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Regulating Power Exchanges

March 28th, 2010 by Leonardo Meeus, Florence School of Regulation

Power exchanges are key market institutions. In the EU, the physical transactions they operate account for about 30% of annual consumption (more than 1000 TWh traded in 2009). They are also playing a growing role in coordinating access to interconnections.

The traditional market for Power exchanges (hereafter, PXs) is an auction organized every day around midday to execute orders for the delivery of electrical energy the next day. Two types of PXs have to be distinguished in Europe. They are:

Merchant PXs: being for-profit market institutions whose income depends on the users they have (i.e., user registration fees, and annual membership fees) and the volume of trade executed by the PX for its users (i.e., commissions on the traded volumes). Merchant PXs are mostly private initiatives that compete with other exchanges and bilateral or over-the-counter markets (OTC). Providing trade services is their core business. Examples of Merchant PXs include APX (the Netherlands), Belpex (Belgium), EPEX (Germany and France), Nord Pool (Nordic region), OTE (Czech Republic), PolPX (Poland), etc.

Cost of Service (CoS) Regulated PXs: being not-for-profit or regulated-profit market institutions whose income depends on approved costs for approved tasks. Like Merchant PXs, some of them charge fees to their members, but these fees are approved by the regulator or the ministry. CoS Regulated PXs are typically public initiatives that perform several tasks. For instance in Spain, OMEL has the additional task of allocating capacity payments. In Italy, GME has the additional task to manage internal congestions in the country. In Greece and Ireland, the CoS Regulated PXs are dispatching power plants.

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The table below summarizes the conclusions of a recent study on the relative positive and negative points of the two types of PXs. Unsurprisingly, it shows that no model of PX provides an absolutely perfect picture for all the relevant criteria.

The more interesting criterion to discuss here is the elimination of cross-border trade inefficiencies.

The new EU model implies that trade across borders at the day-ahead stage will be transacted as a bundle “energy – access capacity” via the PXs. Unlike a CoS Regulated PX, a Merchant PX has a clear incentive to cooperate in the implementation of this model as it can generate significant additional trade volumes and thus income for the PX.

Note that the potential benefits may not materialize because eliminating existing cross-border trade inefficiencies is far from trivial. For instance in the cooperation between NordPool and EEX (the so-called Dome Coupling initiative) the potential benefits did not materialize – at least initially – because the involved PXs did not coordinate the calculation of their prices, and did not harmonize sufficiently their operation.

However, a set of promising regulatory actions could help to materialize the potential benefits of the EU target

Regulated price properties. In the Trilateral Market Coupling (TLC) initiative,stakeholders had agreed with regulators on a set of price properties that the coordination initiative would comply with: e.g. prices have to be equal if there is unused capacity. The properties were defined so that the initiative should eliminate all cross-border trade inefficiencies, which it then also did. For Pan-European initiatives, price properties will be more complicated to define, but they would anyway have to be defined and regulated.

Minimum prerequisites. Pre-requisites for the implementation of the target model have already been suggested at the Florence Forum. They include: use of a single pricing algorithm, harmonized gate closure times, sharing of all bid data between PXs, compatible bids/products, etc. The experience with Dome Coupling however indicates that there are many factors that can contribute to inefficiency so it could be difficult to make a good working list of prerequisites. Considering, however, that regulators will need to regulate the price properties of the initiative coming from PXs, a prerequisite could be that the costs of setting up and running the initiative are covered by the regulated tariffs, as in the TLC initiative.

Apply netting at the day-ahead stage. In the TLC initiative, TSOs have continued to organize separate auctions for long term rights to trade across their borders so that the OTC markets can continue to compete and complement PXs. At the day-ahead stage, the TSOs calculate the available capacity, deduct the capacity they have already auctioned, and add the part of that capacity that has not yet been used. This remaining capacity is then used by the PXs to coordinate the execution of their day-ahead orders books. There are still inefficient nominations from the long term auctions, but the TSOs apply “netting” so that inefficient nominations before the day-ahead stage simply increase the remaining capacity at the day-ahead stage.

Leonardo Meeus, Florence School of Regulation, European University Institute and University of Leuven

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