Capacity Mechanisms: management of
Interconnectors and cross-border
effects
David Newbery
University of Cambridge
Cambridge Spring Research Seminar
16th May 2014
http://www.eprg.group.cam.ac.uk
Outline
• What is the problem?
• Energy-only markets and capacity payments: theory
– policy failures, price caps
• Proposed EMR capacity auction
– defended by missing money (VOLL > max energy price)
– complications: risk, market coupling rules
• Interconnectors: problems
Energy Policy
Research Group
D Newbery
2
What is the problem?
Ofgem’s derated capacity margin
System Operator’s
problem
Source: DECC IA
First Capacity
Auction delivery
Interconnectors by 2018
IFA
Britned
Moyle
EWIC
NEMO
Eclink
Total
to France
to NL
to NI
to RoI
to Belgium
to France
2 GW
1 GW
0.5 GW (or 0.25?)
0.5 GW
1 GW
1 GW
6 GW
• potential swing 12 GW = 20% peak demand
• emergency SO actions cannot reverse IC flow
Key question - what contributon to derated capacity?
Poyry (2012): 50-80% depending on margins abroad
Energy Policy
Research Group
D Newbery
4
Energy-only markets
• If generators can (and are allowed to) bid
scarcity prices no problem?
– France (de facto monopoly) bids high peak prices
– GB has adequate capacity and flat prices
• Wind, PV, cheap coal, low C prices drive clean
spark spreads negative (in DE especially)
– electricity prices affected by policy
=> policy uncertainty undermines peaking
investments needed
Capacity contracts to address policy failure
Energy Policy
Research Group
D Newbery
5
France much peakier than GB
European power exchanges 2012
€ 100
€ 1,000
€ 900
€ 800
€ 700
€ 600
€ 500
€ 400
€ 300
€ 200
€ 100
€0
0.0%
€ 90
€ 80
Euros/MWh
€ 70
0.5%
1.0%
1.5%
2.0%
€ 60
€ 50
France
UK MIP (Euros)
Germany 2012
Netherlands
€ 40
€ 30
€ 20
€ 10
€0
0%
10%
20%
30%
40%
50%
60%
percent time price higher than
70%
80%
90%
100%
Capacity payments: theory
Efficient price = SMC + CP
SMC = system marginal cost, CP = capacity payment
CP = LoLP*(VoLL - SMC)
LoLP = Loss of Load Probability in each hour
LOLE =  LoLP over year (Loss of Load Expectation)
set at 3 hrs in GB
=> VoLL = Value of Lost Load = £17,000/MWh
• Max price in Euphemia day-ahead = €3,000/MWh
– Max price in France = €3,000/MWh
– Max price in SEM (Ireland) = €1,000/MWh
Newbery 2014
7
Experience in the Pool and BETTA
• The Pool (1990-2001) had an explicit CP at
LoLP*(VoLL-SMP), VoLL = £(2013)5,000/MWh
– (but SMP is as bid, not SMC)
• NETA/BETTA was an energy-only market with a
Balancing Mechanism, System Buy and Sell prices
– reformed many times, long side defaults to prompt price
– initially pay-as-bid, then average of last N MW
– consulting on Significant Code Review to deal with 2015/16
How well did they signal scarcity?
Energy Policy
Research Group
D Newbery
8
Pool prices were peakier than spot market
as they had a capacity payment
UK price duration curves 2012 and Pool Purchase price 1998-9
Price duration
£100
£400
£350
UKRPD Cal 2012
N2EX 2011-12
APX 2011-12
PPP 1998-9 at RPI
£/MWh
£80
£300
£250
£200
£150
£100
£50
£(2012)/MWh
£60
£0
0.0%
0.5%
1.0%
1.5%
percentage price higher than
£40
£20
£0
0%
10%
20%
30%
40%
50%
60%
-£20
percentage price higher than
70%
80%
90%
100%
2.0%
CP in the Pool - 50% revenue in 1.8% (158) hours
PPP-SMP 1998-9 at 2012 RPI prices
£100
100%
£80
80%
£(2012) /MWh
£300
£60
60%
£250
£200
£150
£40
40%
£100
£50
£0
£20
0.00%
0.50%
1.00%
1.50%
£0
2.00%
20%
0%
0%
5%
10%
capacity payment
15%
percent total capacity revenue
20%
Pool prices 1998-9 and System Buy Price 2008
Price duration curves Pool 1998-99 and Balancing 2008 at 2013 CPI prices
£800
£200
£700
£600
£500
£400
£150
£300
PPP £(2013)/MWh
£200
£100
£0
0%
£100
1%
2%
3%
4%
5%
Balancing prices peakier than Pool
£50
£0
0%
10%
20%
30%
40%
50%
60%
70%
percent price higher than
PPP
PPP-SMP
System Buy Price 2008
80%
90%
100%
Imbalance prices not adequately marginal?
Price duration of System Buy Price 2013-4
£100
£350
£300
£250
£200
£80
£150
£100
£50
£0
£60
1%
1%
2%
2%
3%
3%
£/MWh
0%
£40
£20
£0
0%
10%
20%
30%
40%
50%
60%
Percent time price higher than
70%
80%
90%
100%
GB Balancing Market
• Ofgem conducts Significant Code Review of BM
• Proposes:
– single marginal price
– load shedding bids at proxy Value of Lost Load
• pVOLL = £3,000 rising to £6,000/MWh by 2018
• DECC sets VOLL at £17,000/MWh
– STOR bids in at f(pVOLL,LoLP)
BM price has never hit even £3,000/MWh
Missing money: 3hrs*(£17,000-6,000)/MWh
Energy Policy
Research Group
D Newbery
13
Capacity to be replaced
Seems small - can it be covered by interconnectors?
Source: DECC IA
GB Capacity Auction
• Pay-as-clear descending clock auction in 2014 for
delivery 2018/19
– max energy price assumed £6/kWh
– LOLE = 3 hrs => VOLL = £17/kWh
– => missing money = 3 hrs*(17-6)/kWh = £33/kW
• new build gets 15 yr contract at auction price
– existing plant: 1 yr contract unless major refurbish
• must be price taker unless good cause, entrants set price
• existing plant can delay until later auction (2017)
• DSR auctioned from 2016: 1 yr contracts
Energy Policy
Research Group
D Newbery
15
Illustrative auction demand curve
£75/kW year
New plant sets
high price for all
No new plant
and price is low
Source: DECC IA
Initially adverse
Net benefit is difference between large producer surplus
and large consumer loss
GB coupled
to NWE 4/2/14
SEM not
until 2016
SWE coupled to
NWE 13/5/14
Issues with interconnectors
• Interconnectors increase security of supply
– provided they are free to respond to scarcity
=> they should have a positive derated capacity
– Poyry estimates 50-80%
• Efficient pricing benefits trading country
– if partner mis-prices they lose
=> efficient pricing drives out inefficient pricing
• But Euphemia imposes €3,000/MWh cap
Energy Policy
Research Group
D Newbery
19
Cross-border capacity procurement
• EU wants any capacity market to be EU-wide
• What contract can deliver capacity from abroad?
– How does specific foreign plant guarantee to export to GB in
stress hours?
• PTR defaults to FTR on the day, but GB price may not
signal true scarcity (and there is a price cap)
– Would it not likely do so anyway without a CP?
• Why not have a contract with the SO for imports over
the interconnector in stress hours?
– Devolve to SO securing supply
– or SO auctions for capacity over IC?
Energy Policy
Research Group
D Newbery
20
Investment in interconnectors
• The economics of investment look good anyway
– and get better with more wind, PV, carbon price floor
• recognising contribution to security increases value
– DC interconnectors are controllable
– GB Interconnectors are logical suppliers of capacity
• problem: TO’s cannot contract for generation
– but SO (abroad) could run auction for capacity and access
=> rent collected by ICs
EU open access to CP needs firm access to ICs
and penalties for non-delivery
Energy Policy
Research Group
D Newbery
21
Conclusions
• Theory of scarcity pricing clear
– leads to CP = LoLP*(VoLL-SMC)
– energy-only markets could do this in theory
• and hedge with reliability options
• main failures: policy uncertainty and price caps
– and lack of credible distant futures markets
• Capacity markets can address these
– but potentially large transfers from consumers
And need much higher Euphemia price cap
Energy Policy
Research Group
D Newbery
22
Appendix
Capacity Mechanisms: management of
Interconnectors and cross-border effects
David Newbery
University of Cambridge
Cambridge Spring Research Seminar
16th May 2014
http://www.eprg.group.cam.ac.uk
Acronyms
BM
Balancing mechanism (or market)
CONE Cost of new entry (net = net of revenue from selling power)
CP, CM Capacity payment, capacity market
DSR
demand side response
EMR (UK) Electricity Market Reform
F(P)TR Financial (physical) transmission right
IC
Interconnector
LOLE Loss of load expectation =  LoLP over year
LoLP Loss of Load probability
PV
Photo voltaic
SEM
Single Electricity Market for Ireland
SMC(P) System marginal cost (price)
SO
system operator
SRMC short-run marginal cost
STOR short-term operating reserve
TEM Target Electricity Market
TO
transmission owner
VOLL Value of Lost Load (£17,000/MWh in GB)
Energy Plicy
Research Group
D Newbery
24
References
• DECC (2102) Electricity Market Reform – Capacity Market
Impact Assessment at
https://www.gov.uk/government/uploads/system/uploads/attach
ment_data/file/252743/Capacity_Market_Impact_Assessment_
Oct_2013.pdf
•Poyry (2012) Poyry (2012) Impact Of EMR On
Interconnection: A report to DECC at
https://www.gov.uk/government/uploads/system/uploads/attach
ment_data/file/252744/Poyry_Report_on_Impact_of_CM_on_
Interconnection.pd?
1
Capacity payments in Irish SEM
• Bidding Code of Practice requires generation to bid
into Pool at SRMC
=> missing money => CP based on VoLL & LoLP
• generators get ex post system MC (SMC) + CP
• VoLL scaled to deliver adequate payment for new
entry, paid part on ex ante LoLP, part on ex post
– stabilises revenue, reduces volatility
• paid on imports, charged to exports
ex post pricing incompatible with TEM
Energy Policy
Research Group
D Newbery
26
SEM Capacity Payments 2012 and 2013
€ 50
100%
50% revenue
in 12% hours
€ 200
80%
€ 100
€ 30
60%
€ 50
€0
0.0%
€ 20
0.2%
2012
€ 10
0.4%
2013
0.6%
0.8%
1.0% 40%
percent of total cap pay
20%
€0
% time
95%
90%
85%
80%
75%
70%
65%
60%
55%
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
0%
Euros/MWh
€ 150
Average €7/MWh
percent of total
capacity payment
€ 40
€ 250
Benefits of market integration for EU 27+2 relative to base case
18
16
Billion Euros/year
14
Optimal TX,
shared reserves,
not balancing
2015
Only half
optimal TX built
12
10
8
2020
2030
Remarkably little
extra compared to
integration
No shared
reserves
6
4
2
0
Integrated
low TX
self-secure
shared balancing
DSR
Scenario
Base case: each country matches average production to consumption
arbitrages over coupled IC’s, no shared balancing or reserves
Source: DG ENER (2013)
28