Designing Liquid, Transparent, Reliable Wholesale Markets
Nigel Evans
Executive Vice President
Head of Global Energy Market Strategy
Competitive Wholesale Markets - Building Blocks
Full separation of transmission/distribution (from generation and retail supply)
Full retail supply competition
Properly incentivised, for-profit SO
Regulation of behaviour based on financial-markets best practice and application of competition laws
And remember
Markets are not “designed”
Establishing competitive wholesale markets- the Pool approach
Establish a market at a specific time day-aheadSolicit offers and bids from generators and customers
Offers designed to reflect generators’ costs (multi-part structure, start-up and no-load costs, minimum run-time, ramp rates and other technical parameters)
Complex algorithms used to calculate a single (hourly or half-hourly) clearing price
Examples: Australia, England & Wales Pool (1990), FERC standard wholesale market design
The day-ahead Pool approach does not work
Repeated daily auction encourages leader-follower pricing strategies with few participants competing to set clearing prices
The complexity of pricing algorithms frustrates transparency
Encouraging significant demand-side participation can be problematic
Straightforward to manipulate prices (problem if the Pool is compulsory, even worse if it’s not)
Difficult to hedge price risk (the complexity of pricing algorithms and ability to manipulate prices discourages non-physical players from participating in market)
Disconnection between day-ahead and real time markets
So what should you do?
Enable all market participants to trade in whatever way they choose right up to real time
Typically participants may trade:
OTC
via exchanges (cleared or otherwise)
Tenors from years to hours (or less)
Participants will decide terms on which they trade, but will typically use a “pay-as-bid” approach
“ I offer to sell you 100 MWh at $21/MWh..Agreed”
So what should you do? Cont...
Transactions take place because
“Longs” will wish to sell
“Shorts” will wish to buy
and “Traders” will wish to trade
Market prices emerge (via price reporters, exchanges, or even mandated reporting) on the basis of prices at which transactions take place
Algorithms play no part in establishing market prices
Maintaining balance in real time
SO (RTO) has responsibility to maintain balance in real time
SO incentivised to balance economically using a broad range of forwards, options and real time actions
SO market power curtailed through:
- separation (and ownership)
- collars on incentive revenues/losses
- market information disclosure obligations
Maintaining balance in real time. Cont..
Out of balance market participants cashed out based on costs of balancing actions (excluding constraint/frequency response action)
Need for on-going surveillance for exercise of locational/temporal market power
How does this work in practice?
New Electricity Trading Arrangements (NETA) replaced England & Wales Pool in March 2001
Power exchanges/brokers have emerged
Price reporting has developed
Liquidity has increased
Volumes bought/sold in the (real-time) balancing mechanism have remained low (2% of physical)
(and in the over-supplied market wholesale prices have fallen)
Tra
din
g P
eri
od
BM IS
T-3 ½ hrsT-One DayT-One MonthT-One Year
Bulk OTC Trading
Standardised Products
Option Contracts
Other Financial Products
PX Trades
The New Electricity Trading Arrangements (NETA)
Exchange LiquidityMonthly Traded Volumes
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02
GW
h
UKPX UKAPX Spectron