Lecture 3: Electricity Markets: Models and Structure

Question 1

Why do we need a other marcet structure than the
Bilateral trading agreements

Answer 1

Bilateral trading agreements do not fulfill the requirements of power markets (Time,Transparency, Prices)

Only multilateral, central platform market institutions can offer the necessarytransparency and coordination in a timely fashion for efficient allocation of generation,
transmission and balancing actions

Bilateral trading agreements only play a role in derivatives / forward markets

Question 2

Which basic market models have we learned about ? Briefly Summerize.

Answer 2

Pool Model
* Central market organization
* Central optimization
* Power Trading compulsory takes place
* in one market
* Generation, Transmission, Balancing is
* optimized simultaneously

Exchange Model
* Decentralized market organization
* Decentralized decisions
* Power Trading voluntary takes place in
* closely linked , interdependent but
* separated markets (Futures,
* Spot, Transmission, Balancing)

Question 3

Market Models: Pool Model

Answer 3

Pool market is centrally organized institution where a complete trading is compulsory for participants there is a centralized manager for the Central optimization where the generation transmission balancing and optimized simmultaniosly. the Pool market Focuses on short term cost optimal allocation of resources with the use of locational marginal pricing

Question 4

Market Models: Exchange Model

Answer 4

Exchange model is decentralized institution where trading is voluntary for participants. Because it is also possible outside of the exchange. There is no central manager and generators optimize their plan themselves. Market prices influence the desicions and investments. Is more than one market are not at the goodly coupled inefficient allocations can occur.

Question 5

Evaluation: Pool Model

Advantages:

• Pool Model is good if ….
• …… cannot play an important role in
  price determination

Answer 5

competition in the market is high.
Demand
Optimization

Question 6

Evaluation: Pool Model

Challanges

Answer 6

Some challenges of the pool model is that we should keep in mind that the Pool market model is efficient in short-term, but not for the long term decisions. Other than that the optimization algorithms also need a high amount of information and thus high costs

Question 7

Evaluation: Exchange Model

Advantages:
- Simpler Implementation
- Active Participation of …..
- Bad market design can be addressed by change to other market platform
- If coordination of interdependent markets is not so important transaction costs are lower

Exchange model
- Decentralized markets can also contribute to cost-minimal supply if expectations of market participants about allocations are correct → good forecasting is required
- Tight coupling of interdependent markets can reduce inefficiencies between generation, transmission and balancing power markets

Answer 7

Advantages:
The exchange model has a simpler implementation where the active participant of the demand takes place. That Market design can be addressed by change to the other market platform.

Question 8

Evaluation: Exchange Model

Challanges

Answer 8

Challenges:
- Bad coordination between interdependent markets
can hamper market results and investment
incentives
- E.g. APX UK, where missing reference price leads
to lower trade volumes and lower transparency in
trading (no arbitrage possible)

Question 9

What are the Benefits of competitive wholesale markets

Answer 9

Effective competition
Efficient investment and improved security of supply
Efficient operation
Efficient risk management
Efficient use and expansion of transmission infrastructure
Unsustainability of subsidies and other inefficiencies

Question 10

Benefits of competitive wholesale

Effective competition

Answer 10

▪ reduce the entry barriers for independent generators and retailers
▪ new entrants can enter the generation and the retail markets separately

Question 11

Benefits of competitive wholesale

Efficient investment and improved security of supply

Answer 11

▪ provide price signals for both demand and supply
▪ encourage new investment
▪ give the signals on the type of investment (e.g. base-load or peak) or choice of
technology that is most required in the market

Question 12

Benefits of competitive wholesale

Efficient operation

Answer 12

▪ give signals to the market to dispatch low cost plant and to plan maintenance at
times with the lowest demand
▪ price signals can encourage flexible customers to reduce their demand at times of
peak consumption

Question 13

Benefits of competitive wholesale

Efficient risk management

Answer 13

▪ allow suppliers and consumers to hedge their portfolio of electricity at a minimum volume and price risk if markets have sufficient depth

Question 14

Efficient use and expansion of transmission
infrastructure

Answer 14

▪ provide the price signals necessary for the TSO and regulatory agencies to identify
when market participants should transmit energy from one zone to another
▪ provide price signals to identify when and where additional interconnection capacity
would be cost effective

Question 15

Which wholesale market participants

With inherent physical position
Without inherent physical position

Answer 15

with... Generators
        Retailers

		without...  Financial traders  -> 
▪ Buy and sell to exploit price
differences (arbitrage)
▪ May take speculative
positions (dis-/aggregate
purchases and sales over
different dimensions)
▪ Intermediary

Question 16

Trading at OTC vs. Time of trading

OTC
* Trading directly between two parties
* Decentralized market without a central physical location
* Multiple prices for one good possible
* Risk that one contracting party does not fulfill its obligation

• E.g. forwards, futures, options
• Exchange of the goods after a predefined timespan (after contract
  formation)

Answer 16

Trading at Exchange vs. Time of trading
Exchange
* Standardized contracts
* Clearinghouse determines the clearing price
* Clearinghouse takes the counter party risk
* Only one price exists for one good at a given time

Spot market
* Seller delivers the goods immediately
* Buyer pays “on the spot”
* Neither party can back out of the deal

Question 17

What are the specs of Spot market

Answer 17

• Alternative, anonymous procurement & trade channel
• Prices are made transparent
• Serves as reference price
• Minimizes transaction costs by processing central
• Liquidity through standardization

Question 18

What are the specks of Futures market

Answer 18

• Basics for risk management / investment security
• Increases market efficiency as arbitrage & speculation
  platform
• Serves as basis of valuation for vacant positions
• Clearing minimalizes default risk of opponents
• Futures market supports liquidity in spot trading

Question 19

Tell the differences between the
Financial Market and the Physical Market in Terms of Trading Types?

Answer 19

In the case of physical delivery, the delivery is fulfilled at a certain place given the payment of money. This physical delivery is always provided for spot transactions and also for options in futures trading.

Financial settlement or cash settlement of forward transactions, on the other hand, is only financially settled. Here, the difference between the price of the forward transaction and the price of the underlying delivery, i.e. the underlying transaction, is financially settled between the buyer and the seller. This means that the buyer and the seller settle in cash the difference between the final settlement price and the agreed price of the futures transaction.

Question 20

Which Trading Products are there in the derivates Market (Terminmarkt)

Answer 20

Forwards
Futures
Options

Question 21

What is Forward in derivative Market ?

What is a Future in derivative Market ?

Answer 21

Unconditional derivative - in both cases
Bilateral contracts - in both cases

The diffrence between the Futures and Forwards lies in the fact that the Futures contracts have standardized specifications such as size, maturity, quality and delivery location. This standardization enables futures to be traded on an exchange. Forwards, on the other hand, are individually agreed contracts between two parties who negotiate directly with each other and negotiate the terms of the contract. This allows the parties to adjust the terms of the contract to their specific needs. However, forwards have the disadvantage of being less liquid than futures, as they are not traded on an exchange and are therefore more difficult to sell.

in Forwards and Futures both the Obligation to buy or sell.

Seller: Obligation to deliver a specified amount of an asset for a predefined
price on a future date (short position)

Buyer: Obligation to buy this amount of the asset for the predefined price
on the agreed future date (long position)

Question 22

Info Wichtig

Both futures and forwards are unconditional Termin(Future) transactions that are essentially the same in their structural design. In both cases, an agreement is made in advance to buy or sell an underlying asset at a certain price on a fixed date in the future. Accordingly, both financial products belong to the group of derivatives whose basic intention is to hedge against market price risks in the period between the conclusion of the contract and the delivery date.

Question 23

What is a Option in a Derivative Markt?

Answer 23

Options are also used in the derivatives market for price hedging, but unlike futures and forwards, they are not mandatory but optional. This means that the buyer of the option has to buy or not the underlying future at pre-agreed price on the agreed day. For this purpose a corrospending premium is paid.exercise date is shortly before the delivery or, the maturity of the underlying futures.

Question 24

Wann gilt als der Zeitpunkt für die Grundlast wann für die Spitzenlast?

Answer 24

A base load or baseload profile is understood to be the uninterrupted supply of power. A peak or peak-load profile is understood to mean a supply during the weekdays from **Monday to Friday **from **8 o’clock in the morning to 8 o’clock **in the evening.

Question 25

How is the Liqiudty in EU Forwrd Markets and what is a Churn Factor?

Answer 25

The liquidity in EU forward markets can vary depending on the specific market and the maturity of the contracts. Generally, the forward markets for commodities such as energy products and agricultural goods are less liquid than the futures markets. This is because forward contracts are typically traded over-the-counter (OTC) between two parties, rather than on an exchange, which can limit their availability and transparency. That being said, there are several established exchanges in Europe that offer standardized forward contracts for certain commodities, such as the European Energy Exchange (EEX) and ICE Futures Europe. These exchanges provide a centralized platform for trading and clearing of forward contracts, which can increase their liquidity and transparency. As for the churn factor, it is a measure of the trading activity or turnover in a particular market or contract. It is calculated as the ratio of the total volume of contracts traded to the open interest (the total number of outstanding contracts) over a given period of time. A high churn factor indicates a high level of trading activity relative to the number of outstanding contracts, while a low churn factor suggests a less active market.

Question 26

Explain the specs of the Day Ahaed Market

Answer 26

Day Ahaed is used for daily optimization of the power portfolio for the next day. optimization is done for every single hour for the following day. The trading participants enter their bids ananymously into the closed order book. Depending on these marginal cost bids a merit order curve is formed. Depending on these marginal costs and already existing delivery commitments from long-term contracts, the power plant operator is willing to produce more electricity and sell it on the dayahaaed trade or vice versa. On the basis of the trading orders received, a price is determined daily for each hour in the auction of the so-called MCP, which applies to each participant.

Question 27

Explain the Specs of the contunious intraday Trading

Answer 27

Intraday trading for 15min 30min or 60 min products. The intraday trading starts in DEU at 3pm on the previous day with the opening auction which allows 96 quarter hours for the next day. From 4pm onwards the other products of the intraday market can be traded before settlement. The intraday trading is done except for the opening auction as a continuous trading instead of an open order book, i.e. everyone can see it. It is pay as bid matching. The opening auction starts at 15:00 and lasts 5 minutes. During this time, market participants can enter buy and sell orders for securities. The orders are collected in an order book where they are prioritized by price and time. At the end of the auction, the opening price for each security is determined. This price is determined based on the total number of buy and sell orders and available liquidity. The opening price is the price at which the most orders can be executed. Once the opening price is set, continuous trading in the Xetra system begins. During continuous trading, market participants can enter, modify or cancel orders at any time. Prices are adjusted in real time to reflect changes in the market

Question 28

Comparison of **call market (Auction**) and **continuous trading** in electricity trading

Answer 28

**Call market** Call auction Bids collected until closing (e.g. 12:00 a.m. / noon) Market clearing price after freeze Closed order book Principle of highest executable volume Examples: Day ahead auction **Continuous trading** Continuous trading Immediate execution if possible Continuous price - Pay As bid Open order book Principle of highest executable volume Examples: Intraday trading

Question 29

What is a quoted Spread ?

Answer 29

*…the difference between Best ask and Best bid of an order book *“The bid-ask spread is the price impatient traders pay for immediacy” A Quoted Spread is the difference between the ask price and bid price of a security or other financial instrument as provided by a market maker or broker. It is also known as the bid-ask spread. The ask price is the price at which a market participant is willing to sell the security or financial instrument, while the bid price is the price at which a market participant is willing to buy it. The Quoted Spread is the difference between these two prices. The Quoted Spread is an important indicator of market liquidity. A tight Quoted Spread, or a small difference between the ask and bid price, suggests high liquidity because it is easier to trade the security or financial instrument quickly without significantly affecting the price. A wide Quoted Spread, on the other hand, or a large difference between the ask and bid price, may indicate low liquidity, as it may be more difficult to trade the security or financial instrument quickly and at a fair price. 𝑄𝑢𝑜𝑡𝑒𝑑𝑆𝑝𝑟𝑒𝑎𝑑𝑖,𝑡=(𝐴𝑠𝑘𝑖,𝑡−𝐵𝑖𝑑𝑖,𝑡)/ 2*𝑀𝑖𝑑

Question 30

What is a Effective Spread?

Answer 30

Der **Effective Spread** ist eine Messgröße für die tatsächlichen Transaktionskosten beim Handel von Wertpapieren oder anderen Finanzinstrumenten. Im **Gegensatz zum Quoted Spread**, der die Differenz zwischen dem Angebotspreis (Ask-Price) und dem Nachfragepreis (Bid-Price) darstellt, **berücksichtigt** der Effective Spread auch die Ausführungskosten, die bei einer **Transaktion** anfallen. Der effektive Spread ist der Spread, den derjenige zahlt, der mit Marktaufträgen handelt - Der effektive Spread bezieht sich auf eine **spezielle Handelsoperation** Large orders change the book in a way, so that the average spread, which is paid for a trade, is higher than the quoted spread

Question 31

How does the Balancing or real time market works?

Answer 31

* Operates after the closure of the spot market * Participants submit bids that specify the prices they require to increase their generation or decrease their consumption for a specific volume immediately * Goal: To balance power generation to load at any time during real time operations * Real time exchange works like a Walrasian auction * Procedure:  Announcement of a price  Sellers and Buyers respond  If the market is not cleared  Announcement of new price

Question 32

Real time exchange works like a **Walrasian auction**, what is that?

Answer 32

A Walrasian auctioneer is a fictive auctioneer who aggregates and adjusts supply and demand According to the aggregated information of supply and demand the auctioneer determines the perfect price Exchange of goods after price fixing In a Walrasian auction, buyers and sellers submit their bids and offers for the goods they wish to buy or sell. These bids and offers are then used to determine the market-clearing prices and quantities that equate supply and demand for each good in the market. The market is said to be in equilibrium when the prices and quantities that are determined through this process satisfy the conditions of supply and demand.

Question 33

We learned about ..... and ..... based market models * Unlike exchange models, ..... models are organized and optimized centrally * Higher competition in the ...... model , demand cannot play an important role in price determination * Simpler implementation ...... model , requiring active participation of demand, ..... market design can be addressed by change to other market platform

Answer 33

We learned about **pool** and **exchange** based market models * Unlike exchange models, **pool** models are organized and optimized centrally * Higher competition in the **pool** model , demand cannot play an important role in price determination * Simpler **implementation** exchange model , requiring active participation of demand, **bad** market design can be addressed by change to other market platform

Question 34

# UE Q1) What are the main drivers for varying electricity prices?

Answer 34

* Installed capacity of renewable energy technologies with zero marginal costs * * Amount of conventional power plants * * Distribution of wind speed (when is the peak output) * * Correlation of electricity output and demand (peak demand and peak output) * * Cross border transmission capacity * * Access to flexible generation (such as hydro) * * Geographical distribution of renewables * * Preciseness of generation forecast (especially wind) * * Preciseness of load forecast

Question 35

# UE Q2) What are the characteristics of the wind energy generation and the transmission capacities in Denmark and Germany? How do they effect the volatility of electricity prices? | Denmark

Answer 35

Wind speed peaks in afternoon (during high load times) Wind speeds are evenly distributed throughout daytime High transmission capacity to Northern Denmark with large hydropower plants ====> Peak and off peak hour prices are estimated to decrease nearly equally due to wind power generation which is also equallz distrubuted trough out the day ====> Wind energy decreases daily price volatility by flattening hourly price profile

Question 36

# UE Q2) What are the characteristics of the wind energy generation and the transmission capacities in Denmark and Germany? How do they effect the volatility of electricity prices? | Germany

Answer 36

* Wind speed peaks at night (during low load times) * Asynchronous wind power output and demand curve * Relatively low transmission capacity to hydro * dominant Austria and Switzerland * Low electricity flow to the Nordic countries * Flow to its neighboring countries with inflexible generation (e.g. France) does not respond much to changes in wind power * Limited access to flexible hydro generation =====> Wind power has a stronger impact on off peak prices than on peak prices Wind power increases the volatility of prices Solar power production only from 6 AM to 8 PM Solar power decreases price volatility

Question 37

# UE Q3) The wind power output and the cross border flows have an impact on the intraday volatility of electricity prices. Explain what effect this has in the Danish and the German wholesale electricity market. | Denmark

Answer 37

**Wind power output** = peak in wind output during peak load hours that amplifies the total impact of wind power on peak hours relative to off peak hours wind power contributes to the **flattening of the intraday price profile** by **decreasing peak prices** more than off peak prices in absolute terms **Cross border flows** = when more wind power is produced in Denmark, exports to Norway are higher while Norwegian hydropower plants produce less (and vice versa) this exchange with the hydro dominant Nordic countries may contribute to similar flattening of the intraday price curve

Question 38

# UE Extra: Explain when we can speak a increasing impact of WindPower on price curve? When does the volatility decreases?

Answer 38

The volatility increasing impact of wind power can be explained **if prices in off peak times** **decrease** **more than during peak hours ,** leading to divergent prices The volatility will decrease if peak prices decrease more than off peak prices so that the hourly price profile becomes flatter

Question 39

# UE Q3) The wind power output and the cross border flows have an impact on the intraday volatility of electricity prices. Explain what effect this has in the Danish and the German wholesale electricity market. | Germany

Answer 39

**Wind power output** = * wind power peaks during off peak hours (Nachts) * if there is an increase in wind power production during off peak hours, then prices will fall more than in peak hours for a comparative increase in wind output off peak prices decrease more compared to peak prices and this results in a higher daily price volatility **Cross border flows** = limited possibilities to balance excess VRE generation due to low transmission capacity the cross border exchange with France has a limited correlation with the German price level, because of the infelxible Frenc Production of nuclear Energy

Question 40

# UE Q4) Which measures should be taken to reduce the price volatility?

Answer 40

* capacity payments that incentivize flexible plants * dispersing wind and solar power farms * integration of neighboring markets * extensions to the transmission network * additional trading opportunities by both producers and large consumers in intraday and balancing markets * design tariffs that incentivize demand response, which is likely to reduce the costs of balancing caused by the intermittency of VRE

Question 41

# UE Q5) Negative prices are a common phenomenon in electricity markets. Explain what they are and how they can arise. Construct a quantitative example to support your explanation. Are negative electricity prices a market failure?

Answer 41

Negative power prices on the electricity exchange occur when a high and inflexible power generation appears simultaneously with low electricity demand. This is often the case on public holidays such as Christmas or Pentecost. Particularly in hours of (predictable) high renewable power supply (lots of wind and sun), power producers offer their electricity for negative prices on the exchange * Negative prices are not a market failure * Negative prices are a sign of very high supply at the market * Is an indicator to provide more flexible supply * However, renewable energies need to get price signals as well

Question 42

# UE Q6) Briefly describe the negative price regulation and occurrence at the EEX. Are they possible and how negative do prices get? How often do they occur?

Answer 42

Negative electricity prices at EEX: Negative electricity prices were introduced in 2007 in the German Intraday market and 2008 on the German/Austrian Day Ahead There are different price caps (Germany: 500 €€/MWh) Comparably rare phenomenon: Day Ahead market 2012: 56 hours on 15 days Intraday market 2012: 41 hours on 10 days (both in Germany) EEG