Alberto Pototschnig | Electricity Markets: The Wholesale Markets

Alberto Pototschnig | Electricity Markets: The Wholesale Markets

hello I’m Alberto patashnik I’m the director of the agency for the cooperation of energy regulators I’m also an advisor with the flooring school of regulation and I’ve been an advisor here for many years since the very early days of the school what I’m going to present today and introductory some introductory ideas on the way in which wholesale energy market operates also electricity markets operate and on the process of integration of national markets into European internal electricity market so first of all I would like to present very briefly the way in which electricity is traded in in wholesale markets electricity can be traded bilaterally which means two parties one wanting to sell electricity the other one wanting to buy electricity getting together sometimes there is an intermediary involved in this may be a broker and but they the terms of the deal are actually agreed between the selling and the buying party but more and more trading actually taking place in organized wholesale energy market like power exchanges here the power exchange is the market place where parties wanted to sell electricity can find parties wanted to buy electricity I will come later to the way in which power exchange operates but for the time being I just want to show that these two different ways of exchanging electricity at the wholesale level in this slide you see on the left hand side trading through a Power Exchange where our generators beat their offer their production into the Power Exchange and then final customers to the extent that they participate directly in power exchanges or wholesale so all sailors traders or suppliers they buy electricity into the part from the Power Exchange trading in electricity either bilaterally or through a Power Exchange we results in positions long positions where market participants will have the right and the obligation take electricity from the market when the delivery time comes so take electricity from the network in fact and a short position where market participant are under an obligation and have the right to deliver electricity to the network and obviously as a result of trading these long and short position will be balanced because every every sale of electricity will correspond to somebody else have imported electricity once these positions are established at gate closure which is the time when no more trading is allowed this position will be turned into a position visa v-not your trading counterparty but rather the TSO the transmission system operators so those with long position would be under no obligation to to take delivery from the network of the electricity and delivery time and those with short position will be under the obligation to deliver electricity to the network at delivery time and to the extent that they do not honor their obligation they would be subject to imbalance charges and these imbalances will be levied by the transmission system operators because as I said after gate closure the obligations deriving from trading will be turned into obligation visa via the TSO so in fact all market participant irrespective the way in which they trade bilaterally or through power exchanges will have had to enter into a into contracts in agreement with the TSO for honoring their their schedule their position coming up from trading and therefore accept to be levied with imbalance charges if they deviate from these positions so this this slide that shows the the other side of the wholesale energy market the you know the arrangements and the relationships which ensure that delivery of electricity takes place and that in fact even if one party defaults on the day in delivering electricity to the grid the other party will be able to take electricity from the grid because as I said after the gate closure all the obligations reverted be severe the TSO so this is what I wanted to say in terms of an introduction now we are looking more specifically to the operation of power exchanges and the first thing that I would like to note is the fact that despite power exchanges not being mentioned in any of the electricity packages that the European Union European communities and the European Union has issued since the mid of the 90s they have developed themselves and they appeared they were established in almost all Member States this has been in most cases a spontaneous process or a national development process over time and will as we will see in a moment these markets have become increasingly integrated and deaf and we are moving now towards a European integrated single wholesale energy market but in this map all countries highlighted in blue are those where power exchanges operator at the moment and as you see it’s basically covering the most of the European Union if they emerge even without being forced by regulation there must be some system-wide and some individual benefits for the market participants and I think you know markets are become becoming increasingly popular in many sectors and the electricity sector is no exception clearly markets deliver a the best price possible because it’s where demand and supply meets so liquidity in the market would assure that the price reflects the fundamentals also through markets is much easier to detect any abusive behavior also markets may establish a separation in avert otherwise vertically integrated industry at the moment the European rules require the separation of the network businesses but not necessarily the separation of the generation and supply businesses and these the integration of these two businesses might lead to reduce level of competition so a market element in there should also help in this respect and finally for new entrants markets are probably the best possibility for procuring the energy that they need or disposing the of the energy that they have without having to knock at the door of the incumbent so there are clear benefits and this is the reason why markets have developed in most European jurisdiction even before there was an obligation to do this and in fact until now there hasn’t been any explicit obligation the only implicit obligation is that as I will show you in a moment the process of market integration relies on market coupling implicit auctions which requires the existence of wholesale electricity markets in all jurisdictions but I require an explicit requirement for establishing power exchanges has never been imposed what is also remarkable is the fact that these power exchanges having been established in different jurisdiction without any coordinated design they all trade they all operate with very very similar features and I would only like to focus on one of it which is the way in which electricity is traded there are two possible ways of trading electricity through auction on an auction-based design or on a continuous basis design in most financial and commodity markets in fact continuous trading continues malarial trading is this what is the more popular way of trading in electricity I think there are good reasons for preferring the auction based mechanism and this is in fact the way in which day ahead markets operate in most if not all jurisdictions in Europe auction based mechanism means that those who want to sell or buy electricity in the market provide their offer of their bid by a set deadline then the mark operator established a merit order of offers and Ameri total bids so where the received bits and offers are ranked according to the price and these two merit orders are then compared and a price is found where the offers of market participant who are willing to sell electricity at least at that price equals the bids from market participants who are willing to buy electricity at no more than that price so in this case you an equilibrium is reached and everyone supplies and people who are market participant who want to buy electricity from the market are sure that they will not pay more or they will not be selling at less than what their preferences this is the way in which most power exchanges work this is the auction based mechanism and this mechanism will ensure by construction that the that the only the most efficient plant will be operating and only the most valuable or the did the market participant for which the electricity is more valuable will be served now this is more important for electricity than it is for other commodities because electricity cannot be stored so the outcome of the market has a direct has direct implications for the pattern of generation and consumption so in in a wholesale energy market based on an auction approach this is actually guaranteed the fact that only the most efficient generation unit are called to operate and that only demand which has the highest value for electricity is actually served energy this is actually delivered by construction in in a wholesale energy market which is based on an auction mechanism and this is actually the way in which the market operates there will be in these slides there is a simplified version of demand and supply curve demand curve is compiled by aggregating the different beads by market participants want to buy electricity from the market and the supply curve is is compiled by aggregating the different offers of market participant for example generators who want to want to supply electricity onto the market by by matching the two curves an equilibrium is found an equilibrium price is found where at that point the same quantity of electricity is available for sale as the quantity of electricity was available for purchase which means that there is the same quantity that market participant who are willing to sell electricity would be happy to sell at that price as the quantity that market participant would want to buy electricity from the market happy to buy at that price and the outcome of the market as it is shown in this in this slide will guarantee that only the most efficient of the ud generating unit with the lowest cost or cost lower than the equilibrium price will be called to generate and only demand for which the value of electricity is higher than the equilibrium price will be said with electricity in this way the value the welfare value of trading is maximized now this is the way in which it is trading is is conducting most power exchanges there is also an alternative way which is bilateral trading but in this case efficiency is not assured by construction because bilateral trade may not involve necessarily the most efficient generating units and the most that the market participant demand electricity for which electric for whom electricity is most valuable so it is only when you have very liquid and very efficient secondary market and when you have very proactive market participants that you can try to achieve the same efficiency results through a continuous trading market then you have by construction through an option based market so this is what I wanted to say you know at this point on this I already mentioned the pros and cons let’s look at the process of integration of of the electricity markets in Europe in a twisted market as as I mentioned how now operating in in most jurisdictions they operate with very similar features they open they’re all based on a day head market there most of them are based on auctions so they are fairly similar the fact that despite the fact that they came they have come to life from very different backgrounds some of them have other results of private initiatives other are actually enshrined in in local laws in national laws some of them owned by tea Essos other owned by market participants so they’re fairly that diverse when it comes to a governance or institutional setting but they all operate very similarly when you come to in create this market you need to be able to move electricity from one jurisdiction to another and traditionally the European Network European electricity network was developed to serve the national markets and for many years the interconnection were mainly established for security purposes for for for stabilizing the frequency in the different jurisdiction not to carry large amount of commercial flows and this is clearly with integration of markets is changing so for the for for some years to come on some borders we will have to deal with congestion congestion is when happens when the commercial flows through an inter connectors cannot be accommodated by the available physical capacity which means that the physical capacity is not sufficient to support the outcome of the market obviously congestion needs to be dealt with and there are two families of methods which can be used and you can either deal with congestion ex-post which means that you allow the market to operate as if there were no constraints on the network and then you take care of the constraints exposed after the market has delivered its outcome or you can deal with the with congestion ex ante now it is clear that if you deal with congested exposed what you do you basically intervene in the outcome of the market and you modify it in a way which is compatible with the available transmission capacity so you change the outcome of our market and you modify it so that it will be it could be supported by the available capacity it is a pretty obvious that you can only use this method if congestion is not a persistent aspect because it it is okay to change the outcome of the market if you do it only a few times a year if you have to do it every day or every other day then obviously you know the the distortions may be quite significant so if you have persistent or significant congestion then an ex-im term mechanism is it’s more appropriate and the exactly mechanism is basically making sure that the outcome of the market already internalizes the available capacity so that the outcome of the market would be by construction compatible with the available capacity and you can deal with cap with the congestion example in an explicit or an implicit way an explicit way is a way in which the capacity the available capacity is allocated as a separate product from the outcome of the market so if you want to trade electricity across a border you will have not only to secure the energy in the market from which you want to take electricity to and to sell the electricity in the other market so to enter into commercial transactions but you will also have to secure the necessary capacity to move power from one market to another there is obviously an issue of coordination because if you only have the energy but not the capacity or vice-versa and obviously is not good enough so more and more and also with the development of markets we have moved an implicit way of handling congestion and implicit way rests on the availability of markets so that trading is actually performed on the market and then capacity is used for linking the markets together in some respect and I will come to some details in a moment there are various ways of implicitly allocating capacity all of them can fall under the general definition of increase in auctions the concept here is that you allocate capacity together with the outcome of the market but strictly speaking implicit auction may also mean that the available capacity on the interconnector is used to allow access of market participants in one area to the to a power exchanges in another area and this capacity will be not allocated to a particular market participant but rather to those market participant who whom who according to the rules will have their bids accepted in the market so in this sense it is a implicit allocation because it follows the outcome of the market to other to other forms of implicit allocation of capacity is market splitting and market coupling here capacity is used for moving power between different areas between power exchanges in different areas and the difference between market splitting market and market coupling market splitting implies that the same power exchange operates in two areas separated by a congestion so the power will move between different areas but both areas in both areas the power exchange would be operated by the same operator market coupling is when you couple different areas the markets in different areas which are operated by different market operators so technically there are exactly the same concepts but they’re just different governors and institutional aspects if we want to go into more details we have price clean price market pathways market coupling and volume based market coupling the price based market coupling is where all the information is actually bundled together information about bits and and I offers in each of the participating markets is brought together and the coupling algorithm determines the price and the volumes in each participating markets in volume coupling the information is still brought together but the coupling algorithm only determines the volume across the congested interconnectors interconnectors while the prices are actually determined by the participating markets in each jurisdiction and there is here the risk that if the coupling algorithm and the algorithm operate in the different markets are not perfectly aligned sometimes you end up with prices in the differentiation which are not perfectly compatible with the flows across the interconnected now what I would like to to complete my presentation with is a bit of an indication of where we are in European level in terms of integrating the market this this slides present the current regional coupling regional markets in Europe as you see most of the jurisdictions in Europe are already apart from having a radio power exchange already coupled with neighboring jurisdiction there is a the Scandinavian market with market splitting all of it operated by North Pole and this dates back from the mid 90s and the whole Scandinavia region was was integrated more than 10 years ago more recently we have integration in other regions and at the moment there are regional markets operating the virion Peninsula in Central Western Europe as I mentioned in in the Nordic market in central Eastern Europe with EMA Slovak Republic Czech Republic and Hungary and then Italy and Slovenia also coupled so the the bid at the moment is to move from this set of regional markets towards a integrated European market this is this is the way in which at the moment we’re visiting this to happen it will be it there is a roadmap which has been developed by body by the agency in cooperation with national regulators with the TSO s and with stakeholders this is a voluntary process which is running in parallel with the with the formal process of frame of guides of network codes established by the third package the idea is to try to move in parallel with the development of the rules also at the same time trying to implement the rules why is that well there are two reasons first is because if we need to heat the 2014 deadline for the integrated internal electricity market there is no way that we can achieve it by starting implementing the rules after they have been adopted the rules have been are being developed now the framework guidelines the network codes as well but we start we expect that the first network code will be adopted through the committee ology process at the earliest towards the end of next year so at that time will be a bit late to start implementing them but also there is another reason the as always that the devil is in the details and by implementing the rules while you’re also writing them you can learn a lot and this experience can be very beneficial when it comes to writing the rules so there are not only a matter of timing but it is also I think a genuine benefit from trying to do pilot projects and pilot schemes to implement it was earlier this final slide shows the road map the darker the color on the map the earlier the region will be integrating into the wholesale European internal market as you see we will start from the central west integrating today to the North Pole to the Nordic market this would happen by the end of 2012 beginning of 2013 the iberian peninsula will come in also pretty soon and then Italy and Slovenia and the Central East should follow later on the idea however is to integrate most of if not all of the European wholesale electricity market by 2014 thank you very much for your attention

One thought on “Alberto Pototschnig | Electricity Markets: The Wholesale Markets

  1. I am going in for a class on wholesale markets in an hour from now. Your video just simplified my studying! Thank you!

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