risk & capacity investment incentives in electricity markets peter jackson department of...
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RISK & CAPACITY INVESTMENT INCENTIVES IN ELECTRICITY MARKETS
Peter JacksonDepartment Of ManagementUniversity Of Canterbury
Outline
My research topic/motivation Investment Optimal Plant Mix Hydro/Strategic concerns Contracts/Portfolios Market Structure/Solutions
My research…..
Evaluate the impact of investor risk on investment decisions
Explicitly deal with impact of Hydro risk Strategic behaviour Deterrence
Outcomes, Solutions Investment/Entry Pricing/Efficiency Market structure
Is not finished (hardly started!!!)
Motivation - Do electricity markets deliver appropriate security?
Security concerns were to the fore with central planners
Central planning proved uneconomic, and often over-investment resulted
Electricity markets have been created in an effort to capture economic efficiency
But private investors won’t invest unless it is economically justified
Private investors face different risks and are investing into a spot market that is susceptible to strategic behaviour
Investment and Prices – Why Invest? Generation plant
can be valued (equivalently) as a call option
Option value is dependent on pricing
Could discount or model risk more explicitly
Basic Screening Curve Analysis
Optimal Plant Mix Risk Free Not Strategic Some energy
limited plant With shortage
costs, fixed costs are recovered in equilibrium
Investment & Risk
My research focus is…… Hydro risk Strategic risk
But there are significant other risks for investors Reliability Regulatory/Political Demand growth Input prices Technological/Resource Transmission*
To a greater or lesser extent all plant faces risks but peaking plant is most vulnerable.
Energy Limited Hydro
Energy must be/should be used Inflow quantities determine total energy
available Reservoir size and plant rating determines
flexibility Inflow sequences are also important Peaking plant may never operate for its true
purpose. Being in the optimal plant mix is not the
same as being in the dispatch.
Energy Limited Hydro
Notional revaluation of fuel and capital cost based on energy available
All plant is impacted but peaking plant is worst off
Peaking Plant – Cautious Entry Given hydro variability, how much peaking
plant is required? Apart from other issues the investor need to
know inflow distribution. What is really important is the PDC, and this
can vary for a variety of reasons eg hydro inflows
But what if PDC is a result of gaming? (And gaming and hydro inflows are probably related)
What is the true underlying PDC? It may be impossible to estimate, especially for an entrant
The Impact Of Risk On Adequacy
Peaking Plant Investment
Price and quantity risk from a variety of sources Natural Strategic
Hydro generation makes forecasting particularly difficult
Not suitable for many standard forms of contract
Finance difficult to obtain given risks So how do we get any peaking plant built at all?
Wider considerations….
Standalone entry very difficult But firms have multiple generation plants,
and contracts in place = lower risk The impact on the portfolio of assets and
obligations is more relevant than the performance of the individual asset
Spot market gaming may increase returns above SRMC and incentivise investment
Strategic firms will not want to settle contract shortfalls with competitors
Deterrence Market structure may (or may not) help
NZ - Market Structure
LP Clearance Market design goals
Allocative efficiency Productive efficiency Dynamic efficiency
NZ Market S.O.E’s & Private investors Energy only market Vertical Integration Hydro influence Few Large customers
Wolak Report, 2009
Potential Solutions
Tolerate gaming Two part markets Capacity ticket systems Current proposals from taskforce
Contracts and Risk I
Consider increasing risk on generators who are unable to cover contractual obligations
Contracts & Risk II
Increasing cost of over contracting improves adequacy but this analysis assumes contracts are exogenous
What if contracts are endogenous? Equilibirum contract prices will be higher for higher risk
Customers will get more security (but pay for it)
What is the relative performance of other solutions? Market power (18% - Wolak) Capacity payments (25% - Initial market study)
Evaluation required
Future Work required
Energy limited plant “MW limited” Dynamic analysis
Plant retirement Demand growth Investment
Strategic interactions Spot market Cautious Entry Deterrence
Complementarity Formulations Evaluate remedies