Economics & Markets: Capacity Markets (Presentation to the CIAC) April 17 th, 2018

Transcription

1 Economics & Markets: Capacity Markets (Presentation to the CIAC) April 17 th, 2018

2 The information contained in this document is for information purposes only, and the AESO is not responsible for any errors or omissions. Further, the AESO makes no warranties or representations as to the accuracy, completeness or fitness for any particular purpose with respect to the information contained herein, whether expressed or implied. Consequently, any reliance placed on the information contained herein is at the reader s sole risk.

3 Agenda Economics of Capacity Market Design Elements Not a review of the CMD proposal but of the economic elements as part of that consideration. Efficiency Criteria Demand Supply Pricing / Mitigation Conclusion

4 The economics of evolving market frameworks

5 Markets drive Efficient Results Markets and competition are used to ensure reliability of the power system at the lowest cost to consumers over the long term Alberta market described as Fair, Efficient and Openly Competitive (FEOC) Important economic principles Fairness: non-discriminatory Openly competitive: low barriers to entry Effective price signals: create incentive and reflect value Orderly dispatch: reflect bids / offers from least cost and up Cost causation: tariffs reflect customer impact

6 Our Market Today Single pool price; signal for dispatch and investment Energy Market Scheduling control area operations Transmission Policy Allocation of transmission and AS costs to consumers Tariff Ancillary Services Short-term reliability and system performance products

7 The Need for Change Current energy-only market was not sustainable Lack of investor confidence -- missing money Reduced access to capital Developers needed more revenue sufficiency, certainty and stability Not designed to achieve low-carbon outcomes Policy Objectives Protect consumers from volatile price swings Ensure a stable, reliable electricity supply Keep pace with the global transition to low-carbon electricity Provide the price stability or revenue certainty needed to attract investment

8 Missing Money in the Energy Only Market In surplus years, the Energy Only Market revenues (even in concert with AS revenues) is insufficient to provide an incentive for new investment This is often referred to as Missing money Missing money occurs as prices clear at zero or negative pricing in flush hours and may not reach scarcity pricing enough to recover. Even in years where it looks like the missing money issue is small, there is still uncertainty of revenue so participants have difficulty financing new investment. Historically, missing money has been addressed by allowing for economic withholding.

9 Our Future Market Long-term supply adequacy objective Capacity Market Tariff Allocation of transmission and AS costs to consumers Efficient dispatch and consumption objective Provides shortterm commodity price signal Transmission Policy Energy Market Ancillary Services Renewable Electricity Contracts Short-term reliability and system performance products Social and environmental objectives

10 About Capacity Markets Capacity markets primarily provide assurance that supply adequacy will be maintained Capacity is the capability of a resource to Generate electricity as required; or In some jurisdictions, willingly reduce consumption as required Main characteristics of a capacity market structure typically include A forward market for capacity which provides a forum for the exchange of capacity as a product Energy and ancillary services market(s) Capacity markets create the opportunity for capacity suppliers to monetize their ability to provide energy when required to maintain system reliability Capacity markets operate in several jurisdictions but each has its own unique features

11 Combined objectives of three markets The design is intended to deliver efficient pricing, supply adequacy and system flexibility across the markets Market Efficient Pricing Supply Adequacy System Flexibility Capacity Market Energy Market Ancillary Services Market Prices to reflect cost of new entry (CONE) Expect prices based on short run marginal cost Clearing mechanisms Index to pool price or Cooptimized to energy market Procures capacity to meet targets Capacity contracts plus non-committed capacity available to meet RT demand Ancillary services to ensure system stability, voltage, security. New resources respond to overall revenues. Prices reflect scarcity, value for ramp, shorter settlement all designed to incent flexibility Product type Technical Requirements Volumes procured

12 The economics of the market design

13 Desired End State of Capacity Market Development The desired end state is a stable and transparent capacity market that relies on competitive market forces, and works efficiently with the energy and ancillary service markets, to achieve sufficient investment to maintain supply adequacy and reliability at the lowest cost for consumers, while working effectively within Alberta s unique electricity structure. April 25, 2017 AESO capacity market design stakeholder session Efficiency Least cost over long run, proper allocation of resources Allocation and balance of risk, ability to manage risk Effective and efficient price signal

14 Capacity Market Economic Fundamentals Demand Who buys? How much? Self Supply Loads, Price Responsive Loads, Demand Response Supply Who sells? Supply Obligations performance, energy market obligations Pricing / Price Signals Capacity market prices Energy market prices / mitigation Net CONE alignment of revenues across markets

15 The Economics of the Demand Side of the Equation

16 Key structural questions demand side 1. Resource adequacy requirement (How much capacity needs to be procured? Includes demand curve) 2. Cost allocation (How will capacity costs be allocated?) 3. Obligation to procure (Who will buy the capacity? Includes question of cogeneration treatment/self-supply) 4. Procurement timing and frequency (When/how often will capacity be purchased?) 5. Term (How long will the capacity delivery period be?) 6. Eligibility (Who can provide capacity? How much can they provide?) 7. Performance assessments (How do we know that capacity has been provided?) 8. Market mechanics (How will capacity market work?) 9. Capacity market settlement (How will capacity providers be paid?) 10. Inter-operability implications (How will capacity market impact the energy and ancillary services markets?) 11. Governance/role of agencies (How is regulatory oversight applied?)

17 Demand in Energy and Capacity Markets Demand In the energy market, demand is instantaneous as energy needs change due to weather, season, time of day and due to industrial requirements Energy demand is met by dispatch of capacity that is online. With the introduction of a capacity market, the anticipated demand in future years is met by first procuring capacity to serve that future need. In the capacity market, demand reflects an expected unserved energy target (based on probabilistic modelling). A capacity target is set to reflect a future forecast of energy needs in the future (example 3 year forward) The first capacity market will be run in 2019 for delivery in 2021

18 Capacity Market Demand Curve Demand In most markets, demand is established by a resource adequacy target on Load Serving Entities (LSEs) For example, Loads or Retailers on their behalf are required to procure capacity to 115% of their estimated peak load In Alberta the demand will be procured through the establishment of a demand curve by the AESO. The AESO will be the counterparty to capacity contracts. Loads will be charged for capacity procured. Option to self supply

19 The demand is set by an administrative demand curve The demand curve sets the upper prices (cap) plus the value as volumes increase over target. A standard downward sloping demand curve Economics of the Demand Curve Key Terminology Elasticity Resource Adequacy Net CONE net Cost of New Entry

20 Capacity Demand Curve: Elasticity and Slope Generally, in the future capacity market, the demand function will be calculated and administered by the AESO Slope of the demand curve, or its elasticity, is set administratively by the system operator to reflect the value of reliability to the consumers (represent the consumers willingness to pay for various levels of capacity) Different slopes can be used to address different design concerns, e.g. market power In the context of capacity markets, demand elasticity is the change in capacity quantity (MW) demanded per change in price ($/MW-day) The more inelastic is the demand, the steeper is the curve The more inelastic demand, the greater willingness to pay More robust to a wide range of market conditions, less risk of procuring excess capacity above requirement The more elastic is the demand, the flatter is the curve The more elastic the demand curve, the less the willingness to pay Lower price volatility, less exposure to exercise of market power

21 Demand Curve Shape: Downward-sloping Convex Demand Curve Point A, the point where the slope of the curve shifts Point B, identifies the level of excess capacity above target capacity as the point at which customers would be unwilling to buy additional capacity unless the price was $0 Point C is at the point where customers are willing to pay a maximum price equal to Price Cap for a minimum required level of reliability Prices are higher at lower reserve margins and lower at higher reserve margins Price, $/MW day Price Cap Net CONE C A B Minimum Target Maximum Capacity, MW Pic 3: Stylized Downward-sloping Convex Demand Curve

22 Relation of the Economics of the Demand Curve to target objectives Price Component Cost of New Entry (CONE) and Net-CONE A reflection of the missing money or net going forward cost for a reference technology Cost of capital investment minus the expected revenues from the energy and ancillary service markets Quantity Component Target quantity (forecast peak load + target reserve margin) Tied to net-cone Minimum quantity (determined by reliability metric) Tied to price cap (multiple of net-cone or gross-cone) Maximum quantity Set at $0 (beyond this quantity, capacity has no additional value)

23 Downward Sloping Convex Demand Curve: pros and cons Pros Limits price volatility Limits ability and incentive to exercise market power Demand curve has the property that relative prices change more gradually with quantity Recognizes extra capacity above target has value (slope and width can be informed by marginal reliability or marginal economic value, although this is not always the case) Can recognize the marginal reliability or economic benefit and allows for better reflection of trade-off between cost of additional capacity and additional reliability when supply is below and above the target Cons Somewhat greater complexity due to additional parameters Slightly greater complexity of balancing the width of the volume procurement (min, target and max parameters) Considerations Wider demand curve reduces price volatility, increases the likelihood of over or under-procurement and steeper demand curve is more susceptible to the exercise of market power Should not be so steep that the entry of just one plant would suppress prices to near zero for many years; the exit of just one plant should not cause prices to rise to the cap

24 Economics / Policy Resource Adequacy A policy decision of society s tolerance for power outages due to a shortfall in bulk power supply Defines the acceptable amount of demand not served due to insufficient generation, on a forward looking planning basis Will be translated into a capacity amount (MW) for procurement in the capacity market Alberta historically had a minimum resource adequacy standard based on an expected level of unserved energy (ISO Rule 202.6) Net CONE net Cost of New Entry Reflects the remaining fixed costs left to be recovered for the reference technology net of expected energy and ancillary services revenue Reference plant selected based on ability to provide capacity when needed at lowest cost Cost Allocation Economic principles related to cost causation, incentives for response, customer choice

25 Conclusions Tradeoff between curve designs. Downward sloping, steepness, price cap, foot Part of policy / regulatory discussion Resource adequacy threshold set by policy Demand curve likely submitted for approval by AUC Establishes pricing in capacity market Relies on forecast of energy and ancillary services revenues Net CONE key part to ensure revenues between markets is sufficient.

26 The Economics of the Supply Side of the Equation

27 Key structural questions supply side 1. Resource adequacy requirement (How much capacity needs to be procured? Includes demand curve) 2. Cost allocation (How will capacity costs be allocated?) 3. Obligation to procure (Who will buy the capacity? Includes question of cogeneration treatment/self-supply) 4. Procurement timing and frequency (When/how often will capacity be purchased?) 5. Term (How long will the capacity delivery period be?) 6. Eligibility (Who can provide capacity? How much can they provide?) 7. Performance assessments (How do we know that capacity has been provided?) 8. Market mechanics (How will capacity market work?) 9. Capacity market settlement (How will capacity providers be paid?) 10. Inter-operability implications (How will capacity market impact the energy and ancillary services markets?) 11. Governance/role of agencies (How is regulatory oversight applied?)

28 Energy Market Supply Curve The supply side of the energy market reflects the volume from all assets as an accumulation of blocks (price quantity pairs) with lower priced blocks representing min run costs, the higher priced blocks to value scarcity. All capacity must offer into the capacity market The inelastic part of the supply curve means that small changes in quantity can lead to large changes in price. Pic. 1: Standard Economic Supply and Demand Curve

29 Capacity Market Supply Curve The supply side of the capacity market will comprise of all eligible capacity resources current resources plus new entrants all competing to provide capacity into a future delivery year and meet obligations for energy delivery (performing on their capacity obligations). All capacity must offer into the capacity market Current resources will compete against new future capacity The supply curve will also be the summary of blocks. Pic. 1: Standard Economic Supply and Demand Curve

30 Competition in capacity resources The supply side of the capacity market will comprise of all eligible capacity resources current resources plus new entrants all competing to provide capacity into a future delivery year and meet obligations for energy delivery Generally, all resources that meet eligibility requirements can participate in capacity markets Includes variable and non-variable supply resources, aggregators, storage, interties Includes competition against capacity committed loads that are also able to supply capacity value The capacity market will capture a significant portion of the investment and retirement signal

31 Incentives related to self-supply All supply is accounted for, however, self supply is discounted off the demand curve and therefore not included on the supply side. Allows some loads to manage capacity costs and mitigate risks Evaluate free rider issue cover system costs, need to cover capacity in contingency Cost allocation signals aligned with customer value leads to best market results.

32 Supply Side Incentives Risk tradeoff in designing term for capacity market The most typical commitment period across jurisdictions is one year, but this is subject to variations; several markets permit new generators to secure multi-year commitment periods Impacts investment decisions, ratio of incumbents to new players in market Most efficient solution consider: Ensure least cost results address risk profile Impact on market liquidity Reduce risk of over procurement Consider fairness / competition impacts of design

33 Energy and Capacity Economics of Ensuring Efficient Pricing in All Markets

34 Pricing and revenue dynamic postimplementation Energy Market Revenue Marginal cost + scarcity pricing (some value for flexibility) Capacity Market Revenues (expected goingforward cost minus expected revenue in EM and AS markets) Ancillary Service Revenue Valuation of flexibility and system security

35 Review of Equilibrium Pricing Demand and supply curves show relationship between price and quantity The equilibrium price is set where the quantity that demand wants equals the quantity that producers are willing to supply Also called the market clearing price Price is set at the margin Marginal Price

36 Real time equilibrium in energy market is determined by instantaneous demand served by supply Price ($/MWh) Peak Price = $50 Demand (off-peak) Demand (peak) Supply 20 Off-peak Price = $ Hourly Power (MW) All available capacity must offer; energy dispatched from lowest-priced offers to highest to meet instantaneous demand orderly dispatch to minimize cost Spot price (System Marginal Price or SMP) is set where supply = demand, in real time, at last block dispatched Pool price set hourly by averaging 60 SMPs Competitive prices determine efficient outcomes, market response

37 Capacity Market Pricing equilibrium In capacity markets the capacity clearing price ($/kw-year) is set at the intersection of the demand and supply curves The capacity market s clearing prices should remunerate investment in capacity at a level sufficient to retain cost-effective existing resources and attract new entry when needed All offers below that clearing price are accepted and become capacity obligations. Supply curve is formed from the capacity resource offers submitted into the auction Demand curve is an essential part of the auction clearing process: It is established through an administrative mechanism that determines demand for capacity resources, and the prices that will be paid for them, at various levels of supply The demand curve should be expected to procure sufficient capacity to enable the ISO to meet its reliability planning obligations In practice, this is assessed on the basis of meeting the established standard over time and under a variety of conditions and shocks Pic. 1: Standard Economic Supply and Demand Curve

38 Market Pricing Impact on Revenues Market design addresses revenue across all markets Introduction of capacity market creates competition for capacity payment Energy market therefore doesn t require full return on capital Changes model for scarcity pricing / shortage pricing Mitigation options Screens and conduct measures Cost based offers in energy market Price Cap / Offer cap / Shortage pricing

39 Market Power mitigation to ensure competitive results Market power mitigation is a means to ensure efficient pricing outcomes when market power is deemed to be present Defining market power the ability to unilaterally or collusively affect market prices through the withholding of capacity from the market (or on the demand-side withholding demand) In Alberta s energy-only market with a low price cap, offers above marginal cost were deemed an acceptable exercise of market power if the direct result was that necessary investment would occur (capturing an effective investment signal) This was a trade-off between static and dynamic efficiency With the addition of a capacity market, this is no longer an appropriate trade-off Most jurisdictions with a capacity market mitigate market power in both the capacity and the energy markets

40 Market Power in the Current Market In Alberta s energy-only market with a low price cap, offers above marginal cost were deemed an acceptable exercise of market power if the direct result was that necessary investment would occur (capturing an effective investment signal). These guidelines were outlined in the MSA Offer Behaviour Guidelines (OBEG) A trade-off between static and dynamic efficiency Supply curve has elastic portions may create asymmetrical risk if not competitive Price Supply made up of unmitigated priced offers, sometimes greatly in excess of marginal cost to reflect market scarcity. Demand Quantity (MW)

41 Addressing Market Power with the Addition of a Capacity Market With a capacity market, above marginal cost* offers in the energy market to capture the investment signal is not required because the capacity market resource requirement determines the volume of capacity to be installed. And the capacity market provides an additional stream of revenues designed to cover the going forward costs of resources needed for supply adequacy *It is recognized that with an offer submitted as a single price in the energy market (single part bid) and assuming self commitment continues, that prices still need to reflect many costs --- O&M, but also carbon costs, cycling, and any shortfall from the capacity revenues or revenue offsets to low priced hours.

42 Current Methods - Market Power Mitigation Fair Efficient and Openly Competitive (FEOC) Regulation Prohibits conduct that does not support fair, efficient and open competition Market Share Cap measure of concentration Transparency of Availability and Outage Records MSA oversight Offer Behaviour Guidelines - OBEG AUC remedy Offer Cap and Floor Economic Withholding No collusion (administered on an ex-post basis)

43 Energy Market -- Market Power Mitigation: Screens and Conduct Threshold Structural approaches to market power consider whether the market structure itself is conducive to the inappropriate exercise of market power. When it is, such as when the market found to be is sufficiently concentrated, then mitigation may occur. Limitations on Market Share Pivotal Supplier Tests Conduct-and-impact approaches to market power mitigation consider whether market participant behaviour reflects the exercise of market power (conduct) in a manner that inappropriately affects market outcomes (impact). Will market power be exercised (or has it already been exercised)?

44 Mitigation of Market Power Economics Need to ensure market is not overmitigated to allow for scarcity pricing Reflects market conditions as they change. Creates value for flexible resources / value Also need to ensure market is not undermitigated Allowing for exercise of market power that sets uneconomic prices provides perverse price incentives and impacts on competition.

45 Economics of Market Power Mitigation in the Capacity Market A number of measures will mitigate supply side market power in the capacity market Offer obligations protect against physical withholding Rules to provide clear and transparent signaling to market about retirement and therefore investment need Ex ante screens and offer caps to prevent abuse / excessive rents.

46 Summary

47 Economic foundation drives market design Efficiency is a function of: Competition open access, transparency Orderly prices, equilibrium to maximize allocative efficiency FEOC mitigation rules to ensure competitive results

48 Summary Energy Market Demand Market is dispatched to meet demand in instantaneous fashion No bids required Loads pay for energy as delivered MWh Supply Suppliers deliver energy to loads through the market Prices are bid mitigated to reflect separate payment for capacity Pricing Single clearing price Pool Price paid to suppliers for delivered energy, and charged to loads (measured in $/MWh) Bid mitigation Scarcity & shortage pricing Capacity Market AESO acts as buyer Customers may self supply Capacity charges apply to loads Suppliers now sell capacity through separate market Pricing represents a secured revenue stream (measured in $/kw-yr) for a fixed term Price cap is a multiple of net-cone

49 Questions?

50 Thank you