Training Module on Electricity Market Regulation - SESSION 2

Q&A Session

Q: Do you think it is necessary a complete separation between SO and TO?. What kind of separation do you think it's going to be needed?

SO and TAO

There are times when transmission asset owners (TAO) compete with generators (gencos) in the market. For example, the System Operator (SO) entity might request the TAO to forego an outage, or return a facility on outage to service ahead of schedule, in order to avoid high-risk situations and the dispatch of expensive generation. In addition, in the planning process, a transmission expansion option might compete against a new generation project for supply to a transmission-constrained area. In these instances, management of a combined TAO/SO entity might have incentive to favour the transmission option over the generation option. In the case of outages, it can be difficult for the regulator to ensure that actions are non-discriminatory. Therefore prohibiting affiliations between the SO and TAO may ensure against discriminatory behaviour.

On the other hand, there are positive aspects of the integrated TSO structure (TAO and SO together). A separate SO entity would own no assets, and would have no capacity to construct new facilities (part of ensuring its independence). It may be difficult to ensure that transmission expansion takes place under such a regime (the SO does not have the capacity to build) if the TAO does not have a regulatory compact making it responsible for transmission expansion. Moreover the unbundling between SO and TAO will require new interface rules and may hamper the coordinated and effective operation of SO and TAO. 

The TSO model has been the prevailing model in Europe.

Recent Development in the EU

Recently the European Commission published new directives for unbundling of transmission and system activities. These have been driven by the fact that many companies in the EU control transmission and system activities, and generation and supply activities. The joint control over regulated and competitive activities may lead to biased cost allocation and thus to increased costs and prices in the regulated sectors. Subsequently this may hinder the development of competition due to prohibitively high network charges. Moreover this would create unfair advantages of the generation and supply activities of the incumbent.

The new directive of the European Commission provides for three unbundling options:

Full Ownership Unbundling

This option suggests complete divesting of the TSO business (TAO and SO, they remain together) from the rest of the activities. The TSO business will be moved to an entity which does not operate in generation and supply markets and provides an unbiased and non-discriminatory treatment to all transmission service users. This entity has full ownership of the transmission assets and is responsible for planning, construction and maintenance of the transmission network. This entity is also in charge of the system operation.

Independent System Operator

The option requires separating only the SO from the other parts of the vertically integrated company, which means that it separates SO and TAO. This option is attractive in particular when the incumbent is a private company and not prepared to sell the transmission assets voluntarily, as a legal requirement to divest might be ridden with constitutional objections. With an independent system operator (ISO) the asset ownership remains unchanged and only the SO is sourced out to an independent company. Depending on the specific design, the ISO can be responsible only for the system operation (scheduling and dispatching of generation and load, congestion management, capacity allocation), or additionally for investment planning and coordination with the transmission assets owner or even maintenance.

Independent Transmission Operator

The ITO is based on a tighter legal unbundling and allows the vertically integrated company to retain their TSO activities. TAO and SO remain together.

Q: You mentioned ''CFD'' (Contract for Differences) in passing. Can you briefly explain the concept behind CFD? 

A Contract for Differences (CfD) is not a physical contract for electricity, but a financial instrument. CfD’s have been used in financial markets as risk management tools, and have also been used extensively in deregulated electricity markets (e.g. gross mandatory pools).

An electricity CfD is a financial contract normally between a generator and supplier which serves to hedge the price risks of both parties.  The simplest form of a CfD is structured to pay the difference between an agreed strike price and SMP between the contracting parties.  This is illustrated below by considering a CfD between a Generator and a Purchaser at a Strike Price of 30 € per MWh.

In Month 1 the Purchaser has paid an average price of 31 € /MWh for the power it has bought from the market. However it has a CfD with a Generator which requires the Generator to make a payment to the purchaser of 1 €/MWh – this being the difference between the Strike Price (30 €) and the market price (31€). The net effect is that, for the volume of energy in the CfD the Generators net payment is 30 and the Purchaser pays the same amount.  Both parties have successfully managed their financial risks.

Q: What is the primordial difference between ''Primary Frequency Control'' and ''Secondary Frequency Control'' besides their order of priority? What is the difference from a physical or features standpoint?

Primary frequency control is the automatic, instantaneous and synchronized reaction of all units connected to the grid, which serves to arrest frequency deviations in the entire UCTE system in the case of disturbances. Within UCTE, the provision of primary frequency control is distributed across all countries and is dimensioned for a maximum instantaneous power deviation in the synchronous system of UCTE of 3000 MW. Please note that UCTE has recently become part of the European Network of Transmission System Operators for Electricity (ENTSO-E). However, we prefer to use the (old) term ‘UCTE’ to avoid confusion with other interconnected systems within the EU, such as NORDEL, Great Britain or the UPS/IPS.

Secondary frequency control serves to replace primary frequency control and restore system frequency to its target level within 15 minutes after incident by restoring the so-called area control error (ACE) only within that control area where the energy balance has been disturbed. Technically, secondary frequency control is realised through the centralized control of particular generating sets by means of automatic generation control.

Both types of control are provided automatically, however the primary control encompasses all interconnected countries and the secondary control reacts locally in the control area where the energy balance has been disturbed.

Q: What about the effects of costs of imbalance on the regulated tariffs? Should they be reflected to the tariffs?

In the European market the costs of imbalances are charged to the balancing responsible parties, and in this way also to suppliers of electricity. In case of competitive retail market it is a decision of the suppliers to decide what portion to include in the end user tariffs. In case of regulated end user tariffs, regulator can disallow to include share of the cost of imbalances in order to encourage reduction of deviations between schedules and actual consumption / production.

Q: In slide 7, you state ''postponing transmission investments which may cause congestions''. Aren't transmission investments made in order to PREVENT transmission congestions? Can you explain this a little better?

Exactly, therefore their postponing may cause congestion. This has been the debate in the European Union in the context of the transmission interconnections.

It should be considered that a complete elimination of congestions may not be economically justified. In addition a better utilisation of the existing transmission interconnection capacity may provide a better solution in some cases and should be encouraged. The latter is related in particular to the properties to the different models for interconnection capacity allocation.

Q: Thanks for good presentation. Can u please elaborate on the existence of long-term contracts in a fully unbundled market? Some argue rightly/wrongly that long-term contracts act as barriers to entry.

Traditionally the long-term power purchase agreements (PPAs) are a typical element of the single buyer model. Given the nature of the PPAs (long term agreements with provisions for mandatory quantity off-takes or/and guaranteed availability payments) the risk is allocated to downstream system level and ultimately to final consumers.

Generators receive guaranteed amount of revenue via a mandatory purchase of electricity from them (mandatory off-take) or/and via guaranteed availability payments (regardless whether they are dispatched or not).

While such long-term arrangements would encourage investors and attract capital in the country, their provisions may constitute an obstacle in more competitive electricity markets models (should regulators and policy makers aim to implement such competitive models). In a competitive environment, independent power producers should assume more risks than they have done under the traditional PPAs.

To avoid any misunderstanding, we do not say that in the restructured electricity industry long-term arrangements may not be necessary or may not exist. However, the major difference is that these contracts are signed bilaterally between two parties and allocate the quantity and price risks solely to both parties. With other words, if the long- term contract is individually rational for the buyer to sign it is her/his decison to do so.

Another issues related to you question is the fact that by locking himself into a long- term contract with the seller, a buyer reduces the size of a potential entrant’s market. In this way the long-term contract may reduce the probability of new entry. As a result, other buyers may have to accept higher prices. There are different views related to this issue. While long-term contract may effectively diminish the market size, they can play an important role to encourage investments and improve competitiveness of sport markets.

Q: The terms ''bids'' and ''offers'' are being used interchangeably. So, who makes the bids? Suppliers? Who makes the offers? Generators?

In previous work we use generation offers and demand bids. I don’t think there are rules here. I have seen all possible combinations.

Reply