APEx Conference 2014 October 26 - 28, Krakow

APEx Conference 2014
October 26 - 28, Krakow, Poland
Capacity is Capacity is Capacity
Mike Thomas
October 2014
Capacity is the ability to avoid involuntary curtailment of load
Capacity is a feature of just about everything
The Lantau Group
Capacity is just one part of a complex overall equation
• What would your fee be if you paid what it costs when you got
sick?
– Cost determined by whether you got sick on a busy day?
– Cost of a rare and unusual treatment?
– Cost of special emergency care?
• What if your diagnosis (forecast) was wrong?
– Who pays for the specialist you later found out you didn’t need?
• If you don’t have enough time to shop around when you are
sick, how do you get “competitive” pricing?
• How would the cost of disaster or pandemic preparedness be
recovered?
• What ifCost,
you didn’t
/couldn’t
pay your share?
reliability,
responsiveness,
and risk management are clearly also key
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Capacity can be measured and valued over different timescales
• Should capacity be priced on same timescale as energy?
– Clearly values “use” rather than existence
• Can the volatile prices that result from inelastic supply or demand be tolerated by the
competition authorities or other stakeholders?
• If capacity is priced separately, what timescale should be used?
– The longer the timescale, the less volatility, but the more risk a price that is too high or too low will
endure much longer
• If capacity is targeted for some future point in time, the pricing may need to be done
early enough to maximise competition for supply
– More elastic supply means less volatile prices
– But greater exposure to forecasting risk
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4
Everyone has their own special problem
Asian countries have many different arrangements to support capacity
• The Single Buyer market
model is the most
prevalent market structure
in the region
• The Energy only market
design is found in Eastern
Australia, New Zealand,
Singapore and the
Philippines.
• An Energy + Capacity
design is found in South
Korea (SK) and Western
Australia (WA)
• And China – neither
energy nor capacity nor
PPA. Just a standing,
periodically changed “on
grid price”
PPAS with Contractual Capacity Payments
Central Planning
Bid-based above SRMC
Merchant
China
Vertically Integrated
Market
Single-buyer Market
Dynamic Capacity Payment
Merchant / Government
Energy + Capacity
Market
Energy-only Market
Standing Buy Price
Planned / Merchant Hybrid
Each has its strengths and weaknesses for different times and different contexts
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What’s going on in some of the regional markets?
•
EO Markets with Price Caps that are Too Low
Singapore (EO  E+C???)
Persistent or Increasing Concern about Market
Power and Bidding?
Stakeholder Concern About Policy Risk?
– New capacity not needed for many years,
but analysis suggests significant increase in • Eastern Australia (EO  E+C???)
volatility will be needed to support new
investment when it is eventually needed
– Government has had problems accepting
price spikes in the past
• Philippines (EO  E+C???)
– Severe price caps
Stalled
• South Korea (E+C)
Is the Grass Greener Elsewhere?
– Energy crisis?
• Western Australia (E+C  EO???)
Some interesting trends and concerns that may support future pressure for new capacity markets
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Big destabilising challenges
Four major stress points emerging
• Fuel markets
• Role of coal and carbon
• Net Demand Growth
• Volatility of outcomes due to external events
Each market has been affected differently
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Why so much concern?
Fuel markets have been pretty disruptive
COAL WINDOW
COAL WINDOW
2006
1991
1997
Discovery of
Malampaya gas
field
NPC/FirstGen sign
GSPAs with SPEX/OXY
1992
Singapore
first gas unit
commissione
d
Singapore
commits to
LNG imports
2001
Commission of
Malampaya
1995
Hong Kong
first gas unit
commissione
d
We’re in a coal window and many Asian countries had previously committed to natural gas
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Why so much concern?
Shift in demand growth in the Western Australian SWIS increased
excess capacity, and launched an industry review by government
Change in Successive Forecasts
WA: SWIS
2006 to 2010
2010 to 2013
The underlying capacity mechanism did not adjust enough to reflect changed market conditions
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Why so much concern?
Severe price spikes in the Philippine WESM during a prolonged gas
supply outage spooked government and regulators
Average monthly WESM spot settlement price* (2007-14)
PhP/kWh
26
Gas scheduled outage
and plant outages
24
22
20
Transformer breakdown and
San Jose substation congestion
18
16
14
12
10
8
Plant forced maintenance
outages and HVDC link
maintenance
Gas curtailments
and low hydro
Plant outages and
coal limitations
Gas curtailments
and plant outages
Plant
outages
ERCregulated
price
reduction
Low
hydro
6
4
2
0
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
Note: * Buying price (with 100% surplus)
Source: PEMC; TLG analysis
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Why so much concern?
Weather effects vary widely over time – the Philippine WESM to deal
with strong swings between El Nino and La Nina
NOAA Oceanic Niño Index (ONI)
Deg. C
3,0
ONI measures average surface sea temperatures and it is used by the
US National Oceanic and Atmospheric Administration (NOAA) for their
operational definition of El Nino and La Nina
El-Nino
2,5
2,0
1,5
1,0
0,5
0,0
(0,5)
(1,0)
(1,5)
La Nina
(2,0)
sty-50
lis-51
wrz-53
lip-55
maj-57
mar-59
sty-61
lis-62
wrz-64
lip-66
maj-68
mar-70
sty-72
lis-73
wrz-75
lip-77
maj-79
mar-81
sty-83
lis-84
wrz-86
lip-88
maj-90
mar-92
sty-94
lis-95
wrz-97
lip-99
maj-01
mar-03
sty-05
lis-06
wrz-08
lip-10
maj-12
(2,5)
Volatile outcomes increase government concern over the market
Source: NOAA
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It’s about risk management – not just efficiency
Can these substantial forces be managed cost-effectively in competitive
but very small markets?
180
Peak Demand (GW)
160
140
120
100
WA (SWIS)
SG (NEMS)
PH (WESM)
80
New Zealand
60
Ireland (SEM)
40
Canada (AIS)
20
EA (NEM)
0
South Korea
US (PJM)
E+C
EO
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Smaller markets, particularly energy-only markets, face several difficult
challenges
• Competitive structure vs scaled-up businesses
• Transparency and depth of contracting
• Challenge of managing evolution (avoiding re-concentration)
• Lumpiness – difficulty supporting the most efficient larger-scale technologies due to a
bigger gap between post-entry prices and pre-entry prices
• Lumpiness impacts on ancillary services costs and cost allocation mechanisms
• Closer proximity and thinner skin relative to government
An EO market design places greater demands on stakeholders to develop and manage their
sufficient risk management strategies and instruments (contracts)
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Risk mitigants
• Significant hydro storage mitigates sharp spikes and reduces volatility
• Large number of players and competitive structure enhances contracting, trading,
transparency, and information content of spot market
• Less peaky load growth and load shape reduces likelihood of “deep” disruptions
• Larger markets can absorb similarly sized “mistakes” (too much or too little) all else
equal over a give timeframe with less price impacts
• Markets can experience many years where supply exceeds demand due to historical
investment, new policies, or fuel-market shifts that support investment independent of a
fully properly functioning EO or E+C market
• Predictable, steady, (not surging) growth
These are just some features that alter the characteristics of risk in different markets
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Key threshold questions for deciding how to remunerate
capacity in your neighborhood
Key prerequisite is to recognise that it takes all three main markets to
determine what type of capacity you get
• Capacity – what is the least expensive way
to avoid involuntary curtailment of load at
peak
• Energy – what determines whether to build
something other than that which is the least
expensive form of standing capacity to
avoid involuntary curtailment of load at
peak
• Reserves / Ancillary Services – what
determines whether to pay to secure
additional capabilities / responsiveness
beyond what capacity and energy
payments support
All sources of capacity have the same
value
Trade off higher capital cost for
improved energy conversion
efficiency
Trade off higher capital costs or
reduced energy conversion
efficiency for other valuable
response characteristics
Determines Optimal Short, Medium, and LongTerm Investment Mix
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The capacity price is the same for all types of capacity-providing technologies
How different market designs work to produce equivalent results
Suppose the price of natural gas falls, relative to coal…
ENERGY PLUS CAPACITY
The energy price must fall –
but by less than the fall in fuel
costs to red – hurting blue
while leaving red and gold
better off.
OCGT
CCGT
The capacity price must
increase to signal more gold,
but not by enough to offset the
loss of value to blue.
TENDENCY
The capacity payment does not
cover the full cost of red, so red
enters only as a combination
energy + capacity play.
COAL
Blue loses unless previously
contracted
CURRENT
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OPTIMAL
ENERGY ONLY
The energy price must get
more peaky and volatile to
signal more gold. But the
higher peak prices are offset
by much lower off-peak prices
to discourage blue.
The shoulder prices must be
high enough to justify the
increased energy conversion
efficiency of red vs gold away
from peak
Blue loses unless previously
contracted
Second prerequisite: determine what reliability means to your market
• Frequency – how often?
• Duration – how long?
• Depth – how many MW?
Systems with infrequent but deep and long shortage risk have
very different capacity capability requirements than systems
with short and shallow interruptions.
You can import another market’s design, but not the local context in which it operates
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Third prerequisite: only consider an EO market if you can tolerate a price
cap fully consistent with your definition of reliability
Required prices and capacity factors for OCGT fixed cost recovery
18000
Aligned
17000
16000
Australian NEM price cap
15000
OCGT LRMC
14000
13000
12000
Fewer than 20 hours / year OCGT operation
SGD/MWh
11000
10000
9000
8000
7000
6000
NEMS Price Cap
5000
Singapore Price Cap
4000
88 hours / year OCGT operation
3000
Not Aligned
2000
1000
OCGT SRMC on Liquid
0
0.00%
0.50%
1.00%
Philippines Price Cap
1.50%
2.00%
2.50%
3.00%
3.50%
4.00%
4.50%
5.00%
Low price caps  lower reliability unless something else “lucky” happens
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Fourth prerequisite – be clear about how you will distinguish scarcity
pricing from market power abuse
• Market concentration
– How to limit it
– Level of cross-ownership
– Control of portions of the load curve
– Simple metrics miss some of the richness of the problem
• Local regulatory definition of market power
– Acceptable margins above SRMC?
• Degree of understanding of investment incentives and risk
– When investments have long lead times, clarity becomes more important
Scarcity pricing is essential in well-functioning EO markets, but can be easily confused with
market power abuse – leading to increased regulatory risk or loss of confidence in the market
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Fifth prerequisite – recognise that capacity is about avoiding involuntary
load shedding, not just about meeting peak demand
Average monthly WESM spot settlement price* (2007-14)
Planned Malampaya
Gas Supply Outage
PhP/kWh
26
Gas scheduled outage
and plant outages
24
22
20
Transformer breakdown and
San Jose substation congestion
18
16
14
12
Gas curtailments
and low hydro
Plant outages and
coal limitations
10
8
Plant forced maintenance
outages and HVDC link
maintenance
Gas curtailments
and plant outages
Plant
outages
ERCregulated
price
reduction
Low
hydro
6
4
2
0
Jan-07 Jul-07 Jan-08 Jul-08 Jan-09 Jul-09 Jan-10 Jul-10 Jan-11 Jul-11 Jan-12 Jul-12 Jan-13 Jul-13 Jan-14
E+C markets can need design features to focus more on shoulder and off-peak supply shocks
(EO markets tend to do this more naturally)
Note: * Buying price (with 100% surplus)
Source: PEMC; TLG analysis
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Sixth prerequisite – understand exposure to energy constraints
• Some markets become energy constrained before they become capacity constrained –
if, for example, they run out of fuel (hydro), leaving ample capacity without ability to
generate sufficient energy
• “Capacity” value must reflect the relative level of “constraint” on supply – a pure
unconstrained capacity resource has greater value than a capacity resource whose
operation cannot be sustained
• Constrained capacity resources still have value – just want to avoid paying extra for the
“unconstrained” value if they cannot provide it
– Hydro constrained resources
– Demand response
These can be particularly vexing issues in both EO and E+C markets
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Summary
• Capacity is capacity.
– It is simply an attribute that is associated with the ability to keep the lights on.
– Other features and sources of value work together with “capacity” to shape investment and
outcomes
• If we say not all capacity is the same, we are confusing capacity and some other thing.
– Capacity -- the least cost option to meet load at a point in time
– Energy – the trade-off between capital costs and energy conversion efficiency
– Ancillary/other services – the tradeoff between capital and fuel costs and the cost of enhanced
flexibility and response
• Choosing between market designs is not a question of whether one is better than the
other, but rather which one fits the circumstances
25 The Lantau Group
Thank you
For more information please contact us:
Power
Utilities
By email
Energy
Mike Thomas
[email protected]
Insight
By phone
+852 9226 2513 (mobile)
Rigour
Value
By mail
4602-4606 Tower 1, Metroplaza
223 Hing Fong Road,
Kwai Fong, Hong Kong
Online
www.lantaugroup.com
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