A Review of Restructuring in the Electricity Business

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1 A Revew of Restructurn n the Electrcty Busness by M. Huneault F.D. Galana G. Gross IREQ McGll Unversty Unversty of Illnos Abstract: Snce the 198's, efforts to restructure the electrcty nustry have receve much attenton aroun the worl. o ate, approxmately twenty states have unerone restructurn to ntrouce formal markets as a vehcle for electrcty transactons. Numerous other states are actvely pursun smlar paths. Althouh the eneral prncples whch have ue restructurn are enerally accepte, a varety of resultn utlty an enery market structures have been mplemente. In fact, opposn market phlosophes have emere. hs paper revews the present state of restructurn aroun the worl, an escrbes key elements such as nustry structures, market phlosophes, spatchn stratees for spot markets an prcn. 1. Introucton: Motvaton an Hstory he economc penulum has swun ecely to the se of free enterprse n most nustralze countres over the last twenty years. hs movement was spearheae n the early 198's n lare part by leaers n Enlan an the Unte States. It followe a eneraton urn whch socal emocratc overnments ntervene more actvely n economc spheres. hs chane n phlosophes has manfeste tself n the restructurn 1 of many lare economc sectors, the latest of whch s the electrcty busness. Essentally restructurn replaces a market structure that lmts profts but cannot stem neffcences by another whch rewars effcency wth proft. Hstorcally, spartes ha always been observe n the prces of electrcty. Intally lnke to local enery resources, these spartes ha been mantane by nsttutonal structures such as state monopoles or strctly reulate prvate utltes servn well-efne an mutually exclusve terrtores. he avent of extra hh voltae transmsson n the 196's allowe for the transfer of bulk power, an even thouh the monopolstc vewpont prevale at that tme, system operators raually ane valuable experence n the manpulaton an commerce of enery on a lare scale. hs set the stae for the lberalzaton of the nustry. he 197's saw tremenous reforms n several major nustres worlwe, nclun telecommuncatons, transportaton an as [Wnston 1993, Chwalowsk 1997, Jess 1997]. It was prectable that smlar pressures woul be exerte 1 In ths paper the term restructurn s preferre to ts oftenuse synonym, ereulaton. he authors feel that the former closer reflects the new realty n whch fferent reulatons have been put n place. 1 on the electrcty nustry. he eneral movement n favor of electrcty nustry restructurn was ntate n the Unte States urn the 197's [Schweppe 1978]. wo basc reforms were avocate: the ntroucton of competton an the mposton of prces reflectn real costs accorn to use. he ea of varable tarffs n a monopoly envronment ha alreay been sueste urn the 195's [Vckery 1955] an snce extene [Boteux 196, Vckery 1971]. he noton of competton n the form of open access to markets an networks by competn proucers, marketers an strbutors came as a result of stanaton n many utltes whch ha been lmte by reulatons wth rear to profts an expanson. Early proponents of restructurn n the Unte States were consumers an marketers n the hhprce markets who souht relef from cheaper nehborn enery markets. he 198's serve as a pero of reflecton n the Unte States an Europe for ereulators who saw certan avantaes n breakn up the monopoly structure of the nustry. hey evelope a eneral "phlosophy" whch woul appeal to all enery market partcpants. he man avantaes of the propose restructurn were expecte to be a reucton n enery prces throuh the openn of compettve enery markets, lon-term ans n effcency, an the nflux of prvate captal. New, more effcent proucers an possbly new transporters / strbutors woul see ther efforts reware wth profts ctate by the marketplace. Note that restructurn oes not necessarly mply prvatzaton, an n many countres crown corporatons are stll very much nvolve n the electrcty sector. In retrospect, other avantaes offere by nustry reforms were equally mportant. In several countres the natonal ebt stfle rowth; there, the publc sector coul no loner meet the nvestment nees of the electrcty nustry. Hence overnments ha two ae ncentves

2 for removn themselves from the enery busness, namely, to free up publc funs an to collect much neee cash from the sale of nustry assets [Wolak & atrck 1997]. Althouh not openly amtte, atonal ncentves attracte some countres towars restructurn. hese were the esre to free utltes from poltcal meln, to push throuh corporate reoranzaton an ownszn, an to enforce effcent busness practces [Runck 1996, U.S. Department of Enery 1997]. In several countres, leslators an nustry leaers prepare ther reforms n concert at both the reulatory an corporate levels. he frst major efforts solcte mostly leal an astratve avce. echnocrats, usn technques from both power systems an economcs, eventually evelope enouh tools to operate ther power systems n the restructure envronment. In ths lht, some major evelopments are the applcaton of marnal cost theory to power system operatons [Schweppe et. al 1988], ts applcaton to the operaton of a pool n a restructure envronment [Hoan 1992], the coexstence of a spot market an blateral contract mechansms [Wu & Varaya 1995], an market evces for transmsson prcn [Chao & eck 1996, Harvey et al 1997, Green 1997]. Snce 1982, several countres have enacte leslaton to open ther electrcty nustres to competton. hree countres are enerally reconze as poneers: Chle (1982) [Runck 1996], Enlan an Wales (199) [Green 1998] an Norway (199) [Moen & Hamrn 1996]. Unbeknown to most nustry observers n the Enlsh-speakn worl, Chle unertook a bol plan of nustry restructurn, passn leslaton n 1982 an raually mplementn the plan throuh the ecae [Bernsten 1988]. he work prouce n Chle nspre several smlar ntatves n Latn Amerca. Arentna, whch experence economc harshps smlar to those n Chle, restructure n 1992 [U.S. Department of Enery 1997]. Several South Amercan countres followe sut from 1993 to 1995 [Runck 1998], as many Central Amercan countres n 1997 [http://www.n.puc.cl /power/ southamerca.htm]. In 1998, Brazl [Secretary of Enery, Brazl] an Mexco [Secretara e Enera, Mexco 1999] ntrouce plans to restructure, but they cannot be sa to be favorn the Chlean/Arentnan moel. he structure evelope n Enlan an Wales sprea to Scotlan an Northern Irelan from 199 to 1992 [Yajma 1997], an certanly nfluence other Commonwealth states such as Australa [Outhre 1998], New Zealan [Rea & Rn 1995] an the Canaan provnces of Alberta [Lonon Economcs 1998] an Ontaro [Ontaro Market Desn Commttee 1999]. he Norwean reform sprea to the other Scannavan 2 countres snce 1995 [Lonon Economcs 1997]. In the Unte States, the poneern leslaton calle URA frst lberalze the trae of electrcty n 1978 [Glbert an Khan 1996]; the EAct of 1992 fnally allowe open access to enery markets [Stalon 1995], but state-by-state restructurn s only now bennn to materalze. resently sx reons fall uner the supervson of socalle Inepenent System Operators, an several other smlar oranzatons are ben contemplate [Eson Electrc Insttute 1999]. Fully operatonal market structures allown spot market an blateral transactons appeare n both Calforna [hlpson & Wlls 1998] an n the JM consortum [Hoan 1998] n he Calforna experence took form after extensve scusson an resulte n a compromse between the pool an "pure" market structures. he resultn open moel s close n sprt to that of Norway, f not n ts actual mplementaton. After years of elberaton, the European Unon submtte a rectve to ts members at the en of 1996, requrn them to present plans by the start of 1999 for the openn of ther electrcty markets by the early 2's [Boteux 1996, ercebos 1997]. Common ponts can be foun n all these reforms, but there reman some profoun fferences n approach. Each reon carres over ts own hstory, eneral vewpont, operatn prncples an ynamcs nto ther new structures. Other reforms, whch cannot be strctly classfe as ereulaton, have been unerway n Eastern Europe (prvatzaton), Southeast Asa (lberalzaton smlar to URA) an Southern Afrca (nternatonal trae) [Izaurre 1998]. 2. Structural Chanes wthn the Electrcty Inustry hree major elements pervae every mplementaton of electrcty nustry restructurn: the openn of enery markets, the unbunln of electrcty servces, an open access to the electrcal networks. he combne expectaton of hher profts an lower prces resultn from the openn of compettve wholesale enery markets s the central theme of restructurn. An essental requrement s that ncumbent proucers an newcomers alke be uarantee access to the market, subject to meetn mal fnancal an techncal stanars. he openn of retal markets, n whch consumers buy from competn provers,

3 consttutes a secon mportant step n lberalzn the commerce of enery. he creaton of a new, autonomous nsttuton, the power exchane (enote X), has facltate the sale of enery between proucers, consumers an marketers over tme horzons whch span hours (spot market), ays, weeks or months (physcal an ervatves blateral markets). hese market mechansms offer fferent avantaes. Unbunln refers to the attrbuton of stnct electrcty nustry functons to stnct corporate enttes (servce provers). hs stemme from the prmary nee to separate the ncumbent transmsson prover, now servn many proucers, from the ncumbent proucer. he "wres" functons reman reulate an must eal wth requests from competn enttes on a nonscratory bass. Other functons offere by autonomous enttes prove strbuton, retal sales, metern an blln n a compettve marketplace. Another servce of prmary mportance, the coornaton of network operatons, s prove by an nsttuton calle the Inepenent System Operator (ISO). he thr element of restructurn, open access to electrcal networks for all proucers s a necessary conton for enery markets to work. In most mplementatons, ncumbent transmsson companes mantan monopoly control an are reulate, but receve some payments relate to market-rven opportunty costs. hese basc restructurn prncples have enerally been put n place by leslaton. Beyon that, the mplementatons vary snfcantly. Bascally two utlty structures have emere. In one varant, separate companes have been forme for each functon; n the other, non-eneraton functons are prove by farly autonomous subsares of a snle parent transmsson company [Rahm & Vojan 1999]. Ether structure s eeme acceptable f partcpants perceve the operaton as ben unbase. Restructurn has brouht about a reefnton of the oblatons, roles an practces of the tratonal nustry partcpants - the reulator, the enerators vsons, an the wres vsons of the utltes. In a monopoly envronment, the reulator typcally has been an nterventonst, actn on behalf of the publc. Its man role ha been to approve tarffs, a job that has now become mostly superfluous. In the restructure envronment, reulators have partcpate n settn up market structures. Its tasks are: creatn rules for partcpaton, efnn the responsbltes, potental rsks an rewars to market partcpants nclun benefts to consumers, mposn lmtatons on the reulate portons of the nustry, an mposn temporary measures urn a transton pero. Startn urn the transton pero, a common role of the reulator s to montor nustry profts to assure that captve consumers are not penalze by overly enerous tarffs. In the restructure marketplace, the reulators' roles have vare accorn to the varous mplementatons. For the most part, they are ntene to be relatvely lht-hane, servn to ensure the far operaton of the market n eneral. he utlty has seen many of ts tratonal responsbltes evolve towars other oranzatons or remove altoether. he oblaton for enerators to serve has been remove n many reons. he oblaton of the utlty to plan,.e. to prepare expanson to meet future nees, has been ven to separate enttes or has sappeare wth the expectaton that market forces wll serve as a substtute. he responsblty of operatn the system has fallen on the X an the ISO, often bult from the ashes of the ol utlty structure. In aton, several scenaros of utlty sementaton have appeare. he nepenent eneratn companes can vary n sze from a snle plant (Vctora, Australa [Department of Enery 1997]) to lare chunks of the eneraton market (Enlan). he process can nvolve a leslate breakup as n Enlan, a quck "voluntary" breakup as n Calforna or Vctora, or a slow vestment over tme accompane by partal reulaton, as recently arrane n Ontaro. Alberta opte to keep ts three major proucers ntact, but n a novel approach they are requre to aucton off ther eneraton to numerous marketers n lon-term contracts [Aamson & Gouln 1999]. In countres wth hyroelectrc resources, hyrolocal basns can be share by nepenent proucers (South Amercan countres, Norway) but are scheule by a central entty. Ownershp of eneratn resources has usually been restrcte to lmt market power, althouh n one case (New South Wales), untl recently, competn plants were all overnment-owne. Separaton of functons usually prohbts cross-ownershp of fferent types of facltes; the only notable fference so far has been n Chle. A few exceptons to the unbunle corporate moel are now appearn. In ts recent leslatve proposals, France expresse ts esre to mantan EDF ntact as a publc servce utlty, wth all the oblatons that entals. EDF woul submt to reulaton but woul compete wth other proucers n ts enery market. In Canaa, the market esn commttee n Brtsh Columba [Brtsh Columba Utltes Commsson 1998] has come out n favor of ths approach, an the feeln s that two other lare provncal utltes, n Québec an Mantoba, wll 3

4 eventually follow that route. In many but not all mplementatons nvolvn publc utltes, restructurn also nvolve prvatzaton of eneraton; reasons have vare but tene to echo local economc concerns. All n all, hher overall effcency cannot be attrbute to ether prvate or publc ownershp [Atknson & Halvorsen 1986]. At frst lance, the wres busness s the least affecte by restructurn. Actually n most mplementatons, restructurn has reuce the scope of actvtes usually performe by transmsson / strbuton provers to the basc constructon an mantenance of the network. However, recent proposals n the Unte States am at creatn busness-orente transmsson companes, or ranscos [Lenar 1998], to ntrouce the same compettveness n the wres busness as n the eneraton busness. 3. Responsbltes of the New Insttutons As note alreay, autonomous enttes have taken over the tasks of eneraton scheuln an network coornaton. he separaton of these enttes nto corporate structures to ft the requre functons vares from one mplementaton to another. hese structures balance questons of effcency an transparency of operaton n the presence of competn nterests. [Rahm & Vojan 1999] summarzes mplementatons n several countres n a clear, succnct form usn block arams. her four block types are the ISO, X, Scheuln coornator (escrbe below) an ransco. For example, n Calforna, the four blocks are separate; n Enlan the ISO, X an ransco form a snle pool, all roupe wthn a common corporaton, the Natonal Gr Company. he Inepenent System Operator s normally the frst to appear n a restructure envronment. Its tasks are we rann an complex. In preparn actvtes for the next ay, the ISO splays mportant network nformaton for market partcpants n the form of network avalablty (ACs an Cs [NERC 1996]) an loa forecasts. It also verfes an reserves requests for transfer capablty prove that they satsfy network securty. In aton the ISO controls network operaton n real tme, ajustn for sturbances an orern the requre ancllary servces neee for network operaton. Such servces nclue loss compensaton, capacty reserves, frequency reulaton, coneston manaement an voltae support. Fnally, the ISO hanles the astraton an blln of network servces. 4 he X collects economc bs submtte for the enery transactons on a short-term spot market, an then spatches eneraton to best satsfy loa. Implemente spatchn functons vary n complexty. In ts smplest form, the X spatch nores network constrants. hen, f network coneston s foreseen, ajustment schemes oble proucers to evate from the ntally announce spatch. roucers are then accornly compensate. More complex spatches nclue network constrants, nteratn nformaton from both the smpler X functon an the ISO. In Calforna, a thr type of entty, calle the scheuln coornator, collects requests for transmsson servces from partcpants who have entere nto blateral contracts. Bascally each scheuln coornator serves a terrtory prevously occupe by one of the state's three lare ncumbent utltes. It was felt that nepenent scheuln coornators coul better serve ther reons by actually facltatn traes an optmzn local arranements, whle freen the ISO an X to concentrate on bulk power transactons [Moore & Anerson 1997]. Consern the enormty of the Calforna market, ther presence reatly eases the buren of the ISO. Autonomous corporate enttes vary but the above scusse functons can now be consere enerc. 4. revaln Operatn hlosophes for Electrcty Markets Ientfable phlosophes have emere n terms of nsttutonal structures an the level of control that they are allowe to exert on commercal actvtes. resently there s no clear wnner. Bascally two poles have forme aroun the pool moel an a market-rven moel wth lttle or no centralze nterventon. Intermeate postons are hel by mxe power exchane / blateral contract moels n whch one or the other oates. Major ponts of contenton between these poles center aroun (1) economc neffcences, an (2) the naequacy of centralze control practces. hs secton expans on these ponts. 4.1 ool Structures In ths paper, a pool s efne as a compulsory power exchane/iso to whch all transactons must be submtte for analyss an approval. Only ment transactons are hanle, typcally over the horzon of one ay. artcpants transact wth the pool rather than wth each

5 other. Requests are treate base on b prces an the avalablty of network resources an enery reserves. ransactons, characterze by pool prces an spatche quanttes, are etere by the pool base on a mathematcal optmzaton, typcally mzn the total b cost. hs often mmcs the central spatch process use n the monopolstc envronment. Moels can also be ajuste to optmze socal welfare, a component of whch s the eman beneft functon. An mportant component of the fnal selln prce to the consumer s the centrally-compute marnal cost arsn from the optmzaton. he components of the fnal selln prce fall nto two cateores: those whch are explctly moele n the marnal prce an those whch are not. he most complex optmzatons ncorporate many marnal-cost-proucn components [Bauhman et al 1997], nclun those resultn from water resource scheuln (New Zealan [Scott & Rea 1995] an several South Amercan countres), unt commtment (Enlan [Ja 1998] an JM [JM 1998]), capacty constrants expresse explctly or as loss-of-loa probablty, an actve power spatchn wth/wthout securty constrants (New Zealan, JM / Enlan, Australan states). Network losses can be hanle wth varyn erees of complexty, whch can be base on a "center of ravty" marnal cost scheme (Chle), areate by zone, base on pro rata methos, or nclue n the marnal prces. he explct moeln of losses or network coneston results n fferent marnal prces n each locaton of the network; these are cone the locatonal marnal prces (LMC) 2. Chares for transmsson between buses are then base on LMC fferences. he cost components not explctly moele n marnal prcn are recovere usn "averae" chares, calle uplft chares n Enlan, or by prce ajustments. reference for a partcular pool prcn moel s justfe by subjectve factors. Such factors are the comprehenson or past experence wth a moel, the smplcty of the soluton, the mportance of central control n scheuln resources, the mportance of representn certan prce components, avoance of hhly volatle prce components, avoance of the mposton of costs whch coul penalze some consumers, an the ncluson of socal costs to be born by all. ool-type markets were the frst to appear, n Chle an then n Enlan an Wales. he Australan states of 2 In the power system context, LMC s a recent term cone by economsts. In the power nustry, ths term has been n use for several ecaes an was tratonally calle the bus ncremental cost [onrajah 1984]. 5 Vctora an New South Wales also operate pools [U.S. Department of Enery 1997]. Most South Amercan countres, New Zealan an JM have mxe systems (pool/blateral) where the pool actvtes oate. Hstorcally, several of the above systems have apple a tht techncal control on power systems operaton. It seems that techncal rather than economc control s stll the man ssue n choosn pool structures. Actually pool economcs have been crcumvente by the creaton of fnancal hees calle contracts for fferences (CFD). In these areements, buyers an sellers set a prce for enery transferre throuh the pool. hat part of the prce not collecte by the pool s pa by one partcpant to the other. hs effectvely takes the form of a fnancal blateral transacton. One crtcsm of CFDs s that snce ther prces o unsclose, pool prces ten to be skewe. It has been estmate that as much as 8% of power sol throuh the pool n Enlan an Wales s also backe by CFDs [Helm & owell 1992] Avantaes an Dsavantaes of ool Operaton Defne by a close set of rules, the pool system can realy be analyze, but ts complexty leaves room for nterpretaton. roponents of the pool moel avance several avantaes: t proves a rorous structure to mze overall economc effcency; t serves as an easly-accesse central clearn house to buy an sell electrcty; t sets market prces accorn to well establshe commoty market rules; t removes opportuntes for arbtrae; t spatches an sets prces for ancllary servces. A realy amtte savantae of the pool s that t s prone to volatle prces, probably ue to ts nflexblty an the mmeacy of the nees t seeks to satsfy. Detractors of the pool moel have mounte much crtcsm [for example, Oren et al 1995]. hey pont out that present market moels o not mze the cost to the consumer. hs s ue to the nherent economc rents rolle nto the prcn mechansms. hey also conten that practces fore n a non-compettve snle-utlty envronment no loner hol true, an that partcpants n a compettve envronment are unuly restrcte by central plannn tools. he unntene consequences of the use of two stanar functons, unt commtment an economc spatch, are snle out here. Unt commtment proves the on-off status of eneratn unts. In a mult-proucer envronment, t effectvely strbutes entry permts nto the market. In many cases, the result of the unt commtment s hhly nsenstve,.e. costs for a we class of commtments ffer by lttle

6 from the fnal soluton [Oren, Svoboa & Johnson 1997]. Moreover, the optmal tself s practcally unattanable, an has to be approxmate by a suboptmal soluton [Zhuan 1988]. Hence any nstance of unt commtment n a lare class of near-optmal commtments woul lkely scrate aanst certan proucers. hs arument convnce Calforna to aopt self-commtment by proucers. Hourly or half-hourly auctons run by the pool are bascally b-base economc spatches. B-base economc spatch can result n a opportuntes, n whch proucers ajust b ata n the hope of eneratn opportunty costs or securn other avantaes [Wolfram 1997, Gross 1999]. Another crtcsm rase relates to the use of the OF whch s ata senstve an non-robust, an therefore cannot be counte on to ue partcpants farly [apalexopoulos 1999]. Msvns about pool operaton o eeper than the above crtcsms however. Detractors fear that as a monopoly power broker, the pool can overchare obscure uplft chares an astratve costs, an has lttle ncentve to ncrease ts own effcency throuh the aopton of more cost-effcent market moels. Alreay n Amercan crcles, newborn ISO structures are ben crtcze as ben neffcent an ant-compettve. Superstructures calle Reonal ransmsson Oranzatons (ROs) are now ben propose to elate many of these concerns [Eson Electrc Insttute 1999] he "ure" Market Moel he see of the "pure" market moel fell n the Amercan Southwest some fve years ao, but t has not yet taken frm root. It ornate n 1994 as a reacton aanst the pool moel propose n Calforna's polcy paper on restructurn [Blumsten & Bushnell 1994]. Lea by acaemcs from Berkeley an senor enneers at acfc Gas & Electrc, an encourae by a rown fleet of power marketers an lare customers, ths roup has looke to evelop market mechansms whch woul requre a mal amount of nterventon from the centralzn nsttutons. Ieally, the ynamcs of supply an eman between knowleeable partcpants n a ecentralze market woul allow each partcpant to reach ts own best eal by reucn or even elatn economc rents. Recourse to blateral contracts was therefore stronly encourae. Market esners n Calforna expermente wth new spot market mechansms base on aucton theory [Sheblé 1996, Sheblé 1998]. artcpants woul respon to marnal costs announce by a central spatcher rather than prove b curves; an equlbrum woul occur after several teratons when the announce prce reache the rht level. Ironcally, ths s qute smlar to the wellknown central spatchn technque calle lambaspatchn [Krchmayer 1958]. Coneston woul be releve n a smlar manner, n that coneston costs announce by for-proft ranscos woul be ajuste untl tenants of unproftable transactons woul voluntarly wthraw from the market. he mal role foreseen for a X woul be to sen prce snals to the market, whle for the ISO t woul be to snal unacceptable moes of network operaton resultn from the commercal requests. he term Inepenent System Astrator (ISA) [Imparato 1999] was cone for ths new mal operator. he pure market theory s stll embryonc, an so Calforna renounce ts mplementaton. he mxe system aopte n Calforna n 1998 proves formal pool structures but also retans some of the openness of the pure market system. A realy amtte shortco of the pure market moel s ts present nablty to properly hanle transmsson-relate costs. Detractors pont out that as t stans, ts mechansms are untre, an they o not uarantee economc effcency nor even stable market operaton. he Calforna experence beot a bevy of consultants who are now tryn to avance the cause elsewhere, but more work nees to be one to further ths approach. he ll-fate Desert Star ISO ntatve (Amercan Southwest) embrace the malst phlosophy, as wll ts successor Mxe ool / Blateral Market Wthout fanfare, Norway opene a mxe power exchane / blateral market n From ts creaton, t has been the worl's most lberal electrcty market. It mmeately remove the oblaton to serve on proucers, an ave all consumers mmeate access to enery markets. Blateral contracts were encourae, an over a pero of fve years power exchane structures were broaene. By 1996, a versfe enery market was n place, consstn of the short term spot an reulatn markets, the loner term futures an optons fnancal markets, an blateral contract markets. rces on all of these are vule an realy avalable, allown to set reference prces an lenn stablty n eneral. It s estmate that 9% of electrcty contracts n the country are transacte throuh blateral contracts. hs market structure expane to other Scannavan countres n 1996, an s controlle by a superstructure known as Norpool. 6

7 Calforna's mxe market went nto operaton n Its power exchane runs both ay-ahea an hour-ahea markets, but blateral transactons are stronly encourae. resently certan restrctons force ncumbent utltes to eal throuh the power exchane. At the en of a four-year transton pero, all partcpants wll be free to transact throuh any of the avalable nstruments. cost prcn. Marnal cost prcn base on the results of economc spatch has been mplemente n all spot markets to ate, whether partcpaton s manatory or optonal. In ths practce, all the power bouht or sol n the spot market oes for a snle prce. Aruments pro an con have alreay been expoune n the prevous secton uner the heans of proponents an etractors. Ben just one player amon many, the X n a mxe system has less mpact than when nterate n a pool. In a mxe system, the X bascally traes n short term an reulaton power. rces reflect the market value of that fnal slce of the power market, an can ten to be volatle because small loa forecast errors appear amplfe on the smaller market. For example, off-peak enery prces as low as $2.41/MWh n Calforna, n June 1998 [http://www.calpx.com], reflect lttle nee for the excess eneraton offere at that tme. he mxe market s not efne by as close a set of rules as the pool. A resultn ffculty for ts esners has been the equtable strbuton of ancllary servce an transmsson chares between spot market an contract partcpants. As n pool operaton, two schools of thouht have appeare. One assumes that servces are bouht entrely on the reulaton market follown marnal prcn mechansms. In the two markets escrbe here, that approach was rejecte. Instea, smpler prcn schemes were mplemente lmtn coneston prce fferences to a reuce number of zones. rces n each zone are mofe base on ajustment bs submtte by partcpants. Costs for averae losses n each zone are recovere throuh uplft chares. Cost-base alternatves have appeare n the lterature [Galana & helan 1999, Gross & ao 1999] allocatn precse losses to blateral contracts. Of the market mechansms scusse above, blateral contracts appear to be the preferre vehcle. At the very least they offer stable prcn. On the other han, lare consumers are no oubt optmzn ther portfolos throuh a mx of enery holns n the varous markets. Rerettably, the nteracton of spot an contracts markets has receve lttle attenton so far n the lterature. A lesson offere by the experence of mxe markets s that the multplcty of fnancal nstruments oes not hamper the techncal operaton of the network. 5. Some houhts on Marnal Cost rcn for Spot Markets A major pont of contenton between proponents of pool an pure markets has been the mposton of marnal 7 here s no oubt that marnal cost prcn proves useful costs snals. Explct moeln of economc processes proves marnal costs ncatn the value of resources as affecte by the constrants lmtn ther use. Wthn moeln accuracy, marnal costs prove the cost of use of the last unt sol. However, marnal costs n themselves are not the actual costs. In the enery market, where eneraton costs/bs ncrease monotoncally wth proucton, the marnal cost prcn mechansm systemcally enerates revenues for proucers; ths s the merchansn surplus. hese revenues o towars payn fxe costs not covere by uplft chares an towars profts. Invual revenues for proucers epen on ther own performances wth respect to the market's areate cost versus loa curve. ypcally n a compettve market, marnal costs ncrease lttle over a we rane of eman. A recent stuy of the early behavor of the Calforna market [Skantze et.al 1999] corroborates ths. In that rane, systemc revenues for proucers are relatvely low. On the contrary, when eman s hh an resources become scarce, revenues soar because the marnal costs/bs are etere by expensve peakn unts an more enerally by market opportuntes. Recent prce spkes n the youn Amercan Mwest market [Rose 1998] are a case n pont. Marnal cost prcn s both a compettve-base an an opportunty-base scheme. In a pool context, t hanles requests n a far, non-scratory manner. It allows potental partcpants free ren to set ther bs, but rewars only the lowest bers wth market partcpaton. It ultmately offers all market partcpants unform contons espte the bs; ths antcpates the behavor of nforme market partcpants, who woul eventually ajust bs, an offers the same avantaes to all. In some markets, coneston rents have been ae to the process. hs oes towars the same eneral ea of curtaln opportuntes of arbtrae for some [Oren 1996], an usn the rewars to pay eneral fxe chares for all. Economsts have lon champone marnal cost prcn, partcularly n commoty markets. Surprsnly, the power enneern communty has not yet publshe any analyss of the proftablty of marnal cost prcn n the emern enery markets. (Maybe we

8 shoul be rean fnancal journals.) Global proft statements of enery companes are realy avalable an ve a eneral ncaton from an accountant's pont of vew, but that oes not prove the esre economc breakown of revenues. Revenues must recover szable fxe costs, such as nvestment an mantenance costs, whch typcally n the electrcty nustry are much hher than n other commoty markets. Several questons woul requre econometrc analyss n each market. For example: How much systemc revenue s bult nto the prcn scheme? Note that f costs/bs ncrease lnearly wth eman, then the constant marnal costs are equal to b costs, an no systemc revenue s forthco. Systemc revenues are only possbly f b curves "turn upwar" wth loa. In partcular, how much revenue s ane n low, meum an hh loa markets? Are proftable hhloa peros requre to sustan the nustry? theoretc approach. [Galana & helan 1999] attrbutes transmsson losses to blateral contracts by nteratn marnal losses. hese technques are certanly useful for etern costs, an coul serve as an analytcal bass for prcn blateral contracts. Inee, the blateral contract market s the ultmate example of a scratory prcn system. Apple to a spot market, they are examples of "you et what you aske for" prcn. hey have the avantae of elatn merchansn surpluses an coneston rents. Stll, economsts shun such a scheme, pontn out that wthout systemc revenues, partcpants woul contnually ajust bs, causn more volatlty an hher prces. Aucton theory woul be the proper settn to test how such schemes woul fare aanst marnal cost prcn on averae. So far, wrtns n the power lterature have not touche on ths. 6. Some houhts on Dspatchn for Spot Markets How much revenue has been bult nto the bs? heorsts conten that n compettve markets there s no room to pa the bs. Is ths true for the electrcty markets? If systemc revenues are nsuffcent, then revenues must be ncorporate nto bs. In the absence of such analyses, some conten that there seems to be no correlaton between true costs, bs an profts. hs sort of nformaton s certanly very senstve an therefore not lkely to be share. It proves mportant snals for nvestment, consumer stratees, etc. Marnal cost prcn prouces optmal prces n the context escrbe earler - antcpaton of ajustments to freely submtte bs an non-scratory prcn. However, examples n the lterature have hnte at other pool prcn schemes that prouce lower areate costs to consumers. Smple examples n the lterature [Jacobs 1997, Debs & Rahm 1999] show nstances of power spatchn whch avo coneston an the accompanyn coneston rents. he resultn cost to consumers s lower than that of the optmal economc spatch. A mathematcal formulaton for mal areate marnal costs to consumers wll be propose further n a revew of spatchn tools. Some scratory cost-base prcn schemes, champone by enneers, have receve relatvely lttle attenton so far. roposals n [Balek 1996, 1997] or [Krschen et. al 1997; Strbac et. al 1998] trace contrbutons from enerators to nvual loas an attrbute transmsson costs to transactons usn a raph 8 he terms aucton an mert orer spatchn are often use n escrbn the attrbuton of resources on spot markets. As mplemente, auctons have been smple mert orer spatches, wth some offern the possblty of upatn bs before the moment of ecson (for example, n Calforna). Another noton bane n more complex spatches s the mzaton of socal welfare, use as a replacement to fuel cost mzaton n tratonal spatch. Actually, mathematcal optmzaton theory shows that all of these methooloes are qute smlar n purpose f not n form. In ths secton we wsh to hhlht these smlartes. Conceptually, the only major fference between central utlty spatchn an the spatch of competn eneraton n spot markets s the replacement of costs by bs. lace n a eneral mathematcal settn, mert orer spatch s an actve power spatch formulate only wth pecewse lnear cost functons, a lossless power balance equaton an constrants on eneraton. hs ffers from a smlarly lnearze, tratonal lamba-spatch only n ts treatment of cost-senstve loas. In conense form, the mert orer expresse as a lnear proram can be formulate as follows: (b + b) ( c + c), s. t. e 1 1 c h = (MO)

9 where b's an c's are the coeffcents of pecewse lnear beneft an cost functons efne over the ranes of loa an eneraton respectvely; e s the unt vector;, are eneraton lmts, an, are loan lmts. c st.. h = k but c h k + + = Mπ C (FC) Due to ts smplcty, ths lnear proram can be solve va the well-known mert-orer alorthm rather than wth lnear proram technques. Cost-senstve loas can be treate ether throuh the socal welfare or the tratonal cost mzaton approaches. Depenn on the approach, loa nformaton s represente n ether the objectve functon or n constrants. Here we show two equvalent quaratc proram formulatons for real power spatch, nclun transmsson constrants. Wth a bt of effort, proof of ths equvalence can probably be extene to more eneral mathematcal settns. he equvalent socal welfare (SW) an mal fuel cost (FC) formulatons are as follows., c b c + B b 1 c st.. h = k h k + + C wth atonal notaton h, h are matrces representn the lnearze loa flow an lne flow relatons k, k are the rht han ses of the lnearze loa flow, an lne lmts respectvely an h (SW) where s the loa vector unrestrcte by cost M s a aonal senstvty matrx of the loas wth respect to prce s the prce vector p he two problems present entcal optmalty contons f the follown contons are met, lnkn the b parameters on one han to the (, M) parameters on the other: p s the set of bus ncremental costs 1 = B2 b1 1 M = B 2 he latter two contons are automatcally met by the efnton of the beneft coeffcents. Note that n the context of problem (FC) the noton of socal welfare nee not be nvoke. he three formulatons splaye so far couple marnal cost prcn to the economc spatch soluton. Below we offer a new formulaton whch apples marnal cost prcn to a fferent spatchn stratey. he object s to efne the parameters an G 1 of the spatchn stratey b 1 (1) = f = + G whch mzes total costs to consumers, assu that the new marnal costs C = C f (2) efne prces. he stratey woul be pecewse lnear versus loa snce coeffcents woul chane as actve 9

10 constrants are met. Certan restrctons coul be place on G 1 to reuce the number of erees of freeom. he mal cost problem (MC) s as follows., G 1 st.. h = k wth π h k (MC) = + G 1 Aan wth quaratc eneraton costs, an wth the spatchn stratey efne by equaton (1), marnal costs are expresse as follows: π C = = C 2 + c1 G = C + G + c G c 2 b 1 1 h Atonal constrants coul be ae to (MC) to ensure that partcpants woul be no worse off than wth an economc spatch soluton; for example: π π π π * * at loa buses at enerator buses where the astersk enotes the optmal soluton to the economc spatch, an subscrpts an pertan to loa an enerator buses respectvely. hese constrants assure a celn prce of π * to loas an a floor prce of π * to enerators. he optmal soluton to ths problem s probably entcal to that of the economc spatch as lon as the latter s unconeste. he former woul choose a fferent route when facn coneston. We have not teste ths formulaton, an so more work nees to be one. Althouh we are not avocatn the use of any new prcn stratey, our purpose s to show that prcn reflects human preferences, an s not carve n stone. 7. Some houhts on ransmsson rcn n a Spot Market ransmsson prcn s a complcate ssue n most restructurn moels. Reulate transmsson companes recover ther costs an ther preefne profts throuh verse schemes. A lare part comes from tarffs, of whch many types have been propose. A smaller part comes from the collecton of real-tme chares n the spot market, such as coneston rents or ajustment bs. he latter have always been eeme a vtal prcn component, snce they force partcpants to respon to snals of scarcty [Ilc et. al 1997]. As note n [Hoan 1992] however, they are purely opportunty costs. Vewe n a settn of classcal economc spatch, the hher costs resultn from coneston are enery costs, ncurre when unavalable cheap enery s replace by hher prce enery. hs n no way affects the transmsson prover. Wth marnal cost prcn, part of the chare collecte n the marnal bus cost oes towars payn that hher prce enery, but part s the coneston chare returne to the transmsson provers. Hoan has champone fnancal nstruments calle transmsson coneston contracts (Cs) to transact coneston chares. Chares for non-enery relate ancllary servces n a spot market can be subject the same kn of opportunty costs [Bauhman & Sq 1991]. 8. rcn Schemes an Some Loner erm Conseratons Well-esne prcn schemes are sa to prove stron snals for nvestment. For now there s no consensus on the rht snals to cultvate, except to say that n stuatons of scarcty, snals shoul scream [Lecnq 1996]. he lterature sens contractory messaes on ths ssue. Consumer-frenly messaes proclam that compettve spot markets normally cut profts to the bone. hs s because provers are not b hher than ther marnal costs to assure a place n the market. On the other han, hh peak-loa prces an coneston rents sen snals for nvestment. It has been observe however that the proporton of lobal revenues recovere uner such contons s relatvely small. What's more, the aton of new eneraton or transmsson resources woul slence those snals, removn the ncentves whch attracte nvestments n the frst place. he snals focus attenton on nees but o not ensure profts to nvestors. It must be conclue that even n the most compettve of markets, provers must extract a reasonable proft n any operatn conton. Smply put, only enerally proftable busnesses attract nvestment. 1

11 Costs assocate wth mantann techncal stanars are not explctly consere n short term prcn. Stanars aress the oblatons to operate well, to bul well an to mantan well. It s felt that these stanars must not be abanone or fall throuh the cracks of a ecentralze nustry structure. How to acheve ths s not yet wellefne. 9. Conclusons All forms of restructurn have been eclare successful by ther authors. hs s enerally true, althouh some mplementatons have been crtcze for ther rocky starts, specfcally concernn excessve profts an nsuffcent consumer benefts (Enlan [Newbury 1995, Wolfram 1998], Alberta [Lonon Economcs 1998]). Success of the restructurn process epens on many factors. he effcency of the market structure, the topc most consere n ths paper, s but one element. Other elements nclue the mprove manaement brouht on by corporate restructurn an the new level of compettveness of the nustry. hese shoul not be confuse wth exoenous factors such as abunance of enery resources an the ramatc rop n the prce of ol over the last ecae. In those states where restructurn has reache beyon ts nfancy, t s enerally aree that competton has renvorate the nustry an has contrbute to reuce prces. Acknowleements. F. Galana aknowlees the support of the the Natural Scences an Enneern Research Councl, Ottawa an the Fons pour la Formaton e Chercheurs et 'Ae à la Recherche, Québec. References Aamson, S., Gouln A.J., "he ABCs of Market ower Mtaton: Use of Actone Bable Contracts to Enhance Competton n Generaton Markets", Electrcty Journal, Vol.12, No. 2, pp.49-55, March Atknson, S.E., Halvorsen, R., he relatve effcency of publc an prvate frms n a reulate envronment: he case of U.S. electrc utltes, Journal of ublc Economcs, Vol. 29, pp , Bauhman M., Sq, S.N., Zarnkau, J., "Avance prcn n electrcal systems, part 1:heory & part 2: Implcatons", IEEE ransactons on ower Systems, Vol.12, No.1, pp , February Bauhman M.L., Sq S.N., "Real-tme prcn of reactve power: theory an case stuy results", IEEE ransactons on ower Systems, Vol. 6, No.1, pp.23-29, February Bernsten, S., Competton, marnal cost tarffs an spot prcn n the Chlean electrc power sector, Enery olcy, pp , Auust Balek, J., racn the flow of electrcty, IEE roceens on Generaton, ransmsson an Dstrbuton, Vol. 143, No.4, pp , July Balek, J., Elaton of merchansn surplus ue to spot prcn of electrcty, IEE roceens on Generaton, ransmsson an Dstrbuton, Vol. 144, No. 5, pp , September Blumsten, C., Bushnell, J., A ue to the blue book: Issues n Calforna s nustry restructurn an reform, Electrcty Journal, Vol. 7, No. 7, pp , September Boteux, M., eak-loa prcn, Journal of Busness, Vol.33, pae 157, 196. Boteux, M. Concurrence, réulaton, servces publques: varatons autour u cas e l électcté, Futurbles, Vol. 25, pp , Brtsh Columba Utltes Commsson, he Brtsh Columba electrcty market revew: Report an recommenatons to the leutenant overnor n councl, ~electrctytaskforce/, January Chao, H.., eck, S., A market mechansm for electrc power transmsson, Journal of Reulatory Economcs, Vol.1, pp , July Chwaloswk, M., How companes fare throuh ereulaton, he Electrcty Journal, Vol.1, No.1, pp.32-4, January Debs, A., Rahm, F, "ower System Control an Operaton n the Open-Access Envronment", course notes, DSI, March Department of Enery (U.S), Electrcty reform abroa an U.S. nvestment, September Eson Electrc Insttute, FERC consultatons on Reonal ransmsson Oranzatons, January Galana, F., helan, M., "Allocaton of ransmsson Losses to Blateral Contracts n a Compettve Envronment", IEEE paper E-212-WRS Glbert, R. J., Kahn, E.., Competton an nsttutonal chane n U.S. electrc power reulaton, n Internatonal Comparsons of Electrcty Reulaton, Cambre Unversty ress,

12 Green, R., Electrcty transmsson prcn: An nternatonal comparson, Utltes olcy, Vol.6, No.3, pp , Green, R., Electrcty ereulaton n Enlan an Wales, n Dereulaton of Electrc Utltes, G. Zaccour, Etor, Kluwer Acaemc ublshers, Gross, G., ao, S., A physcal flow-base approach to allocatn transmsson losses n a transacton framework, IEEE ransactons n ower Systems, to appear. Gross, G. et al, Stratec bn n electrcty eneraton supply markets, IEEE ES Wnter Meetn, February Harvey, S., Hoan, W.W., ope, S., ransmsson capacty reservatons mplemente throuh a spot market wth transmsson coneston contracts, Electrcty Journal, Vol. 9, No. 9, pp.42-55, November Helm, D., owell, A., "ool prces, contracts an reulaton n the Brtsh electrcty supply nustry", Fscal Stues, Vol.13, No.1, pp.89-15, Hoan, W.W., Contract networks for electrc power transmsson, Journal of Reulatory Economcs, Vol.4, pp , Hoan, W.W., Gettn the prces rht n JM: What the ata teaches us, Electrcty Journal, Vol. 11, No. 7, pp , September Ilc, M., Hyman, L., Allen, E., Younes, Z., ransmsson scarcty: Who pays?, Electrcty Journal, Vol. 1, No. 5, pp , July Imparato, C., Comments n a anel Sesson on Market-Makn Attrbutes of Alternatve ISO Structures, IEEE ES Wnter Meetn, February Izaurre, A. K., rvate partcpaton n the electrcty sector - Recent trens, /notelst.html#power, September Jacobs, J.M., Artfcal power markets an unntene consequences, IEEE ransactons on ower Systems, Vol.12, No.2, pp , May Jess, M., Restructurn enery nustres: Lessons from natural as., ftp://ftp.ea.oe.ov/pub/ol_as/feature_artcle/ 1997/restructurn_enery_nustres-lessons/pf/pe.pf, Ja, S.., A Stuy of the Enlan an Wales ower ool, Masters' thess, Department of Electrcal Enneern, McGll Unversty, November Krschen, D., Allan, R., Strbac, G., Contrbutons of nvual enerators to loas an flows, IEEE ransactons on ower Systems, Vol.12, No.1, pp. 52-6, February Krchmayer, L., Economc Operaton of ower Systems, J. Wley an Sons, Lecnq B., eak-loa rcn for ransmsson n a Dereulate Inustry, S.M. thess, echnoloy an olcy roram, MI, Lenar,., Gettn the ranscos rht, Electrcty Journal, Vol. 11, No. 9, pp , November Lonon Economcs Inc., Draft paper on the power pool n Alberta, html, July Lonon Economcs Inc., Overvew of Norpool, Moen, J., Hamrn, J., Reulaton an competton wthout prvatzaton: Norway s experence, Electrcty Journal, Vol. 9, No. 2, pp , March, Moore, I., Anerson, J.H., Introucton to the new Calforna power market, July NERC, Avalable transfer capablty efntons an eteraton, June Newbery D.M., "ower Markets an Market ower", Enery Journal, Vol. 16, No. 3, pp.39-66, Ontaro Market Desn Commttee, Fnal Report of the Market Desn Commttee, January Oren, S.S. et al, "Noal rces an ransmsson Rhts: A Crtcal Apprasal", Electrcty Journal, Vol. 8, No. 3, pp.14-23, Aprl Oren, S.S., reempton of CC s an eaweht loss n centrally spatche electrc systems wth compettve eneraton, Unversty of Calforna Report W-41, Oren, S.S. et al, Volatlty of unt commtment n compettve electrcty markets, IEEE paper /97, Outhre, H., A revew of electrcty nustry restructurn n Australa, Electrc ower Systems Research, Vol. 44, pp , apalexopoulos, A., Comments n a anel Sesson on Market- Makn Attrbutes of Alternatve ISO Structures, IEEE ES Wnter Meetn, February ercebos, J., La éréulaton e l nustre électrque en Europe et aux États Uns, Revue e l Énere, No. 49, pp , September hlpson L., Wlls H.L., Unerstann Electrc Utltes an De-Reulaton, Marcel Dekker,

13 JM, JM LM mplementaton trann course, Aprl onrajah R., Dervaton an Applcatons of Optmum Incremental Costs, M.S. hess, McGll Unversty, Rahm F., Vojan A., "Meet the Emern ransmsson Market Sements", IEEE Computer Applcatons n ower, pp , January Rea, E.G., Rn, B. J., A spatch-base prcnnov moel for the New Zealan electrcty market, Report EMRG-W- 95-2, Unversty of Canterbury, Rose, J., Why the June prce spke was not a fluke, Electrcty Journal, Vol. 11, No. 9, pp. 65-7, November Runck, H., oneern electrcty reform n South Amerca, IEEE Spectrum, pp , Auust Runck, H. et al,, Latn Amaercan Dereulaton rocesses, IEEE ower Enneern Revew, Vol. 18, No. 12, pp. 1-23, December Schweppe, F.C., ower systems 2': herarchcal control stratees, IEEE Spectrum, pp.42-47, July Schweppe F.C., Caramans M.C., abors, R.D., Bohn R.E., Spot prcn of electrcty, Kluwer Acaemc ublshers, Scott,.J., Rea, E.G., Moelln hyro reservor operaton n a ereulate electrcty market, Report EMRG-W-95-5, Unversty of Canterbury, Secretara e Enera e Mexco, "olcy roposal for Structural Reform of he Mexcan Electrcty Inustry", Secretary of Enery, Brazl, Brazl electrcty sector restructurn project, ppub3p.htm/. enerators an loas to flows, IEEE ransactons on ower Systems, Vol. 13, No. 2, pp , May Vckrey, W., Some mplcatons of marnal cost prcn for publc utltes, roceens Amercan Economc Assocaton, Vol.45, pp , Vckrey, W., Responsve prcn of publc utlty servces, Bell Journal of Economcs an Manaement Scence, Vol.2, No.1, pp , Wnston C., Economc Dereulaton: Days of Reckonn for Mcroeconomsts, Journal of Economc Lterature, Vol. 31, pp , September Wolak F.A., atrck R.H., Inustry Structure an Reulaton n the Enlan an Wales Electrcty Market, n rcn an Reulatory Innovatons uner ncreasn competton, M.A.Crew (e.), Kluwer Acaemc ubl., Boston MA,1997. Wolfram C.D., Stratec Bn n a Mult-Unt Aucton: An Emprcal Analyss of Bs to Supply Electrcty n Enlan an Wales, eo, Department of Economcs, Harvar Unversty, Wolfram, C., Increases n executve pay follown prvatzaton, Journal of Economcs an Manaement Stratey, Wu, F., Varaya,., Coornate multlateral traes for electrc power networks: heory an mplementaton, Report W-31, Department of EE&CS, Unversty of Calforna, Berkeley, June Yajma, M., Dereulatory reforms n the electrcty supply nustry, Quorum books, Westport, Connectcut, Zhuan, F., Galana,F.D., owars a more rourous an practcal unt commtment by Laranan Relaxaton, IEEE ransactons on ower Systems, Vol. 3, No. 2, pp , May Sheblé, G., rce-base operaton n an aucton market structure, IEEE ransactons on ower Systems, Vol 11, No. 4, pp , November Sheblé, G., Aent-base economcs, chapter 6 n ower System Restructurn: Enneern an Economcs, Etors Ilc, Galana an Fnk, Kluwer Acaemc ublshers, Skantze,., Chapman, J., rce ynamcs n the ereulate Calforna enery market, IEEE ES Wnter Meetn, February Stalon, C.G., "Increasn Competton n the Electrc ower Inustry",n Reulatn Reonal ower Systems, IEEE ress Strbac, G., Krschen, D., Ahme, S., Allocatn transmsson system usae on the bass of traceable contrbutons of 13

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