A common response to energy-market risk is a complex market infrastructure, with significant administrative effort and cost dedicated to managing the risks and ensuring that the market functions in a transparent and effective manner. But is market complexity a necessary byproduct of competitive markets? Must all electricity markets be burdened with what we in the United States have come to accept—bid-based regimes, multi-part bidding, locational-marginal pricing, financial transmission rights, ancillary services co-optimization, day-ahead and real-time markets, complex price caps, virtual bidding products, or capacity markets? Are all of these market instruments really necessary to ensure fair and open access to electric transmission lines?
Some nations in Asia have politely said no, but their “no” is not to electric competition in general, but to complexity in market design. In the past few years, a number of countries in Asia have explored setting up competitive wholesale energy markets and turning their local version of what has been called “the last great monopoly” into a truly competitive enterprise. Their governments have watched the deregulation efforts in the United States. In the PJM Interconnection and New York Independent System Operator, electric competition has led to approximately $400 million to $1.3 billion per year in estimated cost savings, but the negative overhang of the Californian market crisis has driven countries like Indonesia and Thailand into the wait-and-see camp, as they indefinitely postpone deregulation of their power systems.
Far from FERC Chairman Joseph T. Kelliher’s goal to create a series of seamless grids across the country, Asian nations have instead learned to custom fit, tweak, and, if necessary, dilute their goals to make competition work effectively. Singapore and Korea each believed in the effectiveness of the independent marketplace in promoting economic efficiency, and accordingly decided to reform their power sector. But each followed its own path, proceeding differently from any energy market in the United States and from each other as well. While one cautiously evolved into a nodal-pool market over a five-year period, the other put in place a cost-based pool to create transparency while mitigating risk and price volatility.
Australia and New Zealand have been among the first to implement competitive electricity markets. The Australian National Electricity Market (NEM) includes the Eastern states—New South Wales (NSW), South Australia, Queensland, Victoria, and more recently, Tasmania. During the early days, the market’s cleared prices were consistently low, resulting from a number of factors including competitive-supply tensions exacerbated by the bidding behavior of government-owned generation in New South Wales. The privatization of assets in Victoria was facilitated through vesting contracts that provided a smooth transition by providing revenue certainty in the early stages of the market.
Over the years, appropriate tweaks and changes have been made to market rules to address regulatory and market issues. More recently, other market-structure issues such as government ownership of generation assets and “retail contestability” gradually are being addressed to enhance the competitive and effective operation of the market. Overall, the National Electricity Market has performed satisfactorily with positive results for consumers in terms of decreasing retail tariffs and a broader choice of supply with superior offerings for both gas and electricity.
After extensive planning and consideration of relevant local topological issues to help ensure a smooth functioning market, the Singapore government implemented a wholesale-pool market in 2003. Starting with a rudimentary form of market structure with a day-ahead trading pool, the Singapore system operated for more than five years before transitioning into a full blown bid-based market in 2003. The regulators introduced a vesting-contract regime in the following year to ensure a peaceful transition to retail competition. The vesting-contract regime required that about 65 percent of the system demand be hedged at fixed prices based on the long-run marginal costs of a combined-cycle gas turbine plant dispatched at the margin. This regime was necessary to curb market power of the three large generation companies under a common ownership, and to ensure price certainty for franchise load. In the long term, the vesting-contract regime also provided revenue certainty, which attracted private investors for additional generation capacity.
The Korean Power Exchange (KPX) operates an electricity market under the Cost-Based Power Pool (CBP) regime. The CBP market provides for competition among generators in a manner that is consistent with the economic dispatch of a plant. Price volatility is minimal, as separate clearing prices are set for both base-load (coal, nuclear) as well as non-base-load (gas, oil) plants. This ensures that plants compete with others in the same technology category—one coal plant versus other coal plants, one gas-fired plant versus other gas-fired plants, and so on. The plants also receive an appropriate capacity payment for declared capacity as the energy payments in the pool are limited to the recovery of variable (primarily fuel) costs.
This interim CBP market was to transition eventually to a bid-based pool market (the two-way bidding pool). However, this has been deferred indefinitely because of uncertainty in the completion of perceived prerequisites for a successful free market, such as privatization of generation assets, reform of the distribution sector, and appropriate education of consumer advocacy groups and unions regarding the benefits of price transparency for wringing inefficiencies out of the existing system.
Deregulation in Japan also has been very gradual. The first step toward deregulation, via amendments to the Electricity Utility Law in 1995, was to allow the electric utilities to buy electricity from outside sources including independent power producers (IPPs). This opened about 30 percent of the electric sector to competition.
Since November 2003, the Japanese Electric Power Exchange has operated a fairly simple spot market and a forward market aimed at sharing excess power among the different vertically integrated utilities, reducing retail costs by optimizing the overall wholesale generation production costs for the entire country.
Since trading on the exchange is targeted around optimizing excess power, and the vertically integrated utility structure is still intact, this market model is very much like a cost-based pool.
In India, the government initiated a policy of power-sector reform and liberalization in 1991 to support economic growth, and consequent amendments in the Electricity (Supply) Act have provided opportunities for private investment in the electricity industry within a market-driven framework. The regional states have endeavored to overhaul the state electricity boards (SEBs) and improve their financial and operational performance. Substantial progress has been made in several states on one of the first important steps in reform, unbundling the SEBs. This commitment to power-sector reform culminated in the passage of the Electricity Act of 2003, which enables private generators to market power directly to consumers or distribution companies, with open access to the transmission system.
As the retail sector grows, the wholesale-power trade also is developing in India. The Power Trading Corp. (PTC) was established in 1999, and has been brokering transactions on a small but increasing scale with five additional trading companies licensed in 2005, setting the stage for a power-trading market to develop in support of private investment in generation.
Although cost-based pools are not viewed by market-design experts as the ultimate competitive solution, there are many benefits to starting with a simpler pool model. As the generators are allowed only to compete on a variable-cost basis, it inherently provides more safeguards against excessive market power than in a bid-based spot market where generators likely would offer high prices to reflect underlying scarcity in supply compared with demand (as was the case with California). The cost-based pool is simpler to implement and minimizes price volatility. The generators will seek to maximize their profits by operating their plants more efficiently and minimizing their overall fleet operating costs.
Another recently deregulated market, the Philippines, demonstrates how the local market design reflects a unique electric topology and generation mix. The Philippines is an archipelago of 7,107 islands, only 2,000 of which are inhabited, stretching from the south of China to the northern tip of Borneo. The high-voltage grid for the country spans 20,949 circuit kilometers across the major islands of the country. The transmission system remains under the control of the national transmission company (TRANSCO), and is currently split into three major grids for the major islands: Luzon, Visayas, and Mindanao. Connection includes a 440-MW HVDC link that runs undersea, making it the first submarine cable system in all of Asia. The three grids eventually will be integrated into a single grid through an interconnection project that is underway. The interconnection will allow the three grids to share excess power with one another
On June 8, 2001, Philippine President Gloria Macapagal-Arroyo signed into law Republic Act 9136, or the Electric Power Industry Reform Act of 2001. This act triggered the implementation of a series of reforms in the Philippine Power Industry, most notable of which is the establishment of a competitive electricity market.
The primary goal of these reforms is to facilitate competitive, efficient, and transparent trading of electricity between generators and wholesale consumers, with the objective of promoting competition in electricity production and supply, and of attracting private investment in the sector. An equally important goal is to give consumers a choice of picking their provider of electricity. The resulting economic price signals from the spot market would assist generators, customers, and network-service providers in their investment decisions.
Prior to deregulation, National Power Corp. (NPC) was the local electric monopoly for generation, wholesale transmission, and sub-transmission networks in the Philippines. The prerequisites for prying open this market included: 1) the unbundling of rates to disaggregate the charges related to transmission, distribution, and supply; 2) the removal of cross-subsidies that existed on the transmission grid and between industrial and residential retail tariff rate classes; and 3) the privatization of at least 70 percent of NPC’s generation capacity in the largest islands of Luzon and Visayas.
The first phase of Philippine electric competition focused on the bulk-power system, with the launch of the wholesale electricity spot market, also called WESM, in June 2006. The market design has some very interesting elements, all of which are contributing collectively to the stability and success of the market.
WESM employs a bid-based market structure that closely resembles the Singapore wholesale electricity market (which went into operation in 2003). It is a mandatory gross pool forcing all qualified market participants to trade through the pool-trading mechanism. However, for purposes of managing risk, market participants are permitted to enter into bilateral contracts for up to 90 percent of their installed generating capacity.
Given the unique topology of the transmission grids, the electricity prices are calculated nodally. This means market prices vary depending on the location in the network and the transmission congestion that exists at specific “pinch points” on the grid. To ensure that no electricity consumer is price discriminated based on location, the loads pay a load-weighted average price, while the generators are selected and dispatched (scheduled to operate) based on the merits of their bids and are paid the nodal price (locational marginal price) at their location. To minimize power interruptions, and to ensure adequate generation reserves are available to all load areas, a parallel regulation and reserves market is scheduled to be operated and co-optimized with the energy market.
So what are some of the market issues that could set back the clock in WESM and require close monitoring?
The Electric Power Industry Reform Act (EPIRA) mandated that at least 70 percent of total capacity of the NPC’s generation assets in Luzon and Visayas be privatized prior to the “open-access” implementation. The target date for the sale of assets originally was proposed for the end of 2005, or when WESM commenced. To date, less than an estimated 10 percent of the sales target has been achieved.
Even if the NPC generation assets are unbundled and plants allocated to a number of portfolios participating independently in WESM, the common-parent ownership is likely to inhibit much needed competitive tension. This lack of diversity in ownership will inhibit competition even if multiple participants are trading these assets in WESM.
This also introduces an uncertain climate for new generation investment because of the perception that a monopoly player controls an uncomfortably large portion of the generation asset base. It makes market participants extremely susceptible to the exercise of market power (predatory pricing) by the largest player. The government is cognizant of the market concerns, and there is an increased momentum to accelerate the sale of generation assets, which is key to a competitive wholesale market.
In fact, that is exactly what happened shortly after the market opened. The first few months of operation seemed bumpy, with public allegations of power-price manipulation as electricity rates in Luzon started to go up. The price escalations allegedly were caused by collusion amongst the limited set of authorized traders on the system, making it look more like an oligopoly than a true free market for wholesale trading of power. The situation was further complicated by the outage of a natural-gas pipeline that supplied many of the gas-fired power plants in Luzon, as well as damage to the grid from a typhoon and unsuccessful attempts to repair the damage.
The Philippines Government moved quickly to reassure and restore confidence in the deregulation process, and tasked the Department of Energy to more tightly monitor WESM to prevent any possible recurrence of the reported price manipulation.
“We are confident in the capacity of the free market for self-repair and recognize that the Wholesale Electricity Spot Market is still in its infancy. Free competition is still the best way to establish prices and we will continue to strengthen this mechanism as the government pursues the privatization of power assets,” said Energy Secretary Ignacio Bunye.
Other uncertainties in the market pertain to management of market-price volatility. WESM has a price cap for generation offers and an administered price-cap mechanism for settlement during suspension of WESM operations. The maturity of the financial contract market, combined with improvement in liquidity in the coming years, should enhance the ability of market participants to manage price volatility.
The Visayas electricity grid is expected to be integrated into WESM in 2007. Given the relatively small size of the Visayas grid, and the limitations on the interconnection capacity between the islands, it may not be very practical to operate the Visayas grid as a market.
The grid also is experiencing capacity shortages that have resulted in periodic blackouts. The successful integration of this grid into the market is a challenge that WESM will soon be forced to face. The most likely way to success lies in a customer-tailored solution that recognizes the unique footprint of the high-voltage topology and the distribution of supply and load.
The different Asian electricity markets have had their share of bumps and bruises on the road to competitive free markets, but many in government and industry deserve credit for confronting their monolithic utility structures and incorporating competitive changes, without disrupting the equilibrium necessary to social order. This would seem to be a rite of passage in market development that could inform those who aspire to move beyond the confines of governmental and market regulation.