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  • Фото автораAlexey Presnov

Energy market reform. Marginal price instead of average price – unreasonable growth or efficiency?

Обновлено: 10 дек. 2023 г.

So, in our last publication, we focused on the fact that Kazakhstan needs a real competitive market in the near future if the country really wants to get out of the current crisis in the electricity sector and the associated centralized heating supply, and at the same time move along the path of decarbonization . The electricity market - with centralized day-ahead supplies - DAM, with a single marginal price at each estimated moment of delivery (usually an hour), supplemented by an intraday auction for selecting pairs of counterparties, allowing for the clarification of applications for the DAM, flowing into a well-designed balancing market that stimulates maneuverable resources, which the industry is so lacking.


The marginal price, at which the so-called real merit order is immediately revealed, that is, the selection of generation in order of “merit”, and not tariffs assigned by someone according to opaque procedures, objectively creates efficiency in the market at every hour, identifying the “best” ”, then “less than best” - until the balance of the preliminary schedule of demand and consumption is closed for the next operating day. If demand is high, the most cost-ineffective resources also pass through, and given the shortage of generation available in Kazakhstan, not only they pass through during peak hours, but also imports from Russia in significant volumes and at a high “special export” price (26– 30 t/kWh). This price will be the upper price cap on the DAM as long as there is a shortage on the market (by the way, today this is the highest tariff for “stirring” in the Single Buyer system).



The marginal price is scary, because it is significantly higher than the weighted average of the Single Buyer today, reaching 18 -19 t/kWh during peak hours. But today there are marginal tariffs, ranked into numerous groups, and we already explainedthat this does not stimulate power plants to reduce costs and some kind of development, but rather exactly the opposite, contributes to stagnation and further degradation of the industry. Let’s imagine, as some suggest, that there are no more tariffs, but the Single Buyer remains on the market, collecting price bids from energy producers and then mixing prices, averaging them over hourly volumes, ultimately paying each generator its own price, and not the highest marginal price, at which the balance is closed at a given hour. In this scenario, the price, at first glance, for consumers should be lower (relatively the same 18-20 tenge during peak hours) than with the marginal option (26-30 tenge from Russia), and this seems to be a more optimal choice from the point of view public good perspective. This pricing method, called pay-as-bid, can be used not only in the SB model, but also in exchange trading. For example, due to the electricity price crisis of 2021-22 in the EU, there were proposals to use it as an emergency measure to reduce consumer costs; some countries use this approach in normal modes. However, upon closer examination, we will see that in fact, in such a model, producers very quickly figure out which of them is the most expensive, clearing at a given hour, and try to submit their application so as to be slightly cheaper than the closing one, and this way to get the highest possible price on the market. At the same time, the most expensive one, in the same logic, will want to become a little more expensive at the moment of the market closure. Sometimes, due to an incorrect assessment, another or a third one may become the finalist, but the essence does not change - pay-as-bid stimulates inflated bids that do not reflect the real short-term costs of generators, and therefore, ultimately, the prices paid consumers will be approximately the same as with marginal pricing. But an important difference between the pay-as-bid scheme will be a much lower efficiency comparing to a single marginal price where all generators with costs lower than those ones closing the balance receive inframarginal rent in the electricity market, which is higher, the more efficient one or another resource, which stimulates them to reduce costs, and therefore to advance on the market.


Another weakness of the current SB mechanism is the preferential purchase of electricity from new and modernized resources, as well as thermal power plants, not to mention renewable energy sources. This not only reduces the liquidity of quasi-competitive bidding, as we mentioned earlier, but also creates wrong incentives for such generation - it is important for producers to generate as much electricity as possible, regardless of its real price and value to the market at one time or another. Even with low demand, these generators, regardless of their technological capabilities and features, are encouraged to work in the base part of the schedule. Not only does this create constant problems in managing the energy system, it deprives the System Operator of some of the maneuverable resources it needs, specially built through tenders and auctions, because it is more profitable for them to work in such a system in the base rather than in peak modes. The marginal market on the DAM, with a single price, with selections regardless of the status of a particular generation, solves both the problem of liquidity - because everyone participates in it, and stimulates the organic application of a particular technology in accordance with its characteristics - resources with low variable costs occupy the base part of the chart, while maneuver resources, usually with higher opex, wait for their peak hour, and are mainly used in the intraday and balancing segments.


It is important to understand that the electricity market in a competitive model is not only a segment of the DAM, it is also the IntraDay and BM - all together they form electricity prices, while the prices for the IntraDay and BM are in one way or another derived from the prices of the DAM. The latter are nothing more than the financial obligations of both suppliers and consumers, respectively, to produce and consume electricity in certain volumes and at given prices by specific hours of the next day. If these financial obligations cannot be met, then in the period up to a certain deadline before the start of physical deliveries (from 2 hours to 5 minutes, depending on the degree of automation of market management and the availability of appropriate resources), participants can adjust their positions by purchasing or selling the corresponding volumes at an intraday centralized auction for selecting pairs of counterparties with matching interests and capabilities. And then, if, nevertheless, the declared prices and volumes, taking into account adjustments at IntraDay, are not supported by actual physical operations, then market participants pay deviations according to the prices of the BM auction, at which the System Operator selects maneuverable resources to maintain frequency and voltage in the system due to the power balance. These three components add up and the sum is the financial result of one or another participant in the electricity market, and that is precisely why, contrary to popular belief in the energy community of Kazakhstan, different technologies for generating electricity, flexible, half-peak or basic, well dispatchable and not very controllable, can compete between themselves in this market, building strategies and tactics for their work depending on their characteristics and capabilities.


But there is another segment that we have already mentioned - the capacity market. In Kazakhstan, such a mechanism has been being used since 2019, but, like the electricity market, it is built on the basis of a marginal tariff for existing generation and individual tariffs for new and modernized capacities. In essence, this is a kind of addition to electricity tariffs for existing generation and separate investment tariffs for certain projects. The old generation compensates for its fixed OPEXes in this market, and the new and modernized generation also compensates for its CAPEXes. Taking into account the fact that there is practically no competition between technologically different resources with different ratios between short-term and long-term costs, variable and fixed, the connection between the capacity market and the electricity market together with BM in the current design turns out to be very weak - tariff decisions are actually made in a manually mode and based, first of all, not on the factors that ensure the lowest costs on the market. The Kazakhstani capacity market is more similar to the classic Single Buyer mechanism, where in order to attract investments, public (in the sense of transferring costs to consumers, rather than transparency) long-term PPA agreements for new and modernized resources are concluded, and the existing generation is given a separate additional payment for the fact that it exists at all (for some reason calling it a service for readiness to bear the load, although in fact the readiness itself, i.e. power, is being sold). It is not without reason that this segment is administered by the same RFC, which is called today the Single Buyer.


The competitive capacity market, which Kazakhstan needs for several reasons, has a completely different design and should pursue different goals. The reasons for introducing capacity markets in competitive conditions are usually associated with the desire to reduce the volatility of electricity prices and ensure greater reliability of the energy system, especially in connection with the growing share of unstable renewable energy sources with low OPEX, to give a clearer signal for the investment process, to ensure replacement obsolete resources with new ones, not exposing the stability of energy supply in the current and long term to unproportional risks. In Kazakhstan, there is no factor of price volatility, there are problems with deficits, there is an increase in the share of renewable energy sources, which already create certain problems in the Southern zone, but the main factor in the introduction of this mechanism in 2019 was rather an attempt to find additional opportunities for investment and indirectly increase consumer payments to curb the growing wear in generation. Plus - an attempt to unify the market design with Russia, where the capacity market has existed for a long time, in the light of integration processes within the EAEU.


But in the transition to a competitive market, where the main task is to maintain the optimal structure of generation to ensure balance reliability in the medium term, taking into account the necessary parameters of current or operational reliability, the current mechanism for selling capacity in the Republic of Kazakhstan must be radically reformatted. Exactly which way and how, how and why an inextricable connection between all segments of the energy market should be provided - we will talk about this in our next publication.


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