Understanding Electricity Markets: Key Concepts and Mechanisms
Key Concepts in Electricity Markets
Consumer Surplus and Producer Costs
Differences between Gross CS and Net CS: The net one only considers the difference between the price offer and the marginal price (multiplied by the power), while the gross one considers the whole price offer multiplied by the power.
Variable and fixed costs for producers:
- Fixed: maintenance, initial cost (building, land, machines), salaries.
- Variable: Fuel, operation costs.
Marginal Price and Producer
Market clearing price is the price that is going to be the most effective and corresponds to the price of the last bid that “stays in”. It is the price of equilibrium between offer and demand, where both cross. The marginal producer is the last producer that will exchange energy. Its price bid will always be the marginal price.
Merit Order Curves
Merit order curves (generation and demand) in the wholesale market:
- Generators: from left (cheapest bids) to right (highest bids).
- Consumers: the order will be the opposite one.
Where both “curves” cross, the marginal price and the marginal producer are defined.
Ancillary Services
Ancillary services objectives in energy markets:
To balance frequency stability (through primary, secondary, and tertiary control), voltage stability (keep V at a specific range through generating or absorbing reactive power), transient stability, and system restoration (black-start capability).
Market forms preferred for these mechanisms depend on the nature of it:
- Long-term contracts: variation of energy must be low, and the availability of power mostly depends on the equipment characteristics.
- Spot market: services where the needs vary substantially over the course of the day and the offers change.
Renewable Energy Regulations
Difference between renewable portfolio standards & competitive auctions:
Renewable portfolio standards establish quota requirements for consumers, suppliers, and/or generators to ensure that a portion of their electricity comes from renewable sources. They set laws to have a part of the demand covered by renewables. Competitive auctions consist of setting an amount of renewable capacity to be built during a specific period and carrying out a bidding process to find the least-costly, most attractive offer from renewable generators. Invest in renewable to see which technology is the best.
Regulatory Schemes for Renewables
4 regulatory schemes for renewables:
- Price-based mechanism:
- Feed-in-tariffs (FIT): guarantee renewable generators a specific price per MWh that is produced.
- Feed-in-premiums (FIP): payments guaranteed to renewable generators on top of existing electricity market prices.
- Other: Tax incentives, Investment incentives, Financing incentives
- Quantity-based mechanism:
- Renewable portfolio standards: Tradable green certificates (TGC) or Renewable obligations (RO): establish quota requirements for renewable sources
- Competitive auctions (Size- or technology-driven): bidding process in order to find the least-costly, most attractive offer.
Natural Monopoly
- Regulator set the price at the value given by the intersection of the demand curve and the average cost curve.
- It is used for commodities involving large fixed costs and relatively small variable costs.
- Examples: Transmission and distribution of electrical energy
Producer Costs
- MC (marginal cost): O&M activities (raw material + labor), that is, variable costs – Cost of the last unit produced
- AC (average cost): AVC (average variable cost) + AFC (average fixed cost)
- AFC (average fixed cost): land, building, machines – Cost of the units already produced
Oligopoly vs. Monopoly
Monopoly has one producer, its ability to affect the price is large and has huge entry barriers whereas the oligopoly has few producers, its ability to affect the price is medium and has some entry barriers.
Centralized Market and Unit Commitment
Is an optimization problem that aims to minimize the total cost of process generation in a specific period by defining an adequate scheduling of generation units (which can be on-line or off-line).
MPA vs. SPA
It considers several time periods simultaneously and enables to include intertemporal constraints (programmable production 24h in advance). SPA just considers one period without intertemporal coupling. MPA allows to include constraints for physical machines and systems.
Electricity as a Unique Commodity
Electricity different commodity:
- Electrical energy is inextricably linked with a physical system that functions much faster than any market
- Energy produced by one generator cannot be directed to a specific consumer can not be distinguished depending on its origin)
- Demand for electrical energy exhibits predictable daily and weekly cyclical variations
Factors Affecting Commodity Prices
Five factors affect the price commodities:
Demand, Supply, Weather, Expectations, Reserves / Storability, Worldwide demand and supply.
Economic Dispatching
Allocating total demand among generating units in order to minimize production cost.
Options: Basic, With generation limits, With losses, With network constrains, Optimal power Flow.
Retail Competition
Retail competition and its characteristics:
- Retail competition
- Bids (retailers) and offers (generators) are de-regulated
- T&D networks are regulated
- Operation and development of power system – Centralized operation
- Minimum cost is obtained at wholesale market
- It requires metering communication and data processing
- Open access to power network
- Separation of activities (unbundling).
Market Clearing Price and Global Welfare
Market-clearing price, marginal producer. Global welfare:
- Marginal price: the point where generation and demand intersect.
- Marginal producer: producer whose opportunity cost is equal to the market price.
- Global welfare: Sum of the net consumers’ surplus and of the producers’ profit. It is maximum when a competitive market is allowed to operate freely and the price settles at the intersection of the supply and demand curves
Trading Mechanisms
Trading mechanisms within de-regulated operation framework:
- The pool:
- Generators submit offers and retailers submit bids
- It is managed by a market operator
- Short-term economic viewpoint
- Futures market (future contracts):
- It allows producers and consumers to hedge against volatility of pool prices
- Medium- and long-term economic viewpoint (days to years)
- Forward markets (forward contracts):
- Bilateral contracting between producers and consumers
- Market operator have to be informed
- Medium- and long-term economic viewpoint