Subject: FW: Frontier Economics' Whitepaper
From: [email-masked]
To: [email-masked]
Cc: [email-masked]
Date: Thu, 24 May 2001 06:54:00 -0700 (PDT)

Rick,

Some comments from Nick are attached below.

Nick's first comment reflects a general concern I had about the paper which 
was it's treatment of imbalance settlement.  I would see this as one of the 
essential elements of market design.  I've always felt that the 
physical/financial distinction was slightly artificial because even with 
"physical" contracts, power systems must have a means for cash settlement of 
imbalances (in the absence of universal controls which limit actual takes to 
contract volumes).  However, the paper does not really pick this up and in 
section 3.1 implies that cash settlement might only be "feasible" in some 
market structures.  I would have added imbalance settlement to section 2.1 
which describes the fundamentals required for any market.  It would also help 
to draw a brighter distinction between spot markets and imbalance settlement.

At the same time I would have dropped the mention of "binding market rules" 
from 2.1.  I'd see this as a subset of the need for an ISO to take over the 
operation of the system in real time rather than as a separate fundamental 
principle.  It's also not made clear in what sense these commitments are 
binding.  Are they binding in a financial sense (in which case they are 
covered by imbalance settlement) or somehow physically (either this is 
unfeasible since units trip etc or it requires some form of balancing penalty 
which is ruled out later in the paper).

I felt that the paper also compounded issues such as LMP's/transmission 
rights with other non-locational elements of market design, this makes it 
difficult to follow in places.  It would be clearer to have the locational 
elements addressed separately as an adjunct to the basic principles.

Centralised unit commitment is put up as an element of the model proposed.  
As Nick hints at below, we wouldn't see this as an essential element of 
market design.  Under NETA, individual participants commit their own units 
with the SO only taking over full control at 3.5 hours out.  Even with 
centralised commitment, I'm not convinced that simple bidding would be 
superior to multi-part bids.  Much here depends on timescales, eg, a 
day-ahead market with simple bids is more exposed to allocative inefficienc 
than a continuous hourly market with simple bids.  Simple bidding was often 
proposed for the Pool, but I think a single daily big would have increased 
prices if two-shifting generators had not been able to reflect their start-up 
and no-load costs separately.  (These elements were also gamed, although this 
game eroded as competition increased.)

Specific UK sensitivities which you may want to finesse in the paper:

? we've consistently opposed locational pricing because of our Teesside 
positions.  Publicly we've argued that the proposals do not provide good 
economic signals over sufficiently long time-periods to enhance allocative 
efficiency and that the transactions costs outweigh any possible efficiency 
gains (constraints only cost about o20m pa here).  Despite arguing our 
commercial position, I'm quite happy with this approach and am genuinely 
sceptical about the benefits of locational pricing in the UK.  This position 
would of course change in much larger, sparse and less-interconnected 
networks such as exist in parts of the US.
? Our fall back position is that any locational pricing scheme in the UK must 
preserve pre-existing implied rights for generators, ie, grandfathering.  I 
recognise that this can be a barrier to competition in some networks with 
imcumbent market power, but I don't think that this is as big an issue in the 
UK (where competition already exists) as it is on the Contintent and in the 
US.

Hope these help, let me know if you want to discuss further.

Paul

 -----Original Message-----
From:  Elms, Nick  
Sent: 22 May 2001 14:29
To: Dawson, Paul
Subject: Frontier Economics' Whitepaper

Paul,

Here's some comments on Frontier's whitepaper. Do you want to discuss them? 

Section 3.1
The distinction between cash and physical settlement of forward contracts is 
blurred. Under NETA contract settlement is achieved by contract notification 
to Elexon. Even then a party doesn't need to deliver on the contract - it 
could cash out at the imbalance price. However, in practice NETA is more 
similar to physical settlement since imbalance price volatility means Parties 
try to avoid imbalances. 

Section 4.1.1
Decentralised commitment doesn't require parties to trade physical 
transmission contracts.  LMPs would also allow decentralised commitment.  It 
is difficult to imagine an efficient dispatch resulting from flowgate trading 
unless there are few transmission constraints and hence few flowgates.  
Simplified flowgates is the same as zonal LMPs.

Interim model (section 5)
1) It will be difficult to impose a single RTO design on the multitude of 
jurisdictions in the US - because of the private stakes in the industry.
2) The proposed day-ahead market need not be run by the ISO.  It's not a unit 
commitment since it may not result in a feasible unit commitment, and even if 
it did Parties may deviate through imbalance trading.  Rather, day-ahead 
trading could be left to the market to develop.  Generators would self commit 
based on their own forecasts of spot prices for the following day and parties 
could hedge their positions through day ahead contracts trading.  These 
day-ahead energy contract markets would be based at hubs - leaving parties 
with basis risk between the hub and their location.  Parties require some 
means of heging the basis risk - financial transmission rights is a 
possibility.

Competitive framework (section 6)
1) Demand side response reduces generators' market power.  Forward 
contracting mitigates the effect of market power on both generators and 
consumers, particularly the impact of short term market power. This may be an 
argument for using HHIs to measure market power.
2) A move towards regulatory intervention every time the supply/demand 
imbalance became tight would add to regulatory risk.  And it may deter new 
entrants if such intervention prevents prices from rising.
3) With full retail competition there is no need to regulate suppliers' 
forward contracting since suppliers can only pass on their competitive costs 
to customers.  Non-eligible customers create a problem.  What price should 
these customers pay?  It is difficult to regulate a supplier's contracts and 
to somehow split its contract costs between eligible and non-eligible 
customers.  This is why a spot price pass-through is suggested.  Financial 
institutions would be free to provide hedging contracts to consumers. Those 
institutions would in turn have financial contracts with generators.  An 
alternative is incentive regulation of suppliers of non-eligible customers.  
To avoid the california problem the regulator would need to limit the 
supplier's downside and upside risk.

Nick