Alex Henney is associated with Energy Economic Engineering Ltd. in London, and has consulted in many countries. As early as February 1987, Henney advocated competitively restructuring the electricity supply industry and incorporating a pool as a real-time spot market. He is the author of A Study of the Privatisation of the Electricity Supply Industry in England and Wales.
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Last year, the Norwegian Market Co. decided to stick with bilateral trading and a spot market. I advised the British gas regulator to facilitate bilateral trading, and the British electricity regulator to stick with "PoolCo."
That is not to imply that the English pool does not have problems. It does. But to understand them (em and more importantly, how to avoid them and do better next time (em one has to look at how the pool was developed and work out the lessons of experience.
The fire and thunder of the U.S. debate lead me to wonder whether the theological point escapes me, or I am unduly eclectic and broad church. Alternatively, can it be that some of the participants in the U.S. debate do not know what they are talking about? Or perhaps some know only too well and have agendas for making money (em not out of "fierce competitive" markets and mother's blueberry pie, but out of obfuscated market imperfections.
Emotive armwaving from the New York Mercantile Exchange (NYMEX), caricaturing a PoolCo as a monopoly with a "big appetite" across two pages of ill-informed assertions, adds to heat but not to light.
As Professor Hogan and Larry Ruff pointed out, the basic economics of PoolCo with contracts for differences (CfDs) and of bilateral trading plus a spot market are similar in principle. As in other commodity markets, the pool or the spot price will drive short-term contract prices, however trading is arranged. Using CfDs around a pool allows two parties to enter into any form of commercial relationship they want. Indeed, the English system can be regarded as a contract-based system with the pool automatically pricing the uncontracted trading.
There are, however, some important differences between the two:
s By requiring all generators to bid, PoolCo may be more liquid than a spot market associated with bilateral trading, because it is not in the interests of dominant players to develop such a market.
s In a system comprising a number of modest-sized companies with thermal plants, PoolCo is better able to retain the benefits of scheduling. (This is not so important in a hydro-based system.)
s PoolCo is more transparent than bilateral trading, which is why some large customers in England supported the latter (em they hoped opacity and confusion would help them to better (that is, discriminatory) prices.
s Accounting will be easier with a PoolCo than with bilateral contracts, which have to be reconciled every hour or half-hour. As the number of contracts increases, so do the data problems.
s PoolCo automatically provides the benefits of aggregation or portfolio scope and is more equitable for smaller generators and customers.
s A properly designed PoolCo provides balancing and ancillary services on efficient terms, allowing no free riders.
Clearly, a well-designed PoolCo will provide the most efficient and equitable market framework, reducing the opportunities to profit from market imperfections.
Professor Hogan was correct to argue that the debate is something of a distraction. A number of other significant and tricky issues, which add up to fair sums of money, should be sorted out if "competitive" power markets are also to be reasonably efficient. For example, How do you charge for voltage and frequency regulation and make them transparent and competitive? Also, How do you charge for the costs of constraints and provide the proper incentives for reducing these costs? Incentives interact with both PoolCo (or the spot market) and transmission pricing in complex ways and, as we found to our cost, it is not difficult to build in perverse incentives.
The design of electricity markets will in practice be based not upon the theoretically desirable, but upon the institutional framework and characteristics of particular electricity market areas. Perhaps the debate has missed the most fundamental point. Namely, the appropriate means of trading is influenced by industry structure: Bilateral trading may be more appropriate than PoolCo with an integrated structure. (Consider that oil spot and futures markets developed hand in glove with the "unbundling" of the oil majors into upstream and downstream activities.) A PoolCo is definitely likely to be easier to implement with a vertically fragmented structure and an independent grid. Indeed, the effect of the Federal Energy Regulatory Commission's Order 636 on gas industry structure suggests that such a structure may well lead that way in the long run.
Further, a PoolCo is complex to negotiate (the English pooling agreement runs to 1,000 pages). Thus, it is key that an electricity market area be under a single jurisdiction, one that has sufficient authority to force agreement if necessary. In practical terms, bilateral trading will likely be available as the default mode, particularly in a vertically integrated industry, and each major company has its own area of control over ancillary services and constraints. Finally, the physical characteristics of a particular system will play a role. For example, large thermal plants are not as flexible to operate as reservoir and pumped-storage hydro, and those with less nimble plants will soon realize they do not want a system whose market rules disproportionately benefits flexible plants.
The likely evolution of competition in many, if not all, parts of the United States will be bilateral trading between utilities, larger customers, and perhaps some retail merchants who will try to package a portfolio of smaller customers. This type of competition will reduce some of the grosser distortions (em such as blatant cross-subsidization and crude mispricing of transmission services (em leaving the integrated utilities with numerous modest areas of market power over ancillary services and constraint costs at the generation level. Merchants may profit from trading on the artificial inefficiencies resulting from the jurisdictional and regulatory failures to resolve issues. A series of regulatory cases will erode these advantages, and calls for complete separation of transmission will increase. When that is done, PoolCos may come into their own, perhaps run by NYMEX. By then, they would have profited from the inefficiencies of the past, and could leave the road from Tarsus understanding something about electric systems and how they differ in detail from the U.S. gas system. t
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