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C.K. WOODEPARTMENT OF ECONOMICS
HONG KONG BAPTIST UNIVERSITY
An overview of electricity market reform and deregulation
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Objective
Present an overview of electricity market reform and deregulation
Offer a list of key questions to help frame the discussion and guide the decision-making process
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Why should we care?
Electricity cannot be economically stored and must be supplied in real time to meet fluctuating demand
Real time demand can sharply spike due to extreme weather and is price insensitive
Electrical equipment can fail unexpectedly
Renewable generation (solar and wind) is as available, intermittent, and non-dispatchable
Reliable supply can only occur with capacity reserve and backup facilities More volatile total demand, more total capacity Higher failure rates, more facilities
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Electricity has no close substitutes for many end-uses (e.g., motor, lighting, cooling, electronics)
Electricity can only be produced and delivered with equipment already in place
Electricity requires capital-intensive investments with long lead time
Electricity service disruption can have large economic consequences
Though dangerous, electricity theft does occur, at times with fatal consequences (e.g., KFC thief)
Why should we care?
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Transformative events
Electricity market reform and deregulation results in (a) competitive wholesale energy markets with hourly prices by location; (b) inter-regional trading; and (c) retail competition for customers
Large-scale renewable energy development requires flexible generation and load to accommodate intermittent, unpredictable and as-available generation (e.g., wind)
Smart grid, smart meters and smart appliances enable electricity product differentiation and responsive/flexible loads
What’s next for Israel?
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What is a desirable outcome?
Safe, reliable, and environmentally friendly service at just, reasonable and stable rates, which requires:
Least-cost investment and operation
Diversified demand-supply mix for energy security, including reliable integration of renewable resources
Efficient pricing of differentiated services to meet diverse customer needs
Investment and pricing decisions sensitive to unpriced environmental factors
Recovery of reasonable risk-adjusted return on and of investments
Performance basedRegulation (PBR):UK and Australia
Government ownership
North America: California,
Texas, PJM, New York,
New EnglandCanada: Ontario and
AlbertaEuropean Union
Australia New Zealand
Market organization optionsWhat are the drivers for change?
Pre-reform: Europe, Ontario, China, Australia, New
Zealand, Singapore
Rate of return (ROR) Regulation:
North America
Degree of decentralized decision making
Privately owned integrated utilities
Market reformand deregulation
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Stylized model
Customers
Distribution Companies Retailers
Wholesale Generation Market
(Pool Structure)
Bilateral Market Financial
(Contracts) Market
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Path to success
Successfulimplementation
Unsuccessfulimplementation (e.g., few sellers)
Existing capacity shortage, slow market entry,
and inelastic demand
Existing capacity surplus, fast market
entry, and elastic demand
Good design Bad design
Marketdesign
Designstage
Implementationstage
Operationstage
Gains: Lower costs, lower prices,more choices, better reliability
Losses: Higher and more volatile prices,capacity shortages, lower reliability
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Status in the US
Source: http://www.eia.doe.gov/cneaf/electricity/page/restructuring/restructure_elect.html
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Anticipated challenges
Electricity deregulation is complicated, with many under-estimated challenges
The cost of setting up and operating an Independent System Operator (ISO) is substantial
Marrying competitive generation with grid operation leads to many markets: (a) energy markets (e.g., forward, day-ahead, hour-ahead, real-time); and (b) ancillary service markets (e.g., spinning and non-spinning reserves, regulation, voltage support, real power loss, energy imbalance)
Electricity spot prices are highly volatile due to random demand, fluctuating fuel cost, unpredictable equipment failure, and intermittent renewable generation, necessitating risk management by market participants
Market power abuse is common in deregulated markets When supply is short, even minor capacity withholding can be highly
effective and profitable, at the expense of consumers
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Electricity deregulation may cause insufficient investment because price and revenue volatility discourages investment, even in the face of capacity shortage
Renewable energy development erodes the incentive to invest in flexible generation critically needed for reliable grid operation
Deregulation can jeopardize reliability: merchant generation investments do not always occur in the right place at the right time
Deregulation seldom reduces generation cost
While competition reduces labor and O&M costs, generation cost may not fall because merchant generation’s capital cost exceeds a regulated utility’s capital cost
Dysfunctional input markets may preclude an efficient output market because of vertical market power abuse
Contract breach can occur, especially when the wholesale market price explodes
Anticipated challenges
Key questions
Question Remarks
What are the key drivers for change? And what does one ultimately want?
As in a medical case, not knowing what’s wrong with the patient, it is difficult to find a fix. Answering these questions sharpens what one wants from deregulation.
Will there be adequate capacity after the reform?
Adequate capacity provides the reserve required for reliable service, stable price, and market power mitigation.
Will many price-taking sellers compete for sales to many buyers?
A few dominant sellers can abuse their market power to raise prices. However, too many sellers can result in fierce price competition, rendering the industry financially unstable.
Will efficient investment occur? Deregulation replaces centralized planning with decentralized decision-making driven by market prices. To date, market competition, absent long-term contracts, has failed to induce much merchant generation in the US.
Will there be sufficient transmission available under open access?
Transmission congestion limits trading that would have caused electricity to flow from low-cost areas to high-cost areas. As well, it creates load pockets and exacerbates market power.
Will the input markets be competitive?
A dysfunctional input market can compromise the economic performance of a wholesale generation market.
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Question Remarks
Will electricity end-users see and respond to wholesale price changes?
Demand response reduces market power and improves reliability. However, electricity consumers, especially households, prefer rate stability and are insensitive to hourly price variations.
Will there be strong and enforceable rules and laws?
They are required to prevent gaming, market power abuse, and contract breach.
How will open access occur? Generation competition cannot occur without open access. If transmission is publicly owned, open access can be more readily implemented than otherwise. The US achieves open access via Order 888 that preserves the rights of transmission owners and allows for stranded cost recovery.
Will transaction costs be large? Large transaction costs dissipate potential benefits from deregulation. Moreover, some transaction costs (e.g., ISO and market set up) must be committed upfront.
Will the post-reform spot price be reasonably stable?
High and volatile prices can doom a market reform because of unstable bills that force politicians “to do something” like price capping which discourages investment.
Will deregulation harm reliability?
Centralized planning and investment have yielded highly reliable service, which may not be the case under decentralized decision-making.
Key questions
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Question Remarks
Will there be active forward trading?
Forward trading facilitates market power mitigation, price discovery, and risk management.
Will deregulation adversely affect income distribution?
Even if deregulation can produce positive net benefits, electricity producers and large customers are likely to receive the benefits, while households and small business customers pay higher rates.
Will there be commitment to deregulation?
If voters and politicians would reverse deregulation after the inevitable price spikes, deregulation should not have occurred in the first place.
Will electricity consumers be made better off?
Deregulation should be based on a careful cost-benefit analysis, not an ideological belief in competition.
Can the projected benefits of deregulation be obtained via other means?
Deregulation is not the only mechanism to improve the performance of an electric sector. Competitive procurement and performance based regulation is a less risky alternative.
If deregulation fails, can it be reversed?
Deregulation often entails divestiture of the integrated utility’s assets. Once done, it is almost impossible to put the pieces back together again.
Key questions
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C.K. Woo, Ph.D. (Economics, UC Davis)
Dr. Woo is Professor and Head of the Economics Department of HKBU and Senior Partner (now on leave) of Energy and Environmental Economics, Inc. (www.ethree.com), a consulting firm located in San Francisco
He specializes in energy economics and applied microeconomics. With 30 years of industry experience, he has participated in electricity market reform in California, Texas, British Columbia, Ontario, Macau and Hong Kong
He has co-authored 12 papers with Professor Asher Tishler on the Israeli electricity industry
He has over 100 papers in such scholarly journals as Energy Policy, The Energy Journal, Energy, Energy Economics, Journal of Regulatory Economics, Journal of Public Economics, and Quarterly Journal of Economics
Recognized by Who’s Who in America, he is (a) a senior fellow of the US Association of Energy Economics; (b) an associate editorial board member of Energy and The Energy Journal; (c) a guest editor for a special issue of Energy Policy on renewable energy
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