The Iberian Electricity Market - Impacts on power producer profits, consumer surplus and social welfare in the wholesale market

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1 ENERGEX 10 th International Energy Forum 2004 Energy & Society: 3 6 May 2004, Lisbon, Portugal The Iberian Electricity Market - Impacts on power producer profits, consumer surplus and social welfare in the wholesale market Jorge de Sousa 1, Victor Mendes 2 1 ISEL - Instituto Superior de Engenharia de Lisboa, and FEUNL - Faculdade de Economia da Universidade Nova de Lisboa Departamento de Engenharia Electrotécnica e Automação Rua Conselheiro Emídio Navarro, Lisboa - Portugal jsousa@deea.isel.ipl.pt 2 ISEL - Instituto Superior de Engenharia de Lisboa, and IST / CEEL - Instituto Superior Técnico / Centro de Energia Eléctrica Departamento de Engenharia Electrotécnica e Automação Rua Conselheiro Emídio Navarro, Lisboa - Portugal vfmendes@deea.isel.ipl.pt Keywords: Iberian Electricity Market, Market integration, Welfare analysis, Energy economics. Abstract. In the past, power electricity systems were run by vertically integrated monopolistic companies, comprising the generation, transmission, distribution and supply activities. This structure has been criticized on different grounds and reforms have taken place in many countries around the world with the commom feature of the introduction of competition in wholesale markets and giving rise to an environment where customers can freely choose their suppliers. Competition among producers should then be promoted in order to increase economic efficiency with the integration of markets one way to achieve this goal. Considering the upcoming Iberian Electricity Market - IBELM (or MIBEL in its Portuguese and Spanish acronym), we outline the advantages and drawbacks of market integration supported by simulations on market behaviour using scenario analysis. Comparison of prices, power producer profits, consumer surplus and social welfare is computed for the autarcy and integrated markets outcome. Under the hypothesis considered in this work we show that market integration is welfare improving, increases Portuguese consumer surplus and Spanish power producer profits, and decreases Portuguese power producer profits. Introduction In the past, power electricity systems were run by vertically integrated, typically state owned, monopolistic companies, comprising the generation, transmission, distribution and supply activities. This structure has been criticized on different grounds and reforms have taken place in many countries around the world. Although different approaches are possible for these reforms, they often share a combination of full market opening, unbundling of transmission activities, regulated access to the network and liberalization of electricity trade [1]. In the European Union a major step towards reform was taken by the Directive 96/92/EC on the internal market for electricity, adopted in 1996 to be implemented by February Due to a number of unsatisfactory aspects, the European Council, at its meeting in Lisbon on 23 and 24 March 2000, called for rapid work to be undertaken in order to complete the internal market of energy and to speed up liberalization in these sectors to achieve a fully operational internal market [2]. The new Directive 2003/54/EC of the European Parliament and of the Council of 26 June, concerning common rules for the internal market in electricity and repealing Directive 96/92/EC, establishes the new rules for the organisation of the sector.

2 The restructured environment is expected to increase the economic efficiency of the electricity industry, being the most significant impacts supposed to emerge in the long run, as a result of better investment decisions. In the short run, market structure is a key determinant of prices in the new electricity markets. In fact, high concentration of generation assets has resulted in weak competition in the wholesale market (e.g. early UK [3] and Spain), while more intense competition has taken place in less concentrated markets (e.g. the Nordic and Germany electricity markets). Therefore, policy makers should pay attention to structural competition policies such as the opening of national markets to international trade and market integration [4]. In this regard, it is of great interest to evaluate the impact of electricity market integration, such as the upcoming Iberian Electricity Market - MIBEL, starting operating on April 2004, which aims the full liberalization and integration of the Portuguese and Spanish electricity markets. Knowing that the acceptability of reforms is very much dependent on the distribution of its costs and benefits among power producers, consumers and tax payers, the impact of market integration should be analyzed in respect to producer profits, consumer surplus and social welfare. For this purpose, a eight scenario analysis is made based on reported data of peak and off peak demand of the typical Spring, Summer, Autumm and Winter days of 2002 for the Portuguese and Spanish systems [5,6]. Iberian power producers are represented in the simulation (Portugal - EDP, Turbogás, Tejo Energia; Spain - Endesa, Iberdrola, Unión Fenosa, Hidro Cantábrico, Viesgo, Gas Natural and Elcogás) with cost functions representing the different tecnologies and installed capacity. Demand is modelled by a sigmoid type function with parameters estimated based on observed demand curve from the Spanish pool (OMEL [7]). Comparison of producer profits, consumer surplus and social welfare is computed for the separated and integrated markets by the intersection of the supply and demand curves. The results show that the average impact of the Iberian Electricity Market is of social welfare improving, increase of Portuguese consumer surplus and Spanish producer profits and decrease of Portuguese power producer profits, in comparison to the autarcy liberalization outcome. Model Demand. The demand curve is obtained by fitting the real data from the Spanish pool with a sigmoid type function, which replicates accurately the demand behaviour, as shown in Fig. 1. P [c /kwh] Q [MWh] Sigmoid Figure 1 Demand curve of the Spanish pool corresponding to the maximum of the 8 May 2002 (OMEL) and the corresponding sigmoid type function fitting (Sigmoid). OMEL

3 The demand curve of the Portuguese, Spanish and Iberian markets is then obtained by extrapolation in accordance with the observed demand in each of the eight scenarios studied. Supply. The supply curve modelling is based on marginal costs and installed capacity by technology for each market. Marginal costs are evaluated considering the reference fuel prices (nuclear, coal national and imported, natural gas, oil and gasoil), the fuel heat of combustion and the plant efficiency. The supply curve obtained by this approach is then shifted right by the amount of hydro power in use, which is considered an exogenous variable to the model. Market equilibrium. The equilibrium price and power in each one-hour time interval of the market is determined by the intersection of the supply and demand curves, as shown in Fig. 2. P [c /kwh] Portugal Spain MIBEL Q [MWh] Figure 2 Equilibrium prices (P) and power (Q) for the autarcy markets (Portugal, Spain) and for the integrated market (MIBEL) corresponding to the maximum of the 8 May Scenario analysis The scenario analysis implemented is based on reported data of peak and off peak demand of the typical Spring, Summer, Autumm and Winter days of 2002, for the Portuguese and Spanish systems. Hydro power for each scenario is considered equal to the observed in each period of simulation, as shown in Tab. 1. Scenario C1 C2 C3 C4 C5 C6 C7 C8 Portugal Hydro [MW] Demand [MW] Spain Hydro [MW] Demand [MW] Table 1 Data used in each of the eight scenarios in respect to the amount of hydro power in use and total demand registered in each system (Source: REN, REE).

4 Results Simulation results of the markets for each of the eight scenarios are presented in Tab. 2 to Tab. 5. Portugal [%] % % % % 0.00% % 0.00% 10.64% % Spain [%] 0.00% 26.88% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 2.36% MIBEL Table 2 Simulated market clearing prices [c /kwh]. Portugal Spain MIBEL [%] % 47.50% % -3.19% 0.00% -9.49% 0.00% 2.67% -5.34% - Portugal [%] % % % % 0.00% % 0.00% 20.64% % - Spain [%] 0.00% 61.77% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 3.95% Table 3 Simulated power producer profits [k ]. Portugal Spain MIBEL [%] 2.64% -3.81% 4.12% 0.45% 0.00% 0.95% 0.00% -0.21% 0.80% - Portugal [%] 24.61% 4.95% 36.35% 4.71% 0.00% 15.52% 0.00% -3.04% 11.94% - Spain [%] 0.00% -4.61% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% -0.44% Table 4 Simulated consumer surplus [k ]. Portugal Spain MIBEL [%] 0.20% 0.04% 0.20% 0.05% 0.00% 0.30% 0.00% 0.00% 0.10% - Portugal [%] 1.62% 0.18% 1.40% 0.52% 0.00% 4.51% 0.00% 0.05% 0.85% - Spain [%] 0.00% 0.03% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% 0.00% Table 5 Simulated social welfare [k ].

5 Conclusions In this paper the behaviour of the Portuguese and Spanish markets is simulated. Both the autarcy and the integrated MIBEL outcome are computed using a scenario analysis, representing the real data of each system in respect to the demand and the hydro power in use. The results obtained show that the MIBEL price is in between the separated Portuguese and Spanish prices, with an average reduction of 25.13%, when compared to the Portuguese market clearing price, and an average increase of 2.36%, when compared to the Spanish market clearing price. The simulated average price for the Portuguese market in autarcy is c /kwh, well below the 4.80 c /kwh average price of the regulated wholesale market registered in 2002 resulting from the established Power Purchase Agreements - PPAs (or CAEs in its Portuguese acronym) between the single buyer (REN) and the Portuguese power producers (CPPE, Tejo Energia, Turbogás). Therefore, the liberalized Portuguese outcome price would be lower in autarcy, and even lower when the integration with Spain occurs. For the Spanish market, it should be stressed the close forecast of the simulated average price of c /kwh with the average pool price of c /kwh. As a result of the price changes computed, it is shown that the integration of the Portuguese and Spanish electricity markets leads to a decrease of the power producer profits by 5.34%, with the Portuguese producers facing a decrease of 40.35% and the Spanish producers an increase of 3.95%. The Iberian consumer surplus slightly increases by 0.80%, which corresponds to an expansion of the Portuguese consumer surplus by 11.94% and a reduction of the Spanish consumer surplus by 0.44%. The Iberian social welfare slightly increases by 0.10% as a result of the increase of the Portuguese social welfare by 0.85% and the absence of change in the Spanish social welfare. Therefore, it can be concluded that the Iberian Electricity Market is welfare improving and implies considerable losses for the Portuguese power producers, with gains for the Portuguese consumers and the Spanish power producers, when compared to the autarcy liberalization outcome. The application and extention of an existing model of market integration [8], in order to consider the strategic interaction of the players, is in progress by the authors and would enable a more consistent set of conclusions in the light of oligopoly game simulation applied to the MIBEL. References [1] International Energy Agency, Competition in Electricity Markets, IEA/OECD, 2001, Paris. [2] Newbery, D.M., Problems of Liberalising the Electricity Industry, European Economic Review 46, [3] Green, R.J., Newbery, D.M., Competition in the British Electricity Spot Market, Journal of Political Economy, Vol. 100, No. 5, [4] Ganslandt, M., Strategic Investment and Market Integration, The Research Institute of Industrial Economics, Working Paper No. 560, [5] REN - Rede Eléctrica Nacional, Caracterização da Rede Nacional de Transporte para efeitos de acesso à Rede em 31 de Dezembro de 2002, March [6] REE - Red Eléctrica de España website: [7] OMEL Compañia Operadora del Mercado Español de Electricidad website: [8] Sousa, J., Integração de Mercados de Energia Eléctrica: Implicações nos lucros das empresas produtoras, no excedente dos consumidores e no bem estar social, 6 th Electrical Engineering College Meeting, Portuguese Engineering Association, May 2003.