CIERRE DE VENTA Y GRABACIÓN POLIZA

Together the daily market and the regulation power market form the markets for short-term delivery of power. The markets, however, fill different functions. The daily market is the core spot market for planned short-term allocation of power. The regulation power market is a residual market with the role of pricing and procuring real-time adjustment capacity, and of handling, pricing and settling deviations between actual deliveries and contracted deliveries45. An efficient and liquid spot market for electricity is vital to the efficiency of the electricity market. In principle the optimal equilibrium spot price equals short-term marginal cost, which in turn equals the short-term marginal benefit of consumption. The spot price thus reflects the marginal value and relative scarcity of power, and is important in the short-term allocation of power as a reference price for all use and production of electricity. Note also that a well- functioning spot market is a prerequisite for a well-functioning futures market for power. At the time, the trading volume on the regulation power market seemed to be relatively high. Concern was whether the high trading volume in the regulation power market came at the expense of the liquidity of the spot market, and whether the overlapping of the two markets would undermine the liquidity and efficiency of the spot market in particular, and the efficiency and functioning of the electricity market in general. A basic question in the quest for improving efficiency was to explain and identify the causes of such a market development in the short-term markets. It is highly probable that the development followed from a multifaceted range of market issues, for example the explicit design of the organized markets, specific features of regulation policy or the general market structure, as well as frictions in the transition from the former system. It is also probable that the different issues were highly interrelated, so that such a development was a product of all these features. For example, in the transition away from the former bilateral contract dominated market system, the market

45

Physical delivery may in the Norwegian electricity system be contracted by the daily market, by bilateral contracts, and at the time also by the contracts of the weekly market which were settled by physical delivery.

design and realized liquidity of the organized forward or futures market may have had a major impact on the liquidity of the spot market; A poorly functioning futures or forward market may cause a greater use of bilateral contracts, which in turn may affect the liquidity in the spot market. This dependence is however reciprocal, as an efficient futures market also depends upon the existence of a liquid and efficient spot market. The liquidity of both markets may further rely on the chosen market design, as well as issues of competition in the general market structure.

While there are many factors which in sum might have accounted for the poor liquidity of the spot market, the focus of our work in Knivsflå and Rud (1995a), Knivsflå and Rud (1995b), and partly Hope, Rud and Singh (1993b), was on the chosen microstructure of the short-term markets. The question asked was whether alternative market design and trading mechanisms could contribute to a more efficient market in general, and in particular a more efficient interaction of the two short-term delivery markets. Before turning to the discussion of alternative trading mechanisms, let us however review some of the perceived problems. Hope, Rud and Singh (1993b) evaluated the current functioning of the markets, and suggested two sources of inefficiency which were thought to be attributed to features of the chosen trading mechanism:

- The interface between the daily market and the regulation power market: Figure 6 illustrates the timing between the daily market and the regulation power market. Orders to the daily market had to be placed before 1200 hours the day before delivery. Shortly after, the daily market was cleared. Delivery on the spot contracts occurs 12-36 hours later. After spot market clearing, any necessary adjustments in consumption and production are in principle assigned to the regulation power market.

One concern was here whether the time lag itself between the clearing of the daily market and delivery could contribute to the enhanced volume of the regulation power market. In

the 12-36 hours from spot market clearing to delivery, the market receives new information, e.g. on temperature and rainfall. The equilibrium contract obligations of the daily market, however, stand firm. The participants have no possibility to undertake any desired contract adjustments to adjust for this new information in production plans or consumption plans. Any deviations, unplanned, as well as any planned discrepancies due to new information, will thus all be handled and registered as deviations in the regulation power market. Compared to a situation with better pre-delivery adjustment possibilities, this set-up was assessed as a factor that possibly contributed to amplifying the level of deviations between the actual load and contractual load, and to enhancing the trading volume of the regulation power market.

Note also that in allocating their trade among the short-term markets, the participants compare prices, costs of trading, as well as possibilities of strategic bidding in the daily market versus the regulation power market. A concern was here whether there were other features of the current trading design that gave the participants incentives to canalize more trade to the regulation power market, i.e. by willfully causing deviations and this way offering capacity in the regulation power market rather in the spot market. The basic question was whether there were issues, such as features of the trading mechanisms, the timing of markets, or differences in market admittance, which promoted such incentives. - Market information from the current trading mechanism: The spot price conveys

information on the market value of the commodity. In an efficient power market the spot price reflects the value of power in alternative use, as well as the cost of supplying additional power on the margin. For hydro-power plants the main short-term marginal cost is not a cash-based cost, but rather the ‘water value’, which is the alternative cost of water. For the individual power plant, this value partly follows from conditions of the plant itself, and partly from the expected future market conditions. The spot price conveys information on the market’s aggregate assessment of the current value, and thus implicitly the expected future value of water. As such, the spot price is an important input to the production decisions of the individual producers. In this the spot price also plays an important role in coordinating the production decisions of different producers. We note that trading mechanism of the daily market reveals the resulting equilibrium price and quantity, but offers no information during the process of market clearing. At the time of trading, i.e. when submitting bids, the available market data is mainly given by the previous spot prices. Different designs of the trading mechanism may, however, convey

different levels of information during the process of trading. The question now asked was whether changes in trading mechanisms, or policies of information disclosure might improve the informational content of prices and also the efficiency of resource allocation. On this basis, our question was whether alternative trading mechanisms could contribute to improved efficiency in the short-term power markets.