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GB Energy Market Structure. David Newbery DECC workshop London, 4 th September 2014 http://www.eprg.group.cam.ac.uk. Imperial College London. 1. 1. Outline. Drivers of business models Benefits and costs of different business models Justification and criticisms

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Gb energy market structure

GB Energy Market Structure

David Newbery

DECC workshop

London, 4th September 2014

http://www.eprg.group.cam.ac.uk

Imperial College

London

1

1


Outline
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?

Imperial College

London

Newbery 2014

2

2


Drivers for electricity
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

Imperial College

London

Newbery 2014

3

3


Theory and reality
Theory and reality

Efficient pricing of electricity requires

Prices varying in response to S&D each second

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?

Imperial College

London

D Newbery 2014

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Gb incentives
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

Imperial College

London

Newbery 2014

5

5


Other possible structures
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?

Imperial College

London

Newbery 2014

6

6


Eu standard market design
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

Imperial College

London

D Newbery 2014

7


Costs and benefits
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

Imperial College

London

Newbery 2014

8

8


Future drivers of change
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

Imperial College

London

Newbery 2014

9

9


Conclusions
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

Imperial College

London

D Newbery 2014

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Gb energy market structure1

GB Energy Market Structure

David Newbery

DECC workshop

London, 4th September 2014

http://www.eprg.group.cam.ac.uk

Imperial College

London

11

11


Acronyms
Acronyms

BCoP Bidding Code of Practice – to bid at short-run variable opportunity cost

CCGT Combined cycle gas turbine; CfD Contract for difference

CRM capacity remuneration mechanism; EMR Electricity Market Reform

FiT Feed-in tariff FR Frequency Response

FTR Financial Transmission Right ISO Independent System Operator

LMP Locational marginal price or nodal price

LoLP Loss of Load probability LSE Load Serving Entity = retailer

LT Long-term PPA Power Purchase Agreement

QoS Quality of Supply RES Renewable energy supply

RO (C) Reliability Option or Renewable Obligation (Certificate)

SB Single Buyer

SMD Standard Market Design (the US model)

SEM Single Electricity Market (of island of Ireland)

SO System Operator TEM Target Electricity Model

WACC Weighted Average Cost of Capital VOLL Value of Lost Load

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