Transcript firm energy to cover dry year

Colombia Firm Energy Auction
Peter Cramton
(joint with Steven Stoft)
18 December 2006
1
Outline
• Purpose of market
• Why forward procurement?
• Key features
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Product
Planning period
Commitment period
Cost of new entry (CONE)
Demand curve
Descending clock auction
Price formation
Performance incentives
Fail-safe mechanism
Secondary market
• Transition
• Supplier concerns
2
Purpose of Market
3
Purpose of market
• Induce just enough investment to maintain
adequate resources
• Induce efficient mix of resources
• Reduce market risk
• Avoid market power in firm energy market
• Reduce market power in energy market
• Pay no more than necessary
4
Why forward
procurement?
5
Why forward procurement?
• New projects compete in advance of entry
– Coordinated entry
•
•
•
•
Less uncertainty in achieving target
Avoid boom/bust
New resources set price directly
Less reliance on demand curve for price setting
• Long-term commitment for new resources
– Reduced investor risk
– Better price signal for new investment
6
Key features
7
Key Features
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Product
Planning period
Commitment period
Cost of new entry (CONE)
Demand curve
Descending clock auction
Price formation
Performance incentives
Fail-safe mechanism
Secondary market
8
Product
9
Product
• Firm energy ― availability of energy
during scarcity events
– Dry year (seasonal scarcity)
– Outages (spot scarcity)
• Scarcity event defined by high energy
price
– Energy price is a transparent trigger
– Energy price is a reliable trigger
10
Product
• Physically-backed energy option
• Firm energy defined by delivery capability in worst-case
benchmark ― a very dry year
– Nameplate capacity (maximum output rate)
– Firm energy (average energy output rate in worst-case
benchmark)
• Thermal example: 92% of nameplate due to outages
• Hydro example: 35% of nameplate due to limited water
• Strike price = Gas index  high heat rate + other VC
– Gas index = New York Harbor residual fuel oil
– High heat rate = 12.482 MBTU/MWh
– Other variable cost = $15.20/MWh
• This is less than the heat rate of all existing gas units
• New thermal peakers have heat rates of 9-10
11
Load Duration Curve and Firm Energy Target
10
Load
(GW)
Target peak load
8
2010 target
growth
6
2005 actual
4
Firm Energy Target
2
0
0%
50%
Duration
100%
12
Single product; single price
• In a hydro-dominated system, there is a
single reliability constraint:
firm energy to cover dry year
• Single constraint implies single product
and single price
• Each new resource is rated for its
incremental contribution to the firm energy
constraint
13
Product is:
• Firm energy + mandatory hedge
• Firm energy =
– Expected annual drought-year energy contribution to
system (if unit disappeared, how much less energy
would the system have—same for hydro and fossil)
• Mandatory hedge =
– Obligation follows load in aggregate
• Unit’s daily obligation based on its firm energy
• Obligation over day tied to dispatch
• Matching obligations with dispatch improves the performance
of the spot energy market
– Rewarded by spot price if produce more than
obligation in scarcity hours
14
Obligation
• Purchase by load is translated into an obligation
for each supplier
– If 98% of target is purchased, then aggregate supplier
obligation is 98% of load in each hour
• Load is unhedged for 2% of load that is not purchased
– True-up at end of each month to adjust for deviation
between monthly target and actual monthly load
• If actual load is 102% of month’s target, then obligations are
scaled down by 100/102. Penalties/rewards are calculated on
this basis.
– Risk from unanticipated load growth is born by load,
not suppliers
15
Settlement
• Settlement is just like settling a conditional
contract for differences in each hour
• If spot price < strike price, then no obligation
• If spot price > strike price, then settle
differences: reward or penalty =
(Q supplied – Q obligation)  (P spot - P strike)
Same as supplier buying from spot market to
satisfy obligation.
• Same outcome if done on unit basis or portfolio
basis
• Supplier optimizes portfolio just as without option
16
Planning period
17
Planning period
• Time between auction date and start of
commitment
• 4 years ― long enough for new entry to
occur (except large hydro projects)
• Makes firm energy market contestable and
allows new entry to set the price
– Existing resources would set the wrong price
because of sunk costs and market power
18
Long lead-time projects
• 4-year planning period may be too short for large hydro
projects (6-8 years to build)
• Allow large hydro projects to lock in auction price from 4year ahead auction seven years (or less) ahead
• Large hydro project is price taker
• Decides after auction a fraction of its firm energy to lock
in at 4-year ahead auction price
• Total quantity of firm energy in years > 4 that load
purchases is limited by a percent of new firm energy
required in that year based on planning projections
Load's Limit on Forward Purchase
Years ahead
7
6
5
Percent limit
40%
50%
60%
19
Planning period
•
•
•
•
First auction Nov 2007 (2011): 3 year
Second auction Jun 2008 (2012): 3.5 year
Third auction Nov 2008 (2013): 4 year
All later auctions (2014…): 4 year
20
Commitment period
21
Commitment period
• New resources ― up to 20 years
– Supplier selected at qualification
– Long commitment lets new resources lock-in firm
energy price, reducing risk and encouraging
investment
– Price is in constant $ (adjusted for inflation)
• Existing resources ― one year
– Does not need long commitment, since costs are
already sunk
– Short commitment reduces risk (more draws from
price distribution)
22
Demand curve
23
Demand curve
Price of
firm energy
2 CONE
Price ceiling
Curve reflects marginal
value of firm energy
Able to withstand scarcity
events worse than worstcase benchmark
CONE
½ CONE
Price floor
 4%
0
Load not fully hedged
Target
Firm energy
CONE = Cost of New Entry (marginal unit)
24
Descending
clock auction
25
Descending clock auction
•
•
•
•
•
Auctioneer announces high starting price
Suppliers name quantities
Excess supply is determined
Auctioneer announces a lower price
Process continues until supply equals
demand
26
Starting price
• Starting price must be set sufficiently high to create
significant excess supply
• Setting too high a starting price causes little harm
– Competition among potential projects determines clearing price;
high start quickly bid down
• Setting too low a starting price destroys auction
– Inadequate supply or insufficient competition
• Price of 2 times Cost of New Entry is recommended
• Note that clearing price will exceed CONE in some years
to the extent it is below CONE in other years (of surplus)
27
CONE updates
• If auction in year t is successful,
CONE in year t+1 = .7 CONE in year t
+ .3 clearing price in year t
• If auction in year t fails,
CONE in year t+1 = CONE in year t
28
Mechanics
• Clock auction done in discrete rounds
• In each round,
– Auctioneer announces
• Excess supply at end of prior round
• Start of round price (higher price)
• End of round price (lower price)
– Each bidder submits a supply curve at all prices
between start of round price and end of round price
– Auctioneer determines excess supply at end of round
price
• If no excess supply, clearing price determined
29
Individual Supply Bid, Round 6
Price
start-of-round
price
$7.00
$6.63
$6.17
$6.00
175
300
end-of-round
price
400 Quantity
(MW)
• Activity rule
– Bidders can only maintain or reduce quantity as price falls
(upward sloping supply curve)
• “Intraround bids”
– More accuracy without too many rounds
– Better control of pace of auction
– Ties are reduced
30
Descending clock auction
Price
starting price
$12.00 = P0
Aggregate supply curve
excess supply
P1
Round 2
P2
P3
Round 3
P4
P5
$6.17 = P6
$6.00 = P6’
Round 1
Round 4
Round 5
clearing price
Demand
Quantity
31
Clearing rule: maximize net value
P
1.
P
2.(a)
S
P
2.(b)
S
S
Unit
accepted
PC
PC
PC
Unit
rejected
D
D
Q
D
Q
Q
32
Information policy
• Demand curve and starting price
announced before auction
• After every round, auctioneer reports
– Aggregate supply by hydro, baseload, peaker
– Excess supply at end of round price
– End of round price for next round
(determined from extent of excess supply)
33
New projects are all or nothing
• Lumpy investment respected; investor
does not fear partial acceptance
• If multiple bidders drop at the clearing
price, the group of bids are accepted that
minimizes excess supply
34
Price formation
35
Market power
• Addressing market power in firm energy market
is essential
• Strong incentive to exercise market power
– Existing resources have substantial sunk costs
– New resources are only a tiny fraction of total
– Market is concentrated
• Any of top-4 suppliers could unilaterally set price
• Long-term price signals are more stable and
efficient if determined from competitive forces,
rather than market power
36
Market power solution
•
New resources
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–
•
Bids are not mitigated in any way
Assumes competition for new resources
Existing resources
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Resources can opt out of market with either an opt-out bid or retirement bid
Opt-out bid
•
•
•
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Retirement bid ― permanent opt out of firm energy market
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Not revealed during auction
Cannot impact the price for existing supply
May be rejected for reliability reasons; gets reliability must run payment if rejected
Submitted four weeks before start of auction
Accepted retirements excluded from any future firm energy payments
Retirements may be rejected for reliability reasons, but only if the reliability problem cannot be
resolved during the planning period with alternative actions, such as transmission upgrades or new
resources
Retirements are posted as soon as they are accepted
Retirements are replaced with new resources in the auction
(represented as a shift to right in the demand curve for all prices below the retirement bid)
Repower bids
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–
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Replacement of generating unit(s) at existing plant
Replacement unit is bid as new resources
Existing unit is a conditional-retirement
37
Repowering bids
• Easily accommodated in auction
• Two types:
– Quick switchovers (down time less than 1
year)
• Repower bid is a new entry bid and a conditional
retirement
– Extended down time (more than 1 year)
• Retirement followed by new entry bid 1 or more
years later
38
Market power solution
• New resources almost always set the price
• Demand curve sets the price in surplus
years in which new entry is not needed
• Retirements occasionally set the price
• Other than retirements, existing resources
never impact the price
39
Replacing accepted opt-outs
• Opt-outs are replaced by new resources
– March up the supply curve revealed in the
clock auction
• But not more than a 30% increase in price
• Any additional replacements occur in
reconfiguration
– All new resources receives this higher price
• Existing resources receive the original
clearing price
40
Performance
incentives
41
Incentives and hedge
• Performance incentive comes primarily
from energy spot price; this is not changed
by hedge
• Hedge assures that normal performance
will receive normal reward in wet and dry
years alike
• Every extra MWh of energy is rewarded
the same with or without hedge
42
Energy price motivates performance
• Hedged resources still face the energy
spot price at all times
– Those that perform better receive more
– Those that perform worse receive less
• An additional incentive to perform is
impact on firm energy qualified for sale in
auctions in future years
• Under performing units are downgraded
• Over performing units are upgraded
43
Fail-safe mechanism
44
Inadequate supply
• If, at the starting price, there is insufficient
supply of firm energy
– New resources are paid starting price
– Existing resources are paid 1.1 CONE
• Rule does not discourage new projects
45
Insufficient competition
• Existing resources, less retirements, are less than
demand at the starting price,
• At the starting price, the firm energy bid exceeds
demand but less than 4% excess, or a supplier’s new
resources are pivotal, and
• At qualification, quantity of new projects from small
players (those with less than 15% maximum firm-energy
market share) > 50% of required new firm energy
• Otherwise insufficient competition:
– Auction held
– New entry paid clearing price
– Existing capacity paid 1.1 CONE (or clearing price if less)
• Rule does not discourage new projects
46
Secondary market
47
Reconfiguration auction
• Takes place at same time as primary
auction
– Primary: 4 years ahead
– Reconfiguration: 3, 2, 1, 0 years ahead
• Reconfiguration includes
– Adjustment of firm energy target for current
forecast
– Supplier’s buy/sell to balance position
(including dispatchable load)
48
Reconfiguration auction
• Standard sealed-bid clearing-price auction
• Same demand curve as in primary
auction, netting out resources already
purchased
• No bid mitigation
49
Monthly spot exchange
• Monthly simultaneous clearing
– Standard sealed-bid clearing-price auction
– Suppliers buy/sell to balance positions
– Demand curve same as in primary auction
50
Transition
51
Transition and timing
Administrative Pricing for New and Existing Based on CONE
2011
Primary
auction
Existing resource
commitment period
New resource
commitment period
Planning period
2007
2008
2009
2010
2011
Planning
period
2012
Primary
auction
2012
2013
… 2030
New resource
commitment period
Existing resource
commitment period
• Transition period 2007-2010
– Administrative firm energy price includes a premium
for cost of energy option
– Existing contracts are modified to subtract the same
premium since prices above the strike price are now
covered by the firm energy payment, not the contract
52
… 2031
Reducing risk in early years
• Early years of auction
– Ceiling and floor on firm energy payment to existing
suppliers
– Spread between ceiling and floor expands after each
competitive auction
– Spread starts at 0 (transition years)
– Increases to
• Ceiling = 2 CONE
• Floor = .5 CONE
Ceiling and Floor for Existing Suppliers in Early Years
Number of competitive auctions
Transition
0
1
2
3
Ceiling = CONE 
1
1.2
1.4
1.6
1.8
Floor = CONE 
1
0.9
0.8
0.7
0.6
4
2
0.5
53
Firm energy to be auctioned
Demand
MW
New
supply
2015
2014
2013
Transition
2012
2011
2010
2009
Existing
supply
2008
2007
Nov Jun Nov Nov Nov
2007 2007 2008 2009 2010
Auction date
54
Supplier concerns
55
Supplier concerns
• Please note that these concerns were as
expressed to CREG on Monday, 5 June
2006, in response to the original CREG
proposal. These concerns may not apply
to proposal presented here, which is
significantly different from the original
proposal.
56
1. Approach not used elsewhere
• Similar approach was adopted in New England
(32 GW peak load) in March 2006
– Approach currently being implemented
– Approach endorsed by FERC
• All elements of proposal are commonly used in
markets around the world
– Options are used everywhere
– Clock auctions used for many years in US, UK,
France, Germany, Belgium, Hungary, Denmark, …
57
2. Call option increases risk
Price Coverage
US$250
Forward
Energy
Contract
US$250
Energy
Option

US$100
Forward
Energy
Contract
US$0
US$0
58
3. Consumers will pay more
• Minimizing risk while addressing market
power and performance incentives means
that consumers will pay less
59
4. Price not a reliable
measure of scarcity
• High prices come from two sources
– Scarcity
– Market power
• Option fully addresses market power in
spot market; thus, high prices can only
come from scarcity
• If spot prices are still unreliable, then
market must have another flaw. Fix it!
60
5. Strike price is too high
• Why not have a very high strike price?
(US$250 or more)
– Benefits of call option are largely lost
•
•
•
•
Load hedge
Mitigation of market power in spot energy market
Mitigation of market power in contract market
Risk reduction
– No reason to set strike price higher than
marginal cost of an expensive thermal unit
61
6. Approach is complex
• Effective firm energy markets are
necessarily complex because the
economic challenges are great, especially
market power
• Proposal uses clear and simple marketbased methods
62
Questions
63