Institut fr Elektrische Energiesysteme

Power System Economics

Lecture 1: Basics Concepts from Economics I

Dr. Pio Lombardi pio.lombardi@iff.fraunhofer.de

LENA Lehrstuhl Elektrische Netze und Alternative Elektroenergienquellen

Magdeburg, 18.10.2011

Materials
Fondamentals of Power System Economics D. S. Kischen G. Strbac

Power system Economics Designing Markets for Electricity S. Stoft

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Agenda
Why Competitions? Actors in the Market Models of Competitions: Monopoly Purchasing agency Wholesale competition Retail competition Fundamentals of Markets Modeling the consumers Modeling the producers Market equilibrium Pareto efficiency

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Why competition?
Vertically Integrated System The consumer had not choise from whom to purchase electricity The distribution utilities had to purchase electricity from transmission and generation who had a monopoly over a wide area The distribution utilities was responsable only for ity sale and distribution in a loca area

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Why competition?
until late 70s Monopoly Private companies:
- Remove the incentive to operate efficiently and encouraged unnecessary investments - Cost of mistakes are passed on to the consumers

Public companies/ government agencies

Politics interfere with good economics

Electricity as object of a market discipline Competition

Efficiency gains Different technologies Benefit of economy progress
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lower Prices

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Actors in these markets 1/3

Generation Companies Transmission Companies Distribution Companies
Retailers

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Actors in these markets 2/3

Market Operator Independent System Operator Regulator

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Actors in these markets 3/3

Small consumers Large consumers

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Generation Company (Genco)

Generation Companies
They produce and sell electricity and services (ancillary) such as voltage control, regulation, reserve needed from the system operator to maintain the quality and security of electricity supply The may own a single power plant of a portfolio of power plants In vertically integrated power systems they are also called as

independent (IPP)

power

producers

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Transmission System Operators (transco)

Transmission Companies
They own transmission assets such as lines, cables, transformers and reactive compensation devices. Sometimes they are subsidiaries of Genco In Europe after the unbundling process the Transmission System Operators (TSOs) have been split from the Genco, in such a case the TSOs are also called

independent operators

transmission

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Distribution companies (disco)

Distribution Companies

They own and operate the distributed networks. Generally the have the monopoly of selling of electricity to all the consumers connected in their network. In deregulated environmental the selling of electricity is decoupled from the operation, maintenance and development of distributed network.

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Retailers
Retailers compete with discos in selling electricity to the consumers. Sometimes they are a subsidiary of the local distribution company. They buy electricity to the wholesale market and sell it to the consumers who do not wish/are not allowed to participate to the wholesale market All the consumers and retailers do not have been connected to the network of the same distribution network The challenge for retailers is that they have to buy energy at a variable price on the wholesale market and sell it at a fixed price at the retail level. A retailer will typically lose money during periods of high prices because the price it has to pay for energy is higher than the price at which it resells this energy. On the other hand, during periods of low prices it makes a profit because its selling price is higher than its purchase price

Retailers

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Market Operator
Generally a Market Operator runs a computer system that matches the bids and offers that buyer and sellers have been submitted. He takes care of the settlement of the accepted bids and offers. It means that he forwards the payment from the buyer to the seller following delivery of the energy. Markets that closes some time ahead of the real time are generally run by independent forprofit market operator

Market Operator

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Independent System Operator

Independent System Operator (ISO) are usually responsible of running the market at the last resort (the market in which the load and generation are balanced in real time) They are responsible of maintain the security of power systems They are independent because the have not favor or penalize one market participant over another

Independent System Operator

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Regulator
The regulator is a governmental body responsible for ensuring the fair and efficient operation of the electricity sector. It determines or approves the rules of electricity markets and investigates suspected cases of abuse of power market. In monopoly markets it sets the price for the product and services

Regulator

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Small consumers
Small consumers
They buy electricity from the retailer and lease the connection to the power system from their local distribution network company. Generally they do not participate to the market.

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Large Consumers
Large consumers
Differently form the small consumers, large consumers often take an active role in the electricity market buying electricity directly through the market. Some of them may offer the ability to control their load as a resource that the ISO can use to control the system. The large consumers are sometime directly connected to the transmission systems

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Models of competition
Monopoly:

enterprise is the only

supplier
Monopoly models in electricity market: Vertically integrated utilities (a) Distribution is handled by separate companies Generation and Transmission are handled by one company (b), which sells the electricity to the local monopoly distribution company This model does not preclude bilateral trading between utilities operating in different geographic areas
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Models of competition
Purchasing agency model: Independent power producer (IPP) sell
electricity to an purchasing agency
Model

The integrated utility no longer own all the generation capacity IPP are connected to the network and sell their output to the utility that acts as a purchasing agency (a) Discos purchase their consume from the wholesale purchasing agency. The rates set by the purchasing agency must to be regulated because it has monopoly power over the discos This model introduces some advantages between generators
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Disco= Distribution company 19

Models of competition
Wholesale competition: no central organisation is responsible
for the provision of energy
Discos purchase energy from generating units Transaction take place in a wholesale market Large consumers able to directly buy from the Genco wholesale market and transmission system remain centralized Retail price remain regulated because each disco do not only operate its distribution network but also purchase energy on behalf of the consumers Consumers cannot chose a competing supplier This model creates competition on generation side but not on distribution side since consumers cannot choose their supplier

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Genco= Generation company 20

Models of competition
Retail competition:
all consumer can choose their supplier

Disco: Grid activities seperates from retail activities No local monopoly for supply Retail price is not regulated Prices are set by thourgh market interactions Operation and provision of networks remain monopoly cost are still charged to all users

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Open questions pro et contra of monopoly

In the monopoly utility model, all technical decisions regarding the operation and the development of the power system are taken within a single organization. It means that, at least in theory, the operation of all the components of the system can be coordinated to achieve least cost operation. Introducing competition the central coordination and control has been lost. However the profit motives encourages generation companies to better take care of their plants, nevertheless it should be proof of this improvement in availability is sufficient to compensate to loss of coordination between power plants In vertically integrated systems utilities can plan their transmission network to suit the construction of new power plants. In a competitive system transmission operators do not know where and when the generators utilities will install their plants.
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Fundamentals of Markets
Evalution of markets Location were people gather to barter goods Virtual environments, electronically trade

Fundamental principle has not changed::

A Market is a place where buyers and sellers meet to see if deals can be made
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Modeling the consumer

A model which describe the behavior of a consumer Individual demand
Number of apples you purchase depend on their price: their will be a price obove which you will decide to buy an other fruit if the price is low you will decide buy more and made sider

The price should be for a consumer to purchase a certain amount

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Modeling the consumer

Surplus
The gross consumers surplus is the total value attached to the purchased commodity (apples)

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Modeling the consumer

Surplus
Market price = $0,40 per apple

The net consumers surplus represents the extra value that you get from being able buying apple at the same price, even through the value you attach them is higher than the market price

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Modeling the consumer

Inverse demand function

Aggregation of demand characteristics of: Large number of consumers Different individual buying behavior of apples For a given consumption level, it measures how much money the consumers would be willing to pay to have a small additional amount of the good considered. Turning this around, it also tells how much money these same consumers would want to receive in compensation for a reduced consumption The marginal value the consumer attach to the commodity

- price of commodity q- quantity

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Modeling the consumer

The gross surplus is represented graphically by the area below the inverse demand function up to the quantity that the consumers purchase at the current market price. The net surplus corresponds to the area between the inverse demand function and the horizontal line at the market price. Power system economics

If the price is 1 then the consumption level is q1 the net surplus is the area A+B+C. If the price increases to 2 the consumption level decreases to q2 and the net surolus decreases too (area A). The marginal benet that consumers get from this commodity is equal to the price that they have to pay to obtain it 28

Modeling the consumer

Elasticity of demand
Increasing the price of the power the demand will decrease, but by how much?

Elasticity

The demand for a commodity is said to be elastic if a given percentage change in price produces a larger percentage change in demand. On the other hand, if the relative change in demand is smaller than the relative change in price, the demand is said to be inelastic

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Modeling the producer

Opportunity costs
There is a price below which she will decide that selling apples is not worthwhile. There are several reasons why she could conclude that this revenue is insufcient. First, it might be less than the cost of producing the apples. Second, it might be less than the revenue she could get by using these apples for some other purposes, such as selling them to a cider-making factory. Finally, she could decide that she would rather devote the resources needed to produce apples (money, land, machinery and her own time) into some other activity, such as growing pears or opening a bed-and-breakfast. One can summarize these possibilities by saying that the revenue from the sale of apples is less than the opportunity cost associated with the production of these apples.

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Modeling the producer

Inverse supply function
Inverse supply function

Supply function

Aggregation of amount of supplied by a large number of producers

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Modeling the producer

Marginal producer is the producer whose the opportunity cost is equal to market price. If the market price decrease a producers may decide that is not worthwhile to continue the production Extra-marginal production is the production could become worthwhile if the price increased Infra-marginal producers is the producer whose the opportunity cost is below the market price

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Modeling the producer

Producers revenue

The producers revenue is equal to the product of the traded quantity q1 and the market price 1.
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Modeling the producer

Producers net surplus

The producers net surplus or producers prot arises from the fact that all the goods (except for the marginal production) are traded at a price that is higher than their opportunity cost.
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Modeling the producer

Producers net surplus

The producers net surplus or producers prot arises from the fact that all the goods (except for the marginal production) are traded at a price that is higher than their opportunity cost.
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Market equilibrium
Assumption of competitive market

Each supplier or consumer cannot affect the price by its actions. The market participants take the price as given. In a competitive market, it is the combined action of all the consumers on one side and of all the suppliers on the other side that determines the price. The equilibrium price or market clearing price is such that the quantity that the suppliers are willing to provide is equal to the quantity that the consumers wish to obtain.

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Market equilibrium

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Market equilibrium
Suppose the market price is 1 < *, where the demand is greater than the supply. Some suppliers will inevitably realize that there are some unsatised customers to whom they could sell their goods at more than the going price. The traded quantity will increase and so will the price until the equilibrium conditions are reached. Similarly, if the market price is 2 > *, the supply exceeds the demand and some suppliers are left with goods for which they cannot nd buyers. To avoid being caught in this situation, they will reduce their production until the amount that producers are willing to sell is equal to the amount that consumers are willing to buy.

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Pareto Efficiency
When a system is completely under the control of a single organization, this organization normally attempts to optimize some measure of the benet it derives from the system. On the other hand, when a system depends on the interactions of various organizations with diverging interests, conventional optimization is not applicable and must be replaced by Pareto efciency. An economic situation is Pareto efcient if the benet derived by any of the parties can be increased only by reducing the benet enjoyed by one of the other parties.
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Thank you for your attention

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