electricity market design at a crossroad

MARKET DESIGN AT A CROSSROADS5 April 2016

Stephen Woodhouse

DECARBONISATION IS TRANSFORMING ELECTRICITY MARKETS

Decarbonisation of the electricity sector is central to Europe’s plans to reduce carbon emissions, and this is set to be achieved through wind and solar

· Intermittent and less predictable generating patterns

· Reduced access to dispatchable generation

· Utilisation of existing flexibility➢ Demand side➢ Cross-border trading

· Investibility of electricity assets➢ Stabilise electricity pricing (relation to ETS)➢ Access to hedging markets

· European target model Mark II➢ Reduced time lag from bidding to execution➢ Utilisation of transmission grid➢ Mobilisation of flexibility➢ Improved investibility

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EUROPE IS DEALING WITH INTERLINKED ISSUES, BUT LACK OF POLITICAL COMMITMENT IMPEDES INVESTMENTLack of firm political commitment prevents solutions with investments based on a proper market framework undistorted by renewables and/or capacity support

2030Climate &

Energy Package

Renewables support

GHG emissions:– Binding overall target– Insufficient tightening of the allowance

marketRenewable energy:– Based on supportEnergy efficiency:– 30% reduction in energy use

● General capacity support bites its own tail: Softens electricity prices and increases investment risk

● Targeted capacity support is difficult to design in a reasonable way:

● Restrictions on use of resources?

Capacity support

● Renewables support distorts ETS and electricity market balance

● Sub-optimal operation of renewables adds to the need of flexibility

• Surplus and low prices in both electricity and allowance markets

• Support distorts the market, whether it is harmonised or not

• No investments without support


‘INTERMITTENCY’ WILL BE A MAJOR CHALLENGE

Wind generation is naturally intermittent, with high pressure, low wind areas covering large areas of Europe at the same time

Weather patterns for 25 December 2006

Generation 22-30 Dec (2030)


CONVENTIONAL CAPACITY FACES NEW RISKS

Increasing levels of intermittent generation across Europe give rise to both price and volume risk for conventional thermal capacity

Can I invest based on the

spark spread?

• Scarcity pricing politically unacceptable (even if it is economically sound)

• No near-baseload operation• Volume risks• Reliance on scarcity pricing

• Market interventions to protect consumers may seriously distort the market

Is infrequent scarcity pricing a credible basis for investment?

Do traded contracts allow both price and volume risk to be hedged?



REGULATORY intervention CREATES ‘MISSING MONEY’

Regulatory intervention and other market-impacting measures (e.g. reserve) impact the price formation and/or the volumes traded in the different timeframes

‘Missing money’

Other limits that ‘block’

the arbitrage between market

timeframes and reduce

liquidity

Indirect impact on

prices from upfront

reservation fees

Price caps and other bidding

restrictions

LARGE EUROPEAN UTILITIES ARE SPLITTING

0

40

20

60

100

80

Inde

x va

lue

(reb

ased

to

100)

STOXX Europe Utilities 600

NewCo

Source: Thomson Reuters

The unfavourable market conditions for traditional production capacity has led some utilities companies to split renewables from other energy production

STOXX Europe Utilities 600 development versus benchmarks2014

140Dow Jones Utilities Average

STOXX Europe 600120

2015


ARE NATIONAL CAPACITY MARKETS THE ANSWER?The response is the development of nationally based CRMs which can (further) distort markets and threaten the coherence of the Internal Market for Electricity

Capacity auctions

Centralised ROs

Centralised ROs

• National CRMs are being introduced, targeting greater investor certainty and generation adequacy

• However, each CRM developed or proposed in Europe is different in design, and there are no workable arrangements yet in place for cross-border participation

• Uncoordinated CRMs risk distorting spot electricity prices, and may harm demand side response, cross-border trading and distort investment decisions

Will national CRMs undermine the goal of the Internal Market for Electricity?

Which of the CRM designs will be accepted by the EC?

What will the EC’s forthcoming market design legislation – scheduled for end 2016 – bring forward?

Capacityobligations

“Scarcitypricing''?


THE LONGER TERM VISION MUST SHAPE THE MARKETS IN THE SHORTER TERM

Evolution of electricity markets

Short- term

vision

• How to defend cashflows in the short-term?

Medium- term

vision

• Can we invest in generation capacity in the face of market volatility?

Longer- term

vision


• What is the future of the European electricity system: a market or a centrally planned economy?

ENERGY MARKETS AT A CROSSROADS….

Will the future energy sector be based on

market principles or are we returning to regulated

investments?

How will EU and national policy objectives be

balanced in the future framework? How will

emissions targets and renewables targets be

balanced?

How will we ensure that investment is made in a

timely and efficient manner?

Re-regulation or liberalisation? Rely on European markets and a strong CO2 regime,or build national solutions with government-channelled investment?

What are the consequences for future electricity market design?


CREATING THE ELECTRICITY TARGET MODEL 2.0Adapting the European electricity target model to fit a world of flexibility

Target model 1.0


Full cost imbalance pricing to cover

LRMC not just SRMC

Co-optimisation of energy and

reserve/ system services

Recognition of energy options in the

market arrangements

Market based allocation of

network capacity across timeframes

Regional coordination of network planning

and resource adequacy

Coordinated security standards

Regional allocation of congestion revenue

and re-dispatch costs

Coordinated and transparent TSO

protocols in emergency situations

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STATUS OF CAPACITY MARKETS IN EUROPE

GBCapacity auctionsSEM

Ongoing price-based capacity mechanism,

Centralised ROs being developed

FranceCPM rules adopted

Jan 2015; First delivery expected

2017; currently investigated by EC

under state aid rules

Portugal Price-based capacity mechanism for new

units

Spain Current price based capacity mechanism being re-developed

Italy Proposals to replace current mechanism with centralised ROs

GreeceTransitional price based;

enduring capacity obligations; Flexibility

market being discussed (targeted cap payment)

Germany Discussions about

introduction of national capacity mechanisms;

Grid stability reserves in south since 2011

Poland Proposals for new market with capacity mechanism

Sweden & Finland Strategic reserve

supplements energy only market

BelgiumMarket wide CPM auction being discussed; Targeted tender cancelled by EC;Strategic reserve since

2014

5 APRIL 2016

electricity market design at a crossroad

Engineering