CAN YOU RELY ON A RELIABILITY OPTION? Andy Kelly National Power Summit, February 2017
OVERVIEW OF PRESENTATION TOPICS New capacity mechanism is complex but aim today to focus on some key topics RO price risks Ø Difference payments Ø Administered Scarcity Pricing (ASP) Competitive Bidding Ø Missing money auction Ø Bidding strategies Lessons from GB Ø Revenue stacking and impacts on bidding Ø Experience from recent auctions 'CAN YOU RELY ON A RELIABILITY OPTION?' 2
EXPLICIT CAPACITY PAYMENT BASED ON RO CONTRACT The I-SEM CRM will take the form of centralised Reliability Options (RO) RO is one-way Contract for Difference (CfD) with a Strike Price (SP) and a Market Reference Price (MRP) Difference payment Difference payment Generators Market operator Suppliers Option fee Capacity charge Generators: receive the option fee ( /kw) arising from the relevant CRM auction Pay the difference payment when the market reference price is higher than the strike price Suppliers: Pay the market price in first instance and then receive a difference payment if applicable Pay a capacity charge in return for the difference payment; this is used to fund the option fees 'CAN YOU RELY ON A RELIABILITY OPTION?' 3
THE I-SEM CRM PAYMENT WILL NOT HAVE THE SAME REVENUE RELIABILITY AS CURRENT BNE MECHANISM Centralised Reliability Options Administered Scarcity Pricing (ASP) Energy market price ( /MWh) Full ASP Operating Reserve Requirement (ORR) X% of ASP Load Loss ASP Function Reduced reserve Highest acceptance à RO introduces a CRM price risk through difference payment Available capacity less demand (MW) à Introduction of reserve scarcity pricing heightens this risk Quantity based CRM brings risks that are absent from a price based mechanism. Other risks such as competitive allocation and procurement levels further decrease payment reliability 'CAN YOU RELY ON A RELIABILITY OPTION?' 4
MARKET EXPECTED TO BE OVER-SUPPLIED IN INITIAL AUCTIONS Plants which do not receive a capacity contract may be expected to exit system Potential that up to 2.6 GW capacity not awarded Reliability Option 2.6 GW 'CAN YOU RELY ON A RELIABILITY OPTION?' 5
COMPETIVE AUCTION PUTS CERTAIN UNITS AT RISK OF LOSING A CRUCIAL REVENUE STREAM A Missing Money approach can be used to establish a merit order to determine clearing prices and winners / losers Costs Revenues Missing Money Anticipated wholesale market revenue (after difference payments) Fixed costs (Annual Opex, Capex) Capacity Auction Bid Anticipated ancillary service revenue (i.e. DS3) Risks & uncertainties: è Range of uncertainty on fixed costs è What DS3 revenues can I expect? è Is bid looking to cover è Will plant need to incur refurb costs è What gross margins are available in market? missing money over >1yr? stays on? è Is there option value in ensuring plant 'CAN YOU RELY ON A RELIABILITY OPTION?' 6
SAMPLE MERIT ORDER FOR MISSING MONEY Fixed costs for new build higher than existing plants as also has to recover CAPEX Most CCGTs require positive, but relatively small bid Supply curve may be steep near clearing. Marginal plants could be lower efficiency CCGTs, GTs, other peakers Many plants expected to cover costs elsewhere includes wind 'CAN YOU RELY ON A RELIABILITY OPTION?' 7
COULD STRATEGIC BIDDING INFLUENCE OUTCOME? 2 1 1 Assessing missing money on a portfolio basis could result in lower overall requirement 2 Adopting a different risk-adjusted approach for marginal plants could increase required clearing price 'CAN YOU RELY ON A RELIABILITY OPTION?' 8
LOCAL CONSTRAINTS NEED TO BE CONSIDERED For system security, there will be second run to address locational issues In this 2-region example: 3 units per region are needed for transmission constraints Units 1-7 are paid clearing price The clearing price is 40/kW Units 9 and 11 are required for system reasons; paid as bid Source: SEMCo 'CAN YOU RELY ON A RELIABILITY OPTION?' 9
GB EXPERIENCE SHOWS THE ABILITY OF DIFFERENT UNITS TO CAPTURE VARYING REVENUE STREAMS IMPACTS OUTCOME Embedded reciprocating engines have put downward pressure on clearing prices as a consequence of this revenue stacking Capacity payments Wholesale revenue Balancing market revenue Ancillary service revenue Embedded benefits ü ü ü ü û Large scale thermal (transmission connected) Small scale thermal (distribution connected) ü ü ü ü ü 'CAN YOU RELY ON A RELIABILITY OPTION?' 10
THREE T-4 CAPACITY AUCTIONS HAVE TAKEN PLACE, AS WELL AS AN EARLY T-1 AUCTION FOR 2017/18 Capacity that was procured (solid) and exited (dashed) the recent capacity auctions Derated capacity (GW) 80 70 60 50 40 30 20 10 0 2014 T-4 2015 T-4 2016 T-4 2017 early auction Existing generation Refurbishing generation Existing interconnector New build generation 80 70 60 50 40 30 20 10 0 Clearing price ( /kw) Clearing prices have remained low, below the price taker threshold There has not been significant large scale new build in any of the auctions The majority of capacity secured is by existing generation However substantial amounts of existing plant have also exited New build interconnector DSR Clearing price ( /kw) The first auctions have cleared lower than expected and failed to deliver significant new build 'CAN YOU RELY ON A RELIABILITY OPTION?' 11
BIDDING STRATEGIES APPEAR TO HAVE EVOLVED OVER TIME Analysis of published capacity available at each round suggests change in approach Approximate capacity per round Round price ( /kw) 80 70 60 50 40 30 20 10 0 40,000 50,000 60,000 70,000 80,000 Capacity remaining (MW) 2014 T-4 2015 T-4 2016 T-4 2017 early auction 2014 T-4 showed a more gradual slope while 2015 T-4 and 2016 T-4 had distinct periods where capacity exited May suggest bidding behaviours became more uniform after the uncertainty of the first auction Exit of significant amounts of capacity came in the 30-35/kW round in 2016, compared to 50-60/kW in 2015 The early auction showed the steepest curve as many plants acted as price takers given the proximity of the delivery period Bidding behaviour of participants appears to have become more similar over the auctions 'CAN YOU RELY ON A RELIABILITY OPTION?' 12
CONCLUSION - CAN YOU RELY ON A RELIABILITY OPTION? Ø The move from an open price based incentive to competitive procurement of reliability options results in new risks for generators Ø RO design gives financial obligation for repayment of value above strike price in exchange for upfront fee Ø Risk of unfunded repayment too high for intermittent generation to participate? Ø Competition for contracts and likely over-supply means some capacity missing out Ø Bidding behaviour of participants will be key to outcome Ø Exit signals for unsuccessful plants? Ø GB auctions has seen several unexpected outcomes Ø Lower than expected clearing prices Ø Range of unexpected new entrants, benefitting from variety of different revenue streams 'CAN YOU RELY ON A RELIABILITY OPTION?' 13
Andy Kelly andy.kelly@poyry.com +44 (0) 7824 145092 Consulting. Engineering. Projects. Operations. www.poyry.com