Market Surveillance. Lessons Learned in Latin America. Prepared by: Ms Beatriz Arizu For: The World Bank Energy Forum.

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1 Market Surveillance Lessons Learned in Latin America Prepared by: Ms Beatriz Arizu For: The World Bank Energy Forum February 2003

2 Electricity Markets in Latin America Organized Power Markets are today in operation or implementation in most Latin America MEXICO GUATEMALA EL SALVADOR BELIZE HONDURAS COSTA RICA NICARAGUA PANAMA COLOMBIA VENEZUELA COUNTRIES WITH POWER MARKETS OPERATING COUNTRIES IN REFORM PROCESS COUNTRIES WITHOUT POWER MARKET GUYANA SURINAME FR.GUY. ECUADOR Results and experiences show the need and benefits of independent Market Monitoring in developing electricity systems, even when market design is cost based and simple. PERU CHILE BRAZIL BOLIVIA PARAGUAY ARGENTINA URUGUAY Market Surveillance in Latin America 2

3 Lessons Learned Putting in place organized electricity markets in developing countries without including independent monitoring and expert coaching for the transition has lead to mistakes in interpretation and implementation that negatively affected reform and could have been avoided The belief that a cost based market design is sufficient to control market abuse or gaming proved to be wrong When there is market power (and all power sectors have a level of market power), it is always possible to abuse, independently of which is the chosen market design A cost based market involves several features that interact and can create distortions, inefficient outcomes or allow gaming Monitoring the efficiency of rules and design requires expertise to identify and correct flaws in advance, before they become unsolvable problems Monitoring the efficiency and transparency of implementation and market development cannot be done from inside the System Operator Market Surveillance in Latin America 3

4 Market Monitoring in a Developing Country Time and money was dedicated to market design and drafting rules, but very little in supporting success of new markets with adequate monitoring Perception that little training and monitoring needed because new market continued centralized cost based dispatch System Operator was given hardware upgrade but little or no training in its new role and implementation problems Quote by a system operator in Central America: Before we didn't have to explain anything to anyone and now we are supposed to explain everything to everyone.. Independent Market Monitoring can provide a double service: Knowledgeable coach to minimize mistakes of new Regulator and System Operator As Market matures, this role should diminish Market Surveillance As Market evolves in competition and regional trading, this becomes the main role Functions Review on design and rules (amendments) Monitor non-discriminatory transmission services and System Operator services Monitor behavior of Market Participants and Market development Market Surveillance in Latin America 4

5 Do Cost Based Markets need Monitoring? Initial belief: cost based market by itself would control market abuse But where market power exists, abuse is always possible Situation is worse with new Regulator or System Operator in the learning stage and/or that has inadequate staff No or very little demand-side participation Cost based markets with mandatory dispatch involve several features There is no best practice in generation capacity markets Always controversial (depends on calculations and assumptions) Playing with assumptions meant significant variation in capacity paid to hydro with respect to thermal Thermal playing with availability or variable cost What exactly are variable costs? Auditing is difficult and costly Variable costs of must run thermal typically higher than similar units that compete Thermal Generator said he could prove his variable costs are any value within a considerable range due to sophistication of natural gas purchasing How is hydro dispatched economically? What are the correct assumptions / methodology for water value? Market Surveillance in Latin America 5

6 Monitoring the Transition: Some real life examples Transition to an organized market needs monitoring, to avoid implementation mistakes and correct as early as possible flaws Panama System Operator interpretation on calculation of water values and Spot prices meant inefficient dispatch of hydro and benefited thermal Generators with high unavailability (buying energy Spot to cover vesting contracts) Thermal Generator maintained high unavailability (no efficiency gains) Correcting implementation took more than a year due to thermal Generators and Distributors opposition (to maintain lower prices) Bolivia: calculation of generation capacity prices used as reference investment cost of thermal peaking unit with installed capacity equal to load growth When economic problems lead to very small low growth, price increased Implementation of generation capacity availability obligations in Bolivia did not include planned maintenance outages Created incentives for Generators to play with maintenance outages Thermal Generator declared low variable costs to be assigned generation capacity payment and then declared a 3 months maintenance Panama System Operator implementation of must run meant that thermal units with long start up time were never stopped Thermal played with generation operation constraints to be scheduled and displaced more competitive generation Market Surveillance in Latin America 6

7 Market Surveillance: Lessons Learned in Latin America Examples from Latin America

8 It is a new experience Initially, Markets in Latin America did not include explicit Market Monitoring Considered not necessary because of cost based design Reform in Central America (1997) initiated the movement towards including details of monitoring (scope) in the rules or regulations In or advising the Regulator Guatemala: Included in Market rules as a role of Regulator Panama: Included in Market rules as an independent group of experts, advisor to Regulator In approved design of Central America Regional Electricity Market, independent monitoring of experts, advisor to Regional Regulator Being discussed in South America but difficult to introduce Markets already in operation: System Operators and/or Participants do not seem to feel comfortable with the idea of independent monitoring Market may include internal monitoring in the System operator, which has not been successful Independence is critical to monitor also the System Operator Uruguay (new): included in Market rules As part of periodic auditing of System Operator; or By instruction of Regulator, in case of disputes or unusual circumstances Market Surveillance in Latin America 8

9 Panama: Role of Market Surveillance Independent Market Surveillance Committee, advisor to Regulator Functions as defined in Market rules Monitor competition and efficiency Assist in rules amendment Analyze complaints Monitor Participant behavior e.g. withholding or abuse in costs Investigate unusual conditions in regional trading and prices Monitor efficiency and non discrimination of System Operator Additional coaching functions that appeared at start up Assist Regulator in comprehension of rules and implementation Facilitate start up and governance of Operation Committee Clarify rights, boundaries and roles of System Operator, Participants and Operation Committee Periodic trips (every 3 months) Three non Panamanian members (Colombia, Argentina and USA) Separate meetings with Regulator, Generators, Distributors, TransCo, System Operator and Large Consumers to listen and discuss concerns Market Surveillance in Latin America 9

10 Experience in Panama: Initial Governance Problems Delays in start up of Participants Operation Committee (consultative Body to oversee System Operator) System Operator said that no written methodology on how Participant representative were chosen made it impossible to authorize representatives proposed by Participants No written Governance procedures Meetings too short to be useful Market Monitoring identified as serious flaw lack of adequate Governance and recommended improvements Grid Code amended to redesign Operation Committee System Operator no voting rights Committee designed and approved operation procedures (duration and periodicity of meetings, decision-making) Regulator has called on a System Operator audit to identify problems / efficiency in staff, and procedures to implement rules and operate the system and the market Market Surveillance in Latin America 10

11 Experience in Panama: Market Rules and Implementation Grid Code and Market Rules Monitoring identified gaps, inefficiencies, and incompatibilities Lack of detailed implementation methodologies Many interpretations by System Operator that changed according to circumstances Exports Market Monitoring explained need for predictability and identified problems of inconsistency Regulator instructed System Operator to agree and draft detailed implementation methodologies Improvements but still not totally successful Approved methodologies not always consistent with rules and leave still open some critical issues But reduced significantly interpretations and disputes problem Successful Market rules amendment process, lead by Regulator System Operator and Participants refused to be involved until Regulator proposed amendments and did a consultation process Market Surveillance in Latin America 11

12 Recommendations Independent Market Monitoring should be included as a standard design in cost based and bid based electricity markets Implementation of organized markets in developing systems / economies needs ongoing support with initial coaching as well as monitoring Market power can be exercised and Participants can game with rules even if market is based on costs Independence is needed to also monitor System Operator Independence and knowledge of Monitors valued by private investor In small countries or initiating reform, expertise and independence from Participants usually will require monitors from other countries Market Surveillance in Latin America 12

13 Market Surveillance: Lessons Learned in Latin America ANNEX

14 Typical Characteristics of Latin America Power Markets Bilateral contracts with Spot Market to balance differences between contract quantities and actual physical quantities Initial (vesting) contracts Spot Market with day-ahead nomination and ex post, hourly energy prices (short term marginal costs) Mandatory centralized dispatch Typically cost based thermal dispatch nomination and hydro optimization centralized calculated or Generators bids on water value Purchasing contracts (vesting or subsequent) hedge financial risk and are not physical Administration of Transmission congestion Nodal prices and congestion costs or must run generation Generation Capacity pricing and buying / selling Capacity obligations for Load Serving Entities Generation capacity payment depends on availability Market Surveillance in Latin America 14

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