Participating in Electricity Markets

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Participating in Electricity Markets. Perspective. Generator Consumer Retailer Operator of a pumped-hydro plant. Participating in Electricity Markets : The Generator’s Perspective. Price. supply. Extra-marginal . demand. Infra-marginal . Quantity. Marginal producer. - PowerPoint PPT Presentation

Text of Participating in Electricity Markets

The Special Case of Electricity Markets

2011 D. Kirschen and the University of Washington1Participating in Electricity Markets1PerspectiveGeneratorConsumerRetailerOperator of a pumped-hydro plant 2011 D. Kirschen and the University of Washington2Participating in Electricity Markets: The Generators Perspective 2011 D. Kirschen and the University of Washington3Marginal, infra-marginal, extra-marginal producersEverything is sold at the market clearing price. Price is set by the last unit sold

Marginal producer:Sells this last unitGets exactly its bid

Infra-marginal producers:Get paid more than their bidCollect economic profit

Extra-marginal producers:Sell nothing

No difference between centralized auction and bilateral market 2011 D. Kirschen and the University of Washington4Extra-marginal Infra-marginal Marginal producerPriceQuantitysupplydemand4Load profile 2011 D. Kirschen and the University of Washington5TimeLoad00:0006:0012:0018:0024:00Minimum loadPeak load5Demand curves for electricity 2011 D. Kirschen and the University of Washington6$/MWhMWhMinimum loadPeak loadDaily fluctuations6Supply curve for electricity 2011 D. Kirschen and the University of Washington7$/MWhMWhBase generationPeaking generationIntermediate generation7Supply and demand for electricity 2011 D. Kirschen and the University of Washington8$/MWhMWhMinimum loadPeak loadPrice of electricity fluctuates during the daymaxmin8Supply curve for electricityIn a centralized market, the supply curve is built by ranking the offers made by the generatorsAn offer specifies the quantity that the generator is willing to sell at a given price 2011 D. Kirschen and the University of Washington9$/MWhMWh9Bidding in a centralized marketHow should a generator bid to maximize its profit?It depends on how much competition it has! 2011 D. Kirschen and the University of Washington1010Market StructureMonopoly:Monopolist sets the price at willMust be regulatedPerfect competition: No participant is large enough to affect the priceAll participants act as price takersOligopoly:Some participants are large enough to affect the priceStrategic bidders have market powerOthers are price takers 2011 D. Kirschen and the University of Washington11MonopolyOligopolyPerfect Competition11Short run profit maximization for a price taker 2011 D. Kirschen and the University of Washington12

Adjust production y until the marginalcost of production is equal to the price

Production costRevenueIndependent of quantity produced because price taker

Output of one of the generators

12Bidding under perfect competitionSince there are lots of small producers, a change in bid causes a change in the order of the bidsIf I bid at my marginal costI get paid the market clearing price if marginal or infra-marginal producerIf I bid higher than my marginal costI could become extra-marginal and miss an opportunity to sell at a profitIf I bid lower than my marginal costI could have to produce at a loss

No incentive to bid anything else than marginal cost of production 2011 D. Kirschen and the University of Washington13PriceQuantitysupplydemand13Profit of an infra-marginal producer 2011 D. Kirschen and the University of Washington14

Variable cost of producing energyEconomic profit$/MWhMWh

14Profit of an infra-marginal producer Selling at marginal cost covers the variable cost of productionThe difference between the market price and the marginal cost must pay for the fixed costs:No-load cost, startup costCost of building the plantInterest payments for the bank, dividends for the shareholdersA plant must therefore be infra-marginal often enough to cover its fixed costsMarket price > marginal cost for enough hours of the year 2011 D. Kirschen and the University of Washington1515Profit of a marginal producer 2011 D. Kirschen and the University of Washington16

Variable cost of producing energy$/MWhMWh

No economic profit!16Profit of a marginal producerIf a marginal generator bids at its marginal cost, it makes no economic profitCovers only its variable cost of productionDoes not cover its fixed costGenerators that are too often marginal or just below marginal will not recover their fixed costs if they bid at their marginal cost of productionThey must include part of their fixed costs in their offer priceTheir offer price is therefore higher than their marginal costThey can do it because competition is not perfect when the load is high because most generators are already producing 2011 D. Kirschen and the University of Washington1717Price spikes because of increased demand 2011 D. Kirschen and the University of Washington18$/MWhMWhNormal peakSmall increases in peak demand cause large changes in peak pricesExtreme peakextnor18Price volatility in the balancing mechanism 2011 D. Kirschen and the University of Washington19

19Price duration curve 2011 D. Kirschen and the University of Washington20

PJM system (USA) for 1999Actual peak price reached $1000/MWh for a few hours(Source: www.pjm.com)20Oligopoly and market powerA firm exercises market power when

It reduces its output (physical withholding)

or

It raises its offer price (economic withholding)in order to change the market price 2011 D. Kirschen and the University of Washington2121ExampleA firm sells 10 units and the market price is $15

Option 1: offer to sell only 9 units and hope that the price rises enough to compensate for the loss of volume

Option 2: offer to sell the 10th unit for a price higher than $15 and hope that this will increase the price

Profit increases if price rises sufficiently to compensate for possible decrease in volume 2011 D. Kirschen and the University of Washington2222Price spikes because of reduced supply 2011 D. Kirschen and the University of Washington23$/MWhMWhNormal peakSmall reductions in supply cause large changes in peak pricesextnorNormal supplyReduced supply23Short run profit maximization with market power 2011 D. Kirschen and the University of Washington24

is the total industry output

Production of generator i Not zero because of market power24Short run profit maximization with market power 2011 D. Kirschen and the University of Washington25is the price elasticity of demand

is the market share of generator i< 1 optimal price for generator i is higher than its marginal cost25When is market power more likely?Imperfect correlation with market shareDemand does not have a high price elasticitySupply does not have a high price elasticity:Highly variable demandAll capacity sometimes usedOutput cannot be stored

Electricity markets are more vulnerable than others to the exercise of market power 2011 D. Kirschen and the University of Washington2626Mitigating market powerIncrease elasticityIncrease number of competitors 2011 D. Kirschen and the University of Washington2727Increasing the elasticity reduces price spikes and the generators ability to exercise market power 2011 D. Kirschen and the University of Washington28$/MWhMWhminmax28Increasing the elasticity of the demandObstaclesTariffsNeed for communicationNeed for storage (heat, intermediate products, dirty clothes)

Not everybody needs to respond to price signals to get substantial benefits

Increased elasticity reduces the average priceNot in the best interests of generating companiesImpetus will need to come from somewhere else 2011 D. Kirschen and the University of Washington2929Further comments on market powerALL firms benefit from the exercise of market power by one participantUnilaterally reducing output or increasing offer price to increase profits is legalCollusion between firms to achieve the same goal is not legalMarket power interferes with the efficient dispatch of generating resourcesCheaper generation is replaced by more expensive generation 2011 D. Kirschen and the University of Washington3030Modelling Imperfect CompetitionBertrand model - Competition on pricesCournot model - Competition on quantities 2011 D. Kirschen and the University of Washington3131Game theory and Nash equilibriumEach firm must consider the possible actions of others when selecting a strategyClassical optimization theory is insufficientTwo-person non-co-operative game: One firm against anotherOne firm against all the othersNash equilibrium: given the action of its rival, no firm can increase its profit by changing its own action:

2011 D. Kirschen and the University of Washington32

32Bertrand CompetitionExample 1CA = 35 . PA $/hCB = 45 . PB $/h

Bid by A?Bid by B?Market price?Market shares?

2011 D. Kirschen and the University of Washington33AB

CA(PA)CB(PB)PAPBInverse demand curve33Bertrand CompetitionExample 1CA = 35 . PA $/hCB = 45 . PB $/h

Marginal cost of A: 35 $/MWhMarginal cost of B: 45 $/MWh

A will bid just below 45 $/MWhB cannot bid below 45 $/MWh because it would loose money on every MWhMarket price: just below 45 $/MWhDemand: 55 MWPA = 55MWPB = 0

2011 D. Kirschen and the University of Washington34AB

CA(PA)CB(PB)PAPB34Bertrand CompetitionExample 2CA = 35 . PA $/hCB = 35 . PB $/h

Bid by A?Bid by B?Market price?

2011 D. Kirschen and the University of Washington35AB

CA(PA)CB(PB)PAPB35Bertrand CompetitionExample 2CA = 35 . PA $/hCB = 35 . PB $/h

A cannot bid below 35 $/MWh because it would lose money on every MWhA cannot bid above 35 $/MWh because B would bid lower and grab the entire marketMarket price: 35 $/MWh

Paradox of Bertrand model of imperfect competitionIdentical generators: bid at marginal costNon-identical generators: cheapest gets the whole marketNot a realistic model of imperfect competition

2011 D. Kirschen and the University of Washington36

ABCA(PA)CB(PB)PAPB36Cournot competition: Example 1CA = 35 . PA $/hCB = 45 . PB $/