David Newbery, DAE Cambridge MIT Energy and Environment Policy - PowerPoint PPT Presentation

David Newbery, DAE Cambridge MIT Energy and Environment Policy Workshop www.econ.cam.ac.uk/dae/research/regulate.htm

• coal privatised on franchise contracts • franchise due to end “1998” • coal faces gloomy future • coal-friendly Labour party elected • electricity prices, profits stubbornly high � Oct 1997 Minister requests RETA � to correct bias against flexible coal 1

Generation in England and Wales by fuel type TWh 350 300 imports 250 hydro+other 200 CCGT other steam 150 Coal Nuclear 100 50 0 2 1990 1992 1994 1996 1998 2000

Coal production and use 120 100 80 million tonnes 60 generation use 40 20 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 est 3 netimports deepmined opencast generation use

Generation in England and Wales TWh 300 PSB / 250 Mission PG NP 200 Mis'n AES Eastern 150 IPP Import NE 100 Magnox 50 0 89/90 90/1 91/2 92/3 93/4 94/5 95/6 96/7 97/8 98/9 99/00 00/01 f'cast 4

British Domestic electricity prices net of taxes 11 10 p/kWh 2000 prices 9 8 7 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Edinburgh London 5

• generators have market power • capacity payments are unnatural • biased against coal • generators get PPP regardless of bid • constraint payments unsatisfactory • no demand side • unsatisfactory governance structure 6

• Pool complexity amplifies market power • ending guaranteed PPP will encourage competition • commodity markets a suitable model • end Pool � end PSA � change governance 7

• Pool replaced by voluntary markets • self-dispatch, physical contracts • SO trades in balancing market to stabilise • pay-bid in BM, different buy, sell prices � costly to be out of balance 8

Forward Markets Bulk OTC Trading Standardised Products Balancing PX Trades Mechanism Spot Market Options/Swaps Other Financial Instruments Financial Markets time Up to several T - 3½ hours T=0 T - 24 hours 9 years ahead Gate Closure Traded period

• Efficiency gains are small and easily lost – Newbery and Pollitt estimate restructuring CEGB lowered costs by 6% • Transaction costs may be large – Electricity: like cocoa or financial services? – Financial services charge 25% of income – Offer estimated restructuring costs at £700+ = 1.5% of PPP 10

• “The Pool is too transparent and discourages bilateral bargaining” • “Making balancing market a poor guide to SMP will encourage contracting” • “If there is no market of last resort then must-run stations have to accept lower bids” 11

• 90% of electricity contracted - what was wrong with Pool contracting? • A penal and opaque BM may encourage contracts but raise transaction costs • advantages incumbents and deters entry � more likely to raise costs and prices because long-run prices set by entry cost 12

• destroying Pool will create new risks � more vertical integration � make entry more difficult � allow total capacity to be controlled � to tighten market and raise prices 13

• The root problem is lack of competition • If this is resolved the Pool may work better • Pool replacement may then be unnecessary, costly and counterproductive – it will accelerate vertical integration – it will raise transaction costs and hence prices – it will deter entry and allow prices to rise 14

• Competition intensified – Jul 99 Edison Mission buys 4GW $472/kW – raises load factor from 25% to 40+ % � SMP falls 20-30% year-on-year – Oct 01 Edison Mission sells at $190/kW • Interconnector raises UK gas prices – CCGT now at margin – more dispersed ownership � more competition 15

Ofgem’s evidence on effect of NETA Annual baseload EFA prices £/MWh 25 NETA Design NETA Go Finalised Live 24 Post NETA, 23 only GTMA Go Live contracts Delayed 22 21 20 19 18 17 ug- 99 ar- 00 pr- 00 1- Jun- 00 1- Jul- 00 ug- 00 ar- 01 ay- 01 1- Jun- 01 1- Jul- 01 1- Sep- 99 ct - 99 1- Nov- 99 ec- 99 1- Jan- 00 1- Feb- 00 ay- 00 1- Sep- 00 1- Oct - 00 ov- 00 1- Dec- 00 1- Jan- 01 1- Feb- 01 pr- 01 1- M 1- M 1- O 1- A 1- M 1- M 1- A 1- D 1- A 1- N 1- A 16 Apr '00 April '01 April '01 SCH 5 ON April '01 GTMA

• The outbreak of post divestiture competition by Edison Mission? • Baseload supplied by inflexible nuclear • Delays in ‘Go-live’ cause contract unwinding? Key question: what caused price decline? 17

• discriminatory auctions discourage collusion • penal imbalances encourage OTC contracts � fiercer competition, chiselling • BM charges those who cause imbalance � better cost allocation and control 18

• revenue equivalence theorem � with risk of inefficient dispatch – supported by lab experiments • BM discourages efficient financial contracts • BM charges are not cost-reflective • BM charges company not system imbalance � excessive self-balancing 19

• more competitive trading • more scope for demand side • forward curves facilitate efficient entry • sharper cost incentives to manage risk � lower prices for all customers 20

• OTC forward baseload prices fall 6% y-o-y • forward peak prices fall 21% y-o-y • markets evolving nicely • Balancing Market 1.5% oversupplied • BM volatile but only 3% of trade • BM price spread narrowing “Real and substantial benefits for consumers” 21

£/MWh 19.50 20.00 20.50 21.00 21.50 22.00 22.50 23.00 27 Mar 29 Mar OTC winter baseload pre and post NETA 2 Apr 4 Apr 6 Apr 10 Apr 12 Apr 16 Apr 18 Apr 20 Apr Winter Baseload year on year 2000/01 24 Apr 26 Apr Winter '01 Baseload 1 May 3 May 7 May 9 May 11 May Winter '00 Baseload 15 May 17 May 21 May 23 May 25 May 30 May 1 Jun 5 Jun 7 Jun 11 Jun 13 Jun 15 Jun 19 Jun 22 21 Jun 25 Jun 27 Jun

Gross and net BM balances 8,000 6,000 4,000 2,000 MW 0 -2,000 -4,000 -6,000 27/03/01 03/04/01 10/04/01 17/04/01 24/04/01 01/05/01 08/05/01 15/05/01 22/05/01 S ettlem ent D ate N et A verage D aily Im balance A verage D aily N egative Im balance 23 A verage D aily P ositive Im balance

Average daily system buy and sell prices Average Daily SSP and SBP since NE TA 200 150 100 £/MWh 50 0 -50 5-Jun 27-Mar 3-Apr 10-Apr 17-Apr 24-Apr 1-May 8-May 15-May 22-May 29-May 12-Jun 19-Jun 26-Jun 24 Average SSP (£/MWh) Average SBP (£/MWh) Linear (Average SBP (£/MWh)) Linear (Average SSP (£/MWh))

Daily costs of NGC’s balancing actions Indicative Daily Cost of Balancing Actions St Fergus Gas Terminal Sruck by Lightning 4.5 4.0 3.5 3.0 2.5 2.0 £(m) 1.5 1.0 0.5 0.0 -0.5 -1.0 17/04/01 24/04/01 01/05/01 08/05/01 15/05/01 22/05/01 29/05/01 05/06/01 12/06/01 19/06/01 26/06/01 27/03/01 03/04/01 10/04/01 25 Value Bids Value Offers Net Cost of Actions

Spread in average BM prices Balancing prices weekday Sep-Oct 2001 70 60 50 40 £/MWh 30 20 10 0 0:00 1:00 2:00 3:00 4:00 5:00 6:00 7:00 8:00 9:00 10:00 11:00 12:00 13:00 14:00 15:00 16:00 17:00 18:00 19:00 20:00 21:00 22:00 23:00 half-hour starting SBP SSP 26

£/MWh 1000 1500 2000 2500 3000 3500 4000 4500 5000 500 0 27-Mar-01 2-Apr-01 8-Apr-01 14-Apr-01 20-Apr-01 26-Apr-01 2-May-01 Daily maximum BM SBP 8-May-01 14-May-01 20-May-01 26-May-01 Balancing Market weekday daily Maximum SBP 1-Jun-01 7-Jun-01 13-Jun-01 19-Jun-01 25-Jun-01 1-Jul-01 7-Jul-01 13-Jul-01 19-Jul-01 25-Jul-01 31-Jul-01 6-Aug-01 12-Aug-01 18-Aug-01 peak SSP 24-Aug-01 30-Aug-01 5-Sep-01 11-Sep-01 17-Sep-01 23-Sep-01 29-Sep-01 5-Oct-01 11-Oct-01 17-Oct-01 27 23-Oct-01 29-Oct-01 4-Nov-01 10-Nov-01

£/MWh 10 15 20 25 30 02/04/01 09/04/01 16/04/01 23/04/01 Weekday HH average spot price 30/04/01 07/05/01 14/05/01 21/05/01 28/05/01 04/06/01 11/06/01 UKPX and APX weekday average prices UKPX av 18/06/01 25/06/01 02/07/01 09/07/01 APX av 16/07/01 23/07/01 30/07/01 06/08/01 weekly UKPX moving average 13/08/01 20/08/01 27/08/01 03/09/01 10/09/01 17/09/01 24/09/01 01/10/01 08/10/01 15/10/01 22/10/01 29/10/01 05/11/01 28 12/11/01 19/11/01 26/11/01 03/12/01

• Market fundamentals drive prices down • Oct 01 contract round 2% up y-o-y • BM volatility/spread � PX prices � OTC prices • BM SBP unpredictable, can be very high • mistakes very costly • incentive not to balance but go long • fear � minimise risks 29

• Hard to get quotes for contracts <2GWh/yr • tariff includes BM premium ~ 5% • penalty if profile differs from historical • hard for demand side to bid, lost DSB 15% • higher management costs � higher delivered electricity prices 30

Very large user electricity prices 4.5 4 p/kWh 2001 prices 3.5 3 2.5 2 1.5 1 0.5 0 1990 1992 1994 1996 1998 2000 31 electricity co al co s t gas co s t elec-co al - FFL

• power exports from CHP down 61% • small genco costs up 16% • wind power can be charged for selling – BM imbalance exceeds energy value • self-insure with own spinning reserve – loss of system multiplexing • Demand forecasting decentralised – system accuracy ~5%, individual > 15% 32