Correlograma de la seria de tiempo ventas (vts)

Often-discussed flaws of current markets and potential distortions are listed. The list is based on a detailed discussion by de Vries [17]. The discussion on the individual elements is intended to be a summary only.

24 CAPACITY MECHANISMS IN MULTI-SERVICE MARKETS

1. Absence of price-elastic demand 2. Price restrictions or price caps 3. Imperfect information

4. Regulatory uncertainty and restrictions 5. Risk aversion

6. Uncertainty of input markets and other externalities

Absence of price-elastic demand

The problems arising from missing demand flexibility and the coinciding lack of demand reacting to prices has been widely discussed [34]. The absence of price-elastic demand is often mentioned as a notorious problem for electricity markets to find a proper market signal, i.e., a market price, which reflects the value of reliability. In other words, due to consumers’ missing possibilities to express their value properly, often due to limited technical infrastructure, information necessary to provide an optimal reliability level is not revealed [41]. Therefore, an energy-only market with limited demand flexibility would be always characterized by prices that alter between prices following relatively low operating costs of generators and the high spike prices that are close to the VOLL in times of scarcity [42]. As such, according to [41], given low demand flexibility, prices for energy cannot solve the reliability problem without selling a reliability product, e.g., in form of a CM.

Two developments are possible to introduce the consumer’s value back into the price signal. One the one hand, market mechanisms are discussed that reflect the value of reliability in a market price, such as for example operation reserves demand curve (ORDC) or via another market in form of a CM. On the other hand, using advanced infrastructure, the demand could be enabled to express its value directly to the market. This could be done via a more explicit price signal, e.g., real-time pricing, or direct subscription models for reliability, as for example capacity subscription (Section 2.4.1).

Price restrictions or price caps

Often-linked to the absence of price-elastic demand, price restrictions or price caps are introduced to the market to avoid the abuse of market power at the supply side in times of scarcity [43]. However, such regulatory intervention with the market prices suppresses the possibility to find the true value of reliability by a market-based mechanism, especially if the price cap is set too low [44].

LONG-TERM GENERATION ADEQUACY 25

Consequently, if the price cap is reached often, it prevents necessary market signals for investment [45], also referred to as the missing money problem. However, [34] argues that even with VOLL-pricing the effect on supply side investment is limited. The price signal might not be strong enough to outweigh the risk linked to the frequency and amplitude of price spikes in a VOLL-pricing scheme, cfr. the after next paragraph on risk aversion. Therefore, VOLL-pricing is in the first place rather a means to stimulate the demand side rather than to win investors over.

In combination with CMs, the level of the price cap and the form of remuneration are interlinked. Yet, [46] highlights that a CM is not only meant as a motivation for allowing a low energy price cap and still providing compensation for generators. A CM is more a mechanism to value availability in times of scarcity rather than replacing a regulatory intervention.

Missing market

As hinted in the previous paragraph, even if the missing money problem could be solved by changing the rules for the price formation, problems remain. One of these problems is often referred to by the term missing market [47].

According to [48], missing markets exist if markets do not allow or limit market participants in transferring risks or other externalities into market signals. A well-known example where the missing market was resolved is the pricing of the externalities linked to CO2-emission, now partly covered in an Emissions Trading System (ETS). Newberry [48] states that the problem of missing markets is also relevant for the electricity market because policy makers are often not willing to put markets in place that could affect market participants’ profits.

With respect to generation adequacy, the absence of a market for reliability either in form of a dedicated market or adequate market signal through energy- based prices is identified as a missing market [42]. In other words, the problem with missing markets arises because there is no market that internalizes security of supply externalities [49]. In that way, a CM could transform consumers’ preferences for security of supply into an explicit capacity target that can be channeled via a CM independently of the actual implementation.

Risk aversion

In combination with a missing market and price spikes, the absence of investment in adequate generation capacity is also linked to the risk aversion of potential

26 CAPACITY MECHANISMS IN MULTI-SERVICE MARKETS

investors [50]. This risk aversion is not exclusive to investors for generation, but can also affect other technologies and the demand side.

As mentioned above, occurrences of energy-based prices that reflect scarcity, and thus are high enough to justify investments in additional generation capacity, are rare and difficult to predict. Extreme price volatility due to both inelastic and volatile demand and supply is the consequence [41]. The volatility of, and uncertainty about, future revenues in combination with significant sunk cost of large investments motivates rational investors to delay investment decisions [33]. Typically, the investors’ behavior is characterized as risk-averse. As stated [51], this has the consequence that even if an investment would be justified by expected revenues, investors defer or even discard a potential investment. In other words, prices must account for the risk and consequently be higher than just necessary to cover the cost [33]. This effect is addressed in Chapter 6. Mechanisms to reduce the uncertainty and volatility of prices are common in most electricity markets. Opportunities to hedge risks and generate revenues are necessary to recover the costs of investments [52]. Typically, forward contracts, either via an organized market or in bilateral negotiations, are used to hedge the risk of price volatility in the short-term [53]. However, those markets address the bulk value of energy and often cover only parts of the market. By extension, a CM can be seen as a regulated mechanism for a product close to forward contracts, sold by all market participants and purchased by a demand side that represents generation adequacy.

Regulatory uncertainty and policy interference

While the above-mentioned factors are associated with the nature of power systems and capital-intensive investment, regulatory uncertainty and other restrictions are of a different origin. Regulatory interventions and policy interference is a consequence of risk-averse demand side and regulators [54]. The mentioned elements are hard to measure and are more reliant on market observations.

Electricity is a vital good for modern society. Consequently, shortages of electricity have significant social and political implications [55]. It is argued that given the importance of security of supply, it is often treated as public good and regulators are encouraged to act early to ensure adequate capacity [56]. At the same time, market participants base their decision on the assumption that the regulator’s decision-making will always prevent supply shortfalls or inordinately high prices [57]. Therefore, politicians, regulators and system operators tend to interfere with the market to ensure a reliable electricity supply at an early stage.

LONG-TERM GENERATION ADEQUACY 27

Moreover, often regulatory decisions are taken to achieve other policy goals interlinked with the electricity markets, e.g., environmental policies. Independent of the intention for the interference, the decisions taken affect the development of the long-term generation mix. This is especially the case if far- reaching decisions are taken with a higher frequency than market participants can adapt. As such, uncertainty about future policies can create a hurdle for investments [58].

Regulatory interference can be of short- and long-term nature, with both having an impact on the development of the long-term generation mix [50]. On the one hand, as an example for a decision that distorts the long-term development, policy choices for or against technologies can be mentioned. In turn, in many markets, it is also not possible for market participants to leave the market, even if the operation of an asset is non-profitable. The suppressed possibility to exit the market might form a hurdle to enter the market in the first place. As example, the grid reserve in Germany prevents generation units to leave the market if they are classified as system-relevant [59]. Another problem arises from unstable policy-making about subsidy schemes for both the investor’s technologies as well as competitors.

On the other hand, short-term regulatory uncertainty emerges from decisions that prevent the forming of price signals. Politically motivated actions might distort the allocation of cost in the short-term, independent of the consumers’ preferences [60]. As an example, the Belgian plan for controlled load interruptions (“Afschakelplan”) [61] can be mentioned. Meant to ensure the security of supply, the actions prevent that prices for reliability can emerge from the market. Another example, which is more difficult to verify, is the fierce reaction by policy makers, often supported by the media, to price spikes at the supply side in times of scarcity even if prices are well below the price cap [62]. Such an implicit “price cap of acceptance” might be an additional distortion to the markets.

Uncertainty input markets and other externalities

Finally, distortions to the electricity market may arise from the uncertainty about the input markets and other externalities. These externalities may be caused by various reasons and can also be specific to a market or country. Common uncertainties to almost all markets are linked to the increasing share of RES or the future prices for primary fuels including coal, oil or gas.

The uncertainty about the availability of RES is caused by its intermittent generation patterns. RES have a significant impact on the operating hours as well as the capacity factor of the remaining generators [52]. In addition to the

28 CAPACITY MECHANISMS IN MULTI-SERVICE MARKETS

above-mentioned impact on the market prices, the uncertainty exacerbates the risk of generators, limited in hedging their risk. This problem is expected to become more severe with further increasing RES generation [41]. Chapter 4 takes up this issue in the discussion of the case study presented.

Another uncertainty linked to the availability of a technology is the discussion of phasing-out certain technologies. In fact, this potential distortion overlaps with regulatory uncertainty. For example, the Belgian nuclear phase-out in combination with potential lifetime extensions can be put forward. The schedule for the phase-out of the nuclear units in Belgium, that make up for about 50% of the conventional generation capacity, has been changed multiple times in the last decade [63, 64]. Even today, the planned phase-out in 2022/2025 is still a subject at the political agenda. The ongoing decision process of the (un-)availability of this large share of Belgium’s base load units is assumed one

of the biggest factors for the investment climate.