Reducing Market Power in Electricity Markets Is asset reallocation the answer? A. Downward * D. Young † G. Zakeri * * EPOC, University of Auckland, † Energy Centre, University of Auckland. EPOC Winter Workshop 2009

Motivation Cournot Model Demand Curve Types of Generators Simple 1-Node Model Effect of asset transfer on price in wet and dry years 2-Node Model Inspired by New Zealand Effect of asset swap on welfare in wet and dry years Benefits of asset swap as a function of demand HVDC capacity expansion Conclusions Overview EPOC Winter Workshop /26

Two reports recently released examine the competitiveness of the New Zealand electricity market: –Prof. Frank Wolak’s report to the commerce commission, –ministerial review into the electricity sector. In this work, we analyse two of the concerns raised: –Lack of thermal competition in a dry year, –Only one firm owning generation assets in both islands. Motivation EPOC Winter Workshop /26

Model Cournot Game The firms are competing in a Cournot game. That is, they choose quantities of electricity to inject into the market, and the price is determined by a demand curve. In our model we assume linear demand curves at each node of the form: where d is the demand at price p = 0, and a is the demand elasticity. EPOC Winter Workshop /26

Model Cournot Game Consumer welfare is computed from the following equation: EPOC Winter Workshop /26

Model Types of Generators In our models we only consider two types of generator: thermal generators and hydro generators. The thermal generators are identical and each have the following cost function: The hydro generators are also identical and each have the following cost function: where h is a parameter which varies depending on lake levels. EPOC Winter Workshop /26

Increasing Thermal Competition Example Wolak’s recommendation A1.17 suggests that in dry years there is insufficient competition for the thermal generation. We have constructed a stylized, single node model which demonstrates that breaking up a large thermal plant may have unintended consequences, depending on the value of water. EPOC Winter Workshop /26 Before SwapAfter Swap

Increasing Thermal Competition Results EPOC Winter Workshop /26

Increasing Thermal Competition Results In wet years, we are increasing the asymmetry of the firms’ costs, and in dry years we are decreasing the asymmetry. Wet Year: Firm A does not use T2 whereas firm B would have → higher prices. Dry Year:Firm A runs T2 more than firm B would have → lower prices. EPOC Winter Workshop /26

Swapping Assets Wolak’s Recommendation The Wolak Report states: The ownership of generation capacity among the four large suppliers could be re-arranged so that each firm owns capacity in both the North and South Islands. This market structure will increase the competitiveness of the market for electricity sales across the two islands." Wolak Report – (A1.20) We investigate the effects of an asset reallocation of this nature over a two node network. EPOC Winter Workshop /26

Swapping Assets Demand Curves Now we will consider a slightly more complicated example, inspired by the New Zealand situation. In this example, we have two nodes joined by a transmission line. EPOC Winter Workshop /26

Swapping Assets Firms In this example, we have four firms owning a total of seven plants. Initially the plants are owned by the four firms as shown in the diagram on the right. EPOC Winter Workshop /26

Swapping Assets Change of Ownership We then swap the ownership of one of the South Island hydros and one of the North Island thermals. In this new situation, we have an additional firm competing in each island, and furthermore we have three firms owning plants in both Islands (as opposed to one initially). EPOC Winter Workshop /26

Swapping Assets No Congestion: Effect on Equilibrium Price EPOC Winter Workshop /26

Swapping Assets Transmission Utilization EPOC Winter Workshop /26

Swapping Assets Impact of Transmission Congestion Suppose now there is a capacity, K = 260, on the HVDC line. For the situation where a = 1 and h = 0.2, the swapping of assets, leads to additional hydro generation in the South Island and decreased generation in the North Island, which causes an increased flow from South to North. This situation gives a congested equilibrium with lower welfare. Before SwapAfter Swap North Island Price South Island Price Consumer Welfare349,356328,763 Total Welfare490,819488,477 EPOC Winter Workshop /26

Swapping Assets Impact of Transmission Congestion The impact on the firms’ profits are detailed in the table below. Before SwapAfter Swap Firm A42, ,651.0 Firm B33, ,651.0 Firm C28, ,580.6 Firm D37, ,651.0 EPOC Winter Workshop /26

Swapping Assets Varying Demand, Fixed Line Capacity Of course, in reality we don’t have one demand realization, we need to consider how demand fluctuates over each day, and throughout the year. The magnitude of the demand affects whether the equilibrium is congested or uncongested, and hence influences the benefits any asset swap. EPOC Winter Workshop /26

Swapping Assets Varying Demand ( h = 0.2, K = 260) EPOC Winter Workshop /26

Swapping Assets Expanding HVDC Line So far we have examined the impact that an asset swap may have on welfare if there were an HVDC line with unlimited capacity or a capacity fixed at 260. We will now examine how the asset swap might affect consumer welfare as a function of the line capacity. EPOC Winter Workshop /26

Swapping Assets Expanding HVDC Line ( h = 0.1, a = 1.0) EPOC Winter Workshop /26

The benefits of asset reallocation depends on the underlying costs of generation. A reallocation, aiming to increase competition in dry years, may decrease competition during wet year. Our simple Cournot model shows an increase in utilisation of the HVDC line in wet years. There is more competition amongst hydro plants in wet years, and firm B, no longer has to run its North Island thermal plant to generate an income. Conclusions EPOC Winter Workshop /26

The HVDC capacity is an important factor in determining whether an asset swap will improve competition: If the line is regularly congested, our model predicts a significant improvement in consumer welfare. However, if the line is rarely congested, our model shows that welfare will either improve marginally, or possibly decrease significantly. Increasing the size of the HVDC to prevent it congesting may have a larger impact on welfare than any asset swap. Conclusions EPOC Winter Workshop /26