Price and Environment in Electricity Restructuring

One purpose of electricity restructuring is to create a market in which prices reflect costs to which both generators and consumers may respond efficiently. Yet in many jurisdictions, spot prices may be quite volatile, and both consumers and generators of electricity have made it clear that they do not prices that are highly volatile. This paper examines price plans that have been and might be used in restructured electricity markets assessing their ability to face consumers with efficient prices at the margin but to minimize their exposure to volatility, considering the welfare losses that may be associated with them. It notes that electricity markets are necessarily artificial and that few have managed to create price plans that seem to improve on the efficiency of pre-restructuring prices. Moreover in the California market, the operation of a separate market for air pollution emissions gave rise to emission prices far above reasonable estimates of environmental harm, further exacerbating wholesale price fluctuations in 2000. Solutions to these problems are explored.electric utilities, electricity restructuring, air pollution, spot market, price volatility, price structure, Ontario

Electricity Restructuring: What Has Worked, What Has Not, and What is Next

In the 1990s and early 2000s, a series of state and federal initiatives restructured electric markets. In many areas of the country generation was unbundled from transmission and distribution and competitive markets for energy generation were established. A decade has now passed since many of these market reforms were implemented, and increasing energy prices have re-focused attention on these reforms. In particular, commentators are blaming the reforms for the rising energy prices and, in several states, legislators are now considering re-imposing regulation. In this paper I discuss some successful features of industry restructuring, and consider areas where further reform may be warranted. It appears that market restructuring is now producing significant tangible benefits in the areas of the country where it has been most fully implemented. Calls for the reimposition of heavy-handed regulation should be resisted.

Volatility transmission and volatility impulse response functions in European electricity forward markets.

A  l’aide de données quotidiennes  sur  la période mars  2001 à  juin  2005, nous estimons un modèle VAR‐BEKK  et montrons  l’existence  de  transmissions  au  niveau  des  rendements  et  des  volatilités  entre  les marchés  forward  de  l’électricité  pour  l’Allemagne,  les  Pays‐Bas  et  la  Grande‐Bretagne. Nous  appliquons  la fonction VIRF de Hafner and Herwartz [2006, Journal of  International Money and Finance 25, 719‐740] afin de mesurer  l’impact  d’un  choc  sur  la  volatilité  conditionnelle. Nous  observons  qu’un  choc  a  un  impact  positif important seulement si son amplitude est grande en regard du niveau de la volatilité à cet instant. Finalement, nous estimons  la densité des  fonctions VIRF pour différents horizons de prévisions.  Ces distributions lissées  sont asymétriques  et montrent que des  évènements extrêmes sont  possibles même si leur  probabilité est faible. Ces résultats ont des implications intéressantes pour les participants au marché dont la politique de gestion des risques est basée sur les prix des options, eux‐mêmes dépendant du niveau de volatilité.Using daily data from March 2001 to June 2005, we estimate a VAR-BEKK model and find evidence of return and volatility spillovers between the German, the Dutch and the British forward electricity markets. We apply Hafner and Herwartz [2006, Journal of International Money and Finance 25, 719–740] Volatility Impulse Response Function (VIRF) to quantify the impact of shock on expected conditional volatility. We observe that a shock has a high positive impact only if its size is large compared to the current level of volatility. The impact of shocks are usually not persistent, which may be a consequence of the non-storability of power. Finally, we estimate the density of the VIRF at different forecast horizons. These fitted distributions are asymmetric and show that large increases in expected conditional volatilities are possible even if their probability is low. These results have interesting implications for market participants whose risk management policy depends on option prices which themselves depend on the characteristics of volatility.volatility spillovers; electricity forward markets; multivariate GARCH; volatility impulse response function; transmission de volatilité; marché forward de l’électricité; GARCH multivarié; Fonction impulsion réponse de volatilité;

Volatility transmission and volatility impulse response functions in European electricity forward markets

Using daily data from March 2001 to June 2005, we estimate a VAR-BEKK model and find evidence of return and volatility spillovers between the German, the Dutch and the British forward electricity markets. We apply Hafner and Herwartz [2006, Journal of International Money and Finance 25, 719-740] Volatility Impulse Response Function(VIRF) to quantify the impact of shock on expected conditional volatility. We observe that a shock has a high positive impact only if its size is large compared to the current level of volatility. The impact of shocks are usually not persistent, which may be an indication of market efficiency. Finally, we estimate the density of the VIRF at different forecast horizon. These fitted distributions are asymmetric and show that extreme events are possible even if their probability is low. These results have interesting implications for market participants whose risk management policy is based on option prices which themselves depend on the volatility level.volatility impulse response function, GARCH, non Gaussian distributions, electricity market, forward markets

Competition Without Chaos

California heralded the New Year with a wave of rolling blackouts, spiraling wholesale electricity prices, and at least one utility bankruptcy. California, which symbolizes the electronic age and represents an eighth of the U.S. economy and its population, faces electricity supply issues not seen since the Great Depression and the collapse of the great utility holding companies. To what extent is California the bellwether for the restructured electric industry in the United States? We do not believe that the recent crisis in California is a signal that competition and deregulation have failed. Indeed, it remains our firm belief that market-oriented restructuring of the electric industry remains the best opportunity to provide consumer benefits and to develop reliable new sources of supply. After all, a major impetus for introducing competition into the generation and marketing of electricity has been the previous failures in long-term planning decisions made by public utilities and their regulators. The regulated monopoly regime simply did not provide the correct economic incentives for a company to provide electric service efficiently. To what extent can other states that have restructured their electric industries expect to see California-like dramatic sustained price increases and supply shortages resulting in rolling blackouts? The root cause of California's problems was its long-term failure to build generating plants during the most sustained economic boom in the state's history. California's most significant restructuring problem was also a local issue. The California restructuring law required utilities collecting stranded costs to retain fixed price obligations to retail customers, while preventing them from hedging their price risk in the wholesale market by entering into long-term supply contracts. The California market design flaws have been avoided in the restructuring legislation enacted by the twenty-four states and the District of Columbia that have restructured electricity markets. Among these states are Pennsylvania and Illinois, the states where Exelon conducts public utility businesses. The restructuring efforts in these other states are generally yielding results quite different from those in California and demonstrate that thoughtful, market-oriented, evolutionary restructuring can work well for all parties. This is not a reason, however, for complacency. Government agencies, utilities and all market stakeholders must work hard to make sure this answer remains valid a few years hence. This work includes establishing appropriate pricing and incentives to encourage the building of new supply and the development of demand-side management programs; establishing regional transmission organizations in order to support the expansion of and appropriate pricing for transmission; establishing appropriate rules and pricing regarding the utilities provider of last resort or default supply obligation. The default supply issue is one of the most significant challenges to the transition to competition. If the delivery companies retain primary responsibility for arranging supply and thus lock up most of the generation sources, the result is reliable service and stable rates for customers. However, new market entrants' access to supply sources will be limited and at high prices, making it difficult for them to compete. To resolve this dilemma, we propose a bifurcated approach to default service offerings and pricing. For large customers, who have the most desirable service characteristics to competitive suppliers and thus more opportunity to hedge their price risk, the utilities' only default service obligation would be unbundled energy at a market price. For mass market customers, who lack hedging ability because of limited, if any, market development, the utilities would provide a fixed price, multi-year energy supply offering. The price for both offerings must include a risk premium adequate to compensate the utility for the risk it assumes and to avoid rates that are too low to allow alternative suppliers to compete. We believe our default supply resolution will achieve the competing goals of price stability, reliability, and the development of a mature competitive market. The California experience is not an accident or the product of bad luck. It is the product of choices, long-term choices about siting generation and transmission, and the more recent choice of a market design that imposed asymmetric risks on utilities to the ultimate detriment of all. If other states make similar choices, similar consequences can be expected to follow. In short, the California experience is no reason to reject restructuring; it is rather a forceful lesson on the importance of doing it right.

How does market architecture affect price dynamics ? A time series analysis of the Italian day-ahead electricity prices

How do changes in the market architecture affect the dynamics of deregulated electricity prices? We investigate this issue in the context of the Italian Power Exchange (IPEX), using data on the daily average day-ahead price (PUN) between April 2004 and December 2008. Estimates of baseline time series models (ARMAX and ARMAX-EGARCH) and their forecasting performances suggest that the trend in natural gas prices, deterministic weekly patterns, the impact of perceived temperatures, persistence in conditional volatility and the inverse leverage effect are essential features of the PUN dynamics. We then augment the best-performing models with dummies that account for changes in the market architecture, such as the introduction of contracts for differences (CfDs) to support renewables, trading of white certificates for energy efficiency, and the demandside liberalization. The findings show that changes in the market architecture have only affected the PUN volatility. Specifically, CfDs have mitigated volatility, while white certificates and demand liberalization have increased it. Moreover, after controlling for reforms the inverse leverage effect vanishes, and the persistence in volatility is lower than in the baseline estimates.electricity prices, Italian power exchange, market architecture, ARMA, EGARCH

The dynamics of hourly electricity prices

The dynamics of hourly electricity prices in day-ahead markets is an important element of competitive power markets that were only established in the last decade. In electricity markets, the market microstructure does not allow for continuous trading, since operators require advance notice in order to verify that the schedule is feasible and lies within transmission constraints. Instead agents have to submit their bids and offers for delivery of electricity for all hours of the next day before a specified market closing time. We suggest the use of dynamic semiparametric factor models (DSFM) for the behavior of hourly electricity prices. We find that a model with three factors is able to explain already a high proportion of the variation in hourly electricity prices. Our analysis also provides insights into the characteristics of the market, in particular with respect to the driving factors of hourly prices and their dynamic behavior through time.Power Markets, Dynamic Semiparametric Factor Models, Day-ahead Electricity Prices

No PUN intended: A time series analysis of the Italian day-ahead electricity prices

How do changes in the market architecture affect the dynamics of deregulated electricity prices? We investigate this issue in the context of the Italian Power Exchange (IPEX), using data on the daily average day-ahead price (PUN) between April 2004 and December 2008. Estimates of baseline time series models (ARMAX and ARMAX-EGARCH) and their forecasting performances suggest that the trend in natural gas prices, deterministic weekly patterns, the impact of perceived temperatures, persistence in conditional volatility and the inverse leverage effect are essential features of the PUN dynamics. We then augment the best-performing models with dummies that account for changes in the market architecture, such as the introduction of contracts for differences (CfDs) to support renewables, trading of white certificates for energy efficiency, and the demandside liberalization. The findings show that changes in the market architecture have only affected the PUN volatility. Specifically, CfDs have mitigated volatility, while white certificates and demand liberalization have increased it. Moreover, after controlling for reforms the inverse leverage effect vanishes, and the persistence in volatility is lower than in the baseline estimates.Electricity prices, Italian Power Exchange, Market architecture, ARMA,EGARCH