dr. Gbor Szrnyi 16 April 2013 General Secretary of ERRA Main - - PowerPoint PPT Presentation

Will the present market model and the regulatory practice deliver adequate price signals for future investments and for flexible system operation of the energy industry?

• dr. Gábor Szörényi

General Secretary of ERRA 16 April 2013

a a a

Potential Regulatory Incentives for Adequate Price Signals Supporting Energy Investments (Generation and Network)

WEBINAR / Вебинар

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Main topics

• Present obstacles and foreseen international

tendencies in wholesale market conditions

• Specific wholesale market structures and conditions in

the market building process – relevant in most of the ERRA countries

• Special effects of the financial and economic crisis in

the transient period of market building (hindering investments) + possible regulatory interactions

• Some result from the ERRA wholesale market

monitoring system

• Case study on market integration – as part of the

solution (indicative price signals)

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Market conditions hindering efficient market operation

Key problems on national and regional wholesale markets:

– Concentrated national markets – Lack of investment (both generation and network) – Security of Supply (gas supply dependency, national/ regional capacity shortage) – Lack of supportive legislative framework – Slow process in market integration – Price trends, end-user price regulation – Lack of real independence of network operators – Limited regulatory power and regulatory incentives

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Some additional circumstances can hinder efficient wholesale competition

Present and foreseen tendencies which can hinder competition:

– Renewable with increasing ratio could be exempted from wholesale competition (feed-in tariff system) – CHP generators (under the new energy efficiency regulation) could be preferred (must run) (similar to the power-desalination co-generation plants) – New nuclear units (if any) foreseen to be invested under long term PPAs – Part of flexible gas fired units taking part in system regulation (compensating weather dependent renewable generation) contracted by system operators – Possible new Capacity Remuneration Mechanism (CRM)

→ Shrinking wholesale (day-ahead) markets (?)

→ Newly invented Central Purchasing Agent (SB) (?)

→ New Market Design (?) (instead of the „commodity only” market)

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General tendencies influencing wholesale market prices

(Source: Formaet) (Source: Red Electrica Espania) German wind

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Prague, Power Exchange Central Europe Daily

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FORWARD CURVE CZ PXE (€/MWh)

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Why the current market prices do not provide incentives for generation investment?

• After the economic crises, when the demand market normally

pushes up the commodity prices, the increasing proportions of the renewable, that have lower variable costs, could significantly change the price movement (either slow down the price increase or even decrease). The effect of these changes cannot be kept within the country borders, especially with the priority dispatch of renewable (at cross-border networks as well).

• Effects of the market price should be analyzed in two different

aspects:

• (1) What(’s) are the effects of the present market prices to the
• peration of the existing generator units and effects on the
• (2) planned new capacities (in line with the predicted future

market prices and foreseen risk elements and risk levels)

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How the current market prices and the increasing renewable ration could determine the operation of the power plants? ad (1)

• The high proportion of low variable cost renewable generators (wind, solar)

in Europe supersedes (squeezes out) the traditional power plants in most

• f the cases.
• If only marginal costs are bid into the market a peaking unit will never

recover its fixed costs (because of its cost structure)!

Cost structure of Power Plants

• The hard-to-predict and variable
• peration of renewable generators

forces the system operators to use the flexible power plants with relatively low utilization level for system balancing purposes.

• These effects result in the so-called

“missing money” problem. This phenomenon itself, without any further measure, does not guarantee that these flexible generation units remain in operation for long term.

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Phelix Baseload Year Futures (Cal-13) Prices and trading volumes

2008 2009 2010 2011 2012

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Why the current market prices do not provide incentives for generation investment? ad (2)

• The present market prices influence decisions on new power plant

investments but other circumstances could effect the outcome of the decision much more, such as: investors’ trust in the integrated energy market; the new financial environment; the stability of climate change and energy policies; and the possibility of low level

• f the market prices of the electricity for long run.

Based on the current market environment and the occurring future structural changes (substantial ratio of intermittent renewable), I believe that the price indications and the hardly manageable risk elements do not stimulate power plant investment at a required level. In addition, these factors do not ensure the sustainable operation of balancing capacities that are necessary to system control.

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Some of the potential measures reducing the negative effects of market distortions?

• What additional steps, if any, should be taken at national and regional level to

ensure that present market rules fully contribute to ensuring generation adequacy and security of supply?

Apart from the hardly predictable production of weather-dependent (intermittent) renewable in every second (in the peak hours as well) the secure and necessary generation adequacy and system flexibility can be improved by the following mechanisms: − The adverse impact of weather-dependent (intermittent) renewable

• n the operation of electricity system and market must be reduced

(e.g. electricity storage; ensure the daily market price forecast for renewable [RES integration into the market through day ahead nominations]) − The futures markets need to be developed (strengthen price indications for investors and risk mitigation [develop forward markets])

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Some of the potential measures reducing the negative effects of market distortions?

Potential regulatory measures (cont.):

• Improving the overall investment environment (continuous

forecast of the security of supply and flexibility; simplified licensing procedure; disclosure/publication of the potential power plant sites with network connection possibilities)

• More support for demand side involvement into the system

balancing (that can be mobilized the most quickly – huge potential!)

• Supporting the demand side energy efficiency measures with

incentive network tariff system (e.g. decoupled rate)

• Network development through incentive tariffs
• Transparent access rules to reach existing cross border

capacities (for system regulation the flexible generators are important!).

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Regulatory position regarding the implementation of any CRM

• First best solution: Market signal based investment
• Second best solution: Adverse impact of intermittent renewable
• n system operation and on market must be reduced + other

market distortions should be eliminated + general investment environment should be improved + more involvement of demand side

• If the best solutions do not work, some capacity mechanism

could be necessary

• Each national market structure and capacity/system flexibility

situation is different: no single, unified best solution but regional harmonization is necessary, otherwise the cross-border trade could be endangered!

• The preparation of adequate and less distorting mechanism

could require years! Some countries prepare it in advance.

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ERRA Members - Map

34 member regulators 1700 trained participants 80 trained Commission ers 4 training Videos 4 textbooks Several issue papers, case studies

Voluntary association

• f national

energy regulators Objectives:

• Improve

regulation

• Strengthen

Regulators with exchange of information, training, and research

• Harmonized

regulatory framework

• Stable

investment climate

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Market Conditions in ERRA countries (1) Specific wholesale market structures and conditions during the market building process – relevant in most of the ERRA cases:

• Concentrated national markets: the incumbent wholesaler still has

dominant position (in some cases with state preference)

• Special circumstances which slow down or hinder new investments:
• during the long lasting market building process the regulatory risk

and merchant risk is relatively high [no liquid wholesale market with

predictable prices, the financial institutions ask for risk sharing and risk mitigation],

• the (affordability led) regulated end-user prices [could have an effect
• n wholesale and generation prices, which do not „allow” adequate return on new

investment],

• the RAB and the RoR calculated by the Regulator do not always

cover the cost [relatively high risk elements and high cost of financing] of network development,

• lack of harmonized capacity allocations rules and harmonized

regulatory frameworks in most cases [hindering cross border network

investments]

• The EC sector inquiry (2007) report highlights the phenomena of regulated

end-user prices acting as a market distortion, especially for industrial users

• Hybrid model (regulated end-user price in major part of retail market 

indirect cap for the free market as well)

• Regulated end-user price for industrial users is not speciality of emerging

markets; out of 29 16(13) EU members have end-user price control at household (non-household) consumers

Retail market: Price Trends

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Market Conditions in ERRA countries (2)

• Security of Supply (gas import dependency, national/ regional

electricity capacity shortage)

• high dependency on one supplier of some markets (new

initiatives on diversifying gas supply),

• present and foreseen capacity shortage in some regions
• Lack of supportive legislative framework: the detailed market and

TPA rules are missing in some markets

• Slow process in market integration: the potential advantages of

integrating national markets – seem to be – evident for most of the players but there are barriers, which need time to pull down;

• political (mis)understanding of protecting national interest
• the time-consuming, very detailed work among TSOs and

Regulators has not reached the necessary level in some regions

• lack of adequate cross border capacities in some cases

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The features of transition: competition dimension

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Regulator’s role regarding PPAs

The Regulators could/should influence the structure and conditions of PPAs;

• The lengths of PPA (too long contracts with significant

capacities could limit the freedom of Government introducing wholesale competition)

• The pricing/payment conditions of the PPA (if significant

capacities) could determine future end-user price (limit the freedom of the Regulator/Government)

• Better to avoid approving the PPAs by Regulators
• Assist in the possible renegotiation process (ensuring the

interest of end-users and investors as well)

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Special Effects of Financial and Economic Crisis in Transient Period of Market Building (1)

Present position of financial institutions in most „ERRA regions”:

• Limited latitude (freedom) of local private commercial banks (affiliates) –

limited availability of funding

• Long Term Debt market has shrunk
• Higher risk sensitivity of banks;

– Country/political risk of transient economies – Regulatory risk of emerging energy markets (market building process) – General energy industry related risk elements (CO2 regulation, fuel prices, SoS, regional market tendencies) – Default-risk (long term PPAs with state owned national champions → annual contracts with market players)

• Shorter terms (10-18 years → 7-12 years);
• Lower leverage (80/20 → 70/30; 50/50);
• Higher margins (3-4x)

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Special Effects of Financial and Economic Crisis in Transient Period of Market Building (2)

Consequences of new position of financial institutions in most „ERRA regions” (special focus on infrastructure):

• Anxious hesitation → Investment programs postponed (newly calculated

financial conditions)

• Limited availability of funding → Only the „best” projects will attract financing
• „Best projects” mean in financial language;

– Limited country/political risk → countries with transient economy → higher risk premium – Limited regulatory risk → transient period of market building → continuous changes → higher risk

• Shorter lending period + lower leverage → higher equity requirements → strong

strategic investors + incumbents could build new projects

Foreseen Consequences of Economic Crisis on Networks:

• Reliability of networks and service quality could reduce [less income (demand↓

by 5-10%) and increased cost (cost of capital↑) of TSO/DSO → less expenditure

• n M&D]

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Potential incentive mechanisms assisting infrastructure development (1)

• Financial incentive is key (Regulatory „pressure”/ obligation for

network development is not enough)

• Potential regulatory tools:
• „Real” evaluation of network asset ( depreciation and cost of capital could

increase among network costs  network charge↑)

• Shorter amortisation period of network elements
• Network charge adjustment during pricing period (activated new investment

elements could be accepted)

• Accepted return could be adjusted to new economic situation (Returns on

Government bonds + risk premium)

• Cross border (inter-TSO) network  higher risk;
• Higher accepted rate of return for new investment
• Exemption from general TPA rules
• Negotiated tariff for gas storage facilities in competitive

environment

Potential regulatory actions:

Potential incentive mechanisms assisting infrastructure development (2) Network charge increase has less influence on end-user tariff during low energy price time-period  time for adjustment

End-user tariff System charge Energy price

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Pricing issues

• f countries with emerging economies

Among these circumstances

• during economic and financial crisis the medium and large end-users are very sensitive to

energy prices → could strongly influence the national economy

• during these years of cutting (reducing) social safety-net the households are also very

sensitive to end-user energy prices → social welfare

How could we (regulators) convince politicians not to interfere (distort) network price regulation and allow market based energy prices (or even cost based regulated prices);

– in countries, where the belief in the market has less tradition? – where the wholesale and retail markets are not functioning well? – where the end-users (industry) are not competitive with higher energy prices? – in countries, where the social welfare is already on very low level with present energy prices?

The political interaction into price regulation has medium/long term effects which could be in contradiction with other political goals (safe and continuous supply and climate change measures)!

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Challenges

• f the Market Reform Process

Security of Supply (SoS) issues during the transient period: Net export position of certain national markets of the CEE and SEE region is diminishing and (is) turning into net import position: If there is a threat of capacity shortage and/or security of supply problems politicians may become concerned and often interact in a way, which does not support competition and regional market building (support national champion, priority at borders, artificial barriers at borders)  Challenge: How to avoid maintaining or re-creating isolated, relatively small national markets instead of establishing regional market conditions. The lack of regional market and the national administrative measures discourage new private investments, especially large scale new generation investment.

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Price level on ERRA markets Low wholesale (energy component „only”) prices in some ERRA countries do not allow private investment in generation

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Capacity Balance in the CEE-SEE ERRA region

• Increasing regional cross border

trade

• Turning to serious net import position
• New generation investment is

needed

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Capacity Balance in the Baltic ERRA region

• Export potential turnes to import

dependency without new investments 28

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Lesson learned in the transient period of market building

• In case of capacity shortage situation (foreseen SoS

problem in gas supply) the market based solution („open” borders, new generation investment on investor risk) could be postponed

• In case of drastic energy price increase tendency (based on
• il, gas, CO2, power [commodity] prices and increased cost of

capital) the market conditions could be hindered (supply with regulated price [USP] instead of market based price)

• Potential attitude of emerging markets with affordability

problems on renewable supports

→ progress, but slowly with the support of the fast developing technologies (e.g. PV) → selective support schemes → predictable, transparent regulatory framework is key!

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Major step in the process integrating national markets in Europe Implicit market coupling: very efficient way of cross border capacity allocation and daily trade among neighbouring markets (PXs)

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CZ-SK-HU MC Project

30/05/2011 Memorandum of Understanding Design & Implementation 06/05/2012 Workshop External Tests

11/09/2012 Successful GO LIVE

Regulatory supervision, support and approval: TSOs and PXs:

Source: MAVIR

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Lesson learned during the Trilateral Market Coupling

Hungarian and regional Day Ahead Market (DAM) prices in 2012 (before and after market coupling) → signifanctly decreased volatality

• The very close cooperation of the

involved stakeholders, the dedicated hard work of the involved experts and managers and the continuous believe in the customers’ benefit of the integrated market were necessary for this successful market coupling.

• Convergence to regional prices (the

prices converged among the three PXs)

→ robust indicative price signal for

investors

• Decreased volatility of prices
• The utilisation of cross-border

capacities increased (limited days of congestion at borders) → potential benefit of traders to optimize portfolio (social welfare effect)

Integration of substantial ratio of renewable resources to the interconnected system creates new challenges for TSOs and NRAs!

Source: MAVIR

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Thank you for your kind attention!

www.erranet.org

Gabor.Szorenyi@erranet.org

Potential Regulatory Incentives for Adequate Price Signals Supporting Energy Investments

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