Market Power Screens and Mitigation

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1 Market Power Screens and Mitigation September 13, AESO Workgroup

2 Energy Market Prices Offer Flexibility Common Elements of Mitigation An offer cap of $1000/MWh is in place in all markets but there can be some flexibility for cost based offers The presumption that marginal cost based offers are representative of competitive offers is used but some flexibility is allowed to reflect the difficulty of precisely determining all costs Opportunity costs are considered as an element of marginal costs (particularly relevant for energy constrained units) Given the self-commitment model in Alberta start-up costs, risk associated with potentially running at a loss and other factors would also need to be considered Transmission constraints are a fundamental consideration as local market power is much more pronounced than overall system market power Ex ante mitigation is generally employed based on a screen Structural and conduct and impact tests Market Monitors are in place in all markets Internal and external monitors in some markets, external only in others 2

3 Energy Market Prices Offer Flexibility Market Power Tests in US Markets There are generally two approaches to testing for market power in the US organized markets see FERC Staff Analysis of Energy Market Mitigation in ISO and RTO Markets, October 2014 A structural approach is based on mitigation when pre-set conditions in the market are met Alberta contemplated a similar approach several years prior to the OBEG which was known as the Red Light Green Light approach PJM uses the Three Critical Suppliers test which basically tests whether a given supplier plus the next two largest supplier are required to serve the market for constrained zones Overall market is generally deemed to be competitive If a supplier is not deemed critical it generally has large amounts of freedom to price on a market basis rather than a cost basis If a resource is deemed critical its offer is mitigated to a maximum price of its variable cost plus 10% A conduct and impact approach has two parts Does a resource s offer exceed its reference cost (marginal cost) by a pre-set threshold? If yes, does the impact increase the market clearing price by more than the pre-set threshold? In the event that both are true the resource s offer is mitigated Capacity market obligations or lack thereof do not impact market power tests and/or mitigation 3

4 Energy Market Prices Offer Flexibility Reference Level Calculation As outlined both market power mitigation approaches require an estimate of the reference price (or variable cost) In ISO-NE and NYISO the market monitor estimates the reference price for each unit Generators have the ability to appeal the determination In PJM generators submit their costs to the ISO under a prescribed methodology 4

5 Energy Market Prices Offer Flexibility Market Power and Offer Rules - PJM In PJM the rules are as follows: An offer cap of $1000/MWh is in place for market based offers and a $2000/MWh cap is in place for cost based offers (requires demonstration of actual costs) Offers are currently held constant for a full day but PJM is attempting to move towards hourly flexibility Within constrained zones the test for market power is the Three Pivotal Supplier (TPS) test TPS: If Total Supply (Largest Supplier + Second Largest Supplier plus Tested Supplier) are less than Demand the test is failed and the Tested Supplier is subject to mitigation In essence if the supply from any one generation owner when combined with the next two largest generation owners are required to supply the market behind the constraint mitigation is in place If a supplier is mitigated due to being critical the offer is set to its reference price which is marginal cost plus 10% Notably in PJM the overall market is considered to be competitive, i.e. in the absence of congestion offers are not mitigated Size of the PJM market is sufficient to lead to competitive outcomes in the overall footprint All FERC rules in terms of anti-competitive behaviour apply 5

6 Energy Market Prices Offer Flexibility Market Power and Offer Rules PJM Source: PJM State of the Market 2016 Illustrates substantial markups above marginal cost in a proportion of units Markups can be as large as seen in Alberta when the offer power mitigation rule is not triggered, i.e. in PJM units not in constrained zones have and exercise considerable flexibility 6

7 Energy Market Prices Offer Flexibility Market Power and Offer Rules ISO NE and NYISO In ISO-NE and NYISO the rules are as follows: An offer cap of $1000/MWh is in place for market based offers and a $2000/MWh cap is being contemplated due to FERC order On the conduct side of the approach in unconstrained zones offers can be the lesser of 300% above the reference price or $100 over reference. If an offer in an unconstrained zone fails the conduct test the impact test is whether the offer increases the LMP by the lesser of 200% or $100/MWh relative to the mitigated offer (marginal cost offer in essence) In unconstrained zones for ISO NE only critical suppliers are subject to the tests (critical supplier is defined as a generator that is required to meet load). In NYISO all generators are subject to the test. In a constrained zone the conduct and impact test are both more stringent. For ISO NE the conduct test is the lesser of 50% and $25/MWh over the reference price. In NYISO the tests are tied to market conditions higher market prices increase the thresholds and more frequent constraints lower the thresholds Key point is generally in the absence of constraints there is considerable leeway in both ISO NE and NYISO to offer energy at up to 300% of variable cost ISO NE has indicated that offers in excess of marginal cost have historically increased prices by 10% to 20% over prices that would have occurred if all offers were mitigated to marginal cost 7

8 Market Power and Offer Rules ISO NE Energy Market Prices Offer Flexibility Source: aff-reports/2014/ad mitigation-rto-iso-markets.pdf As noted generators are allowed to offer mark-ups as high as 300% over variable cost provided they are not in a constrained zone Self-scheduled generation (price taking) and generation owned by LSE s accounts for a large proportion of the market; as such most offers do not illustrate a markup but the top 10% of markups show prices 60% to 300% in excess of marginal cost 8

9 Energy Market Prices Offer Flexibility Market Monitoring The screens and mitigation outlined in previous sections are in place within the ISO market software, i.e. ex ante mitigation occurs rather than ex poste penalties Market monitors are both internal and external PJM has only an external market monitor ISO-NE and NYISO have both internal and external monitors The presence of ex ante mitigation does not preclude examination of behaviours that are potentially anti-competitive 9

10 Screens and Mitigation Purpose of Screens/Mitigation The concern with market power appears to be that if the energy market is not mitigated consumers will pay too much in total due to the addition of the capacity market and/or that the volatility associated with an un-mitigated market is undesirable Lack of confidence that the use of net CONE in the capacity market will effectively mitigate total revenues Uncertainty in future prices increases in the presence of an unfettered market, i.e. volatility will be higher if there is no mitigation The risk is then that net CONE will be set against an expectation that is incorrect due to offer behaviour Generators and consumers both face this risk, i.e. if net CONE is set against a price expectation that embeds material offer mark-up and the mark-up does not occur total revenue will be too low. The reverse is true from a consumer perspective. Reasonable balance provides the ability to manage real-time risks and minimize administrative burden against the value of improving the relationship between expected net CONE and actual net CONE 10

11 Screens and Mitigation Screen Options for AB High level question is structural offer cap versus conduct and impact approach Conduct and impact more difficult to implement in AB due to real-time only structure, i.e. the impact screen requires the price to be calculated twice with and without a given offer. Expectation that the real-time market structure will exist in 2021 due to suggests structural approach is simpler and can accomplish necessary level of mitigation Simple versus complex Offer cap for all mitigated resources at a multiple of deemed marginal cost? For example, daily offer cap estimated at 300% of SCGT marginal cost Offer cap at individual unit s marginal cost requires much more administration of marginal cost estimation, difficulty with identifying all costs, etc. Who to mitigate? All participants? Mitigates participants with no reasonable expectation of market power 5% market share threshold for mitigation? Safe harbor type approach participants with less than 600 MW of capacity would not be mitigated for example. Requires establishment of a threshold but is simple to administer. Mitigate only during certain times, i.e. 3 critical supplier type test mitigate only in hours where the market is less likely to be competitive. Complex and requires real-time estimation and action. 11

12 Screens and Mitigation Mitigation Levels Goal of mitigation is to create outcomes that more closely track perfect competition where price theoretically equals marginal cost Challenges include: Marginal cost seldom known with certainty Some risks such as recovering startup costs, opportunity costs, elements of variable maintenance costs, etc are not easily known Over mitigation risks market confidence in the ability to fully recover costs from the spot market, i.e. with self-commitment it may become difficult for some units to recover start-up and minimum load costs Over mitigation creates large administrative burden How much mitigation allows proper mix of ability to manage risks in the market versus confidence that the market is competitive? Incentive and ability to increase prices is the key question Historically market power was generally observed when prices increased quite dramatically, i.e. from $50/MWh to $500/MWh+ due to offer behaviour Given the uncertainty of the price impact market power exercise entails a risk/reward estimate if the reward is reduced both the impact and likelihood of market power fall as well 12

13 Options for AB Options for Alberta Simple public offer cap sufficiently high to allow risk management and reasonable selfcommitment 300% of SCGT marginal cost as an example Is this sufficient to allow all generators to manage risks associated with start-up costs and minimum stable output requirements? Very low administrative burden post day ahead offer cap based on transparent formula Risk of forcing offers below cost for some small portion of the fleet cost based exception process required Simple public offer cap per the above with exception for safe harbour 5% market share exemption as an example Continue current offer cap for small generators ($999.99) Presumption that market power is very limited for small participants so mitigation reflects administrative burden for little to no value Transient market power may exist in some hours for even small generators but market power concerns generally require the ability to persistently raise prices 13

14 Impact of Market Power Options for Alberta Unit specific offer cap tied to marginal cost Typical in other jurisdictions where market power is a concern (constrained zones) Requires more data and administration that a system offer cap tied to generic costs Question of safe harbour applies in this case as well Dynamic offer cap based on structural competitive test such as 3 critical suppliers Enact lower offer cap only when market concentration is deemed to create risk of structural market power, i.e. calculate at T-2 and apply either to all participants or just those exceeding the concentration threshold Increased administration, complexity, etc but only mitigates the market when competitive outcomes are unlikely Risk that price outcomes are counter intuitive in some hours, i.e. hours that approach the mitigation threshold may have higher prices than hours that are just beyond the threshold Note that other markets typically allow the market to operate when the risk of market power is minimal, i.e. PJM does not mitigate in unconstrained zones for example 14

15 Impact of Market Power Other Considerations Capacity that does not clear the capacity auction Should a different set of energy market power rules exist where capacity does not clear? General approach in US markets is that market power concerns are independent of capacity obligations Less mitigation on resources without a capacity obligation is potentially concerning Entire portfolios benefit from market power so the risk of overpaying due to market power is not tied to whether or not a resource has a capacity obligation Alters the incentives in the capacity market auction in effect may lead to more mitigation in capacity auction to reflect an incentive to not clear resources Ancillary services market typically garners much less attention in AB for market power Mitigation has largely occurred through the hydro PPA historically (large player with a short position in the market) Market power in ancillary services (under current rules) can be seen either from lack of participation or price behaviour Energy market mitigation may effectively mitigate ancillary services as ancillary services prices are largely determined by energy prices A real-time AS market (concurrent with energy market offers) would have uncertain impacts 15