise. As a comparison, Nord Pool has an offer cap of €2000.
33 Siddiqi, Shams N, 2007: "Resource Adequacy in the "Energy-Only" ERCOT Market", Proceedings from Power Engineering Society General Meeting, 2007, IEEE.
34 Schubert et al, 2006: "The Texas Energy-Only Resource Adequacy Mechanism", Electricity Journal, Vol.19, issue 10, p. 39-49.
Texas two-step method for dispatching the market while mitigating locational market power35.
Other existing energy only-markets are, for example, the Australian National Electricity Market (NEM) and the US-Midwest. The Nordic market can also be described as a typical Energy Only-market. Sweden, Finland and Norway have however implemented additional systems on top of this for ensuring peak load capacity36. Typical for all these markets are that they have high offer caps.
5.2.2 Capacity Payments
The Capacity Payment-design can be described as a way of redistributing money to owners of power plants in order to keep these plants up and running. It is simple in theory, but has been proven difficult to implement in a satisfying way. The problems have mainly been to create incentives to actually have the production units available when needed, and also to create a good distribution model of payments. This approach consists of central planning to a large extent.
A rather direct method to remedy the missing money-problem is to give payments to generators that equal the missing part. This approach has been tried in several markets, e.g. Spain, UK, Argentina, Chile and Colombia.
A general approach with this design is to have a prerequisite of availability in production.
This is however not always the case. The payments need to be matched to different kinds of production, i.e. a valuation of each production type has to be made somehow. Based on this valuation, which reflects the contribution to the systems reliability, payments will be given to producers. Most implementations seem to have had their own methods of determining the payment level to producers. One specific problem has been to determine
35 Siddiqi, Shams N, 2007: "Resource Adequacy in the "Energy-Only" ERCOT Market", Proceedings from Power Engineering Society General Meeting, 2007, IEEE.
36 These will be described later on in the thesis. The capacity is however used in the regulating market and not procured as "normal" production intended for the energy spot market.
the value of hydro power, since precipitation affects reservoirs and thereby availability in production.
A typical prerequisite is a central planned capacity target and an estimation of the capacity needed to be installed.
Depending on how the scheme is constructed, payments can be given to power units with, or without, requirements of actual production. That is, payments may be given to plants with no other requirement than existence, or as uplifts on energy revenues. There are of course more parameters that can differ, but many are likely to be specific to each market. The usual way of financing a system like this is to make consumers pay for it via prorated uplifts on their bills, and to have a TSO to be in charge of delivering the
payments to generators.
This approach is allegedly a not a very good one. The resulting effects have for example been distortion of energy prices, which has been the case in UK, and uncertainty in whether the payments actually go to financing peaking units, like in Spain37. The Spanish capacity payment-system has essentially two flaws: it lacks incentives for producers to have their production available when needed in real situations, and it does not give incentives to actually have sufficient capacity (even if payments are present).38
37 Oren, Shmuel, 2000, “Capacity Payments and Supply Adequacy in Competitive Electricity Markets”, Proceedings from VII Symposium of specialists in electrical operationa and expansion planning, 2000.
38 Vazquez et al., Enhancing power supply adequacy in Spain: Migrating from capacity payments to reliability options, Energy Policy volume 35, issue 9, 2007.
5.2.3 Energy Call Options
The Energy Call Option-design revolves around using a variant of call options for energy in order to secure peak load capacity. The idea is to use the revenues from selling the energy option, i.e. the option premium, to cover for the missing money. This design incorporates a market for options, in which market forces indirectly will set a price on capacity and generate adequate production capability. There are different proposals of how to use call options. It can be used as a strict hedge tool with or without centralized demands for amount of load to secured, or it can be in a scheme with a predetermined capacity target which is met through a centrally determined and uniform strike price for call options. The design dampens price volatility and can enable a long-term stability for new investments.
The literature uses varying names for this approach, which can appear in slightly different forms but revolves around the same core; the financial instrument designated Call
Options. Several proponents39 argue that this may be a reasonable way to ensure long term adequacy. It will be accomplished by introducing a "new" instrument for trading energy.
An option is in financial terms a right, but not an obligation, to buy or sell (depending on if it is a call or put option) a specified amount of a good, at a specified price and point in time. If the option owner chooses to use the option, it is said to have been exercised. The predefined price level is called strike price, which in effect is a price cap, sort of
speaking. If an option is exercised when the spot price is higher than the strike price, the player who exercises the option will pay less that the current market price. The seller of a call option will receive an option premium as compensation. There are combinations and variants of this financial instrument used at a daily basis on most exchanges around the world, but that will not be covered here.
39 Oren, Vazquez, Bidwell et al.
The specific difference between call options in this case and the "normal call options" is that there will be a connection to an actual physical delivery of electricity in order to guarantee an adequate supply. The Call Options used in these designs can however be constructed in such a way that it is allowed to exercise them in a pure financial
transaction only, if the electricity is not needed at the moment.
Depending on which exact design we look at, we find different approaches regarding strike prices, obligation to buy or sell and trading of options et cetera.
Oren argues that Load Serving Entities (LSE) should be obligated to buy call options to cover amounts of load proportional to their peak loads, but does not specify a centrally determined capacity target, but he implies a centrally determined strike price.40 Bidwell on the other hand argues for both capacity target and strike price to be centrally
determined, but does not explicitly mention any obligations to buy or sell options, but the system is more or less an ICAP-system (see next section) but with options as the
instrument.41 The capacity target is the main thing that separates these two approaches, and by that makes a distinction. Vazquez et al. on the other hand delivers a similar approach42, focusing on the Spanish capacity payments.
A strike price which is administratively set will be based on forecasted consumption together with the marginal cost of the most expensive generating unit in mind. The strike price will be set to a level slightly higher than this most expensive unit's marginal cost.
The reason for this is to avoid distortion of spot market prices. Given that a system of call options is implemented, the existence of a strike price will in effect act as a price cap on the wholesale market if the load is to be covered by options. This means that retailers will be protected against price volatility on the spot market, and that generators will get revenues from option premiums instead of gaining these from high spot prices. The usage
40Oren, Shmuel, 2005, "Generation Adequacy via Call Options Obligations: Safe Passage to the Promised Land", Electricity Journal, Vol.18, Issue 9, p. 28-42
41 Bidwell, Miles, 2005, "Reliability Options: A Market-Oriented Approach to Long-Term Adequacy", Electricity Journal, Vol.18, Issue 5, p. 11-25.
42 Vazquez et al, 2002, 2006, 2007.
of call options would therefore, in theory, generally lead to more available generation, which would render in further reduction of volatile spot prices over time.
C*
Price of options
Supply of options Pexcess
Demand (Capacity target)
Quantity of options
Peq
Figure 9: A market with supply of options and a centrally determined capacity target.
Bidwell further argues for a long-term forward market with auctions where the option premium is set. By also allowing potential generators to bid in this market, competition is increased. Vazquez et al and Oren are also arguing for lag and lead times in connection to the auctions, in order to spur new entrants to the markets.
A side effect from this design approach is that if market entry barriers can be reduced and if the trading of options allows future installations of generation to compete, there will be more competition via the threat of new power. This will lead to reduced
incentives for generators to exercise market power43. Bidwell suggests a lag-time of three
43 Bidwell, Miles, 2005, "Reliability Options: A Market-Oriented Approach to Long-Term Adequacy", Electricity Journal, Vol.18, Issue 5, p. 11-25.
years between the auction of the deal and the period when energy is supposed to be available according to the option. This will increase the competition by introducing potential new power.
To sum it up; Supervised by a TSO, Generators and LSEs will trade physical call options amongst each other at a centrally determined strike price. The trading of call options can render in differing prices of the options, i.e. varying option premiums, which are the base of revenues for generators in times of peak loads instead of the, today, insufficient scarcity revenues from energy markets. The effect of a trading scheme for these options will be that the market will adjust the amount of available power production (i.e. supply) according to demand. This will in theory lead to adequacy. The exact outlines of how the trading of options will take form are however not written in stone. It could be a centrally administered market or conducted at existing exchanges' OTC-markets.
5.2.4 Capacity Markets - ICAP and Succeeding Approaches
The ICAP-design is a centrally created market for capacity in which market players are enforced to meet a preset level of capacity which is based on their share of the peak load.
This is done through a credit system, in which market players participate in an auction where they trade their credits and thus, in theory, create a market price on capacity. The amount of credits corresponds to the centrally determined capacity target. The ICAP uses artificial demand curves, which are used to find a market price on capacity. These
demand curves have been remodeled from basically being vertical to become sloping over the years in order to amend problems like rapidly changing prices and to create better investment signals. The design approach allegedly leads to higher costs in general and not necessarily available production capacity in peak load situations.
ICAP, or Installed Capacity, is a system in which all LSEs have to provide an amount of power to the market, which corresponds to their share of the peak load. It uses capacity credits, which can be traded in order to fulfill the responsibility. The system approach is
