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The Single Electricity Market in Ireland

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1 The Single Electricity Market in Ireland
When I was first asked to talk I thought that it would be good opportunity to advertise our new market and if the chance came along to see ireland in the rugby cup semi finals well them I would be a lucky man. As a manager the SEM should achieve its goals and in the fullness of time I hope that we are more Bernard laporte than Eddie O’Sullivan. You already have had a partial introduction …. I arrived on the market design for this project after the high level design had already been determined and it has helped me to believe in karma. During my time in Ofgem in london I spent a lot of time defending bilateral trading systems and exposing the deficiencies of pool systems I would appreciate it if the audience would not quote myself back at me. I came back to NI from Ofgem to take up a policy position in a government department in NI where I developed the policy underpinning for the All Island Development Framework. Like all good policy makers I hoped that I would not have to get involved in the detail of market development again, but karma took be by the hand and made me revisit my earlier statements. Tony Doherty Northern Ireland Authority for Utility Regulation

2 Outline Background to the markets Challenges Objectives of market
Market Design What happens next? Would like to give you an introduction to the two markets Outline the challenges it was faced with The objectives of the new market design A quick run through the design itself and Spend a minute or two on what happens next.

3 Background Republic of Ireland Northern Ireland 26,627GWh 9,026 GWh
Installed Capacity 7920MW Around 1.8 million consumers State control of most of the industry Bilateral Physical Contracts Northern Ireland 9,026 GWh Installed Capacity 2270MW Around 0.7 million consumers Fully privatised industry Bilateral Physical Contracts As you can see we have two systems; the market in ROI is just under three and a half times that of NI in terms of installed generation capacity two and a half times as big in terms of customer numbers; NI’s industry is fully privatised while that in the Republic is still substantially in government hands. The main similarity is that we are both currently running bilateral physical markets but that is where the similarity ends. It has been argued that the lack of transparency in both markets could have been a major factor in limited number of new entrants that the market has attracted both in generation and supply. there is little interconnection to GB although this is changing and by 2012 (check) there should be another 500MW link. The concentration of generation plants is also quite high. Although there are three separate generators in NI, the existence of long term PPAs mean that the concentration levels are quite high. HHI in excess of 1800 is highly concentrated by american merger guidelines. The average age of generation plant on the island had been increasing for some time however the recent replacement of two of the three major generators in NI and several plants in the Republic has started to bring this numbers down. Interestingly though, the concentration of the market has not improved. The next slide will give you an idea of split by fuel type. Interconnection with GB; 500MW current with another 500MW planned HHI (energy) ~ 3000 Average age of plant (by MW) on island ~18 years

4 Generation Mix As you can see NI due to recent new investment is heavily reliant on gas as a fuels source and no surprise to anyone who has visited Ireland is that we have been able to put our more windy areas to good use and we have a healthy contribution from wind generation. You can already see that there are some fuel diversity benefits to combining the two markets. So what are the main reasons for creating the new market (next slide)

5 Why are we doing this? Government policy
All Island Development Framework Political Drivers Economic Drivers European policy This was a common question that I would ask myself when I would wake up in a cold sweat in the middle of the night worrying about the lights going out. In November 2004 while working in the Department we produced a document that created a road map for all island cooperation on energy issues. The AIDF stated that “An All-island Energy Market should provide for competitive, sustainable and reliable markets in electricity and natural gas on the island of Ireland at the minimum cost necessary. It should operate in the context of the EU internal energy market and should deliver long-term economic and social benefits that are mutually advantageous to Northern Ireland and the Republic of Ireland. Customers, irrespective of where they live, should be free to source their energy needs from suppliers and service providers anywhere on the island and generators be able to participate freely regardless of the jurisdiction.” ~Economies of scale and scope The main identifiable benefits were A larger open and transparent market More efficient despatch Energy prices set competitive manner through a transparent trading system A stable investment location that would promote new entry both in generation and supply Security of supply Shared cost of fuel diversity Reduced duplications of functions I have already alluded to some of the challenges that the market faces (next slide)

6 Challenges for the SEM Relatively small market with little interconnection Two Governments; two System Operators; two Regulators New generation investment needed Potential for significant market power issues In addition to an overly ambitious timetable for reform We had two legislatures ( and therefore two currencies and tax systems) , two regulators, two transmission owners, two system operators and a range of market participants. A relatively isolated market, The need for new investment in the Republic to take account of aging plant and given the high degree of market concentration there was a strong need to devise some mechanism of at least mitigating the impact of the abuse of market power. We would, of course, have supported some form of divestment of generation to deal with market power issues but that was subject to political rather than economic consideration. So as you can see we had a job that that would make any regulator get up out of bed in the morning. So we set a number of objectives for the market design and they were (next slide)

7 Objectives of SEM Deliver efficient level of sustainable prices to customers….supply that is secure in short and long run on an all-island basis Promote competition Minimise transaction costs for participants and customers; and Enable demand side management We condensed these requirements into the following points; We wanted to [read slide] So a number of criteria were considered to determine the high level design [next slide]

8 Design Selection – Centralised vs Decentralised
Security of Supply - greater price transparency improves longer term investment signals Efficiency - transparency helps address dominant structure improving market efficiency Equity - obviates need for physical contract making access easier for new entrants Competition – harder to compete in decentralised market with few players I appreciate that there is no consensus in market design and ones success or failure can only be determined ex post, so the secret to good market design is to take account of your underlying market characteristic and hopefully not to be there when it is reviewed which will allow the new administration to blame the old administration. We opted for a centralised system in the form of a gross mandatory pool and for simplicity and transparency we went for a single unconstrained pricing schedule. We went for a centralised system because…. SoS – greater price transparency allows prices to be forecast more easily giving improved investment appraisal mechanisms, improving competition and security of supply in the longer term Efficiency - requirement for parties to bid publicly into central market reduces the opportunity for large dominant incumbent to behave in predatory manner (or at least makes it easier to detect) and eases path for new entrant, improving market efficiency. Equity – requirement that all power clears at a single price means it is not NECESSARY to have a physical contract to trade. CfDs required to hedge but less onerous to obtain than a physical contract. This makes the market more equitable between existing (particularly dominant) players and new entrants. Competition - A decentral market with few players is harder for new entrants to compete in. [next slide]

9 Design Selection – Central vs Self Commitment
Security of Supply – greater flexibility to TSO Stability – greater TSO control Practicality – reduction in pre-despatch requirements A lot of theses decisions were influenced by our new relationships in inexperience with market and system operation in two jurisdictions. The centralised system would lead to a slightly more efficient despatch than a self-commitment market. However, the implementation costs and operational costs to the Market Operator and cost of participation meant that these efficiencies would be significantly eroded. Cost and simplicity We opted for a centralised system versus a self commitment system because it promoted; SoS – Long gate closure gives TSO more time to secure system. Self commitment requires shorter gate closure to give participants maximum time commercially – less secure. Lower cost implementation compared to Self commitment. Stability – greater TSO control gives clearer TSO view of indicative dispatch so they can take necessary actions to maintain system stability. Practicality – MO would need to deliver larger number of pre-despatch schedule info to allow participants to be able to respond in self commitment world. Such level of information flows not required under central despatch, reducing dependency on computer systems etc. So what are the key feature of the market: [Next slide]:

10 Key Features of the SEM Gross mandatory marginal pricing pool operated on an unconstrained basis Short Run Marginal Cost bidding in energy market Explicit Capacity Payment Mechanism (CPM) Directed Contracts Market Monitoring Unit New regulatory body for oversight of market We opted for a gross mandatory pool for the reasons outlined above In part to avoid the market manipulation that can arise in pool systems, a short run marginal cost bidding rule was included in all generators’ licences. This would make it easier to regulate participants behaviour. However, this would mean peaking plant who would normally bid up at time of system stress in order to recover its fixed costs would be left short. Therefore an explicit capacity payment mechanism was included. Which I will come back later. Given the high level of concentration in the market, it was decided that the best way to mitigate against the abuse of the market was to make contracts available to supplier at prices determined by the regulators at a proxy of the market level. Although this strategy does not stop a dominant generator from abusing his position, it does mitigate the impact of any abuse. Of course, it has been argued that structural solutions are more effective at addressing dominance but this was outside the control of the regulators. As I have already mentioned, certain generators have sought to exploit pool systems in a number of different markets. One of the best defences against this is an active market monitoring unit who enforces licence conditions on bidding rules and can pursue any potential anti competitive behaviour. This unit is located in both regulator’s offices and will produce regular reports on the development of the market. Although the regulator in the republic of ireland does not have competition powers, we have developed a relationship with the competition authority in the republic of ireland and have put in place measures to cooperate under the European Competition Network so that we can investigate with equal power on both sides of the border. [next slide]

11 Market Monitoring Unit
Directed Contracts Suppliers Market Power MWh MWh ESB NI Gens Others Others NIE PES ESB PES Pool Generators £ € Single Market Operator (Joint Venture) IT Systems / Invoicing / Settlement / Credit And this give us the basis structure of the market. The key features are [read off slide] The market is run on an unconstrained basis. To avoid problems with abuse of the bidding rules a SRMC bidding rule was introduced and a market monitor to enforce it. Given that this rule would mean that peaking plants (at the margin) would not recover their fixed costs, it was determined that a CPM would be necessary to attract new investment. I will describe the mechanism later. Given the multi-jurisdictional nature of the market there would need to be a new regulatory entity to regulate the market. Risk

12 Rationale for a CPM Prices – prospect of more stable prices;
Market entry and risk – stable predictable cash flows will reduce the risk premia for new investment; Intervention – energy only pool would attract more political/regulatory intervention; Transparency – greater transparency in pool prices; Competition – attract new entry and improved availability; Dominance – can help with dominance There were a number of reasons for having an explicit capacity mechanism. Prices avoid the peaks of an energy only pool. Provides a stable ‘bankable’ income that would help serve to attract new entrants. The volatility mentioned above would serve to attract regulatory and political attention that would decrease confidence in the market from an investment perspective Would provide greater transparency in pool prices by ensuring that only short run marginal costs are reflect in energy prices. All of the factors above should serve to increase competition And help deal with dominance by ensuring that only appropriate costs are bid into the energy market this making detailed and time consuming estimates of fixed costs for dominant players unnecessary. Although a new generation investor would make inframarginal rent from the marginal pricing system in the energy market even with a short run marginal cost bidding rule, at the margin a peaking plant would not recover its fixed costs.

13 Objectives of the CPM Incentivise appropriate levels of market entry and exit; Not ‘double pay’ generators; Reduce risk premium for investors; Reduce market uncertainty; Be compatible with the energy market; Be transparent, predictable and simple to administrate; Encourage short-term availability when required; Encourage efficient maintenance scheduling; Not increase costs to customers for desired security margin; Not unfairly discriminate between participants; and Encourage an efficient mix of plant types. Read through objectives As you will have picked up from the objectives of the mechanism, it was to be all things to all men and the only things that we didn’t include were motherhood and apple pie. Some of the points play against eachother, we are to incentivise entry and reduce market uncertainty but not increase costs to customers. And the ability to not increase costs for customers and at the same time reduce market uncertainty and the risk premium for investors is the Holy Grail that regulators have been searching for years.

14 CPM Key Features Fixed amount of cash (the Pot) per year
Pot determined as Price x Volume Price: Best New Entrant Peaking Plant fixed costs Volume: Capacity required to meet adequacy standard Pot allocated for Generator Payments: Fixed (year ahead) Variable (month ahead) Ex-Post (month end) Generators paid when available Pot allocated for Supplier Charges: Based on demand


16 What happens next? Market trials on track Go Live on 1 November
All Island Gas Market Regional Electricity Markets In 2006 the European Regulators (ERGEG) launched the Electricity Regional Initiative (ERI) The Electricity and Gas Regional Initiatives are European-wide initiatives intended as a concrete contribution to the integration of national markets by facilitating the creation of regional energy markets, in electricity and gas respectively. Such regional market integration is a practical and achievable way of delivering step-wise progress towards a competitive single European market for electricity and gas.

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