Developing a Risk Adjusted Pool Price in Ireland s New Gross Mandatory Pool Electricity Market

Transcription

1 1 Developng a Rsk Adjused Pool Prce n Ireland s New Gross Mandaory Pool Elecrcy Marke Déaglán Ó Dónáll and Paul Conlon Absrac-- The Sngle Elecrcy Marke (SEM) Programme, whch esablshed for he frs me a gross mandaory pool on an all Ireland (Norhern Ireland and Republc of Ireland) bass came no effec on he 1s November As he Publc Energy Suppler, ESB Cusomer Supply (ESB CS) was poenally exposed o he volale prce flucuaons ha he new pool marke creaed, whou he ably o pass hs prce rsk drecly on o s largely domesc cusomer base. As such, hedgng hs prce exposure va Conracs for Dfference (CfD s) was a key mperave of ESB CS s radng sraegy. However he resulan prce forward curve ncorporang he CfD s coss, when modeled as volume a a fxed srke prce, dd no accuraely reflec he prce sgnals n he pool (a key prncple for arff seng as spulaed by he energy regulaor). Ths paper wll deal he analyss and decson makng process ha ESB CS underwen n order o develop a rsk adjused pool prce forward curve by sculpng he forecas pool prce forward curve, based on he rsk assocaed wh dfferen perods. The RAPP curve was used for seng real prces n he new marke o reflec he underlyng expeced day/ngh and seasonal prce elecrcy cos dfferenals whle recoverng he premum assocaed wh ESB CS s CfD purchases. Index Terms Ireland, elecrcy, arffs, ESB, hedgng, rsk, radng, supply, CfD, SEM I I. NOMENCLATURE AIME All Island Marke for Elecrcy CER Commsson for Energy Regulaon CfD Conrac for Dfference ESB CS ESB Cusomer Supply NDC/DC Non/Dreced Conracs PES Publc Elecrcy Suppler RAPP Rsk Adjused Pool Prce SEM Sngle Elecrcy Marke SMP Sysem Margnal Prce (Pool Prce). II. INTRODUCTION n June 2005, he respecve ransmsson sysem operaors n he Republc of Ireland and Norhern Ireland sgned a formal Memorandum of Undersandng, underlnng her commmen o combne he sklls and resources o work jonly on a number of mporan naves as par of he all-sland projec. The Sngle Elecrcy Marke (SEM) Programme was subsequenly esablshed o focus on he delvery of a sngle wholesale elecrcy marke for he sland, whch n urn has led o he formaon of he All- Island Marke for Elecrcy (AIME). AIME came no effec from 1 s November 2007 as a gross mandaory pool, wh he followng characerscs [1]: - Sngle prce seres ex pos one prce per radng perod - Day ahead gae closure - Complex bds - Dual currency - Ex ane ndcave marke schedule - Unconsraned un commmen - Consran paymens ESB s he sae owned vercally negraed uly n he Republc of Ireland and ESB Cusomer Supply (CS) s s rng-fenced, ndependenly operaed, elecrcy supply company, regulaed by he CER as he Publc Energy Suppler (PES)/suppler of las resor. ESB CS serves some 2 mllon domesc, ndusral and commercal cusomers (resdenal cusomers and small o medum szed busness cusomers make up he vas majory (99%) of he cusomers served by ESB CS). As he PES, ESB CS s responsble, under he approval of he regulaor (CER) for seng he publc elecrcy prce arffs on an annual bass. Undergong he arff seng process n he run up o he sar of he sngle marke requred sgnfcan changes n lne wh he new modales of he pool marke. ESB CS purchases energy a he wholesale level o mee s cusomer s energy demand (plus ransporaon losses). The larges componen of energy wholesale coss s he cos of elecrcy purchased n he pool a prces whch reflec he marke value of wholesale elecrcy (whch n urn are expeced o reflec he margnal coss of he margnal generaor). Ths componen s referred o as he Sysem Margnal Prce (SMP) 1. As almos all of he energy for ESB CS cusomer demand and ransporaon losses s purchased n he pool, hs s of parcular focus for he ESB CS Prcng Team. Under AIME, he SMP vares by half-hour radng nerval and n order o sablse he prce of elecrcy over a perod, ESB CS eners no Conracs for Dfferences (CfDs) wh 1 The erm SMP s used when referrng o he margnal cos of elecrcy as purchased from he pool.

2 2 generaors. Sablsng he prce a whch energy s bough n he Pool s known as hedgng or conracng and may brng an addonal cos (or produce a dscoun) relave o he SMP [3]. III. ENERGY CONTRACT COSTS AND PRICING As ESB CS offers regulaed fxed arffs, has as a key objecve o hedge s exposure o he varable SMP (.e. fx s npu energy coss va CfD s) o he exen ha s economc o do so o mnmse he rsk of under-recovery. The acual cos of a conrac s he dfference beween he srke prce of he conrac and he ouurn SMP.e. he ncremenal dfference relave o he ouurn pool prce. Ths cos s also known as he hedgng premum (alhough n some cases may be a negave cos.e. a dscoun). As well as he hedgng premum, for each half-hour radng perod, where ESB CS s under-hedged mus buy elecrcy from he pool a he pool prce o mee s aggregae cusomer demand requremen [4]. Conversely, when over-hedged sells elecrcy back o he pool a he pool prce. So here wll almos always be a poron of resdual demand/supply a whch ESB CS s fully exposed o pool prces. These coss (wholesale energy, hedgng premum and resdual) should be he man npu o he arff seng process n he form of an Energy Conrac Cos Forward Curve, whch s he demand weghed average cos of energy purchased va conracs and he resdual demand Pool coss. However, wh he nroducon of cos reflecve prcng, s no longer approprae o use he ECC Forward curve as has flaened ou he forward pool prce and herefore does no gve he correc economc prce sgnal; ngh V day; weekday V weekend; summer V wner (explaned n furher deal below). The ECC Forward Curve can however be ransposed o an approprae forward cos curve for prcng arffs, he Rsk Adjused Forecas Pool Prce. Ths rsk adjused pool prce (RAPP) s he key npu no he ESB CS arff seng process under he SEM, and whle he ECC Forward curve s no longer requred for arff seng, defnes he overall energy coss, and ses he overall consran for he RAPP model, so mus sll herefore be calculaed. The followng secons deal he mehodology by whch he RAPP s formulaed. A. Hedgng Prce Rsk Under he AIME pool arrangemens, he ncumben publc elecrcy generaors (n he Norh and Souh) were requred by he Regulaory Auhores o aucon a fxed amoun of her generang capacy a pre-deermned prces o all supplers n he marke, va Dreced Conracs (DC) for Dfferences. (Dreced Conracs are so called as he volume and prce a whch hey mus be sold are deermned by he Regulaor). These conracs, coupled wh a more general aucon of Non-Dreced Conracs (NDC), allowed boh supplers and generaors o aan some level of prce and cash flow cerany. In oal four conrac ypes were offered by generaors n he aucon process (peranng o Baseload, Md Mer 1 & 2 and Peak volumes, see Table 1). ESB CS bd for conraced volume on he bass of s forecas SMP and demand levels. In oal 23 DC and 9 NDC aucons ook place over a hree monh perod n he run up o he marke Go-Lve dae. Under hese aucons, supply companes were able o purchase a fxed volume n MW a a gven prce on a monh by monh bass. In oher words, for a gven conrac ype, a fxed prce could be aaned by a supply company for a gven volume of demand, n every half hour o whch ha conrac apples for he gven monh. As oulned n Table 1 he CfD s only apply on defned days and, for se perods whn hose days, bu s no dffcul o see ha under hese defnons s possble o have all four conrac ypes n place, over a gven perod (16:30-19:00), on a gven wner busness day. TABLE I CFD DEFINITIONS UNDER AIME 2007 Conrac Sar End Apples Type Tme Tme Baseload 24 hours per day All year Md- Mer 1 Md Mer 2 07:30 23:00 Busness days and non-busness days 2 07:00 19:00 Weekdays ncludng holdays Peak 16:30 20:00 6 wner monhs Whle hese conracs allow us o acheve a fxed prce for a fxed volume n MW over a monh, n order o develop he RAPP, s necessary o calculae he weghed average conrac srke prce for each conrac ype and for each radng perod whn he monh (.e. by half hour). The weghed average srke prce s hen used o deermne a half hourly ECC (forward curve). Ths s acheved by deermnng monhly conraced volumes and coss (by conrac volume) based on he oucome of he auconng process, bearng n mnd ha for a gven conrac ype here may be a number of successful rades applcable n ha monh. For a gven conrac ype n any parcular monh, hs equaes o he followng formulae. V mc = ( vc, d h) = ( V mc C mc pcs, ) (1), (2) ( Cmc Vmc) p was / Where = (3) V mc = Monhly Conraced Volume (MWh) v c, = Volume (MW) by conrac for all rades n a gven monh

3 3 d = Applcable conrac days for a gven monh and conrac ype h = Applcable conrac hours for he gven conrac ype p cs, = Conrac srke prce Cmc = Cos of he conraced volume for he monh Pwas = Monhly weghed average srke prce The monhly weghed average srke prce s applcable a he half hourly level, for each conrac ype purchased, and as a resul, he Energy Coss ncurred by ESB CS due o conrac hedgng and resdual pool purchases can be expressed as: EC fc = m, ( pwas, m vc), + ( p smp v rd ) (4) dscoun of hese hedge conracs relaed o he forecas pool prces. Ths gves rse o a problem, as dscussed brefly above, n ha, he resulan Energy Cos Forward Curve (EC fc ), whch s a funcon of he varous conrac srke prces for he hedged volume as well as he SMP (for a level of un-hedged pool volume), does no accuraely reflec he prce sgnals from he pool (.e. s no reflecve of shfs n demand ha are represenave of a ypcal demand profle). A s smples, he prce modelng dffculy can be llusraed for a sngle baseload conrac: /MWh Srke prce modelng loses emporal prce varaons Where: EC fc = Energy cos forward curve (for boh hedged and un-hedged demand); p was = Weghed average srke prce for each half hour n monh m by conrac ype ; vc, = Half hourly Conraced (hedged) Volume by conrac ype ; psmp, = Half hourly Pool Prce; vrd, = Resdual (Un-hedged) Demand Volume Ths gves he oal energy coss ncurred by ESB CS for he hedgng and resdual pool volume purchases, and as explaned above, esablshes he overall consran for he rsk adjused pool prce model. B. Allocaon of Pool Coss for Fxed Tarff Cusomers In parallel wh he aforemenoned auconng process, he CER requred ha ESB CS subm s 2007/08 arff proposals for he frs year of operaon of he new marke. In lne wh s sauory and lcense oblgaons he man objecves for ESB CS n seng hese arffs are o acheve cos reflecvy and non-dscrmnaon across all cusomer arff groups, as well as o provde approprae economc prce sgnals o cusomers [5]. Consequenly, energy purchases are opmsed on a porfolo bass for fxed arff cusomers.e. he purchase of hedges s opmsed for he overall demand of all fxed arffs ogeher raher han for any arff ndvdually. Therefore, n order o reflec pool marke energy cos sgnals n s arffs, ESB CS mus allocae (SMP) generaon coss o he dfferen arff caegores based on forecas pool prces adjused o reflec he rsk premum / 2 For non busness days, under he Md Mer 1 conrac, only 80% of he conraced volume s applcable Ths s depced for he aggregaed CS demand n he chars below. Fgure 1 shows a ypcal ESB CS demand profle for a domesc cusomer wh seep mornng and evenng peaks. Ths curve s refleced n he pool prce forecas curve as shown n Fgure 2. Fgure 3 however shows he much flaer Energy Cos Forward Curve, deermned by (4), whch ncorporaes he hedgng conrac coss. Ths curve s flaer because reflecs he fxed prces ESB CS had obaned from he aucons. MWh /MWh 400, , , , , , ,000 50, Fgure 1: ESB Domesc Cusomer 24 hr Demand Profle

4 4 /MWh Fgure 2: Average daly pool prce forecas Fgure 3 Average Daly Energy Cos Curve (ncorporang hedgng coss) I s clear from Fgure 3 ha he energy cos curve does no reflec he underlyng demand from he marke (as depced n Fgures 1 and 2). Therefore any arffs, bul from hs cos base, wll no comply wh he regulaors crera of achevng cos reflecvy for all PES arffs. I s herefore necessary o adjus he energy coss (.e. o develop a new forward cos curve) n order o more accuraely reflec he prce sgnals from he marke. Ths requres he addon of a rsk based adjusmen o he forecas pool prce (SMP) for he 48 * 335 radng perods (based on an 11 monh nal marke perod / arff year), ncorporang no only he relave demand bu also reflecng he premum pad on he varous conracs purchased. The over rdng consran on hs adjusmen o he pool prce was ha he oal energy coss usng he new Rsk Adjused Pool Prce (RAPP) mus equal he energy coss as calculaed usng he conrac coss (plus resdual pool elemen). Ths consran s defned mahemacally as: premum. In heory he rsk premum pad can be spread usng any number of mehodologes. Two mehods were consdered by ESB CS Prcng: 1. Conrac Prcng Mehodology 2. Pool Exposure Mehodology Boh hese seps and he wo mehodologes consdered are dscussed n furher deal below. C. Deermnng he Hedgng Conrac Premum Before he rsk premum can be spread across he pool prce s necessary o asceran s overall value for he arff year. The rsk premum pad for hedged conracs can be defned as he dfference n revenue from he Toal Energy Coss (.e. he prce pad for boh hedged and unhedged volume) and he cos of purchasng he same volume enrely from he pool (Pool Coss). Ths reflecs he oal premum pad and herefore he amoun ha mus be recovered va he rsk adjusmen. ( ) R p = ECfc psmp, V (6) Where Rp s he overall rsk premum (or dscoun) pad on he hedged conracs. D. Spreadng he Premum: Conrac Prce Mehodology Ths mehodology reles on he hypohess ha a baseload conrac, durng peak perod hours, s, for all nens and purposes, a peakng conrac and should be prced accordngly, and lkewse for md-mer conracs durng he peak perod ec. The rsk premum amoun, calculaed from (6), can be spread across he pool prce (SMP), such ha for any gven radng perod (assumng jus hree conrac ypes, of baseload, md-mer and peak 3 ): ( prap V) EC fc =, (5) p rap, = p smp, + Base Premum f =b/l hhour + Md-Mer Premum f =m-m hhour + Peak Premum f =peak h hour (7) Where: V = Toal Demand Volume by half hour P rap, = Half Hourly Rsk Adjused Pool Prce The challenge for ESB CS Prcng eam was wo fold: ) To deermne he oal conrac premum pad n he year and; Ths has he effec of resrucurng he conracs no daly conracng perods and ransformng he srke prces for ndvdual conracs o effecve peak, md-mer and baseload prces for each perod, depced concepually n Fgure 4 below. MWh Peak Vol MWh ) To spread ha premum across he forecas pool prce (SMP) Md-Mer Conraced Volume Md-Mer Peak Md-Mer Whle he frs sep s relavely sragh forward, he second requres ha he premum s spread across he forecas pool prce n such a way ha he coss reflec he underlyng prce rsk assocaed wh he hedge. For example, o accuraely spread he premum, he pool prce durng he peak perods should receve he bulk of any rsk adjusmen, n order o reflec ha, n order o oban prce cerany durng hese hours, ESB CS mus pay a hgher Baseload Conraced Volume hours baseload baseload Fgure 4 Concepual Illusraon of Conrac Prcng Opon 3 As saed, four conrac ypes are acually offered, hese nclude wo Md-Mer conracs offered n he NDC Aucons. Three conrac ypes are used here for llusraon purposes only. hours

5 5 Under hs approach, a second consran s nroduced, n ha for each conrac perod only he cos for ha conrac can be recovered. Thus by prcng a poron of a conrac based on s rsk n accordance wh he me of day, (.e. ncreasng s prce) a resdual volume amoun for ha conrac wll need o be lowered n prce n order o mee hs consran. Ths can be formulaed mahemacally n (8) and (9), represenng he lef hand sde and rgh hand sde of Fgure 4 respecvely for a parcular conrac ype n a gven day as: C d and C ( V cd pwas) = [ ( V cpwas) j + ( Vcd - Vcp) j ( p d = cp was- radj) -, j Where Cd = Daly Conrac Cos; V cd = Daly Conrac volume; V cp = Rsk Adjused Conrac perod volume; cp was = Rsk Adjused Conrac Perod Weghed Average Srke Prce; r adj = Requred adjusmen o srke prce (8) j] (9) days of he arff year exceeds he rsk premum oal calculaed n equaon (6) above, hus breachng he overall model consran. Tha needs o be reconcled n he model subsequenly one opon s by scalng he prema so ha he sum of he prema agree wh he overall premum. E. Spreadng he Premum: Pool Exposure Mehodology Under hs mehodology, havng asceraned he conrac premum amoun, he RAPP model deermnes he ESB CS average poenal marke exposure (rsk) consoldaed by Summerday, Summerngh, Wnerday, Wnerngh, Wnerpeak perods. These perods also correspond wh he Seasonal Tme of Day (STOD) perods used for varous ESB CS arffs. For each perod an exposure rao s calculaed wh respec o he Summerngh perod (whch reflecs he lowes exposed perod). Ths represens he amoun by whch he summerday, wnerday, wnerngh and wnerpeak perods are more exposed n comparson o he base level (.e. Summerngh perod). A premum, X, s added n hese raos (a he approprae perods) o he SMP so ha he [SMP + Premum X] * Demand = Toal energy coss from purchased conracs and resdual pool volume (where X s a funcon of he exposure rao). The Goalseek funcon n Mcrosof Excel s hen used o deermne X. The exposure raos are made up of prce exposure and volume exposure elemens, o deermne he revenue exposure (he produc of he prce and volume elemens). The exposure raos are calculaed by: = half hourly nerval over he conrac; 1. Deermnng he dfference n prce beween he cenral (50 h percenle) vs. hgh (95 h percenle) SMP forecass j = half hourly nervals over he rsk adjused conrac perod. 2. = ΔP Deermnng he resdual ( un-hedged) volume o whch ESB CS s exposed = ΔV As an example, a Md-Mer hedge of 200MWh per hour 3. Deermnng he revenue exposure composed of he a a srke prce of 75/MWh, appled over a 10 hour perod SMP cenral/hgh prce dfferenal and he un-hedged equaes o a conrac cos of 150,000. However, f he peak volume = ΔP * ΔV conrac srke prce s 85/MWh and he peak perod s four hours n lengh (ncorporang four hours of he md-mer The raos calculaed for each opon are dsplayed below. conrac), hen under hs mehodology, he md-mer hedge TABLE 2 durng he four peak hours should be valued a he POOL EXPOSURE RATIOS RELATIVE TO SUMMER NIGHT 85/MWh prce, yeldng a cos value of 200 * 4 * 85 = 68,000. Thus a furher 150,000-68,000 = 82,000 need Opon Summer Summer Wner Wner Wner day ngh day ngh Peak only be recovered over he md-mer perod, whch n urn 1. Prce values he resdual md-mer conrac volume a Exposure 68.33/MWh raher han 70/MWh The premum amoun pad (over and above he pool Volume Exposure coss) as equaed n (6) for each conrac ype s hen 3. deermned on a daly bass (whn he lms of he Revenue consrans defned above) and he rsk adjusmen Exposure calculaed as he premum dvded by he demand over ha perod. The rsk adjused prce s hen bul up as per (7). The opon seled upon by ESB CS reflecs he exposure These calculaons are carred ou eravely for each day n (n MWh) ha ESB CS faces n he pool (va s un-hedged he arff year, o deermne he RAPP forward curve. I demand) and he amoun (n /MWh) by whch he sngle should be noed ha, dependen on he relave value of marke prce, durng hose exposed perods, mgh ncrease conrac-ype prces, here s a poenal for over recovery or above he cenral SMP forecas poson (o he hgh SMP under-recovery on energy coss - whereby he amoun forecas),.e. Opon 3. For example, usng he revenue recovered by makng hese rsk adjusmens across all 335 exposure opon, he premum amoun added o he SMP

6 6 durng he Wnerpeak perod wll be mes he premum amoun added o he SMP durng he Summerngh perod. Ths reflecs he exposure (n MWh) ha ESB CS faces n he pool (va s un-hedged demand) and he amoun (n /MWh) by whch he sngle marke prce, durng hose exposed perods, mgh ncrease above he cenral SMP forecas poson (o he hgh SMP forecas. By means of an example, usng hs mehod, he premum amoun added o he SMP durng he Wnerpeak perod wll be mes he premum amoun added o he SMP durng he Summerngh perod. F. Concluson The Pool Exposure mehodology was chosen by ESB CS for mplemenaon n he RAPP model, as par of he AIME go-lve, prmarly for he ransparen way n whch hghlghed he poenal exposure ha ESB CS faced from he marke. In addon was presened n a srucure ha mached ESB CS STOD arffs. Fgure 5 depcs he oupu from hs process, comparng he SMP, EC fc and RAPP fc for a ypcal day under he SEM. Ths char clearly shows he flaer ECC, as well as he rsk premum spread over he shape of he SMP. negral par of he ESB CS arff prcng sysem. Whle he mehodology for spreadng he rsk premum assocaed wh hedgng conracs over he forecas SMP curve s kep under revew, he RAPP Mehodology wll be employed agan for he forhcomng arff year commencng 1 s Ocober IV. ACKNOWLEDGMENT The auhors graefully acknowledge he conrbuons of Davd Tolly, DLT Consulng (UK) who frs proposed a Rsk Adjused Pool Prce forward curve, he Commsson for Energy Regulaon (CER) and Frank Burke, Rsk Manager, ESB CS for her work on he developmen of he model. V. REFERENCES [1] The Sngle Elecrcy Marke (SEM), Tradng and Selemen Code, Verson 2, AIP/SEM/07/223, Commsson for Energy Regulaon, Norhern Ireland Auhory for Energy Regulaon, May [2] R. Turvey and D. Anderson, Elecrcy Economcs, A World Bank Research Publcaon, 1977, p15 [3] ESB Cusomer Supply Tarff Mehodology Saemen, Commsson for Energy Regulaon, cer07108, Augus 1, 2007 [4] C. Harrs, Elecrcy Markes, Prcng, Srucures and Economcs, Wley Fnance, 2006, p 175 [5] Inerm Publc Elecrcy Supply Lcence Graned o Elecrcy Supply Board, Commsson for Energy Regulaon, cer06073, May 01, Prces ( /MWh) VI. BIOGRAPHIES SMP ECC RA PPx Fgure 5 Comparson of Energy Conrac Coss, SMP and RAPP for a ypcal day Paul Conlon s a Senor Energy Analys wh ESB Inernaonal. He holds a Masers n Engneerng from Queen s Unversy Belfas and an MBA n Inernaonal Fnance from he Smurf Busness School, Unversy College Dubln. Paul specalzes n provdng echno-economc and sraegc analyss o clens n he energy ndusry and has advsed prvae corporaons as well as governmen agences and deparmens on a wde range of economc, commercal and regulaory ssues. Paul s a member of he Insue of Chemcal Engneers. Déaglán O Dónall B.E. (Unversy College Dubln) s Prcng Manager whn ESB Cusomer Supply and a par-me lecurer n Energy Economcs a Trny College Dubln. He has held a number of managemen posons n ESB Cusomer Supply and ESB Neworks. Déaglán s a member of he Insue of Engneers n Ireland. The RAPP model was used successfully n he real arff seng process for he frs me when seng arffs for he new arff year from November 2007 and s now an