Reforming the Mexican Electricity Market: Design and Regulatory

Issues

Juan Rosellón DIW Berlin and CIDE

1 Berlin Conference on Energy and Electricity Economics (BELEC 2015)

28-29 May, 2015

Outline

1. New industry and institutional structure

2. Challenges: – Market design under the assumptions of the

energy reform

– Introduction a nodal-price system and FTR auctions

– Transmission network expansion and large-scale renewable integration

3. Implications for policy making in Mexico

2

Outline

1. New industry and institutional structure

2. Challenges: – Market design under the assumptions of the

energy reform

– Introduction a nodal-price system and FTR auctions

– Transmission network expansion and large-scale integration renewables

3. Implications for policy making in Mexico

3

Generation System Control and

Electric Market

Qualified Users

Basic Service Users

Consumption Retailing

Private Parties

Regulated Supply

Long Term Contracts

Spot Market

Auctions

Short Term Transactions

New industry structure ANEXO MEM.PPTX

and Contracts

Transmission Distribution

Unregulated Supply

Subsidiary “B”

Subsidiary “A”

Subsidiary “C”

and Contracts

4

New institutional framework

5

Pre

-Refo

rm

Re

form

Approve Expansion Plan

Permits

Generation “Modality”

Minimum consumption to be Qualified User

Market Monitor

Requirements for Clean Energy

Contracting Requirements

Administer CEC’s

Reliability Standards Svc. Quality Requirements

Final Rates (Basic Service)

Final Rates

Participate in Final Rates

Participate in Final Rates

Dispatch Rules

Reliability Standards

Expansion Plan Expansion Plan

Generator Interconnection

Approve Expansion Plan

Operation of Short and Long Term Markets

System Operation

Planning and Interconnection Studies

Regulated Tariffs

Approve expansion plan

Marketing Control/Dispatch Transmission Generation Distribution

Supervision of Interconnection

Initial Market Rules

Clean energy potential in Mexico

Renewable Energy Potential

Installed Capacity

2° semester 2014

(MW)

Actual Generation

Year 2013

(% of total GWh)

Actual Generation

+ Proven Resources

Actual Generation

+ Proven Resources

+Probable Resources

Actual Generation

+ Proven Resources

+Probable Resources

+Possible Resources

Wind 1900 1.38% 5.30% 5.30% 34.80%

Geothermal 823 2.04% 2.22% 22.52% 40.03%

Solar 64 0.01% 0.65% 0.65% 2,189.40%

Mini Hydro 419 0.54% 1.72% 9.48% 24.35%

Total 3206 3.97% 9.89% 37.95% 2,288.59%

• Mexico has sufficient resources to exceed its goals of 35% non-fossil generation in 2024, 40% in 2035 and 50% in 2050.

• Portfolio standard will assure that they can be developed.

Solar Resources Wind Resources Geothermal Resources

6

Opportunities for transmission investment

Existing Program: In the 15 year plan, CFE has included 19.3 billion USD of transmission projects including 19,555 circuit-km of lines.

Planning: Expansion plan will be proposed by an independent entity with a mandate to promote open access (CENACE).

100

120

140

160

180

200

35

40

45

50

55

60

65

70

20

13

20

14

20

15

20

16

20

17

20

18

20

19

20

20

20

21

20

22

20

23

20

24

20

25

20

26

20

27

20

28

Tran

smis

sio

n (

c-km

)

De

man

d (

GW

)

Demand Growth vs. Transmission Expansion

Demand

Transmission

85% growth

18% growth

• Transmission in US and Canada expands faster than demand growth.

• Expansion in Mexico should become more aggressive.

Implementation plan

Electricity Market

Transmission and

Distribution

Electric Industry

2014 2015 Aug Sep Oct Nov Dec Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec

First Market Rules Rules

Electric Market Operation

Clean Energy

Universal Service

Fund Creation

CENACE . Creation Decree

National Electric System Development Program

Program

Model Contracts

Resolution

Regulated Rates Resolution

Bylaws Bylaws

Certification

Clean Energy Guidelines

Resolution

Clean Energy Requirements

Resolution

Basic Service Auctions

Operation

Terms of Separation CFE

Resolution

Restructuring of CFE Legal Separation

CRE SENER Responsibility: 8

Outline

1. New industry and institutional structure

2. Challenges: – Market design under the assumptions of the

energy reform

– Introduction a nodal-price system and FTR auctions

– Transmission network expansion and large-scale renewable integration

3. Implications for policy making in Mexico

9

Challenges

• Key issues related to the implementation of the of the Mexican electricity reform.

• Optimal design of an electricity market driven by the assumptions of the energy reform, e.g., network expansion, horizontal and vertical integration, ISO’s corporate governance.

• Implementation of a nodal pricing system and introduction of financial transmission rights (FTRs).

• Optimal regulation of the transmission network to promote large-scale integration of renewables.

10

First issue: Electricity market design under the assumptions of the energy reform

• First problem: horizontal competition in the generation subsector under a dominant incumbent (CFE): – And under the existence of IPPs with long-term contracts of

energy sales to CFE

– How to accomplish a level-playing-field to allow fair competition?

• Second problem: regulation of the transmission network: – Application of an incentive mechanism to promote the efficient

regulation of the operation and expansion of the Mexican networks.

• Third problem: corporate governance and regulation of the independent system operator (CENACE): – What would be the structure of incentives for the ISO? Would

be a profit-maximizing dispatch entity? Or welfare-maximizing? 11

12

A combined merchant-regulatory mechanism Rosellón, J. and H. Weigt (2011), “A dynamic incentive mechanism for transmission expansion in electricity networks – Theory, modeling

and application”, The Energy Journal, 32(1), 119-148.

Upper level problem: Profit maximizing Transco:

s.t.

Regulatory constraint

ISO welfare maximization:

Line capacity restriction

Energy balance

Plant capacity restriction

s.t.

Lower level problem:

T

t ji

ttt

i

ti

ti

ti

ti

FkijkcNFgpdp

,,)(max

1 1 1

( )

1( )

t w t w t t

i i i i

i

t w t w t t

i i i i

i

p d p g F N

RPI Xp d p g F N

,, ,0

max ( )d

tid

t t t

i i i id g

i t i t

W p d d mc g

i,tggt,

i

t

i

max

ijkpf tij

tij

tidqg ti

ti

ti ,

13

MAPA 2. Zonas congestionadas en México

Fuente: Elaboración propia con base en mapa de la SENER (2008).

14

GRÁFICA 1. Desarrollo de los precios en México

Fuente: Elaboración propia.

15

Second issue: Introduction to the Mexican electricity market of a nodal-price system and

FTR auctions

• Transition to nodal prices starting from

subsidized prices

• Model to study initial free allocations of FTRs to smooth out revenue or cost shocks (distributive efficiency)

• Grandfathered FTRs

16

Market clearing

min𝐺

𝑚𝑐𝑝𝐺𝑝 ,𝑡

𝑝 ,𝑡

𝑑𝑛 ,𝑡

𝑛

− 𝐺𝑝 ,𝑡

𝑝

− 𝑔𝑛 ,𝑡𝑅𝐸𝑆

𝑛

= 0

0 ≤ 𝐺𝑝 ,𝑡 ≤ 𝑔𝑝𝑚𝑎𝑥

Congestion management

min𝐺𝑈𝑃 ,𝐺𝐷𝑂𝑊𝑁 ,Δ

𝑚𝑐𝑝(𝐺𝑝 ,𝑡𝑈𝑃 − 𝐺𝑝 ,𝑡

𝐷𝑂𝑊𝑁 )

𝑝 ,𝑡

𝑑𝑛 ,𝑡 − 𝑔𝑝 ,𝑡 + 𝐺𝑝 ,𝑡𝑈𝑃 − 𝐺𝑝 ,𝑡

𝐷𝑂𝑊𝑁 − 𝑔𝑛 ,𝑡𝑅𝐸𝑆

𝑝∈𝐴 𝑛

− 𝑏𝑛 ,𝑛𝑛Δ𝑛 ,𝑡

𝑛𝑛

= 0

0 ≤ 𝐺𝑝 ,𝑡𝑈𝑃 ≤ 𝑔𝑝

𝑚𝑎𝑥 − 𝑔𝑝 ,𝑡

0 ≤ 𝐺𝑝 ,𝑡𝐷𝑂𝑊𝑁 ≤ 𝑔𝑝 ,𝑡

ℎ𝑙 ,𝑛Δ𝑛 ,𝑡

𝑙

≤ 𝑝𝑙𝑚𝑎𝑥

Δ𝑛′ ,𝑡 = 0

Kunz, F., K. Neuhoff and J. Rosellón (2014). "FTR Allocations to Ease Transition to Nodal Pricing: An Application to the German Power System," Discussion Papers of DIW Berlin 1418, German Institute for Economic Research.

17

FTR allocation

min𝐺

𝑚𝑐𝑝𝐺𝑝 ,𝑡

𝑝 ,𝑡

𝑑𝑛 ,𝑡 − 𝐺𝑝 ,𝑡

𝑝∈𝐴 𝑛

− 𝑔𝑛 ,𝑡𝑅𝐸𝑆 − 𝑏𝑛 ,𝑛𝑛 Δ𝑛 ,𝑡

𝑛𝑛

= 0

0 ≤ 𝐺𝑝 ,𝑡 ≤ 𝑔𝑝𝑚𝑎𝑥

ℎ𝑙 ,𝑛Δ𝑛 ,𝑡

𝑙

≤ 𝑝𝑙𝑚𝑎𝑥

minΔ

𝜀

𝐹𝑇𝑅𝑛𝐷

𝑛

− 𝐹𝑇𝑅𝑛𝑅𝐸𝑆

𝑛

− 𝐹𝑇𝑅𝑝𝐺

𝑝

= 0

𝐹𝑇𝑅𝑛𝐷 − 𝐹𝑇𝑅𝑛

𝑅𝐸𝑆 − 𝐹𝑇𝑅𝑝𝐺

𝑝∈𝐴 𝑛

− 𝑏𝑛 ,𝑛𝑛 Δ𝑛 ,𝑡

𝑛𝑛

= 0

𝑐𝑟𝑡𝑇𝑆𝑂 − 𝑝𝑟𝑖𝑐𝑒𝑠𝑙𝑎𝑐𝑘 ,𝑡 − 𝑝𝑟𝑖𝑐𝑒𝐴 𝑛 ,𝑡 𝐹𝑇𝑅𝑝

𝐺

𝑝

− 𝑝𝑟𝑖𝑐𝑒𝑠𝑙𝑎𝑐𝑘 ,𝑡 − 𝑝𝑟𝑖𝑐𝑒𝑛 ,𝑡 𝐹𝑇𝑅𝑛𝑅𝐸𝑆

𝑛

− 𝑝𝑟𝑖𝑐𝑒𝑛 ,𝑡 − 𝑝𝑟𝑖𝑐𝑒𝑠𝑙𝑎𝑐𝑘 ,𝑡 𝐹𝑇𝑅𝑛𝐷

𝑛

= 0

ℎ𝑙 ,𝑛Δ𝑛 ,𝑡

𝑙

≤ 𝑝𝑙𝑚𝑎𝑥

Δ𝑛′ ,𝑡 = 0

18

No FTR allocation Full FTR allocation

Average change in surplus of demand in the high wind winter week under production-based allocation approach

19

20

Third issue: Optimal incentive regulation of the transmission network and large-scale renewable

integration

Schill, W.-P., J. Egerer, and J. Rosellón (2014), “Testing Regulatory Regimes for Power Transmission Expansion with Fluctuating

Demand and Wind Generation.” Journal of Regulatory Economics. Online First. http://dx.doi.org/10.1007/s11149-014-9260-0

Issue 3.1: Transmission expansion under renewable integration of with time resolution and supply and

demand fluctuations

• Understanding how to regulate and expand transmission networks under large-scale renewable integration in Mexico.

• Include fluctuating renewable energy with hourly time resolution so as to substantially increase the applicability of regulatory mechanisms.

21

Lower level as in Hogan et al. (2010), but with more time resolution:

, ,

1 2

4 5

, , , , , , , , , 1, , ,

0, , ,, ,

,

, , , 1, , ,

,

,

, , , 2, , ,

,

, , ,

1max ( )

1

. . 0 ( ) , ,

0 ( ) , ,

n tq

n t n t n t s s n t tq g

t T n N s Sp s

l n

n t l t l t

n l t

l n

n t l t l t

n l t

n s t n

s

p q dq c g

Is t P l t

X

IP l t

X

g B

, , , , , , ,

, , , , 4, , , ,

, , 5, , ,

0 ( ) , ,

0 ( ) , , ,

0 ( ) , ,

nn nn t n t n t

nn

n s t n s n s t

n n t n t

q p n t

g g n s t

slack n t

Upper level as in Rosellón and Weigt (2011):

, , , , , , , , , , 1

1max

1n t n t n t s n t t l l tt t

pt T n N s S l L tt t

p q p g fixpart ec ext

s.a.

, 1, , , , 1, , , , 1

n N

, , , , , , , , ,

n N

1

HRV

n t n t n t s n t t

s S

HRV

n t n t n t s n t t

s S

p q p g fixpart

RPI X

p q p g fixpart

1 ,

1

(1 )CostReg CostReg

t l l tt t

l L tt t

fixpart ec ext r fixpart

22

Comparison of welfare and extension results

HRV much closer to wf-optimum in all cases robust!

Fluctuating demand and wind power both increase the gap between wf-max and the regulatory cases.

-20%

0%

20%

40%

60%

80%

100%

Sta

tic

DRes

WindR

es

Sta

tic_t10

DRes

_t10

WindR

es_t

10

DRes

_250

DRes

_500

DRes

_100

0

Sta

tic_x

4

DRes

_x4

WindR

es_x

4

Sta

tic_e

r

DRes

_er

WindR

es_e

r

HRV NoReg CostReg

Ten regulatory periods Higher extension

costs

More wind Endogenous line

reactance

Figure 17: Social welfare gain of extension compared to WFMax for different model runs

23

Third issue: Optimal incentive regulation of the transmission network and large-scale renewable

integration

Egerer, J., J. Rosellón and W-P. Schill (2015), “Power System Transformation toward Renewables: An Evaluation of Regulatory Approaches for Network Expansion,” The Energy Journal, Vol. 36 (4)

Issue 3.2: Transmission expansion under the dynamic transformation of the generation park towards

renewables • Rationality of transmission investment under a

dynamic process of renewable integration. • Transmission investment under gradual substitution of

conventional energy (e.g., coal or fuel oil) with renewables (wind, solar or geothermal energy).

• Diverse developments of the technological mix in the generation park that implies different network congestion scenarios.

24

Development of the congestion rent

25

Table 1: Welfare changes relative to the case without extension

Weights Static Temporarily

increased

congestion

Permanently

increased

congestion

Permanently

decreased

congestion

1 2 3 4

WFMax 0.29% 1.28% 11.62% 0.00%

NoReg 0.00% 0.00% 9.25% 0.00%

CostReg 0.00% 1.27% 9.22% 0.00%

HRV Laspeyres 0.25% 1.01% 9.02% -0.17%

Paasche -0.11% 0.38% 9.39% -0.32%

Average Lasp.-Paasche

0.29% 0.89% 9.21% -0.32%

Ideal 0.29% 1.28% 11.62% 0,00%

26

Outline

1. New industry and institutional structure

2. Challenges: – Market design under the assumptions of the

energy reform

– Introduction a nodal-price system and FTR auctions

– Transmission network expansion and large-scale renewable integration

3. Implications for policy making in Mexico

27

Implications for policy making in Mexico

• Analysis of allocative, productive and distributive efficiencies in the electricity sector.

• Increase in economic welfare. • Efficient integration of renewable energies into

transmission networks (with consequent reduction of greenhouse emissions).

• Efficient expansion of transmission networks. • Nodal-price systems and financial hedging mechanisms

that grant adeaquate property rights which incent efficient investments

• Research results with potential to be applied in actual public-policy making: CIDE-CRE academic agreement (Rosellón, 2008): – Policy decisions in the natural-gas industry regulatory reform

back in 1995. 28