Why introducing implicit auctions in the Central South region?

Potential gains from improving allocation methods of day-ahead cross border capacity

Milan21 April 2008

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GME’s analysis focused on the Italian borders in order to:

identify the potential for efficiencies gains from the adoption of implicit

auctions instead of explicit auctions as a mean to allocate cross border

capacity at day-ahead stage;

give, where possible, a quantitative background to assessment of the

superiority of implicit auctions in short term trading, as stated by the first ETSO-

Europex JWG as well as EU documents (report on the 1228 cross-border

regulation);

give, where possible, a quantitative background to the evaluation of the

opportunity to adopt implicit auction mechanisms for each of the analyzed

borders

Aims of GME’s study

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Regulation (EC) 1228/03

Regulation (EC) n. 1228/2003 (art. 2):

Congestion management methods shall be market-based

capacity shall be allocated only by means of explicit (capacity) or implicit

(capacity and energy) auctions

Both methods may coexist on the same interconnection

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In the last years, several European institutions and associations expressed their

position regarding DA implicit auction as a mean for the allocation of cross border

capacity:

DG for competition

DG Energy and Transport

ERGEG

ETSO

EUROPEX

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European Commission

DG for competition Energy sector inquiry, January 2007

“Although explicit auctioning is theoretically and with perfect foresight

an efficient mechanism and it is in practice compatible with Regulation

1228/2003, it has efficiency deficits compared to implicit auctioning

especially where intraday and balancing markets are illiquid. With implicit

auctions results of trade are less likely to have economically irrational use

of the interconnector capacity”

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European Commission

DG Energy and Transport, Report on Regulation 1228/2003 on cross border trade in electricity, May 2007

“In the future, more capacity will be allocated through implicit auctions.

The so-called market coupling method developed by ETSO and the

association of European Power Exchanges (EuroPex) has, at the

moment, the highest potential of truly integrating the European

electricity market through implicit auctions at the day-ahead stage.”

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ERGEG

Coherence and Convergence Report, July 2007:

“It is now widely recognized that for the day-ahead timeframe, implicit

allocation methods are more efficient than explicit auctions and

should be the target mechanism for all regions for the day-ahead

timeframe”

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EUROPEX-ETSO

Interim Report “Development and Implementation of a Coordinated Model

for Regional and Inter-Regional Congestion Management”, April 2008:

“Implicit auctioning may be superior to explicit auctioning in

allocating capacity even for immature energy markets, provided at

least one of the coupled markets has a reasonable level of liquidity”

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GME has identified 4 areas in which potential for efficiencies gains may arise

from the adoption of implicit auction:

lower operational risks

lower trading risks/costs

impulse to the growth of the liquidity in local energy markets

netting of the flows and more efficient use of the capacity

Potential for efficiencies gains

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7.00

1. Nomination to Terna of yearly and monthly capacity rights

7.50

2. Publication by Terna of daily ATC and opening of day-ahead explicit auction

8.20

3. Gate closure of day-ahead explicit auction managed by Terna

8.30

4. Publication by Terna of results of day-ahead explicit auction

9.00

5. Gate closure of GME’s day-ahead energy market

Example: Time schedule of day-ahead auctions managed by Terna

Operational risks may arise because explicit auctions at day ahead stage require in a very tight timeframe:

TSOs and PXs to coordinate the functioning of the capacity market (managed by TSOs) and the energy

market (managed by PXs)

Operators to set up and send their bids/offers to the energy markets on the basis of the results of the

capacity auctions

7.00

1. Nomination to TSOs of yearly and monthly capacity rights

7.50

2. Publication by TSOs of daily ATC for implicit auction

8.20

3. Gate closure of day-ahead explicit auction

8.30

4. Publication of results of day-ahead explicit auction

5. Gate closure of involved day-ahead energy markets

Example: Indicative time schedule of day-ahead implicit auction

Lower operational risks

By integrating capacity and energy markets, DA implicit auctions reduce those risks

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With DA explicit auctions, since there are two different markets for the capacity and the energy:

Operators have to coordinate their capacity and energy positions. Therefore, their bidding

strategy must take into account the trading risk due to the separate trading of capacity and energy

Problem of asymmetry of information may be relevant, especially in presence of immature energy

markets that do not have a clear price signal

Operators have to bear the costs of participating to two different markets/platforms (guarantees,

IT,…)

By integrating capacity and energy markets, DA implicit auctions reduce, ceteris paribus, trading

risks and trading costs

Lower trading risks/costs

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Impulse to the growth of the liquidity in local energy markets

Experiences show that implicit auctions for the management of cross-border capacity can be

successfully launched even in presence of illiquid local energy markets if at least one of the coupled

market has an adequate level of liquidity.

The ratio is that by coupling, via an implicit auction mechanism, two local energy markets, the liquidity

of the immature market is going to increase since its participants may access to the liquidity of the

more mature market:

in 1998, Nord Pool, already operating in Norway and Sweden, was extended to Finland

in 2006, the Trilateral Market Coupling (TLC) between France, Belgium and Netherlands was

launched by launching, at the same time, the Belgian energy market

The development of local energy markets brings, indeed, benefits in terms of competition and

transparency

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Netting of the flows and more efficient use of the capacity

The superiority of DA implicit auction in allocating cross-border capacity, respect to DA explicit auction,

relies on two main features:

DA implicit auction allocates the cross-border capacity between two areas as a function of the price

differential of the prices in the area energy markets.

DA implicit auction enable the netting of the flows in opposite direction

Therefore, the outcomes of a DA implicit auction ensure that:

the net cross-border schedules go always from the low price area towards the high price area

the congestion revenue calculated on the basis of price differential is the “true” congestion revenue,

unlike with explicit auctions where, as it may turn out, there can be a congestion revenue even if there is no

congestion

DA Implicit auctions:

are compatible with explicit auction for the allocation of longer term capacity rights (weekly, monthly,

yearly products)

are compatible both with a “flow-based” capacity model (PTDF/BC) and with ATC/NTC framework as well

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PB

PriceDAMB

Energy

DA implicit auction and long term explicit auction

Import from B to A Import from A to B

NTCBA NTCAB

PA

PriceDAMA

Energy

Net Export CurveA

Capacity allocated with explicit auctions of long-term products and nominated

Net cross border schedule

PA

PB

Commercial schedule resulting from DA implicit auction

PA* = PB*

PB*PA*

Net Export CurveB

ATCBA ATCBA

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Quantitative background

GME analyzed on the border between Italy and those countries with a liquid index of hourly day-ahead energy prices:

France (PowerNext)

Austria (EXAA)

Switzerland (EEX-CH)

For Italy, the price of northern zone of IPEX was considered.

Inefficiencies in cross border schedules in 2007 is calculated as the “estimated value of the unused cross-border

capacity”1:

(NTCL H – FLOWL H) * (PrH – PrL), where:

NTCLH is the hourly NTC, published by TSOs in the Auction Rules, in the direction from the lower area price to the higher

area price. NTC values have been reduced accordingly to the notices of curtailment published on Terna web-site, during

2007.

FLOWL H is the hourly day-ahead net scheduled flow published by ETSOVista.

PrH and PRL are, respectively, the hourly prices, respectively, in the higher and lower area price.

1The concept of “estimated value of unused cross-border capacity” was adopted in the Energy sector inquiry (January 2007), by the DG for competition for calculating the inefficiency on the Dutch-German, French-UK and French-Spanish borders (see DG Competition Energy Sector Inquiry, par. II.3.5.3, January 2007)

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The “estimated value of the unused cross-border capacity” represents only a proxy of the

inefficient use of the cross-border capacity that could be reduced by adopting DA implicit

auction. It relies on the following assumptions:

demand and supply curves in the neighboring

markets are, respectively, flat and rigid, i.e. prices

would not change if cross-border schedules change

liquidity of neighboring markets would not

change (increase) in case of coupling

bidding behavior of the operators would not change in case of coupling

Estimated value of the unused cross-border capacity

PA - PB

FlowB AFlowA B

NTCA B NTCB A

Estimated value of the unused cross-border capacity

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In 2007, cross border schedules on the Italian border

with France, Austria and Switzerland were:

45 TWh

14% of the energy sold on IPEX (incl. OTC)

33% of the energy sold on the Northern zone of

IPEX (incl. OTC)

Cross-border schedules

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Prices

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Cross-border schedules

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Price difference vs cross-border schedules

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Price difference vs cross-border schedules

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Price difference vs cross-border schedules

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2007: prices in Northern zone of IPEX 2007: net cross-border schedules

Italian prices are higher most of the times,

but….

…operators expected Italian prices to be

always higher!

Price difference vs cross-border schedules

91% of the hours: higher than PowerNext

prices 99.6% of the hours: import from France

82% of the hours: higher than EEX-CH prices 99.6% of the hours: import from Switzerland

93% of the hours: higher than EXAA prices 100% of the hours: import from Austria

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“Adverse” schedules and prices in 2007

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“Adverse” schedules and prices in 2007

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Estimated value of the unused cross-border capacity

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Prices

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In the last quarter of 2007 we find more than

80% of the estimated value of unused

capacity

In the last quarter of 2007 price difference

changed sign more frequently!

Estimated value of the unused cross-border capacity and prices

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The analysis of the Italian, French and Swiss cross border schedules and prices highlights

that:

when the sign of price difference does not change (i.e. Italian prices are higher), the

estimated value of unused capacity is negligible

when the sign of the price difference changes more frequently (prices converge), the

estimated value of unused capacity sharply arises!

Is day-ahead implicit auction the solution?

Other aspects should be evaluated:

presence of overlapping countries raises coordination issues with coupling project in

other relevant region (CWE, CEE)

evolution of prices

cost/benefit analysis of introducing implicit auction

introduction of intraday trading could reduce the inefficiencies arising from DA explicit

auction

Conclusions and final remarks

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Analyzing the schedules on the Slovenian-Italian and Greece-Italian borders during 2007, it

should be underlined that:

in 77% of the hours Italy imported from Slovenia

in 28% of the hours Italy imported from Greece

The direction of the flows between Italy and Slovenia and Italy and Greece changes more

frequently than on the other Italian borders!

Assuming that frequent changes in the direction of cross-border flows imply frequent

changes in price differences, then efficiency gains by implementing implicit auctions may be

considerable.

Moreover, great benefits could be gained in term of impulse to the growth of liquidity in less

mature markets

Conclusions and final remarks

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Thank You for Your attention!

Gestore del Mercato Elettrico SpAViale Maresciallo Pilsudski, 92 - 00197 Roma

tel. + 39 06 8012.1 fax +39 06 8012 4524 www.mercatoelettrico.org info@mercatoelettrico.org