Lecture 9

Power Markets III: Security of supply and market design,

reserve power markets

Energy Economics and Modelling (EEM),

DTU Management
Supply Adequacy and
Market Design
Learning goals

• Define what security of supply is

• Understand how investments are made to achieve security of

supply

• Reflect on electricity market designs that can guarantee

investments
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Security of Supply

There are many definitions. We will use this one:

Definition
Security of Supply: Security of supply exists when electricity
Reliability consumers are able to obtain electricity of
defined quality when they need it, at cost-
reflective and transparent prices
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Security of supply / Reliability (in electricity Markets)

Reliability

Adequacy Security

Investments
Definitions
Adequacy The ability of the electric system to supply the
energy demand at all times, considering
scheduled and unscheduled outages of system
elements.

Security The ability of the electric system to withstand

sudden disturbances.
 Refinancing of fixed costs and investments
General refinancing of power plants on the market
• Bidding: short-term marginal costs of their power plants
• Refinancing of fixed costs and investment, if more expensive power plants are
price-setting sufficiently
→contribution margins
• Most expensive power plant cannot achieve sufficient contribution margin

Load Load
Marginal Margi
Costs nal
Costs

Contribution
margin to cover fix
Contribution costs
margin to cover fix
costs

Volume Volume
Refinancing of peak load power plants
Options for refinancing peak load power plants

• Peak-load power plants demand a higher price than their short-term input costs
(markups), which they can impose on the market in scarcity times

• In some countries, laws against restraints of competition can make it difficult for
operators of peak load power plants to bid with markups

Marginal
Load
Costs

Contribution
margin to cover
fix costs

Volume
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Price spikes for peakers

Peak prices: when demand sets the price, peaker power plants
can earn contribution margins to cover fix costs and capex

Value of Loss
Load (VoLL)
Excursion: Value of Lost Load – VoLL
Definition
Monetary indicator expressing the costs associated with an interruption of
electricity supply.
• The VoLL is determined by an estimate of the cost supported by the
consumer following a service interruption or by the payment that
consumers pay or are willing to pay to avoid a shortage.

• In markets where consumers face price variation, VoLL is minimized.

– Currently electric-intensive industry reveal their VoLL when they
disconnect
– Small consumers do not so (?)
• VoLL is hard to estimate since it varies widely depending on consumer
class, business sector, duration of outage:
e.g. MISO (Midwest SO) estimates the VoLL at $730-$2510/MWh for
residential, $15,000-$50,000/MWh for businesses, and $16,000-
$78,000/MWh for large industrials.
Excursion: Value of Lost Load - VOLL

What is your Value of Loss Load?

VoLL - Survey
Mentimeter:

www.menti.com

Code: 3339 2326

Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Price spikes for peakers - Example

A peak power plant with an annual capex of 100,000 €/MW should be
financed via contribution margins earned in the hours when demand
(VoLL) sets the electricity price of the market.

How many VoLL-prices do we need to finance a new peak capacity

investment?

Assumption: p = VoLL = 1000 €/MWh

Annual capex of investment: 100 k€/MW
cvar = 100 €/MWh
𝐶𝑎𝑝𝑒𝑥 𝐶𝑎𝑝𝑒𝑥
#ℎ𝑜𝑢𝑟𝑠 = =
𝑀𝑎𝑟𝑔𝑖𝑛𝑠 𝑝 − 𝑐𝑣𝑎𝑟

100.000€/𝑀𝑊
= = 111 ℎ
1000 − 100 €/𝑀𝑊ℎ
Stocktaking of the Energy-only Market
Most electricity markets still function as an Energy-only Market :
• reliable supply of customers since the beginning of liberalisation
• a capacity gap in the different electricity markets is foreseeable

The marginal cost market does not clarify the remuneration of the
"last/peak power plant”
• Peak power plants in the merit order always earns only its input costs,
but not their fixed costs; peak-load pricing recently occurred
→ see current price crises
• Missing-money problem?

Renewable energies reduce the market prices but do not cause the
missing-money problem
• The remuneration of peak-load power plants also without RES unclear
• RES dampen prices, the market is reacting to → decommissioning
Current discussion about market design
Missing-Money-Problem
supply
MC [€/MWh] demand
Missing-Money
p*3 = (p*3 – pmax) ∙ x3

pmax • Price caps to avoid market

power abuse in oligopolistic
p2 markets
Gas
turbine
• Missing contribution margins
CCGT
to cover fix or capital costs
Coal
p1
Lignite
coal

Nuclear
x1 x2 x3 [MW]
Current discussion about market design
Missing-Money-Problem

MC [€/MWh] supply demand

Missing-Money
p*3 = (p*3 – pmax) ∙ x3

pmax
• Price caps to avoid market
power abuse in oligopolistic
p2 markets
Gas
turbine
• Missing contribution margins
CCGT
to cover fix or capital costs
Coal
p1
Lignite • Market design discussions
coal started already in the early
2000es (Oren 2000, Joskow
Nuclear and Tirole 2000)
x1 x2 x3 [MW]
How to overcome missing
investments?
Submarkets and clearing time

Call of primary /
secondary

Secondary reserve market

reserve
Delivery of

Primary reserve market

minute reserve market

schedules (02:30
pm)
Intraday
Capacity up to 30 min
Market trading

Day-Ahead
previous to supply

spotmarket
Delivery of
Energy

Forward market Call of minute

reserve
6 years 1 year 1 week 09:00 11:00 12:00 03:00 pm 12:00 pm 12:00
am am pm

}
Auctioning of

Intraday
Monthly

transmission
auction

auction

auction
auction
Yearly

Daily

capacities

Date DTU Title

Energy-only Market vs. Capacity Remuneration Mechanisms

Energy-only Market
• Power plant operators are only remunerated for delivering energy,
which means if they actually produce electricity and sell it on the
exchange or via bilateral trading. The maintenance of the power plant
and the resulting fixed costs are not remunerated.

Capacity Remuneration Mechanisms

• In addition to the energy-only market, power plants are awarded
additional revenues via additional mechanisms for keeping their
capacity in the market/system.
• “Capacity markets" are one option how to do this.
Energy-only Market vs. Capacity Remuneration Mechanisms

Collection of arguments for the “Energy-only market (EOM)":

• The EOM has so far efficiently balanced supply and demand
• The EOM allows the European integration of the electricity markets
• Expected shortages are reflected in rising prices on the futures markets

Advantages:
• Opportunities and risks of investments remain with the investors
• different flexibility options equally encouraged
• market design relatively simple and transparent

Disadvantages
• The level of performance of the EOM does not have to be in line with the
politically expected level.
Energy-only Markt vs. Capacity Remuneration Mechanisms

Arguments for a Capacity Remunaration Mechanism:

• EOM does not provide sufficient incentives for new investments
• Investors do not want to cover the price risk
• Investors do not invest in new capacities/keep old ones in the market
→required power plant capacities are missing to cover (peak) demand

→Public authorities define the level of security and purchase it

• via central capacity market (auctions)
• or via decentralised obligation on energy suppliers
Capacity Remuneration Systems - Overview I

Description Declaration
low

• Direct investment subsidy • Mechanism is often linked to other

for new construction policy objectives (e.g.
Simple
1 • Demand conditions possibly environmental objectives)
capacity
subsidy specified (e.g. type of plant,
operator)
• Direct payment for equipment • System was used in Spain and
Complexity

Index-
2 provision based on a shortage Ireland
based
index • Objective: To ensure the
capacity
payment • Criteria: Availability, existing availability of existing plants in
capacity, seasonal factors case of high demand
Strategic
medium

3 • Some x% of the generation • Model established in Germany

Reserve capacity is taken out of the and Sweden/Finland, to ensure
market and reserved for critical peak load
periods (spike prices) • Model refers to generation plants
• Remuneration for this part of that might be mothballed and
the capacity in the system demand side management
Capacity Remuneration Systems - Overview 2

Description Declaration
• Premium for the provision of new • Proposed as part of the
medium

Capacity plants to compensate for missing debate in Germany in 2014

4
Tender contribution margins (missing money) • Applied in many countries
• Tendering via auction procedure with growing demand

• Trading options on power plant • Model launched in Brazil,

Realiability capacities against option premium Columbia
Complexity

5 • Enables hedging against

Options • Realisation of option in case
market price > strike price price spikes in the market

• Fully developed capacity market with • Processes introduced in

6 Capacity target capacities defined by central the USA (PJM, NE-NO)
high

market planner • In USA secondary

• Bidding process for secure market tur Guarantee of
generation and load management long-term flexibility
against capacity constraints
Centralized Approach via Capacity Market

Capacity provision
Capacity
Capacity payment
market

Levy of capacity
payments
Electricity
Capacity
supply
providers
(supply, Retailers End consumers
storage, flexible End consumer
demand) electricity price

Wholesale Wholesale
Electricity Electricity
electricity price electricity price
supply supply
Wholesale electricity market (EOM)
Energy-Only Market and Strategic Reserve

Stand-by cost 1 Including levy of strategic reserve cost

Strategic Central
Activation cost
reserve regulatory body

Electricity supply Fee for strategic

reserve cost

Capacity Electricit
providers y supply
(supply, Retailers End consumers
End consumer
storage, flexible electricity price1
demand)

Electricit Wholesale Electricity Wholesale

y supply electricity price supply electricity price

Wholesale electricity market (EOM)

Break !!!
Reserve power market
(Ancillary services)
 Basic information about balancing energy

TSOs must ensure that the balance of power generation and power consumption in the
control area is maintained at all times.

TSOs procure balancing / control power in different qualities (primary, secondary and
minute reserve)

The balancing power qualities differ both in terms of the principle of demand and activation
and in terms of their marketing (in particular the deadlines)

The amount of balancing energy tendered and then

activated by the network operators from the demand side
Generation Consumption
of the balancing power/energy market.

Feed-In Feed-Out

Quelle: https://www.tennet.eu/de/strommarkt/strommarkt-in-
deutschland/bilanzkreise/
 An Overview over balancing power qualities

The grid frequency is the essential control variable when using the balancing energy
Primary reserve derives its control variable directly from the system frequency
Secondary and tertiary (minute) reserve receive their control from the responsible
transmission system operator (TSO)

Grid frequency
limits
automatic deviation returns to
activation in from target setpoint
case of value
deviation
from target Frequency
value
Containment Reserve
replaces / ensures
automatic operational
activation in readiness
ÜNB
ÜNB
case of system
automatic Frequency
ÜNB
TSO balance
incident Restoration Reserve
replaces / ensures
operational readiness
manual activation
depending on the use of
the aFRR manual Frequency
Restoration Reserve
Sequence of use of balancing energy in case of perturbance
 Frequency Containment Reserve (FCR)

• The main task of the FCR is to stabilize the grid frequency as quickly as possible after a
disturbance event.

• FCR is activated non-selective and is based on the grid frequency alone.

• The activation is carried out by the decentralized control equipment of the power
plants.

• Primary control is designed as proportional control: The demand is proportional to the

deviation of the grid frequency from the setpoint of 50 Hertz.

• Limited capacity → the TSOs strive for a replacement of the FCR by secondary reserves
(aFRR) as soon as possible.
Grid frequency

Primary control reserve

ÜNB
ÜNB Secondary control
ÜNB
TSO
reserve

Tertiary reserve
 Automatic Frequency Restoration Reserve (aFRR)
• aFRR is used automatically and in those control zones where the cause of the
system imbalance is present.

• Balancing power is activated in the order of the cheapest energy prices ("Merit Order“
of activation) of the successful bidders of secondary control reserve.

• Secondary control reserve must be activated within 5 minutes (in other countries 3
min).

• Secondary control reserve has so far mainly been

provided by thermal power plants, or by pumped storage power plants.

Grid frequency

Primary control reserve

ÜNB
ÜNB Secondary control
ÜNB
TSO
reserve

Tertiary reserve
 Manual Frequency Restoration Reserve (mFRR)

• mFRR is handled via schedule deliveries. Upon request for activation, mFRR supplier
delivers schedule to the TSO.
• Activation time for mFRR within 15 minutes.

• Lower technical requirements allow for provision by units such as fast-starting gas
turbines, pumped-hydro storages.

• The mFRR is not automatically used to replace the aFRR. TSO decide case by case
about the situation in aFRR and the predictable further development.

• As with aFRRs, the mFRRs are called up in the order of

the cheapest energy price bids of the successful
bidders in the auction for the mFRR reserve. Grid frequency

Primary control reserve

ÜNB
ÜNB Secondary control
ÜNB
TSO
reserve

Tertiary reserve
How is balancing energy procured on the market?
Submarkets and clearing time

Call of primary /
secondary

Secondary reserve market

reserve
Delivery of

Primary reserve market

minute reserve market

schedules (02:30
pm)
Intraday
Capacity up to 30 min
Market trading

Day-Ahead
previous to supply

spotmarket
Delivery of
Energy

Forward market Call of minute

reserve
6 years 1 year 1 week 09:00 11:00 12:00 03:00 pm 12:00 pm 12:00
am am pm

}
Auctioning of

Intraday
Monthly

transmission
auction

auction

auction
auction
Yearly

Daily

capacities

Date DTU Title

Fundamentals of the balancing energy market
Role of the system operators
The system operators (TSOs) are not allowed to own facilities ("unbundling").
Provision realized via procurement from market participants.
Reserve power auctions, specified by quality and product run by TSOs

Core elements of the reserve power auction

Bids for secondary and minute reserve contain a power price and an energy price ("multi-
part bid auction") in addition to the amount of capacity.
Power price: Remuneration for the reservation of flexibility [EUR/MW]
Energy price: Remuneration for actually activated balancing energy [EUR/MWh].

Two-stage procedure determines which market participant delivers balancing energy:

1. Award for power reservation according to the power price bid (day-ahead)
2. Activation of the power provided by the awarded stage 1 bids in the increasing order of the
energy price (“Merit Order of Activation", in quasi real-time)
Specification of products (from 01.07.2020)

FCR aFRR mFRR

Gate Closure Time 8:00 a.m., d-1 9:00 a.m., d-1 10:00 a.m., d-1

Time Slices 6x4h 6x4h 6x4h

Product Differentiation none (symmetrical) positive / negative aFRR positive / negative mFRR

Minimum bid / offer 1 MW 1 MW 1 MW

increment
Award Capacity Price Merit Capacity Price Merit Capacity Price Merit
Order Order Order
Activation Proportional to the Energy Price Merit Order Energy Price Merit Order
frequency deviation
Compensation Marginal Pricing Pay-as-bid Pay-as-bid
(Capacity Price) (Capacity and Energy (Capacity and Energy
Price) Price)

*according to the German reserve

power system, DK/Energinet applies
marginal pricing
Capacity Price and Energy Price

What does the TSO pay for?

Capacity price: remuneration for the provision of flexibility [EUR/MW]
Energy price: remuneration for eventually activated balancing energy [EUR/MWh].

P P

Note: Capacity is exclusive

Capacity must not be used to
provide balancing power and sell
energy on the day-ahead market at
the same time.

Capacity Energy
Exercise: revenues of a provider

What does a provider receive?

Product: aFRR_POS_12_16 (positive secondary control power 12:00-16:00)
Capacity: 50 [MW]
Capacity price: 10 [EUR/MW]
Energy price: 150 [EUR/MWh].

In the delivery period between 12:00 and 16:00 o'clock, the awarded capacity will
expectedly be activated in 7% of the time. Calculate the total expected revenue of the
supplier.
t

Revenues power (capacity) provision: P P

50 MW * 10 EUR/MW = 500 EUR

Revenues from activation calls:

50 MW * 4h * 0.07 * 150 EUR/MWh = 2100 EUR

Total revenues:
500 EUR + 2100 EUR = 2600 EUR

Capacity Energy
BREAK !!!
Trading game: Auctioning

▪Auctioning of 6000 MW reserve power for period t:

• Pay-as-bid Auction

▪Every player has a portfolio of power plants with their according capacity
and marginal costs. Based on these information the players have to bid for
the reserve power auction:
• capacity volume
• power/capacity price
• (activation) energy price
▪The auctioneer clears the market and calculates the revenues
▪ Different auction rounds

▪Determine the results in each round! Discuss the strategies

BACKUP
Pros and Cons of different CRM types

Advantages Disadvantages
• High transparency • Effectiveness not guaranteed
1
Simple • Simple implementation • Disturbance of the profitability
capacity of existing plants
subsidy
• Strong market intervention

• Possible national • Index formation not transparent

Index- implementation • Compensation is difficult to
2 based
• Regional focus possible determine
capacity
payment • Strong market intervention

• Economically efficient by • Can be used to avoid peak prices

3 Strategic including existing plants → Possibility of market
Reserve
intervention
• Flexible to design/adapt
• Danger of underused capacities
• Small market intervention
Pros and Cons of different CRM types

Advantages Disadvantages
• Legal framework in place • Strong market intervention
4
Capacity • High transparency • Deterioration for existing
Tender • Accuracy through focus capacities
on needed capacities • Focus on single technologies
instead of competition
Realiability • High accuracy • Very complex and hardly
5 Options • Transparent and non- tested
discriminatory • Strong market intervention

• Market-oriented design • Highest complexity, possibly

6 Capacity Freedom from discrimination strong need for adaptation
market possible • Technically very complex
• Economically efficient implementation

Reading material: A survey on electricity market design: Insights from theory and real-
world implementations of capacity remuneration mechanisms - ScienceDirect
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Optimal price spikes for peakers

Traditional Pricing Solution:

• Build 8 [GW] of capacity
• Use screening curves and LDC to determine that trade off
point is 6 [GW] of base generation and 2 [GW] of peak
generation.
• Set prices such as they cover the average cost of generation for
every generator.

Result
• Base load amount is fine.
• Does not consider the real cost of peak
production.
• Peak demand is higher than socially optimal, the
peak price is paid by everyone!

17 / 50
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Optimal price spikes for peakers

Motivation
“If the costs of peak usage were paid for entirely by the users of
peak power, consumers would consume less on peak.”

A better solution is to introduce price spikes and a capacity cap (K):

18 / 50
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Optimal price spikes for peakers

Motivation
“If the costs of peak usage were paid for entirely by the users of
peak power, consumers would consume less on peak.”
Optimal solution is to introduce price spikes and a capacity cap
(K):
• Price spike has duration D p s in the load duration curve, the
time at which generation is at full capacity K .
• We want to relate the average cost of producing the peak
energy, with the value of energy for consumers (we need
VOLL)
• Average cost of producing 1 [MWh] of energy for the price
spike:
$6
ACe = + $30 per [MWh]
D ps
19 / 50
Introduction Fixed Costs and Price Spikes Nordic System Adequacy Capacity Markets What did I learn?

Optimal price spikes for peakers

Motivation
“If the costs of peak usage were paid for entirely by the users of
peak power, consumers would consume less on peak.”
Cost for producing energy should equal the value consumers have
for it:
• From demand curve we know that value of energy for
consumers is $1000 per [MWh]
• Then:
$6
V O L L = $1000 ⇒ + $30 = $1000 ⇒ D p s = 0.62%
D ps
• Or generically:
FC p e a k
D ps =
Elec. Value − V C peak
20 / 50
Zoom on bids pricing

single-price auctions pay-as-bid

Transparent and competitive Producers are paid on the basis

+ market in real time. of their price offer
Exercise of market powers, in Price set according to producers'
particular for producers with a market expectations.
diversified portfolio.
- Once again, market failure
Explicit agreements or even reinforced by a concentrated
collusion. market.

48