Electricity Market Reform - International Association for Energy

Avoiding Pitfalls in China’s Electricity
Reforms
June 2017
Michael Davidson
Institute for Data, Systems, and Society, MIT
Ignacio J. Pérez-Arriaga
Sloan School of Management, MIT
IIT Institute for Research in Technology, Comillas University
Reforming an Electricity Sector
• Most countries have some market restructuring:
– Traditional vertically-integrated utilities (govt-owned or
exclusive franchise) → Competition in some segments
• “Standard liberalization prescription”
– Reduce conflicts of interest in new institutions
– Create proper incentive regulation for monopolies
– High degree of integration between operations and markets
(Hunt 2002; Joskow 2008)
Diverging Systems and Benefits
• In practice, systems frequently diverge from “textbook”
(Williams and Ghanadan 2006)
–
–
–
–
Range of degrees of operation-market integration
Persistence of legacy central planning institutions
Competition structure, conflicts of interest, ownership reforms...
Industrializing countries face particular challenges (Jamasb 2006)
• Benefits can vary
(Zhang et al 2008)
– Various necessary institutions and conditions interacting
3
Evolution of China’s Electricity Sector
• 1949-1985: Vertically-integrated state-run utility
– Provincial development-focused
State finances limited
• 1985-1997 (Reform 1): Local gov’t, private & foreign investors
– “Competed” with ministry
Inefficient plan allocation
• 1997-2002 (Reform 2): Corporatization, unbundling generation
– Separate grid & generation
• Incomplete restructuring (Andrews-Speed 2013; Zhang & Heller 2007):
– Legacy quota allocation and price-setting institutions retained/modified
– Heavily dominated by state-owned enterprises (SOEs) w/weak profit motives
– Strong local government protectionism
– Insufficient regulatory oversight
– Renewable energy integration challenges
4
Latest Reforms (State Council 2015; NDRC 2015; etc.)
Slowly reduce planned
quotas
T&D regulated cost recovery
Retail competition
New market exchanges
Introduce generation
price competition
Open up some distribution
competition
5
Pitfalls from International Contexts
1. Reliance on physical not financial contracts
2. Long-term contracts before sufficient short-term markets in
place
3. Retail pricing not on reference energy prices
4. System operation conflicts of interest
Pitfall #1
RELIANCE ON PHYSICAL NOT
FINANCIAL CONTRACTS
7
Theory
Settlement
Dispatch
8
Theory
Financial
Contracts
Settlement
Dispatch
9
Theory
Physical Contracts
Settlement
Dispatch
10
Theory (2)
• Difficult for market actors to assess impact of single
scheduled flow on network conditions
• Financial contracts leaves system operator unconstrained:
determine dispatch with full knowledge of network
conditions
• In practice, hinges on transmission rights:
– With no congestion, or highly predictable congestion: bilateral
“wheeling” contracts can resolve
– As networks become more meshed / unpredictable: physical
contracts lead to increased efficiency losses
(Hunt 2002; Hogan 2003)
11
Examples
Southern Africa Power Pool (SAPP)
• 90-95% electricity thru long-term physical contracts
• Wheeling arrangements, non-economic flows
(Rose 2017)
PJM
• In 2004, AEP joined PJM ISO, previously connected via
bilateral contracts
• Trade increased and estimated US$160 mn saved
(Mansur & White 2012)
12
France-Spain uneconomic trades
Source: OMIE 2015
13
After EU short-term market
Source: OMIE 2015
14
Indications of China’s Reforms
• Physical contracts predominate:
– Quotas = MT energy contracts
–  same for bilateral contracts (month to year)
• Networks under-considered:
– Intra-provincial: no transmission rights
– Inter-provincial (crossing price zones): limited market pilots
(NDRC 2015)
15
Pitfall #2
LONG-TERM GENERATION CONTRACTS
BEFORE SUFFICIENT SHORT-TERM
MARKET
16
Theory
• Markets function by matching marginal supply and demand
Source: Ventosa et al 2013
• In electricity, the market is naturally differentiated by both
time (minutes ~ hour) and location (e.g., substation)
• To price financial contracts correctly, need accurate reference
prices
(Schweppe et al 1988) 17
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ontainers/com.apple.
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Sample of nodal prices in PJM
PJM节点价格的例子
https://edata.pjm.com/eContour/#
Out-of-merit-order
• Long-term contracted plant (A) with higher cost than
marginal unit (B) must be dispatched
A
B
Dispatch less
Dispatch more
19
Examples
UK BETTA
• Imbalance market grew out of 1990s spot market
• Benefits of self-commitment
• Though, benefits decreasing, and challenges with
renewables
(Green 1999; Sioshansi et al 2008; DECC 2015)
California
• Long-term financial contracts may be desirable
(Bushnell et al 2008)
20
Indications of China’s Reforms
• Long-term contracts (month or longer) are “primary”
electricity product
• Short-term balancing markets deemed “supplementary”
– No incorporation into existing markets with bilateral contracts
• System operation increasingly constrained
– Quotas have greater flexibility than contracts in dispatch
(State Council 2015; NDRC 2015; Interviews 2016)
21
Pitfall #3
RETAIL PRICING NOT BASED ON REFERENCE
ENERGY PRICES
22
Theory
• Benefits of retail competition mixed:
– Promise: demand bidding ensures investment incentives and
prevents overly high clearing prices
– But inefficient pricing more likely from regulated tariff structures
than lack of retail competition
• In future with large DR, retail could become more
important
(Hunt 2002; Joskow 2008; MIT 2016)
23
Most US states Do Not Have
Source: Morey and Kirsch 2016
24
Examples
Spain (retail competitive)
• Subsidized default tariffs too low  retailers drop
consumers
India (not retail competitive)
• Distcoms prefer not to buy when default tariff too low
(can occur daily)
• Huge debt in distribution segment
(Kumar & Chatterjee 2012; Swain 2016)
25
Indications of China’s Reforms
• Strong interest in retail competition, multiple pilots and
companies created
• Generation side of these markets essentially unchaged:
MT energy without reference short-term prices
26
Pitfall #4
SYSTEM OPERATION CONFLICTS OF
INTEREST
27
Theory
• Well-functioning (wholesale) markets:
– Require non-discriminatory operation = no considerations
beyond efficiency and grid reliability
– Should reduce direct political intervention (e.g., thru quotas)
– Should avoid indirect conflicts of interest (e.g., system operator
with financial interest in transactions)
(Hunt 2002; Joskow 2008)
28
Examples
Transmission
Owner
System
Operator
Market
Operator
29
Examples
Transmission
System
Owner
Transmission
Operator (TSO)
(e.g. Spain)
System
Operator
Market
Operator
30
Examples
Transmission
Owner
Transmission System
Operator (TSO)
Independent
System Operator
System
Market
(ISO)
Operator
Operator
(e.g., PJM)
31
Indications of China’s Reforms
• Current approach follows neither model:
Transmission
Owner
Grid Company
System
Operator
“Relatively Independent”
“相对独立”
Market
Operator
• Postage stamp pricing  indirect conflicts
32
Conclusions
• Current indications show China’s market reforms failing to
address some key pitfalls based on first principles and
international lessons
• Implications for lost efficiency gains, distributional
impacts, and renewable energy integration
• Need for analysis of different “partial reform”
trajectories…What are 2nd best policy options?
33
Michael Davidson
michd@mit.edu
THANK YOU
34
References
Bushnell, J. B., Mansur, E. T., & Saravia, C. (2008). Vertical Arrangements, Market Structure, and Competition An
Analysis of Restructured US Electricity Markets. American Economic Review, 98(1), 237–266.
DECC. (2015). Electricity Market Reform: Contracts for Difference. UK Department of Energy and Climate Change.
Retrieved from https://www.gov.uk/government/collections/electricity-market-reform-contracts-for-difference
Green, R. (1999). The electricity contract market in England and Wales. The Journal of Industrial Economics,
47(1), 107–124.
Hogan, W. W. (2003). Transmission Market Design (Faculty Research Working Paper Series). Harvard University.
Retrieved from http://papers.ssrn.com/abstract=453483
Hunt, S. (2002). Making Competition Work in Electricity. New York: John Wiley & Sons.
Joskow, P. (2008). Lessons learned from electricity market liberalization. The Energy Journal, 29(2), 9–42.
Mansur, E. T., & White, M. (2012). Market organization and efficiency in electricity markets (Working Paper).
Hanover, NH: Dartmouth University. Retrieved from
http://www.dartmouth.edu/∼mansur/papers/mansur_white_pjmaep. htm
Morey, M., & Kirsch, L. (2016). Retail Choice in Electricity: What Have We Learned in 20 Years?. Electricity
Markets Research Foundation.
National Grid. (2011). National Electricity Transmission System Seven Year Statement. Retrieved from
http://www2.nationalgrid.com/WorkArea/DownloadAsset.aspx?id=43266
NDRC. (2015). Notice Regarding Improving Inter-Provincial Inter-Regional Electricity Trade Price Arrangements
(No. 962). Beijing: National Development and Reform Commission.
OMIE. (2016, January). European Wholesale Electricity Market: Challenges and Goals. Madrid.
Rose, A. (2017). Improving the performance of regional electricity markets in developing countries: The case of
the Southern African Power Pool (Ph.D. Thesis). Massachusetts Institute of Technology.
Schweppe, F. C., Caramanis, M. C., Tabors, R. D., & Bohn, R. E. (1988). Spot Pricing of Electricity. Boston, MA:
Springer.
Sioshansi, R., Oren, S. S., & O’Neill, R. P. (2008). The Cost of Anarchy in Self-Commitment-Based Electricity
Markets. In F. P. Sioshansi, Competitive electricity markets : design, implementation, performance. Amsterdam:
Elsevier.
State Council. (2015). Opinion Regarding Deepening Electricity Sector Reform (No. 9). State Council.
Ventosa, M., Linares, P., & Pérez-Arriaga, I. J. (2013). Power System Economics. In I. J. Pérez-Arriaga (Ed.),
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Regulation of the Power Sector (pp. 47–124). London: Springer.

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