Your Competitive Edge In Energy

Designing Liquid, Transparent, Reliable Wholesale Markets

Nigel Evans

Executive Vice President

Head of Global Energy Market Strategy

Competitive Wholesale Markets - Building Blocks

Full separation of transmission/distribution (from generation and retail supply)

Full retail supply competition

Properly incentivised, for-profit SO

Regulation of behaviour based on financial-markets best practice and application of competition laws

And remember

Markets are not “designed”

Establishing competitive wholesale markets- the Pool approach

Establish a market at a specific time day-aheadSolicit offers and bids from generators and customers

Offers designed to reflect generators’ costs (multi-part structure, start-up and no-load costs, minimum run-time, ramp rates and other technical parameters)

Complex algorithms used to calculate a single (hourly or half-hourly) clearing price

Examples: Australia, England & Wales Pool (1990), FERC standard wholesale market design

The day-ahead Pool approach does not work

Repeated daily auction encourages leader-follower pricing strategies with few participants competing to set clearing prices

The complexity of pricing algorithms frustrates transparency

Encouraging significant demand-side participation can be problematic

Straightforward to manipulate prices (problem if the Pool is compulsory, even worse if it’s not)

Difficult to hedge price risk (the complexity of pricing algorithms and ability to manipulate prices discourages non-physical players from participating in market)

Disconnection between day-ahead and real time markets

So what should you do?

Enable all market participants to trade in whatever way they choose right up to real time

Typically participants may trade:

OTC

via exchanges (cleared or otherwise)

Tenors from years to hours (or less)

Participants will decide terms on which they trade, but will typically use a “pay-as-bid” approach

“ I offer to sell you 100 MWh at $21/MWh..Agreed”

So what should you do? Cont...

Transactions take place because

“Longs” will wish to sell

“Shorts” will wish to buy

and “Traders” will wish to trade

Market prices emerge (via price reporters, exchanges, or even mandated reporting) on the basis of prices at which transactions take place

Algorithms play no part in establishing market prices

Maintaining balance in real time

SO (RTO) has responsibility to maintain balance in real time

SO incentivised to balance economically using a broad range of forwards, options and real time actions

SO market power curtailed through:

- separation (and ownership)

- collars on incentive revenues/losses

- market information disclosure obligations

Maintaining balance in real time. Cont..

Out of balance market participants cashed out based on costs of balancing actions (excluding constraint/frequency response action)

Need for on-going surveillance for exercise of locational/temporal market power

How does this work in practice?

New Electricity Trading Arrangements (NETA) replaced England & Wales Pool in March 2001

Power exchanges/brokers have emerged

Price reporting has developed

Liquidity has increased

Volumes bought/sold in the (real-time) balancing mechanism have remained low (2% of physical)

(and in the over-supplied market wholesale prices have fallen)

Tra

din

g P

eri

od

BM IS

T-3 ½ hrsT-One DayT-One MonthT-One Year

Bulk OTC Trading

Standardised Products

Option Contracts

Other Financial Products

PX Trades

The New Electricity Trading Arrangements (NETA)

Exchange LiquidityMonthly Traded Volumes

-

2,000

4,000

6,000

8,000

10,000

12,000

14,000

Apr-01 May-01 Jun-01 Jul-01 Aug-01 Sep-01 Oct-01 Nov-01 Dec-01 Jan-02 Feb-02 Mar-02 Apr-02 May-02

GW

h

UKPX UKAPX Spectron

www.caminus.com

Presented to the

National Energy Marketers Association

Annual Conference June 21, 2002

Washington, DC

© 2002 Caminus Corporation