Electricity Market Management: The Nordic and California Experiences

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1 Electricity Market Management: The Nordic and California Experiences Thomas F. Rutherford Energy Economics and Policy Lecture 11 May 2011 This talk is based in part on material pepared by Einar Hope, Norwegian School of Economics and Business Administration Overview Some lessons from the Nordic, European and US power market reforms Special characteristics of electricity in market terms Market design of organised power markets Some competition issues: Potential sources of potential market power Market design of retail markets and some retail competition issues Regulation of network infrastructure. Some regulatory issues 1

2 Some characteristics of electricity as a commodity Multi-dimensional product: energy(kwh), capacity(kw), voltage, frequency, security of supply, location etc). Demand elasticity: price, income (short run - long run) Derived demand. Low energy cost in relation to total cost Seasonal variations: year, day. Load curves Capacity adjustments. Hydro, thermal Long term investments. Generation, network Self service system 2

3 Characteristics of electricity markets Electricity cannot be stored (hydro), homogeneous commodity Instantaneous balancing of supply and demand by system operator Very low short run elasticity of demand; also long run; derived demand; price signals with a lag, limited real-time pricing. Also low short run supply elasticity Capital intensive, lumpy, irreversible and durable investment; fixed cost, sunk cost. Long lead times Capacity constraints in transmission; the network as a market Market power issues deriving from characteristics and properties of electricity P c Cost Curve P Price Rent C 1 Plant q Figure : Industry cost (supply) curve. The rent concept 3

4 Unit variable cost Demand Gas-turbine Gas Oil Nuclear Hydro q Figure : Industry cost curve for energy. Merit order system D high D low MC Q low Figure : Marginal cost in a hydro power system _ Q Q 4

5 Welfare analysis economic efficiency Economic efficiency concepts Static efficiency Technical efficiency. Productive efficiency Allocative efficiency X-efficiency (inefficiency) Dynamic efficiency Technological change Product innovation, etc Rent seeking Decomposition of efficiency concepts. Performance criteria: Efficiency dimensions Static efficiency (operation) Cost efficiency Optimal use of total production and grid capacity Dynamic efficiency (investment/innovation) Optimal dimensioning of production and grid capacity Introduction of new technology and products in the value chain (incentives for innovation) Facilitating market integration; spacially, across energies, and in relation to other products/sectors Capacity enhancing investment versus investment in flexibility Security of supply; reliability 5

6 Economic efficiency and market failure Sources of market failure Public goods External effects in production and consumption Market imperfections Economies of scale (natural monopoly) Monopolisation Lacking markets Competition monopoly regulations Imperfect information; asymmetric information Uncertainty Market failure in energy markets Some lessons from the reform of the electricity industry The Energy Act of 1990 in Norway: Establishing electricity markets, common carriage, vertical separation, regulatory system A common Norwegian-Swedish market from An integrated Nordic market from 2001 Considerable gains from deregulation - still a considerable potential, especially in the grid and from further integration of energy markets Reduction in the general price level of electricity - greater volatility of prices 6

7 (Cont) Greater flexibility on the demand side and change of consumer behaviour: New contract forms, price competition, change of supplier, price information systems, risk hedging facilities, customer focus Entry of new players in the markets: Brokers, traders, clearing companies, retail chains, petroleum companies, financial analysts, international energy companies New organisational forms: Co-operative and outsourcing arrangements, e.g for power purchasing, invoicing, metering etc. Concern model, horizontal and vertical integration to end-consumers, separation and unbundling of competitive and monopoly functions (Cont) Ownership structure - cross-ownership, privatisation Long gestation period for competition in retailing Inertia and opposition to change from suppliers: Ownership structure, production orientation, market power, political influence. Consumer inertia/local loyalties, inexperienced consumers operating in new markets Primitive risk hedging facilities and contracts for small consumers (households) - but developing Regulatory lag - regulatory uncertainties 7

8 Design of organized power markets Organized power markets operated by NordPool: Elspot (physical spot market deliveries) Eltermin (futures and forward contracts) Elbas (thermal power adjustment markets) Eloptions (European and Asian power options) Design and operation of green electricity markets Markets operated by grid operators: Regulation Market (Norway/Statnett): capacity market; balance market between real and planned exchange in the delivery phase on short notice (15 min) cont Elspot: daily trading for delivery next day for each of 24 hours. Price and quantity by noon - market contracts by 2.30 p.m., based on equilibrium price of aggregate supply and demand schedules (system price) Eltermin: Futures market for hedging of power contracts up to three years ahead. Daily market settlement of the difference between system spot price and contract price. For forward contracts settlement only in the delivery week - no daily settlement 8

9 cont Elbas: market for adjusting imbalances for thermal producers in Finland and Sweden after completing their Elspot trade. Continuous trading for single hours up to two hours prior to delivery Clearing functions: Power Clearing System and Nordic Electricity Clearing (NEC operated by NordPool) of spot and futures contracts. Clearing also of bilateral contracts as of Some 280 customers trading at NordPool (power producers, distributors, industrial companies, large retail customers, brokers, traders etc.) cont NordPool is a non-mandatory pool: around 70 % of total traded volume through organized markets; liquidity and efficiency? On the whole: a successful market reform: considerable efficiency gains, integration effects and greater flexibility for consumers 9

10 What went wrong in California? Electricity industry before regulatory reform in April 1998: Three large investor-owned utilities (IOUs) Vertically integrated into generation, transmission and distribution Significant out-of region energy needed to serve in-state demand. (Ca. 25%) Retail electricity rates regulated by California Public Utilities Commission (CPUC) Wholesale prices and transmission tariffs regulated by Federal Energy Regulatory Commission (FERC) Factors contributing to crisis Small amount of new capacity built in California during 90 s, and also in surrounding states Higher natural gas prices Forced outages since summer of 2000 Price inelastic wholesale demand Retail price freeze Few consumers face real-time price Price cap on wholesale price Regulatory differences between federal and state (FERC and CPUC) 10

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