Firmness - financial hedge between bidding zones or capacity product
Saturday, 03 May 2014 13:15

 

Who will pay for market spread? 

 

 

Financial risk exposure of market spread compensation

 

Pursuant to ENTSO-E data the price spread between neighbouring bidding zones can be significant and can persist for significant periods of time.

 

Teoretical maximum price spread example:

 

NWE region after NWE go live will be harmonized at +3000/-500€/MWh (amounting to a theoretical maximum price spread at the level of €3500).

 

Large price spread in practice:

 

The price spread between France and Britain on 8th February 2012 due to a spike in the French day ahead prices (the French price reached 1938.5 €/MWh).

 

At stake are firmness regimes for market parties on 24 borders across Europe.

 

The core of the current views' discrepancy is as follows:

 

1. ACER's preference is for transmission system operators (TSOs) to reimburse the day-ahead market spread, instead of the price paid at auction;

 

2. ENTSO-E argues that the day ahead market spread is unknown at the time of the cross-zonal capacity allocation and can be many times greater than the initial price paid at auction.

 

ENTSO-E explains in conclusion that the divergent position between ENTSO-E and ACER is due to a fundamental different perspective on the type of product TSOs offer to market parties: ACER conception that TSOs offer a financial hedge between bidding zones, and TSOs approach viewing capacity product reflecting the capability of the transmission network to transfer energy with the associated risks.

 

Consequently, according to the TSOs stance, to the extent that the market spread exceeds the initial price paid at auction, the TSO has to cover the costs from elsewhere, be it congestion income from the current or other timeframes (congestion income being the TSO revenue derived from selling cross zonal capacity products) or from network tariffs (see: Supporting Document for the Network Code on Electricity Balancing of 23 December 2013).

TSOs believe that the risks should be shared between those using the interconnections and TSOs, whereas ACER believes that all the risk should be borne by TSOs.

  

Firmness regimes put at disposal

 

Different types of market spread compensation are cited (after the ENTSO-E) in the box.

 

It is noteworthy, Option A (firmness based on initial price paid) is is the most common compensation arrangement across Europe today.

 

 

Option A Firmness based on initial price paid

 

Initial price paid compensation gives transmission right holders compensation usually between 100% and 110% of the original price paid at auction, although this is border dependent.

 

This was part of ENTSO-E's original position.

 

However responding to stakeholder and ACER feedback, ENTSO-E has moved away from this position and has provided a compromise solution.

  

Capped compensation variants are categorised into two families denoted as Option B1 and Option B2.

 

 

Option B1 

 

Firmness based on capped market spread compensation (congestion income cap)

 

Capped market spread compensation means that curtailed transmission rights holders are compensated on the market spread between bidding zones as long as there has been sufficient congestion income received by TSOs to pay out from.

 

Compensation is capped by a predefined time period of congestion revenue (e.g. monthly or annual).

 

Under this regime, market participants share the risks with TSOs. Under normal curtailment conditions, market parties receive market spread compensation.

 

However when an extreme event occurs, the cap for the compensation may be reached so that market parties share some of the financial burden.

 

Compared with initial price paid compensation (option A) moving to capped market spread is a significant increase in firmness costs compensation for many borders and TSOs.

 

Option B2  

Firmness based on capped market spread compensation (price cap)

 

Price capped market spread compensation means that curtailed transmission rights holders are compensated on the market spread differential as long as it is less than a predefined cap.

 

This ensures that under normal system conditions, market spread compensation is paid. However when an extreme event occurs, the price cap may be reached.

 

Under these circumstances, market parties would share some of the financial burden (similar as for option B1). TSOs envisage that price cap compensation could be implemented together with a congestion revenue cap, rather than being mutually exclusive.

 

The reason for combining a price cap with a congestion cap is to avoid situations where extreme price differentials and multiple curtailments exhaust all congestion income leaving some parties uncompensated. This ensures that as many market parties as possible are compensated.

 

 

Option C 

Firmness based on full market spread compensation

 

Market spread compensation means that curtailed transmission rights holders are compensated at the market spread between bidding zones. Under this regime, market participants do not share any of the risks and TSOs are exposed to the full risk and associated financial consequences which may impact network tariffs.

 

Likely impacts

 

What is the scale of the problem? ENTSO-E indicates that capacities between bidding zones are variable, but are generally of the order of a few GW.

 

Hence, under market spread compensation, for a 3000MW curtailment and with a €3000 price spread, TSOs would be obliged to pay out €9million per hour.

  

It shows that the costs of market spread compensation can be considerable and have the ability to reach magnitudes of the order of €millions per hour, if the curtailment lasted a few hours/days/weeks/months.

 

This, however, also evidences the scale of the potential risk on the part of market actors, on occasion where  the compensation would be capped.

 

The proposition TSOs have at present is a mixture of Options B1 and B2.

It centers on the long term firmness deadline, which is the nomination deadline for physical transmission rights or between 19 and 2 hours before day-ahead market gate closure for financial transmission rights.

 

For curtailments between the auction and the long term firmness deadline, compensation is capped at the long term transmission rights' congestion income.

 

For curtailments between the long term firmness deadline and the day-ahead firmness deadline, compensation is capped at the total monthly congestion income.

 

Where the compensation cap is hit, priority in compensation payments will be given to curtailments occurring between the long term firmness deadline and the day-ahead firmness deadline.

 

This, according to the TSOs analysis, should increase the level of firmness market participants see the closer they get to real time and reflect the shorter time they have to react.

 

ENTSO-E argues that under normal and severe system conditions ENTSO-E's proposal gives market parties a financial hedge for most curtailments and only in very exceptional circumstances would this be capped to avoid an excessive impact on end users via network tariffs.

 

In all other cases, the risk is not shared with market parties and is born entirely by TSOs.

  

This proposal, in the ENTSO-E view, is balanced in terms of risk sharing and introduces the incentives for market participants to support system security, hence it has been finally submitted to ACER. Results of this discussion are not known yet.

 

Among the ENTSO-E key arguments appears also the one, saying that existing European legislation defines how congestion income is used - among others, "guaranteeing the actual availability of the allocated capacity".

 

However, to my understanding "guaranteeing the actual availability of the allocated capacity" can be safeguarded at two equivalent levels: physically (as TSOs intended) or financially (as ACER demands). When TSOs in particular situations are not capable of ensuring the agreed levels of firmness physically, there should be a consequent shift to financial safeguards i.e. compensation (and rather in full amount of market spread than only partially).

 

The ACER's approach seems to be a clear follow-up to the "copper-plate" model of the European single electricity market and, as it seems, its implementation would greatly simplify day-to-day operation of the market.

 

Or maybe I'm wrong...?

 

 

See also: Firmness of allocated cross-zonal capacity

 

  

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