Imperial College
London
GB Energy Market Structure
David Newbery
DECC workshop
London, 4th September 2014
http://www.eprg.group.cam.ac.uk
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Imperial College
London
Outline
• Drivers of business models
• Benefits and costs of different business models
– Justification and criticisms
• Future drivers of change
– Security, affordability, sustainability and the EU
How to allocate risk and incentivize investment?
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London
Drivers for electricity
• short-term volume and price volatility => need to contract
• very durable capital, high ratio of capital to variable cost =>
confidence in future pricing and/or long-term PPA
• non-storable, subject to congestion => LMP, complex
transmission charges/contracts (FTRs, etc)
• QoS and SO: value varies over space and by millisecond
=> specify contracts for inertia, fast FR, various reserves (1,2,3, up/down),
reactive power, ramping constraints, black start, ...
• Other objectives: carbon, renewable targets not commercial
=> long-term contracts, undermine credibility of future spot prices
• Interconnectors part of TEM but countries acting as autarkies
Future policy uncertainty, inefficient pricing, turbulent policies
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Theory and reality
Efficient pricing of electricity requires
• Prices varying in response to S&D each second
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Australia has 5 minute pricing in real-time market
Frequency response needed in 1-5 seconds
Tender auctions may be cheaper than spot markets for some services
Contracts needed to hedge risk and incentivise responses
• Investment needs forward prices for 15-20+ years
– Or ability to predict confidently and hedge
• Investment needed is either capital-intensive (low-C) or has
low capacity factors for balancing intermittency = risky
How to allocate risk to incentivise and reduce cost?
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GB incentives
• Lack of pool encouraged vertical integration
– balancing mechanism opaque, poorly designed
– with energy-only market => self-balance
– fairly sticky domestic customers provides quasi-LT hedge
=> discourages merchant entry
• RES + high gas prices discourage flexible CCGT
– CPS + EPS discourage coal => capacity crunch => CRM
• ROCs volatile, wind exposed to imbalance
 contract with Big 6 or face high WACC => CfDs
• Connect and manage + uniform pricing
=> locate in Scotland=> congestion=> bootstraps £2b
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Other possible structures
• SMD in the US
– has LMP, ISOs + unit commitment with central dispatch,
capacity auctions with obligations placed on LSEs, ISO
involved in transmission planning
• Other states keep to regulated cost-of-service utility
model to minimise cost of new build
• SEM is trying to adapt gross pool + unit commitment
and central dispatch subject to BCoP + CRM with TEM
• LA has moved to LT capacity auctions for new build
ISO or SO? Energy-only, capacity markets or Pools?
SB, PPAs or LT contracts? Extent of regulation?
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EU Standard Market Design?
• Central dispatch in voluntary pool
– SO manages balancing, dispatch, wind forecasting
– LMP + capacity payment =LoLP*(VoLL-LMP)
– Hedged with reliability option (RO)
=> reference prices for CfDs, FTRs, balancing, trading
• Auction/tender LT contracts for low-C generation
– Financed from state investment bank
• Credible counterparty to LT contract, low interest rate
– CfDs when controllable, FiTs when not, or
– Capacity availability payment plus energy payment
• Counterparty receives LMP, pays contract
• Free entry of fossil generation, can bid for LT RO
– To address policy/market failures
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Costs and benefits
• Investment needs low WACC
=> Predictable policies & markets or long-term contracts?
=> efficient risk allocation and management
• Who can control imbalance risk? Not wind
– But need incentives to offer ancillary services
• Efficient location and congestion management
– Can this be left to TNUoS and redispatch or is LMP needed?
• Trading on Euphemia –3-part or “complex” bids?
• Retail supply – why not a regulated default supplier?
Markets incentivise but challenging to get prices right
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London
Future drivers of change
• Innovation => competitive contracts for RDD&D
– LCNF & NICs OK but SET-Plan needs dedicated funding
– CCS as demo – but is the funding well targeted?
– Hinkley Point – to learn how to do nuclear – but pricey!
• EMR: why fix strike prices and not auction?
– Why over-procure capacity before learning about supply?
• Smart meters
– why universal? Why so complex and costly?
• Low-C policies (ROs, CfDs, FiTs, CERT etc)
– why charged to electricity consumers? Why not raise VAT?
Unclear objectives => lack of coherence, piecemeal policy
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Imperial College
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Conclusions
• Low-C investment is durable and capital intensive
– needs stable credible future prices to invest
– or guaranteed contracts for cheap finance
• EU policy is a messy 27-state compromise
– neither stable nor credible
• Each country searching for best solution
– some mix of contracts and capacity markets
• Gains from cross-border trading higher with RES
– share reserves, renewables to reduce investment
rapidly evolving environment for utilities
D Newbery 2014
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Imperial College
London
GB Energy Market Structure
David Newbery
DECC workshop
London, 4th September 2014
http://www.eprg.group.cam.ac.uk
11
Acronyms
BCoP
CCGT
CRM
FiT
FTR
LMP
LoLP
LT
QoS
RO (C)
SB
SMD
SEM
SO
WACC
Bidding Code of Practice – to bid at short-run variable opportunity cost
Combined cycle gas turbine;
CfD
Contract for difference
capacity remuneration mechanism;
EMR
Electricity Market Reform
Feed-in tariff
FR
Frequency Response
Financial Transmission Right
ISO
Independent System Operator
Locational marginal price or nodal price
Loss of Load probability
LSE
Load Serving Entity = retailer
Long-term
PPA
Power Purchase Agreement
Quality of Supply
RES
Renewable energy supply
Reliability Option or Renewable Obligation (Certificate)
Single Buyer
Standard Market Design (the US model)
Single Electricity Market (of island of Ireland)
System Operator
TEM
Target Electricity Model
Weighted Average Cost of Capital
VOLL Value of Lost Load
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