Transcript Document 7183849

Three Lecures on
Understanding Electricity
Markets: Introduction
Derek W. Bunn
London Business School
Derek W. Bunn is currently Professor and Chairman of the Decision Sciences subject area and
Director of the Energy Markets Group at the London Business School. Having read Natural
Sciences at Trinity College, Cambridge, he received at PhD in Economics from London Business
School (1975), and was subsequently elected CEGB Fellow in Engineering Economics at Worcester
College, Oxford University. Occasionally since then, he has been a visiting professor at Stanford
University in California. Author of over 180 research papers and 10 books in the areas of
forecasting, decision analysis and energy economics, the latest of which are Systems Modelling for
Energy Policy (Wiley, 1997), Strategic Price Risk in Wholesale Electricity Markets (Risk
Publications, 1999) and Modelling Prices in Competitive Markets for Electricity (Wiley, 2004). He is
Editor in Chief of the Journal of Forecasting, Honorary Editor of Energy Economics, as well as
having served on the editorial boards of 12 other academic journals. As a prominent international
advisor on energy economics, he has consulted for many global energy companies and advised a
number of government agencies.
London Business School, Sussex Place, Regents Park, London NW1 4SA, ENGLAND
Tel: [44] (0) 20 7706 6874, Fax: [44] (0) 20 7724 7875,
Overview: Three Lectures
1. Understanding Liberalised Electricity Markets
How the Competitive Markets Work
Transmission, Trading and Retail Issues
Institutional Change and Regulatory Policies
2. Modelling Strategic Market Evolution
Strategic Behaviour and Gaming
Agent Based Simulation Methods
3. Econometric Modelling of Price Formation
Fundamental and Dynamic Analysis of Prices
Volatility and Risk Premia
Transmission Capacity Auctions
Today’s Agenda:
1. Electricity and Energy Market Drivers of Change
Global Issues in Power and Gas
Fundamentals of Power System Economics
2. Wholesale Market Mechanisms:
Price Setting and Price Manipulation
3. Competitive Market Evolution
Strategic Opportunism and Regulatory Restraint
Tomorrow will then mainly be on modelling…..
The Global Context…….
27% of the World Population have No Electricity
In SE Asia it is 60%
In Sub Sahara Africa it is 78%
80% of those without power are Rural, and
many live on Small Islands….
Electrification is a social and economic need,
but how and who will provide?
These will require quite different solutions from the
network systems we see in developed countries
The Investment Challenge……
IEA projects current trends lead to a 60% increase in world
energy demand by 2030….
85% of this will be fossil fuel (coal, oil, gas)
66% will be in the developing world
Over half of the oil will still be from OPEC
“No power costs more than no power” (Indira Ghandi)
Economic growth in many developing countries has been
restrained by power shortages
World Electricity Investment needs to be $16 trillion and in
OECD alone, $4 trillion
For growth, replacement, and infrastructure
But Governments now expect the Market to Provide….
Electricity is produced as a commodity…..
as a service……
Generators
Transmission
and consumed
Consumers
Physical Electricity
Flow
Distribution
Unbundling and the Introduction of Markets
Generators
Consumers
WHOLESALE
MARKET
Transmission
Suppliers
RETAIL
MARKET
Contract Flow
Physical Electricity
Flow
Distribution
The Standard Electricity Liberalisation ….
Wholesale Competition introduced between generators to lower the
commodity price
Wholesale Markets (Pools or Exchanges) facilitate trading
Retail Competition introduced between retail distributors to lower the
cost of service.
Network Monopolies, Transmission and Distribution, remain Regulated.
Full Unbundling of the Ownership of Generation, Transmission,
Distribution and Retail usually advocated for efficient new entry and exit.
(But Vertical Integration is becoming widely tolerated )
Electricity Liberalisation became a world trend …
Why?
Belief in markets to deliver more efficient investment and productivity gains.
This should lead to lower prices (?)
Ideologies: Popular Capitalism, Privatisation, Single Markets
Leaders and Followers…
Early 1990s: Chile, NZ, UK, Norway
Mid/Late 1990s: California, NE US, Australia, Nordic, Spain, Germany
2000s: Italy, France & the rest of the EU,
And then there were the crises: California, Enron, British Energy and
Blackouts …..
But Energy Policy is delicate and contradictory….
The Electricity Sector is being shaped by inherent conflicts….
Institutional Drivers
Economic Ideologies of Liberalisation
Industrial Competitiveness
Concerns about security of supply
Responsibilities for public service
Worries on Global Warming
Fundamental Drivers
Demand and Supply
Geopolitics of Fuels
Strategic Drivers
Shareholder Value: Growth and Returns
Market Structure and Market Power
Fundamentals First…………….
Before competitive markets arrived, the major
uncertainties were
Demand Growth
Technology Choice
Fuel Costs
These are still fundamental, especially the primary
fuel markets: coal, oil and gas
And this is the way Commercial forecasting products
still work.
Analysts used to think demand increased
exponentially, simply with GDP and Population……
German Energy Forecasts
But we are now aware of declining energy intensities…
Total Energy Consumption per $GDP
16,000
14,000
12,000
10,000
United States
United Kingdom
8,000
Germany
France
6,000
4,000
2,000
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Total Energy Consumption per $GDP
120,000
100,000
80,000
United States
United Kingdom
Germany
France
China
India
60,000
40,000
20,000
0
1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
Oil is still the Basic Commodity
Transport is crucial, but still widely used for
Power Generation
Gas Prices are often linked
Continental European Gas Prices tend to
lag 3-6 months to a moving average of
6-9 months Oil Prices
Always been difficult to forecast Oil Prices….
In 1982, when considering new power investment in
the UK….
Observe the implicit
Random Walk thinking…
Even an apparently wide range soon appeared too
narrow…
By the 1990s, analysts thought oil was “mean10 year High, Reference and Low Oil Price
reverting”
Scenarios
(US Dept of Energy)
Oil ($/bl)
Jan 2005
Forecast2F
orecast004
H
R
L
19
85
19
87
19
89
19
91
19
93
19
95
19
97
19
99
20
01
20
03
20
05
50
45
40
35
30
25
20
15
10
5
0
Gas has now become a major focus of interest….
Million Barrels Oil Equivalent / Day
Global Gas Demand overtakes Oil ~ 2020 to 2030
160
140
Gas Demand
120
Oil Demand
100
80
CAGR: 3.5% (2005 – 2015)
60
CAGR:2.2% (2005 – 2015)
40
20
0
1980
1990
2000
2010
2020
2030
0
Trinidad
Netherlands
Turkmenistan
Malaysia
Norway
Australia
Indonesia
Iraq
Nigeria
Venezuela
Algeria
TCF
USA
UAE
Saudi Arabia
Qatar
Iran
Russian Fed.
Where are the Gas Reserves?
Gas – Proved Reserves
1800
1600
1400
1200
1000
800
600
400
200
Liquefaction costs trend continues
700
$ per tonne of capacity
600
500
400
300
200
100
0
1990
1995
1999
2000
Future LNG
Global LNG Supply Sources
90
80
Guinea
70
Snøhvit
Libya
Angola
UAE
60
Yemen
Venezuela
Oman
bcfd
50
Brunei
Bolivia
Egypt
40
Malaysia
30
Trinidad
Australia
Indonesia
20
Nigeria
Algeria
10
Iran
Qatar
0
2005
2010
2015
2020
Electricity Fundamentals Continued….
Before competitive markets arrived, the major uncertainties were
Demand Growth
Fuel Costs
Technology Choice
And Investments reflected an Economic and Political mixture of
High capital cost/low operating cost plant for baseload (eg nuclear)
Low capital cost/high operating cost plant for peaks (eg gas)
Demand Drivers are Fundamental:
In the longer term, we have
economic activity, population growth
technological change and conservation
In the shorter term, we have
weather (temperature, cloud cover, wind)
daily and seasonal patterns of consumption
unusual business and social events
Typical Summer and Winter Demands
GW 55
50
Typical Winter Peak
45
40
Typical Winter Day
35
Typical Summer Day
30
25
Minimum Summer Day
20
15
00:00 02:00 04:00 06:00 08:00 10:00
12:00 14:00 16:00 18:00
20:00 22:00
24:00
Weather Effects on Winter Demand
Meteorological
Variable
Response (MW)
Temperature (a fall of 1
Celsius in freezing
conditions)
+ 400 (1%)
Wind (an increase of 10
knots in freezing
conditions)
+ 700 (2%)
Cloud cover (from clear
sky to thick cloud)
+ 1500 (4%)
Precipitation (from no
rain to heavy rain)
+ 800 (2%)
* Based on 500MW Source NGT
Generating Unit*
Effects of popular weekly TV shows, eg “EastEnders”
5th Ap ril 2001
43000
42500
Wh o w ant s t o be
a m i l io na ir e? C B
10 0 M W
41500
E m m er da le E N D
/ W at chd og E N D
39 0 M W
Wh o w ant s t o be a
m i l io nai r e? E N D
15 0 M W
E m m er da le C B 160 M W
M O T D B ar cel on a
v Li ve p
r oo l H T
14 0M W
41000
R eg io nal Va ri at i ons E N D
pl us L IG H T IN G UP
14 0M W
40500
40000
P eak P r ac ti ce C B
10 0M W
Ea st Ende rs END
plus LIGH TIN G UP
2 29 0 MW
5
:2
0
21
5
:2
21
0
:1
21
5
:1
21
0
:0
21
5
:5
:0
21
0
20
5
:5
20
0
:4
20
5
:4
20
0
:3
20
:3
5
T im e (BST )
20
0
20
:2
5
:2
20
0
:1
:1
20
5
20
0
:0
20
5
:0
20
0
:5
:5
19
5
19
0
:4
:4
19
5
19
0
:3
:3
19
5
19
0
:2
:2
19
5
19
0
:1
:1
19
5
19
:0
19
:0
0
39500
19
MW DEMAND
42000
Unusual TV events are harder to predict……
31000
Full-Time
600 MW
Audience: 12 - 14 million
Demand
30500
30000
Half-Time
900 MW
29500
England V Germany
Previous Saturday
29000
28500
Time
So what does this mean for the mix of
generating plant?
Some plant has to respond quickly to demand and
may not run for very long
What kind of start-up and running costs do we need
for this purpose?
This is known as “peaking plant”
In contrast to plant which is the cheapest to run
continuously throughout the day and night
Which is known as “baseload plant”
German Technology Mix
•Gas is mainly
peaking
•In the UK, it is
mainly baseload
The Economic Mix of Technologies
The system consists of Peaking and Base Load Plant which
differ in terms of:
Basic Economics:
Base load is low variable cost
Peaking is low investment and fixed cost
Technical Capabilities
Peaking Plant will have to be more flexible
with faster start-ups, and lower start-up costs.
The Cost of Power from Each Technology
Depends upon Both Fixed and Variable Costs
And also…?
Utilisation…………
Apart from the fundamental demand cycles,
In competitive markets, the utilisation
depends upon competition in the wholesale
market.
In the wholesale market, the “Stack” of plant
is the basic concept for price formation….
Prices in Wholesale Markets (Power Pools) are often set as follows
For Each Trading Period (eg Hour), Demand is Forecast or Bid into the market,
Plant are Stacked According to Offer Prices ie marginal cost plus Mark-Up
Market Price is the Price of the most Expensive Genset Required to meet the Forecast
120
January 20th 1997
100
Price
80
(£/MWh)
60
40
20
0
5000
10000
15000
20000
Capacity (MW)
25000
30000
35000
Why are Wholesale Power Prices
simply not Proportional to fuel prices?
Price £/MWh
90
80
Power
70
60
50
Gas
40
30
20
10
0
1999
2002
Oc De Fe Ap Ju Au Oc De Fe Ap Ju Au Oc De Fe Ap Ju Au
Figure 1.1 British daily average
t- cn- g- ( 50%
r- prices
b- gas
c- and
t-power
gas-b- r- n- g- t- c- b- r- n- g00 00 00 01 01 01 01 01 01 02 02 02 02
00 00 00
99 efficiency
99power
assumed)
SOURCE: Heren
18-Jun-03
28-May-03
7-May-03
16-Apr-03
26-Mar-03
5-Mar-03
12-Feb-03
22-Jan-03
31-Dec-02
6-Dec-02
15-Nov-02
25-Oct-02
4-Oct-02
12-Sep-02
21-Aug-02
31-Jul-02
10-Jul-02
20-Jun-02
28-May-02
7-May-02
15-Apr-02
21-Mar-02
28-Feb-02
7-Feb-02
Gas
17-Jan-02
24-Dec-01
3-Dec-01
12-Nov-01
Power
22-Oct-01
1-Oct-01
10-Sep-01
17-Aug-01
27-Jul-01
6-Jul-01
15-Jun-01
24-May-01
2-May-01
9-Apr-01
1-Oct-00
1-Jul-99
1-Apr-98
Why are Forward Prices Closer?
£/MWh
45
40
35
Spread
30
25
20
15
10
5
0
-5
Why do Electricity Market Prices Differ?
Monthly Average of Selected European Spotmarket Prices and Price Indices (May 1999 - April 2000)
60
NordPool
SWEP
50
UK Pool
Price [Euro/MWh]
40
APX-Base
30
APX-Peak
20
G'burg-Base
G'burg-Peak
10
Spain-Pool
0
Jän 00
Feb-00
Mar-00
Apr-00
May-99
Jun-99
Jul-99
Aug-99
Sep-99
Oct-99
Nov-99
Dec-99
60
Price (€/MWh)
But these change and so, Two Year’s later……………
120
100
80
40
20
0
3
3
-F
28
3
-0
eb
-F
21
3
-0
eb
-0
eb
-F
14
-0
eb
03
03
03
03
03
02
02
02
2
2
2
2
2
02
-0
ov
-0
ov
-0
ov
-0
ov
-0
ov
ec
ec
ec
ec
an
an
an
an
an
-F
07
-J
31
-J
24
-J
17
-J
10
-J
03
-D
27
-D
20
-D
13
-D
06
-N
29
-N
22
-N
15
-N
08
-N
01
Nord Pool
Spain
Netherlands
France
Germany
UK
Hydro Intensive Systems have Prices which
Depend Upon the Weather…
But the Story of Prices in the UK was Market Power and Regulatory Risk
Time Weighted Average Monthly Pool Prices
£24 Average Price
Cap
£ 6 0 .0 0
PSP
£ 5 0 .0 0
P rice / M W h
PPP
£ 4 0 .0 0
SMP
£ 3 0 .0 0
£ 2 0 .0 0
£ 1 0 .0 0
£ 0 .0 0
A p r90
O c t90
A p r91
O c t91
A p r92
O c t92
A p r93
O c t93
A p r94
O c t94
M o n th
A p r95
O c t95
A p r96
O c t96
A p r97
O c t97
A p r98
O c t98
Focus on Wholesale Markets in context……
ENGLAND & WALES ANNUAL ELECTRICITY PRICE HISTORY 1990 - 2003
95.00
90.00
85.00
80.00
75.00
70.00
65.00
Price (£/MWh)
60.00
55.00
50.00
45.00
40.00
35.00
30.00
25.00
20.00
15.00
10.00
5.00
0.00
1990/91 1991/92
Source: EIA
1992/93
1993/94 1994/95
1995/96
1996/97
1997/98
Retail Price (Household)
Retail Price (L. Industry)
Coal Marginal Cost
CCGT Marginal Cost
1998/99
1999/00
2000/01
2001/02
Wholesale Price
2002/03
Electricity Value Chain
Value chain for supply of a typical household in Germany (2003):
30 %
7%
wholesale
trade
production
transport
63%
distribution
retail
9,7 ct/kWh
Additional fees and taxes (42% of total bill):
1,8 ct/kWh
concession fee
0,8 ct/kWh
subsidies for CHP
and renewables
2,05 ct/kWh
electricity tax
2,3 ct/kWh
VAT
16,7 ct/kWh
EC Breakdown of Expected Electricity Prices in 2004
for 50 MWh/year small commercial customer (€/MWh)
Regulatory Benchmarking is becoming more
Prevalent……….
Key Market Issues in the Electricity Value Chain
1. The Wholesale Market:
How do Pools and Power Exchanges work?
How is real-time Energy Balancing achieved and paid for?
Efficiency of prices in the short term
Investment signals for the longer term
2. The Transmission System
Third Party Access and Use of System Charging
Inter Regional Trading
System Balancing
3. The Distribution Network
Regulation
2. The Retail and Energy Supply Business
Market Segmentation and Churn Rates