An electricity Market – What is it?
The Nigerian Power Sector Reform reached another milestone with the “handover” of certificates of ownership to new owners of the privatised Power Infrastructure. The next crucial stage is the declaration of the electricity market that characterises a privatised electricity supply industry. In a sense, Nigeria is in an advantageous position when it comes to Privatisation of the Electricity Supply Industry because it can learn from the mistakes and gains from advanced economies that pioneered the restructuring of electricity supply industries for over twenty years now.
So what is an electricity Market?
Simply put, it is an arrangement to effect the sales, purchases and short-term trades of electricity. In this market, electricity, like every commodity, can be bought, sold and traded. Wholesale transactions in an electricity market are typically cleared and settled by a designated market operator or by an independent special-purpose entity charged exclusively with that function. The commodities within an electricity market generally consists of two types – namely, Power and Energy. Power in this case is the metered rate of transfer of electrical energy measured in Megawatts (MW) and Energy is the quantum of electricity that flows through a metered point for a given period and it is measured in Megawatts-hour (MWh). Contrary to common perception, a buyer of electricity is not purchasing Megawatt-hours of energy produced by a specific generation unit but the right to withdraw that quantity of MWhs from a specific location in the network and a seller is paid for injecting a certain quantity of MWhs into the grid at a specified location in the network. Thus, an electricity market is open to anyone including Generators, Power Marketers who buy and re-sell electricity, Independent Power Producers, providers of ancillary services such as Short-Term Operating Reserves (STOR), if they have secured appropriate licences to participate in the market.
What makes an electricity market different from other markets?
The electricity market shares several features with the Financial and Securities market. Participants buy and sell rights to inject and withdraw electricity from the Transmission Network, much as investors in securities buy and sell ownership shares of firms. The difference is in the physics of producing electricity. Virtually all electricity produced must be delivered to final consumers through the Transmission Network, and so the action(s) of other market participants directly impact the ability of a market participant to sell or consume electricity. One problem that comes to mind straight away is the status and reliability of the Transmission Network. Interestingly, although all market participants share a common interest in the reliable operation of the Transmission Network, they may often find it unilaterally beneficial to engage in anti-trust and anti-competition behaviours that degrade the overall reliability of the Transmission Network just to get financial advantage and create wealth for themselves. This will be particularly more destructive in an environment where corruption holds way. A popular trend is one supplier withholding capacity from the day-ahead market in order to increase the price it receives for the energy it sells. This can create a reliability problem for all other suppliers because the system operator will be unable to dispatch the necessary generation units to the levels needed to meet with real time demand without increasing the risk of system collapse.
Whereas antitrust and anti-competition laws are enough for securities and stock market, the required monitoring process for an electricity market is more involving. This is all the more so because, electricity market failures are more likely and substantially more harmful to consumers than other market failures because of how electricity is produced and delivered and the crucial role it plays in a modern economy. Hence, a prospective market monitoring process backed by the prevailing regulatory authority must be put in place at the start of the market.
Another similarity between electricity market and the securities market is that the smooth running of the market requires both parties to each transaction to comply with all contractual obligations with maximum liquidity existing within the spot market. Further to this however, a necessary condition for an efficient wholesale electricity market is that participants produce or consume electricity under the terms and conditions specified in their bids into the market. Failure to comply with contractual obligations not only increases the cost to the violating firm on future transactions, it can also reduce the reliability of the Transmission Network and therefore the cost of other suppliers and load-serving entities transacting. It is instructive to mention that an effective electricity market will require sufficient liquidity to ensure that unexpectedly large transactions can take place at virtually any instant in time without causing substantial price movements. Otherwise, prices will be extremely sensitive to small changes in amount of energy purchased or sold in the market. This can also lead to the illiquidity of the forward market wherein, if either side of the market is uncertain about the terms and conditions of delivery of a forward contract for electricity, it will increase the cost of participating in the forward market and thus reduce the liquidity of the forward market.
Whereas participants in financial markets have different choices as regards how to obtain the commodity traded, buyers and sellers of whole sale electricity have no choice as to how to take or provide delivery of the electricity they have purchased or sold. All electricity must be delivered through a single Transmission Network serving a given geographic area. If the network is poorly operated, this increases the cost of participating in the wholesale electricity market for all entities. The spot market is always an alternative option available to buyers and sellers so it is the relevant opportunity cost of participating in the forward market. Consequently, there is much greater need for market monitoring in electricity markets relative to financial markets because one supplier’s privately profitable behaviour can significantly degrade the ability of another supplier to inject the energy it has sold or more importantly for consumers at certain locations in the network to withdraw energy they have purchased. As mentioned earlier, electricity markets require demand to equal supply at every instant of time at every location in the transmission network. But electrons flow according to the laws of physics and not according to the terms of a financial contract to the extent that a privately-profitable behaviour of one market participant that degrades system reliability can immediately reduce the ability of other buyers and sellers to fulfil their contractual obligations. Furthermore, if one market participant decides to misbehave and make more profit by injecting significantly more or less energy into the network than the system operator expects, this can limit the ability of other suppliers and load-serving entities to inject and withdraw energy from the network. Such profit-maximising strategies by participants in an electricity market make it a market requiring tough and consistent monitoring processes.
Finally, electricity is also unique in the sense that the technology of producing and delivering electricity places significant constraints on how wholesale electricity market can operate. For this reason, it is important to have a synergy between the design of the market protocols with the design of the engineering protocols used to operate the system. In this regard, there is need for both engineering and economics expertise interacting seamlessly to achieve a successful and efficient market monitoring process.
The afore-mentioned reasons underscore why electricity markets must be monitored to ensure there is liquidity both in the spot and short-term forward markets. Best results are achieved if this market monitoring process is independent of the system operator, the market operator and all other market participants.