Interruptores basados en MZI

Determining the Market price

Most of the European Power Exchanges set energy prices based on the marginal price auction (or single price auction), this means that all generators are paid the market clearing price. The highest accepted supply bid is the one that determines the price.

In the spot market, the participants specify how much electricity they wish to buy or sell at a given price. For each hour during the following day the participants’ bids are aggregated into supply and demand curves.

The supply curve consists of the participants’ aggregated sales bids in terms of each technology’s variable production cost, or the marginal cost which corresponds to the cost of increasing or producing one additional unit. The demand curve consists of the participants’ purchase bids also in terms of price and quantities.

The combination of price and quantity where the supply and demand curves match determines the market clearing price.

Hydro Nuclear CCGT

CCGT

Coal Coal

Fuel oil & GT Wind Quantity (MW) Variable cost (€MW/h) Supply (sell) Demand (Buy) Depends on gas & coal price

Source: own elaboration

Figure 6. Supply curve construction

The supply curve aggregates the bids on a merit order from the unit of production with the lowest marginal cost up to the marginal cost of the last unit of the production needed. This means that demand and supply meet at the lowest possible cost.

Once we have described how the supply curve is shaped, it is essential to explain the factors influencing the variable cost bided.

Fuel cost, carbon allowances cost and variable O&M represent the variable cost that comprises the sale bids. Apart from wind and water power the rest of technologies must rely on the cost of their fuel to operate.

Fuel prices

Fuel costs are a share of total generation costs and vary significantly among technologies. Wind has no fuel costs. For nuclear power, fuel costs represent a small component of nuclear power generation, between 8 and 11%. For CCGTs, fuel costs account for about 75% of total costs. A 50 % increase in uranium, gas and coal prices would increase nuclear generation costs by about 3%, coal costs by about 20% and CCGT costs by about 38% (IEA, 2006).

x Coal prices: The coal-fired power stations depend on buying coal for fuel; when coal becomes more expensive the cost of generating electricity from this fuel rises.

There is a price level on which burning coal to produce power becomes uneconomic and such level of activity may decline. Consequently, the supply will be reduced and boosts prices on the Power Exchange. In 2005, gas-fired generation contributed a lower share of the increasing power needs, because high gas prices provided strong incentives for an increase in coal-fired generation from existing plants.

x Gas prices: Nowadays gas-fired plants are becoming more “popular” in Europe due to a range of advantages. As with coal-fired capacity, these power stations depend on buying gas for fuel. Lower gas prices would improve the terms for such output, which in turn could increase electricity supply, and cut prices. Demand for gas in power generation in the OECD increased from 213 bcm in 1990 to 447 bcm in 2004; an annual average growth of 5.4% (Gas Market 2007).

Considering that the price of natural gas tends to be volatile in some markets, this seems an important drawback for CCGTs. However, it must be remembered that where gas sets the electricity’s marginal price, this volatility can be recovered from the market. In this case, of course, high gas prices directly translate into high electricity prices. High gas prices make other alternative technologies more competitive.

Gas prices are typically indexed to crude and/or oil products such as Low Sulphur Fuel Oil, High Sulphur Fuel Oil, and gas oil; so gas price will increase: when the world crude-oil market tightens, when there are low inventories, when demand rises and refinery capacity meets its production, or when there are speculative facts about geopolitical situations, with a time lag which depends on the indexation mechanism included in the gas pricing formula.

x Carbon allowances prices: The European Emissions Trading Scheme (ETS) limits CO2 emissions for some industrial sectors; since 2005 each country allocates

its allowances to companies which are free to trade them within the EU. Carbon allowances (EUAs) and carbon credits (CER´s) are traded as a commodity. Power stations with carbon emissions must buy EUAs or CERs to cover a possible shortage of such allowances.

If the price of EUAs or CERs is high, generating electricity from fuels such as coal and gas becomes more expensive, and the cost could rise. The price could increase by the amount of the EUAs and CERs, because these are input factors.

Demand side also affects the electricity price on the spot market by moving the demand curve (from Xo to X1), as shown in the figure below: if the demand curve

moves this will require that more expensive technologies operate to cover the demand.

Hydro Nuclear CCGT Coal Fuel oil & GT Wind Quantity (MW) Variable cost (€MW/h) Supply (sell) Demand (Buy) Xo X1

Source: own elaboration

Figure 7. Supply curve construction

Some of the factors that affect the demand curve displacement are the following:

x Weather and temperature conditions

Precipitation: The level of precipitation is significant for pricing on the Power Exchange. Plentiful rain and snow means more water to drive the turbines, which in turn boosts supply. An increase in precipitation alone will normally reduce electricity prices.

x Temperature conditions

Temperatures influence daily demand for power. Colder weather boosts demand, which can lead in turn to price increases.

x Electricity transmission

Transmission capacity: Capacity shortages in the transmission network could increase prices if demand in one area exceeds supply. Lack of capacity means that power cannot be acquired from regions with a surplus.

x Seasonability

Demand differs between seasons (winter/summer), days (weekdays/weekends), and hours (peak/off peak). This seasonal and day variation implies that some generators only run a couple of hours per year

x Level of economic activity

General economic fluctuations such as booms and recessions also impact in the electricity consumption and, thereby, trading in power because power market is influenced by fluctuations in other raw materials and currency markets.

x Economic factors

Generating capacity: Expanding generating capacity will increase the supply of electricity, which could reduce prices.

x Currency movements

Most raw materials are priced in US dollars. A lower exchange rate for the dollar cuts the cost of coal, gas and other fuels to lower the price of electricity.