Lecture 3 – Electricity Markets: Models and Structure Flashcards
What are the types of market models?
Pool model
Exchange model
What are the properties of the pool model?
• Central market organization
• Central optimization
• Power Trading compulsory takes place in one market
• Generation, Transmission, Balancing is optimized simultaneously
• Generation side is predominantly active in the markets, Demand is forecasted but not active in the market
• Compulsory trading facilitates coordination between generation and transmission → Locational Marginal Pricing
• Markets for balancing power are also included in the pool
• Focus on short-term cost-optimal allocation of resources
What are the properties of the exchange model?
• Decentralized market organization
• Decentralized decisions
• Power Trading is voluntary and takes place in closely linked, interdependent but separated markets
• Trading is possible outside of the exchange
• Generators individually plan & optimize their generation schedules and coordinate themselves with TSOs
• Most countries have a central auction for hourly contracts and a reference price for each time slot
• Market prices influence decisions, especially in investments
• More than one exchange platform leads to competition, that allows for corrections of bad market design or inefficiencies
• If different markets are not adequately coupled, also inefficient allocations can occur because of the decentralized architecture
Advantages of pool model?
- Pool Model is good if competition in the market is high
- Demand cannot play an important role in price determination
- Optimization problem deficits in reality can be kept to a reasonable minimum
Disadvantages of pool model?
• Possible wrong incentives through side payments for Long-term decisions → lack of new generation capacity
• Compulsory participation on one platform is suppressing competition of markets → no pressure to change for poorly designed platforms
• “Truth telling” is not incentive compatible for the parameters that influence the side payments for generators → private cost information is undisclosed
• Strategic behavior must be sanctioned by explicit mechanisms
• Optimization algorithms need high amount of information about relevant parameters and thus cause high information and control costs
Advantages of exchange model?
- Simpler Implementation
- Active Participation of Demand
- Bad market design can be addressed by change to other market platform
- If coordination of interdependent markets is not so important transaction costs are lower
Disadvantages of exchange model?
- Bad coordination between interdependent markets can hamper market results and investment incentives
- E.g. APX UK, where missing reference price leads to lower trade volumes and lower transparency in trading (no arbitrage possible)
Who are the market participants with inherent physical position?
Generators (sell) and retailers (procure)
Who are the market participants without inherent physical position?
Financial traders
What are the properties of trading at OTC?
• Trading directly between two parties
• Decentralized market without a central physical location
• Multiple prices for one good possible
• Risk that one contracting party does not fulfill its obligation
What are the properties of trading at Exchange?
• Standardized contracts
• Clearinghouse determines the clearing price
• Clearinghouse takes the counter party risk
• Only one price exists for one good at a given time
What are the places of trading?
OTC and Exchange
How is trading divided based on times of trading?
Derivatives market and spot market
What are the properties of derivatives market?
• E.g. forwards, futures, options
• Exchange of the goods after a predefined timespan (after contract formation)
What are the properties of spot market?
• Seller delivers the goods immediately
• Buyer pays “on the spot”
• Neither party can back out of the deal
Differences of spot market against futures market?
• Alternative, anonymous procurement & trade channel
• Prices are made transparent
• Serves as reference price
• Minimizes transaction costs by processing central
• Liquidity through standardization
Differences of futures market against spot market?
• Basics for risk management / investment security
• Increases market efficiency as arbitrage & speculation platform
• Serves as basis of valuation for vacant positions
• Clearing minimalizes default risk of opponents
• Futures market supports liquidity in spot trading
What are the types of trading?
Financial market and physical market
What are the properties of the financial market?
• Buyer and Seller agree that the price difference between stipulated price and future market price for a certain delivery will be balanced in cash
• Market participants hedge against risks
• Derivative markets can be designed for physical and financial fulfillment
What are the properties of the physical market?
• Buyer and Seller agree to deliver and pay power at a future delivery period with certain amount, load profile and place of delivery for stipulated price
• Spot markets are always related with a physical fulfillment of the trade
What are the load patterns?
- long term supply (long term contract via OTC)
- base load (contract via OTC or exchange)
- peakload (contract via exchange usually)
- rest of the gaps filled by hourly bids on supply side or demand side
Properties of forwards?
- Unconditional derivative
- Bilateral contracts
- Seller: Obligation to deliver a specified amount of an asset for a predefined price on a future date (short position)
- Buyer: Obligation to buy this amount of the asset for the predefined price on the agreed future date (long position)
Properties of futures?
- Unconditional derivative
- Same structure as forwards
- Only participants with an account at a Clearinghouse of an exchange can deal with futures
- Standardized contracts (quality, amount, notation, delivery date and location)
- Commitment to buy or sell a base value at a certain time in future for a today set price
Properties of options
- Conditional derivative
- Right to buy or sell on or till the last trading day a certain amount of a base value for a today set price. A corresponding premium has to be paid for the option
How long back do different tradings take place?
OTC- year, months
Futures - (years) months, weeks
Day ahead - upto 14 days
Intraday - 1 day - 75 mins
Balancing - 60 min - 3 s
When is intraday market vs day-ahead market used?
• Electricity is traded in Europe usually up to four years ahead of time – either bilaterally or exchange based
• Most short-term transactions are hosted at a day-ahead auction
• In Central Western Europe (CWE), continuous bilateral and exchange based trading is pursued until gate closure, typically 30 min before real time
• An intraday auction has been added to intraday trading in Germany
What are the properties of call market?
▪ Call auction
▪ Bids collected until closing (e.g. 12:00 a.m. / noon)
▪ Market clearing price after freeze
▪ Closed order book
▪ Principle of highest executable volume
Examples:
▪ Individual hour and block contracts
▪ Day-ahead auction
What are the properties of continuous trading?
▪ Continuous trading
▪ Immediate execution if possible
▪ Continuous price
▪ Open order book
▪ Principle of highest executable volume
Examples:
▪ Individual hour and block contracts
▪ Intraday trading
What is the price determined at a call auction?
- Uniform pricing mechanism
- Market-clearing price = intersection of the aggregated demand and supply curves
➢Provides maximum trade volume - The price is either the highest supply bid or the lowest demand bid
How is the price determined in continuous trading?
• Pay-as-bid mechanism
• Matching bids:
− matching according to price acceptance of bids of the opposite side
− incoming bids are checked against and matched with the bids in the order book according to price/time priority
• Precedence of bids:
− Bids with no price limit have precedence over bids with a price limit
− sale bids with a lower price limit take precedence over sale bids with a higher limit
− purchase bids with a higher price limit take precedence over bids with a lower limit
− In the event of bids having the same limit, time applies as the second criterion
➢ bids that were entered earlier have priority
Definition of quoted spread?
• …the difference between Best ask and Best bid of an order book
Quoted spread = (Ask - Bid)/(2*Mid)
What is the advantage of quoted spread?
easy to calculate
What is the disadvantage of quoted spread?
usually only implicit transaction costs of small trades captured (varies temporally)
Definition of Effective Spread?
Effective spread is the spread, which is actually paid by someone who trades with market orders.
Effective spread = D*((price - Mid)/ Mid) where D is 1 for buying indicator and -1 for selling indicator
What is the advantage of effective spread?
Capture the actual, implicit transaction costs
What is the disadvantage of effective spread?
Requires trading instructions for calculation. Heuristics are necessary to derive trading instructions from trading and quota data
What are the types of bids at the spot market (spot trading - day ahead market)?
Hourly bids and block bids
Describe hourly bids?
▪ Arrangement possible for every hour of a day
▪ To place/delete buying and selling orders up to 14 days in advance
Describe block bids?
▪ Maximum over 24 h (complete baseload)
▪ Free definable amount of hour contracts for fulfillment, place able as block bid. It is possible to fulfill a complete block
Properties of balancing or real-time market?
• Operates after the closure of the spot market
• Participants submit bids that specify the prices they require to increase their generation or decrease their consumption for a specific volume immediately
• Goal: To balance power generation to load at any time during real-time operations
• Real-time exchange works like a Walrasian auction
• Procedure:
− Announcement of a price
− Sellers and Buyers respond
➢If the market is not cleared→Announcement of new price
