7. Security of Supply - Details

Question 1

Why do market agents supposed take wiser investment decisions than the government?

Answer 1

Investors pay for their mistakes through direct economic losses

Question 2

Name 3 market imperfections

Answer 2

1. Market is risky (generators & consumers are risk averse)
2. Distortion of market signals
3. Lumpiness of investments

Question 3

What is meant through market incompleteness?

Answer 3

• generators have issues hedging their risks
• > they install less capacity than required

The long-term segment of the market does not develop as necessary and this impedes generators to hedge their risk.

In pursuit of protection against low-price scenarios, generators tend to install less capacity than the optimal one and this affects system adequacy

Question 4

Why does demand seem unconcerned about security?

Answer 4

They don’t want to be bound for a long time because they assume there will always be electricity and that prices could change to their advantage

Question 5

What happens with the reliability of the system with a lower price cap?

Answer 5

the lower the reliability of the system

Question 6

Which are the different approaches to system adequacy?

Answer 6

1. Energy-only markets
2. Capacity remuneration mechanisms
3. Implicit regulatory safeguards

Question 7

What is an energy-only market

Answer 7

• The regulator does not interfere with the market

- Demand learns to manage risk by being more active in the long-term

Question 8

What is a capacity remuneration mechanism?

Answer 8

Intervention from the regulator aiming at guaranteeing the security of supply

Question 9

Which types of CRMs exist?

Answer 9

1. Price-based

2. Quantity based

Question 10

What is a price-base CRM?

Answer 10

Participants receive a payment per MW (capacity payment) that they offer to the market

Question 11

What are the problems with price-based mechanisms

Answer 11

1. Lack of commitment for the generators & weak economic incentive to be available when needed
2. No guarantee that any desired investment target will be achieved

Question 12

What is a quantity based mechanism?

Answer 12

The regulator establishes the desired quantity [MWh] and allows the market to set the right price

Question 13

Which designs exist in a quantity-based CRM?

Answer 13

1. Strategic reserves
2. Capacity obligations
3. Capacity auctions
4. Reliability options

Question 14

What are strategic reserves?

Answer 14

Strategic reserves consist of separating off a certain amount of generation capacity that does not participate in the energy market unless the regulator or the system operator finds it necessary.

Dispatched when the market price exceeds a predetermined triggering price

Question 15

What are the problems with a strategic reserve?

Answer 15

1. If the price is too low, it represents a hidden price cap which does not allow resources in the market to recover their fixed costs
2. If it is too high, demand may wonder what is the point of paying reserves if the price reaches the value of lost load anyway

Question 16

What are capacity obligations?

Answer 16

• Generating units receive credit for their installed capacity, de-rated according to a predefined methodology to take possible outages into account

supposed to guarantee that enough installed capacity will be available to supply demand during stress events.

Question 17

What are capacity auctions?

Answer 17

Centralised procurement: the responsibility of procuring long-term capacity contracts is assumed directly by the regulator, who assesses demand growth and launches centralised tenders for its coverage

Question 18

What are reliability options?

Answer 18

The specific type of reliability product, which associates the physical long-term capacity contract with a financial call option, which limit the remuneration that resources can obtain during scarcity conditions

Question 19

Which are the implicit regulatory safeguards?

Answer 19

1. State-owned power company
   (Shares the regulator’s concerns about system reliability and takes investment decisions that reflect such concerns more than economic rationale
2. Horizontal concentration
3. Advanced procurement of operating reserves (hidden targeted capacity mechanism)

Question 20

Which are the design elements of capacity mechanisms?

Answer 20

1. Procurement process
2. Contract provisions
3. Reliability product
4. Performance incentives

Question 21

Which elements make up the procurement process?

Answer 21

1. Buying side
2. Level of centralization
3. Selling side

Question 22

Which elements make up contract provisions?

Answer 22

1. Lag period (contract signature - delivery time)
2. Contract duration (determines level of hedgin, should be long enough
3. Indexation forumals (to update CRM remuneration)
4. Financial warranties

Question 23

Which elements are relevant in performance incentives?

Answer 23

1. Penalty rate
2. Overperformance payements
3. Exemptions and penalty caps

Question 24

Which are the types of reliability products?

Answer 24

1. based on capacity or on energy, depending on the type of scarcity conditions in the system
2. can remunerate just the availability of resources to produce the committed product
3. require its physical delivery → can be coupled to the physical delivery or not

Question 25

Whats the difference between capacity- and energy constrained systems?

Answer 25

• Capacity-constrained systems have trouble in covering peak demand because it lacks installed capacity (MW) to satisfy peak demand
• In energy-constrained systems, the system could satisfy peak demand but would not be able to supply the load during the remaining hours of the day or week. The problem is a lack of energy (MWh).
  → Energy-constrained systems are those with a large share of hydropower in their generation mixes
  ⇒ Congo, Brazil

Question 26

Important elements in relability products

Answer 26

• Critical period indicator

- Constraints on tradable quantities

Question 27

What is a critical period indicator?

Answer 27

The methodology to identify scarcity conditions

• short-term price
• stress events

Question 28

What are barriers to CRM cross-border participation in Europe?

Answer 28

1. Mistrust of fulfilment of cross-border contracts during scarcity conditions.
   • For CRM to work, the system operator of the country launching the CRM must be sure that during scarcity conditions, the foreign resources are available
   • But most electricity laws in Europe say that exports to other countries are to be interrupted in case of a domestic emergency of supply
   ⇒ solution: stronger coordination among system operators