Design Alternatives Sheet: The Objective Function in Capacity Market Clearing

Transcription

1 Design Alternatives Sheet: The Objective Functin in Capacity Market Clearing 1.1 What is the bjective functin when ptimizing the auctin clearing? Maximizing Scial Surplus Typically, the market clearing prcess is a prcess t maximize scial surplus. Scial surplus is the difference between the market value f the prduct (indicated by the demand curve) and the prductin cst f the prduct (indicated by the supply curve). Chart 1: Cnsumer Surplus, Prducer Surplus, and Scial Surplus DRAFT Fr DISCUSSION Page 1 Select AESO Label

2 Scial surplus is als the sum f cnsumer surplus and prducer surplus. Cnsumer surplus is the difference between the market value f the prduct and the market price paid by the cnsumers. Prducer surplus is the difference between the market price received by the prducers and the prductin cst f the prduct. Graphically shwn in Chart 1, the cnsumer surplus can be represented by the area under the demand curve and abve the market price (the green area) and the prducer surplus can be represented by the area belw the market price and abve the supply curve (the yellw area). Scial surplus is the area belw the demand curve and abve the supply curve (the sum f the green area and the yellw area). At the price and quantity where the marginal value and marginal prductin cst equal (i.e. where demand curve intersects the supply curve), the scial surplus is maximized and the market is at the equilibrium with the quantity Q 0 and market clearing price P 0. If the vlume prduced is lwer than the equilibrium level Q 0, e.g. at Q 1 (Chart 2), the market price wuld increase frm P 0 t P 1. At Q 1 and P 1, there wuld be a lss in bth cnsumer surplus and prducer surplus. The lss in cnsumer surplus includes the prtin transferred frm cnsumers t prducers due t the higher price (indicated by the rectangle B) and the deadweight lss (indicated by the triangle C) due t the unrealized net value. The lss in prducer surplus is caused by nt prducing the additinal quantity t capture additinal prfit (indicated by the triangle F). The ttal lss f scial surplus is the sum f the areas C and F. This is the deadweight lss caused by prducing at a quantity belw the equilibrium. Chart 2: Deadweight Lss When the Vlume is less than Equilibrium DRAFT Fr DISCUSSION Page 2 Select AESO Label

3 If the vlume prduced is higher than the equilibrium level Q 0, e.g. at Q 2, the market price is reduced frm P 0 t P 2. At Q 2 and P 2, cnsumer surplus wuld increase frm the area indicated by A t the area indicated by A+C+E (the sum f the green area and the range area). Hwever, the prducers wuld prduce at a lss (indicated by the areas between the supply curve and the price, i.e. the sum f the areas E and F).The increase in cnsumer surplus is at the expense f the lss f prducer surplus, which includes the transfer f prducer surplus t cnsumers (area C) and a prtin f the lss incurred by prducing at a cst higher than price (area E). The remaining prtin prducers lss incurred by prducing at a cst higher than price (indicated by the area F), is the net reductin f scial surplus. This is the deadweight lss caused by prducing at a quantity abve the equilibrium. Chart 3: Deadweight Lss When the Vlume is Greater than Equilibrium DRAFT Fr DISCUSSION Page 3 Select AESO Label

4 In the capacity market, the marginal ffer frm a resurce may nt be divisible, i.e. the marginal ffer may be an indivisible ffer, als knwn as a lumpy ffer, an inflexible ffer r a Fill r Kill (FOK) ffer. With an indivisible marginal ffer, the market cannt be cleared at the quantity and price that maximizes scial surplus and a deadweight lss wuld ccur. This can be illustrated by Charts 4-7. Chart 4 shws that if the marginal ffer is divisible and the marginal ffer can be partially cleared, the scial surplus is maximized if the market clears at vlume Q 0 and price P 0. Chart 4: Prcurement Vlume and Market Clearing Price that Maximize Scial Surplus DRAFT Fr DISCUSSION Page 4 Select AESO Label

5 Hwever, if the marginal ffer is indivisible, a deadweight lss wuld ccur. If selecting the entire indivisible blck, the prcured vlume Q 1 is greater than the ptimal vlume Q 0 and a prtin f the resurce s cst is abve the value f the capacity prduct. Althugh the capacity market clearing price des nt change, it causes a deadweight lss. The deadweight lss is indicated by the red triangle A in Chart 5. Chart 5: Deadweight Lss if Selecting the Entire Indivisible Offer DRAFT Fr DISCUSSION Page 5 Select AESO Label

6 If nt selecting the indivisible ffer, the market clearing prcess may nly select up t the ffer right belw the indivisible marginal ffer. Because the prcured vlume Q 2 is less than the ptimal vlume Q 0, a prtin f scial surplus is lst. The lss in scial surplus is a deadweight lss, indicated by the red triangle B in Chart 6. 1 Chart 6: Deadweight Lss if Selecting up t the Resurce Whse Offer is Belw the Indivisible Marginal Offer 1 At vlume Q 2, the market clearing price may be set at P 2 r P 2. The ptins are discussed in questin 1.2. DRAFT Fr DISCUSSION Page 6 Select AESO Label

7 The market clearing prcess may skip the indivisible marginal ffer and clear a prtin f the f the least cst divisible resurce whse ffer price is abve the indivisible marginal ffer (e.g. Resurce 4). Hwever, this wuld als create a lss in scial surplus, which is the deadweight lss indicated by the area in red (area C) in Chart 7. This is because a lwer-cst resurce is skipped and a higher-cst resurce is selected instead. Area C represents that scial surplus that cannt be realized when the indivisible marginal ffer is skipped. Chart 7: Deadweight Lss if Skipping the Indivisible Marginal Offer When the marginal ffer is indivisible, the capacity market clearing prcess may set the bjective functin t maximize scial surplus thrugh minimizing deadweight lss, r nly maximize scial surplus when ding s des nt cause a net lss in cnsumer surplus. DRAFT Fr DISCUSSION Page 7 Select AESO Label

8 Descriptin Optin 1: Maximizatin f Scial Surplus The clearing prcess f capacity auctin uses the ptimizatin algrithm that minimizes the deadweight lss. Optin 2: Maximizatin f Scial Surplus with N Net Lss in Cnsumer Surplus Minimizing the deadweight lss nly when there s n net lss t cnsumer surplus. Advantages The verall scial surplus (the sum f cnsumer surplus and prducer surplus) is maximized and the market is efficient. May save prcurement cst in a particular auctin (but this needs t be cnsidered in the cntext market s ability t prvide reliability at the lwest cst ver time). Disadvantages May incur higher prcurement cst in a particular auctin (but this needs t be cnsidered in the cntext market s ability t prvide reliability at the lwest cst ver time). The verall scial surplus may nt be maximized and the market efficiency is lst. It may cause market price t be depressed and the efficient entry int the market may be discuraged DRAFT Fr DISCUSSION Page 8 Select AESO Label

9 Analysis Chart 8 illustrates that Optin 2 may cause the market price t be depressed and the efficient entry int the market may be discuraged. Chart 8: Illustratin Hw Efficient New Entry May be Discuraged When Inefficient Price Signal is Sent In Chart 8, Resurce 3 is an indivisible ffer and the market clearing prcess has t determine whether it shuld clear up t the ffer right belw the indivisible ffer (i.e. prcuring Q 1 ), clear the entire indivisible ffer (i.e. prcuring Q 2 ), r skip the indivisible ffer and select the lwest ffer abve the indivisible ffer (i.e. prcuring Q 3 ). Chart 8 assumes a case where selecting the entire indivisible ffer wuld minimize the deadweight lss and maximize scial surplus DRAFT Fr DISCUSSION Page 9 Select AESO Label

10 and skipping the indivisible ffer and selecting the lwest ffer abve it wuld incur the greatest deadweight lss. Chart 8 als assumes that the marginal ffer price sets the market clearing price. 2 Resurce N is the ptential new resurce whse cst ffer price wuld be P n. If nt clearing the entire indivisible ffer but nly clearing up t the ffer immediately belw it, it wuld avid a prtin f cnsumer surplus being transferred t prducers (indicated by the area f the blue rectangle) due the higher market clearing price. Optin 2 wuld nt chse t clear the entire indivisible ffer if the prtin transferred frm cnsumer surplus t prducers is greater than the amunt f deadweight lss that culd have been avided (indicated by the difference between the area f the green triangle and the area f the red triangle). As the result, Optin 2 wuld prevent the market frm clearing at the level where the deadweight lss is minimized (i.e. P 2 ). Ptential new entries whse cst is abve P 1 and belw P 2 wuld be nt able t enter the market, althugh their participatin wuld yield the prcurement vlume Q n at the market clearing price P n and increase bth cnsumer surplus and prducer surplus ver time. Other Jurisdictins PJM Maximizatin f scial surplus. 3 ISONE Maximizatin f scial surplus 4 UK Maximizatin f scial surplus when it des nt cause net lss f cnsumer surplus. 5 Ireland Maximizatin f scial surplus. 6 2 The market clearing price may als be set at the pint n the demand curve that is crrespnding t the prcurement vlume Q 1 as ppsed t by the marginal ffer price. 3 PJM s capacity market clearing prcess maximizes scial surplus thrugh minimizing the deadweight lss.3 PJM s ptimizatin may select frm amng multiple pssible alternative clearing results that satisfy such requirements, including, fr example (withut limitatin by such example), accepting a lwer-priced Sell Offer that intersects the Variable Resurce Requirement Curve and that specifies a minimum capacity blck, accepting a higher-priced Sell Offer that intersects the Variable Resurce Requirement Curve and that cntains n minimum-blck limitatins, r rejecting bth f the abve alternatives and clearing the auctin at the higher-priced pint n the Variable Resurce Requirement Curve that crrespnds t the Unfrced Capacity prvided by all Sell Offers lcated entirely belw the Variable Resurce Requirement Curve. PJM, OATT Attachment DD, sectin Where the requirement that ffers and bids clear r nt clear in whle (Sectin III ) prhibits the descending clck auctin in its nrmal prgressin frm clearing ne r mre Capacity Znes at the precise amunt f capacity determined by the Capacity Zne Demand Curves specified in Sectin III , then the auctineer shall analyze the aggregate supply curve t determine cleared capacity ffers and Capacity Clearing Prices that seek t maximize scial surplus fr the assciated Capacity Cmmitment Perid. The clearing algrithm may result in ffers belw the Capacity Clearing Price nt clearing, and in de-list bids belw the Capacity Clearing Price clearing. ISONE, Market Rule 1 III There may nt be an exact match between the supply capacity and the Demand Curve, wing t the lumpy nature f individual CMU capacities. Where this ccurs, the Clearing Algrithm is used t determine the Clearing Price and vlume. The algrithm cmpares the merits f ver-prcuring r under-prcuring capacity by cnsidering the integral f the Demand Curve at the tw pints that are abve and belw the target vlume and subtracting the additinal csts assciated with ver-prcurement. UK, Capacity Market Rule 5.9.6, and Natinal Grid, Capacity Market User Supprt Guide. 6 The bjective f the System Operatrs in applying the methdlgy is t seek t maximise the Net Scial Welfare, I-SEM Capacity Market Cde F DRAFT Fr DISCUSSION Page 10 Select AESO Label

11 Assessment Against Evaluatin Criteria The desired end state The desired end state is a stable and transparent capacity market that relies n cmpetitive market frces, and wrks efficiently with the energy and ancillary service markets, t achieve sufficient investment t maintain supply adequacy and reliability at the lwest cst fr cnsumers, while wrking effectively within Alberta s unique electricity structure. Optin 1 maximizes scial surplus and prduces efficient price signal t guide investment. This wuld allw supply adequacy and reliability t be maintained at the lwest cst fr cnsumers ver time. Optin 2 may nt maximize scial surplus. The capacity market price may be depressed t levels that discurage efficient new entry that wuld ver time bring abut the lwest cst t cnsumers. Ptential criteria fr supply adequacy and reliability The capacity market shuld cntribute t the reliable peratin f the electricity grid and implementatin shuld be cnsistent with, and cmplementary t, existing measures aimed at ensuring reliability. In the shrt term bth appraches will likely result in adequate supply ffered t the market. Over the lng term, Optin 2 may nt prvide the crrect price signals fr new generatin see additinal cmments related t fair, efficient and penly cmpetitive belw. Ptential criteria fr the capacity market The capacity market shuld be fair, efficient, and penly cmpetitive. Optin 1 maximizes scial surplus by minimizing the deadweight lss, therefre it is cnsistent with this criterin. Optin 2 may unduly depress the capacity price and discurage efficient new entry and may nt be deemed fair. Optin 1 better meets this criterin. Ptential criteria fr csts and risk The market structure, which includes the capacity market, energy market and ancillary services market, shuld create cnditins such that private investment can be reasnably expected. As described in the Analysis, Optin 2 may have a negative impact n private investment even if the investment wuld increase bth cnsumer surplus and supplier surplus and enhance market efficiency. Ptential criteria fr flexibility The tw Optins d nt differ in meeting these criteria Ptential criteria fr timely develpment Cmmn practices and lessns learned frm ther capacity market implementatins shuld be leveraged as much as practicable and applicable. Amng the jurisdictins reviewed, UK uses Optin 2 and all ther markets use Optin 1. DRAFT Fr DISCUSSION Page 11 Select AESO Label

12 1.2 What is the capacity clearing price if the entire supply curve r selected resurces are belw the demand curve? It is pssible that the entire capacity supply curve r the prtin f the capacity supply curve cnsisted f all the selected resurces lies belw the capacity demand curve as shwn in Chart 9 and Chart 10 respectively. In bth cases, the prcurement vlume is Q p. Hwever, at quantity Q p, the market clearing price is nt unique as the incremental cst f prviding quantity Q p (represented by the supply curve) and the incremental value f the capacity at quantity Q p (represented by the demand curve) are nt equal. A chice has t be made as t whether the market clearing price shuld be set by the supply curve at P 1 r by the demand curve at P 2. DRAFT Fr DISCUSSION Page 12 Select AESO Label

13 Chart 9: The Entire Supply Curve Lies belw the Demand Curve DRAFT Fr DISCUSSION Page 13 Select AESO Label

14 Chart 10: The Supply Curve f Selected Resurces Lies belw the Demand Curve Descriptin Optin 1: Capacity Market Clearing Price set by the Incremental Cst If the entire supply curve r all f the selected resurces are belw the demand curve, capacity price is set by the ffer price f the Optin 2: Capacity Market Clearing Price set by the Incremental Value If the entire supply curve r all f the selected resurces are belw the demand curve, capacity price is set by the intersectin between the DRAFT Fr DISCUSSION Page 14 Select AESO Label

15 Optin 1: Capacity Market Clearing Price set by the Incremental Cst last selected ffer price. Optin 2: Capacity Market Clearing Price set by the Incremental Value vertical line drawn frm the quantity prcured and the demand curve. Advantages Lwer prcurement cst. Incent new resurces t enter the market and increase scial surplus vertime. Disadvantages May prevent new resurces that are able t enhance market efficiency frm cming t the market Higher prcurement cst. DRAFT Fr DISCUSSION Page 15 Select AESO Label

16 Analysis Chart 11: Clearing at the Incremental Value Ptentially Increases Scial Surplus In Chart 11, assuming Resurce 2 is the last resurce prcured and the ttal prcurement vlume is Q p, if the market clearing price is set by the ffer price f resurce Q p and P 1, the New Resurce whse cst is higher than P1 wuld nt enter the market. Hwever, if the market clearing price is set by the demand curve at P 2, the New Resurce may enter the market and allw the prcurement vlume t increase t Q n at a price lwer than P 2. This wuld increase the net scial surplus represented by the area in green. Absent f the new entrant, this increase in scial surplus wuld nt have realized. Other Jurisdictins Capacity market clearing price set by the incremental cst: UK, Ireland. Capacity market clearing price set by the incremental value: PJM and ISONE. DRAFT Fr DISCUSSION Page 16 Select AESO Label

17 Assessment Against Evaluatin Criteria Ptential criteria fr the capacity market The capacity market shuld be fair, efficient, and penly cmpetitive. Because Optin 2 allws new resurces t cme in the market s that mre capacity wuld be available at lwer prices and scial surplus wuld increase ver time, Optin 2 better meets this criterin. There shuld be a well-defined prduct and an effective and efficient price signal. The price signal sent under Optin 2 wuld attract new resurces t cme t the market efficiently. Therefre, Optin 2 meets this better meets this criterin than Optin 1. Ptential criteria fr csts and risk The market structure, which includes the capacity market, energy market and ancillary services market, shuld create cnditins such that private investment can be reasnably expected. Optin 1 wuld nt attract new resurces that can enhance reliability at lwer price but Optin 2 wuld. Optin 2 better meets this criterin. There shuld be an effective balance between capacity cst and supply adequacy. Optin 2 allws effective balance between capacity cst and supply adequacy in a mre efficient way ver time, as new resurces wuld cme t the market and increase reliability at lwer price. Optin 1 is nt able t achieve this. Ptential criteria fr timely develpment Cmmn practices and lessns learned frm ther capacity market implementatins shuld be leveraged as much as practicable and applicable. Capacity price in UK and Ireland is set by the supply curve, i.e. at the incremental cst. Capacity price in PJM and ISONE is set by the demand curve, i.e. at the increment value. DRAFT Fr DISCUSSION Page 17 Select AESO Label

18 Appendix: Established Desired End State, Criteria and Assumptins The desired end state The desired end state is a stable and transparent capacity market that relies n cmpetitive market frces, and wrks efficiently with the energy and ancillary service markets, t achieve sufficient investment t maintain supply adequacy and reliability at the lwest cst fr cnsumers, while wrking effectively within Alberta s unique electricity structure. Ptential criteria fr supply adequacy and reliability The capacity market shuld achieve desired reliability bjectives by creating a measurable supply adequacy prduct designed t prvide energy prductin r reduced cnsumptin when needed. The capacity market shuld cntribute t the reliable peratin f the electricity grid and implementatin shuld be cnsistent with, and cmplementary t, existing measures aimed at ensuring reliability. Ptential criteria fr the capacity market The capacity market shuld be fair, efficient, and penly cmpetitive. The prcurement f capacity shuld emply market-based mechanisms and a cmpetitive market fr capacity shuld be develped. A wide variety f technlgies shuld be able t cmpete t prvide capacity prvided they are qualified t meet the eligibility criteria. Capacity market mechanisms, utcmes and relevant data shuld be transparent. There shuld be a well-defined prduct and an effective and efficient price signal. Ptential criteria fr csts and risk Investment risks shuld cntinue t be largely brne by investrs rather than cnsumers. The market structure, which includes the capacity market, energy market and ancillary services market, shuld create cnditins such that private investment can be reasnably expected. There shuld be an effective balance between capacity cst and supply adequacy. The term f the capacity bligatin shuld be as shrt as pssible while ensuring supply adequacy bjectives are achieved thrugh sufficient investment in new capacity supply. The design shuld allw cnsumers t manage the cst f capacity if and where apprpriate. Ptential criteria fr flexibility Unique aspects f Alberta s electricity system shuld be cnsidered in the design f the capacity market (e.g. nature f lad/generatin, levels f cgeneratin, limited interties, large gegraphic area, etc.). The capacity market shuld be cmpatible with ther cmpnents f the electricity framewrk. Ptential criteria fr timely develpment Market shuld be targeted t pen in 2019 fr start f first capacity prcurement fr delivery f capacity starting in Changes t the energy and ancillary service markets required t achieve the mst efficient steady state electricity market pssible may need t be staged t ensure timely initial implementatin. Simple and straightfrward implementatin shuld be a pririty. DRAFT Fr DISCUSSION Page 18 Select AESO Label

19 T the extent a staged implementatin f the verall electricity market is pursued, the expected timing and nature f future changes shuld be prvided befre pening the first prcurement. The risks f regulatry delay and need fr re-design shuld be minimized. Cmmn practices and lessns learned frm ther capacity market implementatins shuld be leveraged as much as practicable and applicable. Assumptins: A capacity bligatin is a frward bligatin n capacity suppliers that requires the capacity sld in the capacity market t be available t prvide energy prductin r reduced cnsumptin when needed and is subject t financial penalty/incentive. All existing capacity must ffer their eligible capacity t the capacity market. Planned capacity must ffer fr the delivery year they are cnnected. The capacity market will be designed as a single zne The resurce adequacy requirement and resulting vlume f capacity fr Alberta will be centrally determined prir t each prcurement. Capacity and energy/ancillary services are separate prducts, and are prcured independently. Participants d nt need have a capacity bligatin in the capacity market t participate in the energy and ancillary service market. While receiving supprt payments, Renewable Electricity Prgram (REP) rund 1 winners are nt eligible t sell REP capacity in the capacity market wing t the Indexed REC payment mechanism chsen; hwever their capacity cntributin will be netted ff the capacity requirement. Capacity market mechanics/behaviur will have regulatry versight. Capacity clearing price frmed in the capacity prcurement prcess is nt subject t adjustment after the fact, unless it is demnstrated that the price utcme resulted frm prhibited behavirs, technical failures r errrs Market utcmes will be the result f market clearing, unless therwise demnstrated. DRAFT Fr DISCUSSION Page 19 Select AESO Label