Imperial College London

GB Energy Market Structure

David Newbery

DECC workshop

London, 4

th

September 2014

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

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?

Newbery 2014

Imperial College 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

Newbery 2014

Imperial College London

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?

D Newbery 2014

Imperial College London

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 Newbery 2014

Imperial College London

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?

Newbery 2014

Imperial College London

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, • Counterparty receives LMP, pays contract

or

– Capacity availability payment plus energy payment • Free entry of fossil generation, can bid for LT RO – To address policy/market failures D Newbery 2014 7

Imperial College London

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

Newbery 2014

Imperial College 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

Newbery 2014

Imperial College London

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

Imperial College London

GB Energy Market Structure

David Newbery

DECC workshop

London, 4

th

September 2014

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

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; capacity remuneration mechanism; CfD EMR Contract for difference Electricity Market Reform Feed-in tariff Financial Transmission Right FR ISO Frequency Response Independent System Operator Locational marginal price or nodal price Loss of Load probability Long-term Single Buyer Standard Market Design (the US model) LSE PPA Load Serving Entity = retailer Power Purchase Agreement Quality of Supply RES Renewable energy supply Reliability Option or Renewable Obligation (Certificate) Single Electricity Market (of island of Ireland) System Operator TEM Weighted Average Cost of Capital VOLL Target Electricity Model Value of Lost Load 12