The right market design for trade between power markets

Michael Giberson

Windpower Monthly has a great article describing changes in the market for transmission capacity between power systems in Europe and the benefits of the changes.  Here is a summary by way of selected quotes, but the full story is worth reading:

Most of the electricity cables connecting Europe were built when electricity systems in each country were monopolised by a single or, at most, a few companies, each operating within their individual monopoly supply areas. Each utility ran its own system and had its own generation backup for emergencies. There was no competitive pressure on the higher costs of such “island” systems since these could easily be passed on to customers who, in those days, had no alternative suppliers that they could switch to.

These interconnectors were built between neighbouring countries’ electricity grids not to enable trading and competition across borders but rather for the utilities to help each other out….  [As the Eurpopean power industry was liberalized] insufficient connection capacity between some of the national electricity networks [emerged as] one of the key problems.  [An] efficient allocation for the scarce interconnector capacity that is available is crucial to make improvements towards an integrated European electricity market.

Before the new [market coupling] system started, transmission capacity available on the two interconnectors was sold to electricity traders in tranches in annual, monthly and daily auctions, called explicit auctions. This happened completely separate from auctioning of electricity with the result that, due to the time lag in buying the transport capacity and the actual time of use, as well as other reasons, inefficiencies occurred.

Transport capacity could be bought ahead of time and hoarded, a form of market abuse. Or transmission capacity was bought for one direction, say from Germany to Denmark, which then turned out to be inappropriate because the price difference between the two was such that the electricity ought to flow in the other direction – from the low- to the high-price zone. In such instances, the electricity did then flow in the wrong direction, contradicting market forces, or not allowing extra capacity to be used – and traders and end users lost out.

Explicit auctions were implemented for interconnectors at most European borders, recounts [EMCC managing director Enno] Bšttcher. “Even though this can be considered as progress compared to the formerly applied first-come, first-served or pro-rata regimes, explicit auctions still have many disadvantages,” he says.

Today, explicit auction methods have become more sophisticated. The fundamental flaw, however, remains: that actual trade of electricity at energy exchanges in the different market areas is separate from transmission capacity, trading leading to market inefficiency. This can be reduced by combining cross-border transmission capacity allocation and electricity trade from one country or market area to another in a so-called market-coupling regime.

Market coupling uses implicit auctioning and focuses on the short term (day ahead), rather than months or a year ahead. The transmission capacity available on an interconnector the next day, as reported by the transmission system operators (TSOs), is matched with electricity bought or sold on the energy exchanges in the two countries involved for delivery the next day, creating a price for the transmission capacity and making it clear in which direction the market requires use of the transmission capacity of the cables.

In effect, market coupling is a charge placed on the power exported or imported between countries when the network interconnector capacity is optimised to reduce congestion.

The result of market coupling is that the interconnected power systems operate more efficiently, benefiting consumers and low-cost producers of power.

As Tres Amigas works out its design for the sale of transmission capacity across the proposed three-way transmission interconnection, market coupling should be among the designs contemplated.

Note that while day-ahead market coupling seems to work well between systems with relatively few interconnecting links, more complex transmission links between systems – say as exists between PJM and the Midwest ISO – may well call for still more extensive coordination. The market coupling principle seems sound, so probably forms an adequate foundation to build upon, but simple day-ahead coordination is likely insufficient. Real-time market coupling, anyone?

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