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6 Reform of the Hellenic Power Market Report for PPC 8 December 2014 FTI-CL Energy

7 Contents Section 1 Executive summary 6 Introduction 6 European Target Model and implications for the Hellenic electricity market design 6 Electricity market design 6 The European Target Model 8 The Hellenic electricity market design and RAE s proposal 10 The current Hellenic electricity market 10 RAE s proposed electricity market for Greece 10 Central Dispatch and Self-Dispatch market design models 13 Market power mitigation in RAE s proposal 15 Maximum percentage of bilateral contracts 15 Limits on bidding in the real-time balancing market 17 Recommendations 17 Section 2 Section 3 Introduction: Greek power market context and ongoing regulatory changes 19 Introduction 19 Hellenic electricity market context 20 Generation mix 20 Transmission network topology 20 Competitive structure 22 Ongoing regulatory changes 23 Other issues 24 Contents of the report 24 European Target Model and implications for the Hellenic electricity market design 25 Key points 25 Introduction 26 Overview of the European Target Model 26 Building blocks of electricity market design 26 What is the European Target Model? 28 How the European Target Model impacts the choice of a market design? 29 Restrictions imposed by the Target Model on market design blocks 30 Forward market 30 Day-ahead market 30 Day-ahead market coupling in Italy 31 Intraday market 31 FTI-CL ENERGY 2

8 Reserves procurement 32 Energy balancing market, including imbalance settlement 33 Conclusions 34 Section 4 Issues with the current Hellenic electricity market design and RAE s reform proposals 35 Key points 35 Introduction 35 Structure of the current and proposed market designs in Greece 36 Current design 36 RAE s proposal for a new market design in Greece 37 Specific gaps between the current and proposed market designs 38 Forward market 39 Day-ahead market 41 Reserves procurement 41 Intraday market 42 Balancing market and imbalance settlement 42 Conclusions 43 Section 5 Central Dispatch and Self-Dispatch market design models 46 Key points 46 Introduction 47 Which market design for Greece? 49 Efficiency of dispatch 49 Market power 51 Physical and technical attributes of the system 53 Transition from the existing market design 56 Unit-based versus portfolio based approach 56 Portfolio bidding in the intraday market RAE s proposal 57 Conclusions 58 Section 6 Market power mitigation measures in RAE s proposal 59 Key points 59 Introduction 60 Maximum percentage of bilateral contracts 60 RAE s proposal 60 Assessment 61 Limits on bidding in the real-time Balancing Market 67 RAE s proposal 67 Assessment 68 Ongoing structural changes and monitoring 70 Conclusions 71 Section 7 Recommendations 72 Key points 72 Introduction 72 Policy recommendations 73 Ensure that portfolio optimisation benefits are obtained for the system and generators 73 Ensure coherence of forward and spot market 74 Market power and abuse mitigation 74 Ensure consistency with past and ongoing reforms 75 FTI-CL ENERGY 3

9 Further issues 76 Conclusions 77 Annex A European Target Model 79 Forward market 79 Relevant Network Code 79 Status of Network Code 79 What is mandatory in the Network Code? 79 What else might be implemented in the market? 80 Day-ahead market 80 Relevant Binding Guideline 80 Status of Binding Guideline 80 What is mandatory in the Binding Guideline? 80 What else might be implemented in the market? 81 Intraday market 82 Relevant Binding Guideline 82 Status of Binding Guideline 82 What is mandatory in the Binding Guideline? 82 What else might be implemented in the market? 83 Reserves procurement 84 Relevant Network Code 84 Status of Network Code 84 What is mandatory in the Network Code? 84 What else might be implemented in the market? 85 Energy balancing market (including imbalance settlement) 86 Relevant Network Code 86 Status of Network Code 86 What is mandatory in the Network Code? 86 What else might be implemented in the market? 89 Annex B Specific gaps between the current and proposed market designs 90 Forward market 90 Existing market 90 RAE s proposal 90 Assessment 91 Day-ahead market 92 Existing market 92 RAE s proposal 93 Assessment 95 Intraday market 95 Existing market 95 RAE s proposal 95 Assessment 96 Reserves procurement 96 Existing market 96 RAE s proposal 96 Assessment 98 Balancing and Imbalance Settlement 99 Existing market 99 FTI-CL ENERGY 4

10 RAE s proposal 99 Assessment 101 Annex C Building blocks of the Central Dispatch and Self-Dispatch market designs 102 Day-ahead market 103 Intraday market 103 Reserves scheduling 104 Balancing market and Imbalance settlement 105 Annex D The DEC game 106 Incentives induced by the interaction of the day-ahead and balancing markets when constraints exist 106 Offering in the import-constrained area 106 Bidding in the export-constrained area 107 FTI-CL ENERGY 5

11 Section 1 Executive summary Introduction 1.1 In April 2014, a working group consisting of Hellenic Regulatory Authority for Energy (RAE), Hellenic electricity market operator LAGIE and Hellenic transmission system operator ADMIE commissioned a study "Basic Design Principles and Timetables for Action Adaptation of Domestic Electricity Market Requirements of the Target Model" to the international consulting company ECCO International Inc. The study has identified a market design option that it considered both compatible with the Target Model and optimal for the Hellenic electricity market, and defined an implementation plan to achieve smooth adjustment of the market design over the years RAE has recently launched a public consultation on this market design proposal (thereafter RAE s proposal ). 1.2 This report analyses the RAE s proposal from a number of points of view: First, it analyses the extent to which RAE s proposal is compatible with the European Target Model; Second, it analyses the extent to which RAE s proposal is fit for the Hellenic electricity market context and specific features; and Finally, it analyses the extent to which RAE s proposal is coherent and the risk of specific elements to create market distortions and unintended consequences. European Target Model and implications for the Hellenic electricity market design Electricity market design 1.3 The electricity market design typically consists of several high-level elements: Forward market; Day-ahead market; FTI-CL ENERGY 6

12 Intraday market; Reserves procurement; Energy balancing market; and Imbalance settlement. 1.4 Figure 1 below illustrates generically these high-level elements, according to their timeframe. Figure 1: High-level elements of the electricity market design Forward Market Day-Ahead market Energy markets Intraday market Transactions occurring among market participants Years ahead Months ahead System Operations Reserve markets Balancing D-1 D H Real time Imbalance settlement Time Transactions concluded between market participants and TSO Source: Source: FTI-CL analysis 1.5 The first three high-level elements (Forward, Day-ahead and Intraday markets) are electricity market transactions occurring among market participants. The latter three high-level elements (Reserve markets, Balancing real-time markets and Imbalance settlement) are System operations since these transactions are concluded between the market participants and the System Operator. This is part of the activities the System Operator carries out to ensure that all the system s demand is met by supply at all times and that all security constraints are satisfied. 1.6 Historically, European countries have chosen a variety of approaches to implement these elements in their electricity markets. The main high-level alternatives of the market design options are the following: Central Dispatch. An arrangement, where the unit commitment scheduling is centralised and market participants are provided with their position, based on a central decision. The Transmission System Operator (TSO) determines the dispatch values and issues instructions directly to generators (or demand). Self-Dispatch. An arrangement where generators determine a desired schedule and commitment for themselves based on their own economic criteria. Under this arrangement, the generators provide the TSO nominations of the intended output of their FTI-CL ENERGY 7

13 generators, which becomes the starting point for the TSO to perform dispatch and balancing activities to meet security requirements. 1.7 European markets operating a Central Dispatch model include Italy, Spain, Ireland, and Poland. Both the current market design in Greece and the RAE s proposal are also Central Dispatch models. Examples of the Self-Dispatch model are in France, Germany, Nord Pool, Great Britain and Benelux. The European Target Model 1.8 The European Target Model is defined by a number of Network Codes that set the rules and obligations that govern access to, and use of, the European energy networks. The European Target Model allows for both Central and Self-Dispatch electricity market design options. The European Target Model stipulates several important high-level principles for the electricity market design: 1 The rules of an electricity market operating in one timeframe should facilitate the efficient functioning and prevent undue distortion of other electricity markets in other timeframes; The market design should facilitate Demand Side Response (DSR) participation, including aggregation facilities and energy storage; and The market design should facilitate participation of Renewable Energy Sources (RES) and support the achievement of the European Union target for the penetration of renewable generation. 1.9 The Target Model imposes requirements to some, but not all, elements of electricity market design for the various markets timeframes: Forward market: The FCA Network Code is not particularly prescriptive when it comes to the forward market. For example, it does not specify how forward markets should be organised, e.g. they may be Over-The-Counter (OTC) or via a power exchange, nor does it define a single target model for forward capacity allocation, e.g. Transmission Rights may be Physical or Financial. 1 ENTSO-E, Electricity Balancing Network Code version 3.0, 6 August 2014, Article 10. While these are with respect to the balancing market, the principles also apply in other markets in the European Target Model. FTI-CL ENERGY 8

14 Day-ahead market: The CACM Binding Guideline requires integration of the day-ahead electricity markets through a market coupling mechanism, with synchronisation of operations in terms of gate closure times, procedures, and transmission capacity allocation across borders. The Binding Guideline is not particularly prescriptive on the products in the day-ahead market. The Binding Guideline states that all accepted bids will have the same price per bidding zone per market time unit (i.e. marginal pricing) but it is less prescriptive on the type of bids that will be accepted. Intraday market: The CACM Binding Guideline requires integration of the intraday electricity markets through the implementation of continuous trading, rather than auctions performed in specific sessions during the day. However, the Binding Guideline allows for a hybrid model combining regional intraday auctions and continuous trading, (e.g. by stopping continuous trading for a limited period of time before the intraday crosszonal gate closure time) if specific conditions are met (e.g. no adverse impact on liquidity of single intraday coupling). Both standard and non-standard intraday products are approved in the Binding Guideline. Reserves procurement: The Electricity Balancing Network Code implies that products for Frequency Restoration Reserves and Replacement Reserves should be standardised and procured in a market-based manner. However, a TSO can request an exemption from the above if it would lead to higher economic efficiency. A TSO-TSO model is preferred; however, an exemption is possible to allow for an extension of the current national mechanisms (i.e. a TSO-BSP model). Energy balancing market, including imbalance settlement: The implementation of cross-border balancing services requires substantial harmonisation in terms of balancing procedures and product design, e.g. standard products and harmonised gate closure times. In terms of procurement of balancing energy, the Electricity Balancing Network Code suggests that the pricing methods are based on marginal pricing (pay-as-cleared), but it allows for exceptions on the basis of efficiency. The Network Code also specifies features of imbalance, e.g. that the imbalance settlement period should be no longer than 30 minutes. Finally, the Network Code allows for both Central and Self-Dispatch models In addition to the Network Codes constituting the European Target Model, the revised State Aid Guidelines recently published by the European Commission may have important implications for the electricity market design. 2 They imply that renewable generation should be integrated in the power markets and bear the cost of their imbalances, and that support 2 EC, 2014 Guidelines on State aid for environmental protection and energy , 2014/C 200/01 FTI-CL ENERGY 9

15 schemes should evolve toward market compatible schemes. They also provide some guidance on the design of capacity remuneration mechanisms. The Hellenic electricity market design and RAE s proposal The current Hellenic electricity market 1.11 The current Hellenic wholesale market design follows the mandatory physical pool model, where demand from suppliers is matched with the supply from the producers. The high-level structure of the Hellenic market and the functioning of the wholesale market is summarised in Figure 9 below. Figure 2: High-level depiction of current Hellenic electricity market design Years ahead Forward Market? Months ahead Day-Ahead market cooptimised with reserves Bid price link Balancing D-1 D H Real time Dual price Imbalance settlement Time Transactions occurring among market participants Transactions concluded between market participants and TSO Source: FTI-CL Energy analysis, Pöyry 2012 study and RAE 2014 proposal 1.12 In summary, the current Hellenic electricity market is characterised by two distinct settlement processes: Day-ahead market, where the Market Operator meets demand for the next 24 hours by accepting bids from generators and suppliers and calculates the SMP prices paid by suppliers to generators; and Balancing dispatch process, where the TSO activates balancing energy via the dispatch process and where the uninstructed deviations from the dispatch schedules are settled in the imbalance settlement process, with imbalance penalties when the magnitude and frequency of deviations reach certain limits. RAE s proposed electricity market for Greece 1.13 In April 2014, a working group consisting of RAE, LAGIE and ADMIE commissioned a study which identified a market design option that it considered both compatible with the European Target Model and optimal for the Hellenic electricity market (thereafter RAE proposal ). FTI-CL ENERGY 10

16 1.14 RAE proposes the creation and/or modification of all markets within the Hellenic electricity market. The resulting high-level market design proposed by RAE is depicted in Figure 3. Figure 3: High-level depiction of RAE s proposed Hellenic electricity market design Years ahead Forward Market NDP declaration Months ahead Day- Ahead Balancing Energy and Reserves Intraday market Bid price link Balancing D-1 D H Real time Possibly single price Imbalance settlement Time Transactions occurring among market participants Transactions concluded between market participants and TSO Source: FTI-CL Energy analysis, Pöyry 2012 study and RAE 2014 proposal 1.15 The RAE s proposal fills a number of gaps in the current electricity market design in Greece, introducing new elements and changing existing ones The existing elements that have undergone relatively little change are: The proposed integrated day-ahead scheduling process co-optimising energy and reserves. This element is broadly similar to the current day-ahead scheduling. The number of reserve products has increased and the products are half-hourly. The marginal pricing will produce a half-hourly price for balancing energy and each reserve product. Balancing market and imbalance settlement mechanisms have been modified but resemble the currently existing ones. RAE s proposal suggests partly keeping the constraints limiting the re-bidding between the balancing bids submitted in the day-ahead and in the intraday timeframe. The question of the dual vs. single pricing of imbalances remains open, i.e. whether long positions are penalised at the same rate as short positions in the balancing market (relative to the overall system position) The new elements are: The physical organised forward markets with conversion of the outstanding position into day-ahead bids; Day-ahead market coupled with the neighbouring countries markets with mandatory unit-based bidding; and Intraday markets introduced first in the form of auctions followed by continuous trading At a high-level, the modifications proposed by RAE seem broadly in line with the European Target Model. Introduction of options for demand participation, the treatment of FTI-CL ENERGY 11

17 RES, and the proposal to introduce balance responsibility of RES in the near future are in line with the Target Model and the State Aid guidelines. A more general evolution of the RES support schemes, with the purpose of making them more market-based, is beyond the scope of the current RAE s proposal Having examined the details of the proposal, we have identified the following potential issues: Potential poor liquidity of the physical forward market. The forward market proposed by RAE resembles much the Italian physical forward electricity market MTE established in However, this market has experienced a poorer liquidity than the concurrent Italian financial forward electricity market IDEX. It is therefore unclear if a complex physical forward market will become a reliable hedging tool for market participants in Greece. Furthermore, the addition of an organised forward market will make implementation more difficult; Potential systematic difference between the day-ahead prices for energy. One possible issue is the existence of two different markets in the day-ahead timeframe (the Day-Ahead market and the Integrated Scheduling Process). Both markets will produce an energy price but will use different types of bids and different algorithms to calculate this price. If there is a systematic difference between prices produced in these two markets, this would create incentives for market participants to shift their sales from one market into another with possible costs to the system; Maximum percentage rule in the forward market. A particular feature of RAE s forward market design proposal is a maximum volume of bilateral contracts (Forward and OTC) set at the level of 20% of the size of participants portfolio for participants with a large market share of end-consumption. This rule can be potentially damaging for the market; and Activity rules limiting the ability to modify bids. The RAE s proposal suggests that Balancing Energy offers submitted for the day-ahead scheduling phase shall be used to limit the Balancing energy offers submitted in the intraday market, this limits the ability to re-bid between the day-ahead and the real-time markets. RAE refers to this proposal as activity rules necessary to avoid manipulation and gaming. Such activity rules may create distortions and are not be consistent with the Target Model We discuss the maximum percentage rule and the activity rules in more details further below. FTI-CL ENERGY 12

18 Central Dispatch and Self-Dispatch market design models 1.21 A fundamental choice of the electricity market design is between the Central Dispatch and Self-Dispatch approaches. This high-level choice will determine a number of specific market design elements in the day-ahead, intraday, reserve and balancing markets Figure 4 below presents a high-level comparison of the Central and Self-Dispatch models. Figure 4: High-level comparison of the Central and Self-Dispatch models Central dispatch Generator Self-dispatch Generator Bilateral contracts Central market Power exchange Bilateral contracts Consumer Consumer Source: FTI-CL analysis of paper 102, Classification of Electricity Market Models Worldwide, On behalf of CIGRE Task Force C5.2.1, In the Central Dispatch model, central dispatch of generating units is done through a mandatory pool. The Central Dispatch model is often referred to as pool model. In addition, the Central Dispatch model generally features unit-based bidding and imbalance settlement. Market participants can strike bilateral contracts along the transactions made in the pool through financial contracts for differences. 3 In Central Dispatch markets, the reserve is procured after the clearance of the day-ahead market and intraday auction sessions are typically sequential. 3 Under a contract for difference (CFD), both buyer and seller submit their bids into the mandatory pool, that are cleared (or not) at the spot price. Then, the buyer pays to the seller the difference between the strike price and the realized spot price. FTI-CL ENERGY 13

19 1.24 In the Self-Dispatch model, generators optimise their portfolio on their own based on bilateral trades. The Self-Dispatch models are also referred to as bilateral model. Although the generators self-schedule their production, they may (and usually do) submit bids into the day-ahead market representing the cost of deviation of their schedule from the initial one. The Self-Dispatch model generally features trading and bidding based on portfolio. Imbalance settlement can also be done on a portfolio basis. Self-Dispatch typically favours continuous intraday markets While the European Target Model does not prescribe a choice between the Central and Self- Dispatch high-level models, RAE proposes to keep a Central Dispatch model, which it links to a unit-based approach. This is primarily because: Self-Dispatching market participants would not be able to reach a dispatch that would result in as much efficiency for the entire market; PPC will be afforded relatively more opportunities under a Self-Dispatch model to utilise its market power; Technical factors support the use of Central Dispatch, e.g. the need for flexibility to accompany RES penetration and the relatively small size of the Hellenic market; and RAE also refers to the Pöyry study that recommended Central Dispatch primarily on the basis of continuity Our analysis of the literature and the Hellenic context shows that one approach is not clearly superior to the other and that both market design families have advantages and disadvantages. However, maintaining the Central Dispatch would allow the least cost implementation and would provide continuity to the market participants and main stakeholders Whereas RAE links its Central Dispatch model with a unit-based approach to bidding, allowing for as much portfolio flexibility as possible with the Central Dispatch model may be the best option for Greece. 4 Portfolio participation can have wider benefits to the system: First, the ability of PPC to self-balance its portfolio would likely reduce the overall system imbalance to be dealt with by the TSO and reduce system balancing costs; 4 Notwithstanding the fact that, as real-time approaches, a unit-based approach becomes necessary to ensure the system remains balanced. FTI-CL ENERGY 14

20 Second, giving the market participants the ability to self-balance could facilitate the entry of Independent Power Producers (IPPs) in the retail market as they seek a natural hedge; and Finally, portfolio-based bidding and imbalance settlement would be compatible with the RAE s proposal to allowing RES producers imbalances to be accounted for on a portfolio basis to facilitate the development of RES in Greece. Market power mitigation in RAE s proposal 1.28 RAE is concerned about the potential abuse of market power and market manipulation in the Hellenic electricity market and hence proposes to mitigate market power in the proposed market design through various activity rules. However, by imposing such activity rules, RAE is not treating the root of the problem and risks distorting the market through its actions In EU Competition Policy, market power issues are generally handled through structural reforms to reduce the market share of dominant players. In the context of the Hellenic electricity market, steps have already been taken in that direction (e.g. the creation of Small PPC ), while at the same time PPC s market behaviour is under constant scrutiny by RAE We discuss below two activity rules, which are likely to introduce distortions in the market: Maximum percentage of bilateral contracts; and Limits on bidding in the real-time balancing market. Maximum percentage of bilateral contracts 1.31 RAE's proposal is to limit the percentage of the portfolio that can be sold in forward markets to the incumbent and the investor in Small PPC. In our view, this proposal can create material market distortion by: 5 Newbery et al (2006) compare structural methods of market power mitigation with market power mitigation through market rules aimed at the actual operations or decisions of the generators in electricity markets. With regards to the latter, they conclude that: These are often regarded as the most heavy-handed form of regulation and most liable to have unintended undesirable side effects. Twomey, P., Green, R. J., Neuhoff, K., & Newbery, D., A review of the monitoring of market power the possible roles of TSOs in monitoring for market power issues in congested transmission systems, FTI-CL ENERGY 15

21 Increasing the exposure of these companies to the volatile spot prices; Reducing liquidity and price discovery in the forward market, which will disadvantage smaller market participants that are not vertically integrated and hence do not have access to a natural hedge; and Offering limited benefit for the spot market liquidity and price discovery We analyse the hedging rates of four large European power generators and how they evolve over time from three years to three months to delivery. This analysis is presented in Figure 5. This evidence suggests that the levels of hedging typically required by power companies in Europe are over 90%, three months out from delivery date. RAE s proposed 20% maximum percentage of forward coverage two days before delivery is completely out of line with common hedging practices. Figure 5: Hedging rates in 2014 for four large European power generators % hedged 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 36m 33m 30m 27m 24m 21m 18m 15m 12m 9m 6m 3m RWE (Germany) E.ON (Central Europe) Vattenfall (Nordic) Enel (Italy) Source: Bloomberg Intelligence Power hedging Tracker, Q RAE is also concerned that, in the absence of the maximum percentage rule, a relatively large share of the system load would be traded through bilateral contracts and only 17% of the system load will be bid in the day-ahead market. However, it is unlikely that this would be detrimental for the day-ahead market s liquidity and price discovery for two reasons: FTI-CL ENERGY 16

22 As European power companies hedge up to 100% of their production in the forward contracts, they use day-ahead markets to adjust their position in the day-ahead market to respond to the short-term changes in the market conditions. It is natural that the volume of day-ahead trades can be materially smaller than 100%; and According to RAE s proposal, market participants will have to bid their capacity into the pool regardless of whether they have contracted their capacity forward or not. However, RAE s proposal suggests that forward positions will be converted into unpriced, dayahead bids rather than bids reflecting the production costs. This proposal may impact price discovery in the day-ahead market. Limits on bidding in the real-time balancing market 1.34 RAE's proposes rules to select offers in the balancing market based on the comparison of the offer prices with those in the day-ahead market to mitigate gaming. These rules may undermine the value of the balancing markets for market participants and limit their ability to reflect the real-time cost increases in their bids. This can also have a negative impact on the bidding and the outcome in the day-ahead market Knowing that the real-time balancing costs may be above the day-ahead cost, generators may increase their day-ahead bids to ensure that the activity rules will not prevent the balancing bids from representing the real-time cost, as depicted in Figure 6. Figure 6: Potential impact of the activity rule on the day-ahead price Price Activity rule Cost DA bid Expect ed RT Cost DA RT Source: FTI-CL analysis Recommendations 1.36 We propose four broad policy recommendations for RAE to improve the Hellenic electricity market design: FTI-CL ENERGY 17

23 Ensure that portfolio optimisation benefits are obtained by both generators and the system: Realise the advantages of portfolio-bidding in the day-ahead market (as in the intraday market); and either allow portfolio-based imbalance settlement or adopt a single-price settlement to implicitly allow for imbalance offset within a portfolio; Consider simplifications to streamline the implementation and enhance the interaction between the forward market and spot market: Continue to develop financial forward markets as opposed to implementing a complex, organised physical market; simplify the link between the forward and day-ahead markets; Remove the maximum percentage and better bid rules which would introduce distortions: While these two rules are designed to limit the abuse of market power, they will have adverse consequences and structural and market monitoring tools are already available to treat the problem at its root cause; and Ensure consistency with the past and ongoing reforms: A number of reforms are underway in the Hellenic energy markets including the introduction of a Capacity Remuneration Mechanism (CRM), the introduction of regulated NOME-type products for base load generation, and the necessary reforms of the retail market. If RAE s electricity market design is going to be successful it needs to integrate with these reforms In addition, we identify four further market design issues that remain unresolved in RAE s proposal that may require more consideration: Aligning market design with the European Target Model versus aligning with Italy: A decision must be made as to the electricity market design that Greece is aiming for over the near-term; Zonal splitting in day-ahead and intraday markets: RAE s proposal should provide for such zonal splitting, although it does not discuss this in detail; Integrating the market design of non-interconnected islands: The market design of the non-interconnected islands is based on the current continental market design and this may need to change; Balancing responsibilities of RES and participation of demand response: There are a number of uncertainties relating to the balancing responsibilities of RES generators in RAE s proposal, as well as the participation of demand response. FTI-CL ENERGY 18

24 Section 2 Introduction: Greek power market context and ongoing regulatory changes Introduction 2.1 The "Target Model" for electricity markets proposed by the European Commission and the Agency for the Cooperation of Energy Regulators (ACER) is a basis for the development of the single market in Europe. New European Regulation - Network Codes - specify the minimum requirements of the Target Model s common architecture of European national electricity markets at each timeframe: forward, day-ahead, intraday, reserves and balancing, and specifies a coordinated approach to allocation of interconnection capacity. 2.2 In April 2014, a working group consisting of Hellenic Regulatory Authority for Energy (RAE), Hellenic electricity market operator LAGIE and Hellenic Transmission System Operator (TSO) ADMIE commissioned a study "Basic Design Principles and Timetables for Action Adaptation of Domestic Electricity Market Requirements of the Target Model" to the international consulting company ECCO International Inc. The study has identified a market design option that it considered both compatible with the Target Model and optimal for the Hellenic electricity market. It also defined an implementation plan to achieve smooth adjustment of the market design over the years RAE has recently launched a public consultation on this market design proposal (thereafter RAE s proposal ). 2.3 This report analyses the RAE s proposal from several points of view: First, it analyses the extent to which RAE s proposal is compatible with the European Target Model; Second, it analyses the extent to which RAE s proposal is fit for the Hellenic electricity market context; and Finally, it analyses the extent to which RAE s proposal is coherent and the risk of creating market distortions and unintended consequences. FTI-CL ENERGY 19

25 2.4 Below we provide a brief description of the Hellenic electricity industry context in which the current power market design reform is proposed. Hellenic electricity market context 6 Generation mix 2.5 According to the 2013 adequacy report of the Hellenic TSO ADMIE, Greece had 17.4 GW of installed capacity in The generation mix and production by technology are presented in Table 1 below. Table 1: Installed capacity and production mix in Greece, 2013 Plant type Installed capacity, % Production, % Lignite 28% 48% Oil 4% 0% Steam turbine gas plants 3% 0% CCGT 21% 25% Large Hydro 17% 11.5% Other RES and CHP 26% 15.5% Source: ADMIE, Capacity Adequacy Study for the Period and Monthly Energy report December 2013 Transmission network topology 2.6 The backbone of the Hellenic transmission system are 400 kv AC lines connecting the north of the country to the Athens and Thessaloniki areas. Most of the country s electricity is generated in northern Greece, close to the major lignite mines, while Athens area in the south represents a main load centre. 66 For the purposes of this report, the Hellenic electricity market refers to the interconnected Greek system only (i.e. not the non-interconnected islands) unless otherwise stated. FTI-CL ENERGY 20

26 Figure 7: Hellenic electricity transmission system Source: ENTSO-E 2013 Map 2.7 The topology of the Hellenic network suggests that congestion is possible. The Hellenic mechanism for Day-Ahead Scheduling (DAS) currently takes into account transmission network constraints in determining the clearing prices and volumes and produces zonal clearing prices at times of congestion between northern and southern Greece. However a zonal wholesale electricity price for generation has not been implemented in Greece. 2.8 The Hellenic system is interconnected with Albana, Bulgaria, FYROM, Italy and Turkey. It is a net importer of electricity, importing 2.1 TWh in Greece imported from Albania, FYROM 8 and Bulgaria and exported to Italy and Turkey 9. In 2012, Greece had 1530 MW of export capacity and 1550 MW of import capacity. 7 8 ENTSO-E, Greece country package Former Yugoslav Republic of Macedonia. FTI-CL ENERGY 21

27 Competitive structure 2.9 The Public Power Corporation (PPC), the largest utility in Greece owns 61% of the installed capacity and generates 67% of the electricity generated from indigenous sources, as presented in Table 2 below. PPC is the only generator possessing lignite and large hydroelectric plants, whereas the Independent Power Producers (IPPs) mainly control CCGT and RES capacity. IPPs control 39% of the total installed capacity and less than 20% of the reliable capacity. Table 2: Ownership structure of capacity and production in Greece, 2013 PPC and IPPs Plant type Installed capacity, % Production, % PPC Lignite 28% 48% Oil 4% 0% OCGT 2% 0% CCGT 9% 8% Large Hydro 17% 11% Total 61% 67% IPPs OCGT 1% 0% CCGT* 14% 17% RES and other CHP 24% 16% Total 39% 33% Source: ADMIE, Capacity Adequacy Study for the Period and Monthly Energy report January to December PPC financial results 2013 (presentation in Athens on March, the 27 th 2014). *Include Aluminium power plants which is partly a dispatchable CHP plant The Hellenic electricity system is characterised by a peak demand of approximately 10GW. The overall electricity consumption is 50.7 TWh 10 in In the retail market PPC holds a 98.3% share The Hellenic parliament passed legislation for the creation of Small PPC in July Small PPC is a new vertically integrated electricity undertaking, established by privatising 30 percent of PPC operations and assets. According to the Hellenic law 11, 2,318 MW of the ADMIE s Monthly Energy report Dec 2013 page 32. ADMIE s Monthly Energy report Dec 2013 page 10. Greek Law 4273/2014. FTI-CL ENERGY 22

28 generation capacity including lignite, hydro and natural gas power plants (currently in operation or with licence to operate), the rights to operate the lignite mines, and 30% of PPC s customer base are to be transferred to a private preferred bidder by the first quarter of This reform aims to increase competition and allow more IPPs, electricity supplies, and power traders to enter the Hellenic domestic market. Ongoing regulatory changes 2.13 In addition to the proposed reform of the power market design, there are several ongoing reforms of the organisation of the electricity market in Greece driven by RAE: RAE plans to introduce auctions for access to the base-load energy, similar to auctions used to increase access to the nuclear energy in France under the loi NOME. These auctions are proposed by the regulator for electricity market reform; 12 they would allow third parties to gain access on lignite and hydro electricity production. According to RAE and LAGIE, 13 access will be gradually gained through forward auctions with a regulated price floor. Allegedly, only electricity suppliers will be eligible to participate in these auctions. The NOME-type auctions are planned to be used as a transitional mechanism for a limited period of time 14 and until the retail market is opened up to competition. The RAE plans to introduce a new Capacity Remuneration Mechanism (CRM) in Greece. In the public consultation launched in summer 2014, RAE establishes new requirements for system reliability that must be addressed in the CRM. In particular, RAE considers that due to the rapid development of variable renewable energy sources (wind and solar PV), conventional capacity adequacy is no longer sufficient for system reliability. Therefore, RAE proposes a broader concept of resource adequacy, including the need for flexible capacity to follow load and to manage the variability of renewable generation RAE, Τελικές προτάσεις της Ρυθμιστικής Αρχής Ενέργειας για την αναδιοργάνωση της εγχωριας αγοράς ενέργειας, November RAE, Ρυθμιζόμενη Προθεσμιακή Αγορά για την πρόσβαση προμηθευτών σε ενέργεια από λιγνιτική και υδροηλεκτρική παραγωγή, 13 May 2014; LAGIE, Σχεδιασμός Προθεσμιακής Αγοράς Φάση Α: version 1.0, 13 May 2014 and RAE, Consultation on NOME-type auctions, August Initially, it was intended to last three years. FTI-CL ENERGY 23

29 Other issues 2.14 There are several other features in the current Hellenic market that may create frictions in the functioning of the electricity market and developing competition. For example: Development of the gas markets lags behind the development of the electricity markets. As of today, there is no liquid market for natural gas in Greece. This may have implications for flexible operation of the Hellenic CCGT plants that have to rely on the flexibility of their long-term gas contracts. The retail electricity tariffs currently in place in Greece feature considerable amount of cross-subsidisation across customer segments imposed by RAE. Such crosssubsidisation may impede development of efficient trading in the wholesale market. Market reform aims at modifying the rules and organisation of the market in the interconnected Hellenic continental system. This will potentially affect the organisation of the markets in the non-interconnected islands, the present rules of which are based on those of the continental Hellenic market. The network will be affected by the interconnection of Crete and the Cyclades islands. ADMIE has taken this into consideration in its Power Adequacy study, as should any future analysis of the Hellenic Power market. Contents of the report 2.15 The rest of the report is structured as follows: Section 3 presents the European Target model for the electricity market and the constraints it imposes on the electricity market design; Section 4 describes the RAE's proposed market design and compares it with the current Hellenic electricity market design, as well as with the design imposed by the European Target Model; Section 5 considers the high-level choice between Central and Self-Dispatch models and proposes a possible hybrid approach for Greece; Section 6 analyses two ways in which RAE proposes to mitigate market power and discusses how RAE is not treating the root of the problem and risks distorting the market: Section 7 provides recommendations for RAE on further steps in the market design reform based on the previous analyses and lists issues that remain open. FTI-CL ENERGY 24

30 Section 3 European Target Model and implications for the Hellenic electricity market design Key points The European Target Model provides some guidelines for the design of electricity markets through the Network Codes. In terms of high-level market design: the European Target Model is flexible and allows for both Central and Self-Dispatch high-level electricity market design options; The European Target Model and the State Aid guidelines stipulate several important high-level principles for the electricity market design, such as prevention of undue distortions across market timeframes, and facilitation of Demand Side Response and RES participation. The European Target Model specifies some elements of electricity market design that are critical for the cross-border integration of European markets: Harmonisation of gate closure time and marginal pricing in the day-ahead market; Implementation of continuous trading in the intraday market. Regional intraday auctions could be combined with the continuous trading across the border within hybrid models; Products in the reserve market should be standardised and procured in a marketbased manner; and Procurement of balancing energy should be based on marginal pricing, but exceptions could be allowed on the basis of efficiency. FTI-CL ENERGY 25

31 Introduction 3.1 In this section we present the European Target Model for the electricity markets and discuss the restrictions this model imposes on the choice of the electricity market design in Greece. We proceed as follows: First, we present an overview of the European Target Model; and Second, we provide a more detailed description of the European Target Model in each block of the electricity market design. 3.2 Detailed summaries of the Network Codes constituting the European Target Model are presented in Annex A below. Overview of the European Target Model Building blocks of electricity market design 3.3 The electricity market design typically consists of several high-level elements: Forward market; Day-ahead market; Intraday market; Reserves procurement; Energy balancing market; and Imbalance settlement. 3.4 Figure 8 below illustrates these high-level elements, according to their timeframe with respect to the moment of electricity delivery in real-time. FTI-CL ENERGY 26

32 Figure 8: High-level elements of the electricity market design Forward Market Day-Ahead market Energy markets Intraday market Transactions occurring among market participants Years ahead Months ahead System Operations Reserve markets Balancing D-1 D H Real time Imbalance settlement Time Transactions concluded between market participants and TSO Source: FTI-CL analysis 3.5 The first three high-level elements (Forward, Day-ahead and Intraday markets) are electricity market transactions occurring among market participants. The latter three high-level elements (Reserve markets, Balancing real-time markets and Imbalance settlement) are System operations, since these transactions are concluded between the market participants and the System Operator as part of the activities it carries out to ensure that all the system s demand is met by supply at all times and that all security constraints are satisfied. 3.6 Historically, European countries have chosen different approaches to implement these elements in their electricity markets. The main high-level alternatives of the market design options are the following: Central Dispatch: An arrangement, where the unit commitment scheduling is centralised and market participants are given their position based on a central decision. The TSO determines the dispatch values and issues instructions directly to generators (or demand). Self-Dispatch: An arrangement where generators determine a desired schedule and commitment for themselves based on their own economic criteria. Under this arrangement, the generators provide the TSO nominations of the intended output of their generators, which becomes the starting point for the dispatch and balancing activities performed by the TSO to meet security requirements. 3.7 We discuss these two high-level market design approaches in more detail in Section 5 below. European markets operating a Central Dispatch and unit commitment model include Italy, Spain, Ireland, and Poland. Both the current market design in Greece and the RAE s proposal also belong to the Central Dispatch design models, as we describe in more details in Section 4. Examples of the Self-Dispatch model are in France, Germany, Nord Pool, Great Britain and Benelux. We address the differences between these two high-level market design choices in more detail in Section 5. FTI-CL ENERGY 27

33 What is the European Target Model? 3.8 European legislation, known as the Third Package, entered into force in September The key aim of the Third Package was to further liberalise European energy markets. To achieve this aim, the Third Package introduced a framework to support the progressive implementation of a European Target Model. 3.9 European-wide Network Codes are central to the development of the European Target Model. These Network Codes form a legally binding set of common technical and commercial rules and obligations that govern access to, and use of, the European energy networks. Network Codes are first drafted by the European Network of Transmission System Operators for Electricity (ENTSO-E), based on the Framework Guidelines defined by Agency for the Cooperation of Energy Regulators (ACER). The Network Codes are reviewed and approved by ACER and then enforced by the European Commission and Member States through the Comitology process. Several Network Codes that define the European Target Model of electricity market design are currently in the process of Comitology: Forward Capacity Allocation (FCA): The FCA Network Code defines the rules of calculating cross-border transmission capacity between bidding zones in the forward timeframe (yearly and monthly mainly) and rules of allocating it via (financial or physical) transmission rights; Capacity Allocation and Congestion Management (CACM): The CACM Binding Guideline (formerly Network Code) defines the rules of calculating transmission capacity between bidding zones that can be national or smaller/larger than national. Further, it defines the market approaches to allocate the transmission capacity in each timeframe: forward, day-ahead, and intraday. These market procedures define a number or constraints that the design of the day-ahead and intraday markets need to comply with to be compatible with the European Target Model; System Operation: This includes Network Codes on operational security, on operational planning and scheduling, on load frequency control and reserves and on operational procedures in emergency situations. These codes define a set of rules for ensuring the operational security of the pan-european power system. For example, they specify the load frequency control processes and rules regarding levels and location of reserves which Transmission System Operators (TSOs) need to hold; and Balancing: The Electricity Balancing Network Code aims to achieve several objectives: a) promote integration of balancing markets through the definition of models for the FTI-CL ENERGY 28

34 exchange of balancing energy for different types of reserves; b) harmonise the terms and conditions of balancing markets, including the pricing of balancing bids; c) standardise balancing products and harmonise imbalance settlement to provide better incentives to market participants to balance the system In addition to the Network Codes constituting the European Target Model, other European legislation may have important implications for the electricity market design, in particular, the revised State Aid Guidelines recently published by the European Commission. 16 How the European Target Model impacts the choice of a market design? 3.11 In principle, the European Target Model does not prescribe a specific high-level choice of the electricity market design in a given country For example, both high-level design families, Central Dispatch and Self-Dispatch, are in general compliant with the European Target Model. However, in practice, countries with a Self-Dispatch market design in place find it easier to make their models compatible with the European Target Model. Countries with centralised design need to develop additional arrangements allowing for them to be compliant with the Target Model. We mention below the examples of such arrangements in Italy and Spain The European Target Model stipulates several important high-level principles for the electricity market design: 17 The rules of an electricity market operating in one timeframe should facilitate the efficient functioning and prevent undue distortion of other electricity markets in other timeframes; The market design should facilitate participation of Demand Side Response including aggregation facilities and energy storage; and The Electricity Balancing Network Code further states that it shall facilitate the achievement of the following objectives EC, 2014 Guidelines on State aid for environmental protection and energy , 2014/C 200/01 ENTSO-E, Electricity Balancing Network Code version 3.0, 6 August 2014, Article 10. While these are with respect to the balancing market, the principles also apply in other markets in the European Target Model. FTI-CL ENERGY 29