Monitoring and Mitigation in Alberta s Capacity Market An Assessment of Threshold Size for Economic Incentives to Withhold P R E P A R E D F O R Alberta Electric System Operator P R E P A R E D B Y Kathleen Spees Hannes Pfeifenberger Colin McIntyre Judy Chang Roger Lueken N o v e m b e r 2 8 th, 2 0 1 7 Copyright 2015 The Brattle Group, Inc.
Capacity Market Power Mitigation The Market Mechanics working group is evaluating market power mitigation options for Alberta s capacity market Several key design questions must be addressed Alberta s unique market structure should be considered in each decision The working group has already analyzed initial indicators of market competitiveness Who to mitigate? Key Mitigation Questions Which participants have the ability to withhold? Which participants have the incentive to withhold? (focus of this presentation) Which resource types should be categorically exempt? How to mitigate physical withholding? How to design capacity must offer obligation? How to review retirement and mothball decisions? How to mitigate economic withholding? How to set no-look offer thresholds? How to manage unit-specific offer mitigation? We provide our view on one question: How large a net long position would an entity or group of entities need to have to be incentivized to withhold in Alberta? (We do not assess how other financial instruments might affect incentives to withhold) 1 brattle.com
Incentives For Net Long Participants to Withhold Withholding capacity is profitable for net suppliers if capacity revenues increase when supply is physically or economically withheld. Total Revenue if Offering All Supply Demand Curve MW NetSupply Original Supply Curve Total Revenue if Withholding MW New New Supply Curve Price New Price Original Original Market Revenue New Market Revenue MW Withheld Original Market Revenue MW NetSupply Price Original New Market Revenue Price New MW New 2 brattle.com
Estimating the Incentives to Withhold Supply Incentives to withhold supply from the capacity market can be evaluated by comparing total revenues with and without withholding. We evaluate three withholding quantities: 550 MW, 225 MW, and 110 MW, which raise prices by 25%, 10%, and 5% of Net CONE under base assumptions. Illustrative Example Entity or Entities with a Total 4,000 MW Net Long Position, Withholding 225 MW Total Revenue if offering all supply MW Net Supply Price Original Total Revenue if offering all supply Total Revenue if Withholding 225 MW MW Net Supply MW Withheld MW New Price New Total Revenue if Withholding 225 MW 4,000 MW $139 $/kw-yr $556 $million 4,000 MW 225 MW 3,775 MW $152 $/kw-yr $575 $million Increase in Revenue if Withholding Supply $19 $million Notes: Assumes supply curve and widest demand curve consistent with Brattle demand curve analysis for AESO. Demand curve with price cap of 1.6x Net CONE and zero crossing point at 125% of reliability requirement. Default clearing price is Net CONE. 3 brattle.com
Effect of Net Long Position Size on Net Revenues Under the flattest proposed demand curve, participants with net long positions ~2,500 MW may have sufficient leverage to break even, but minimal incentives to do so. Larger portfolios increase incentives to withhold. Withheld MW Min. Net Long Position (MW) (% total cleared MW) 550 MW 2,790 (19%) 225 MW 2,440 (17%) 110 MW 2,310 (16%) Clearing Price Increase ($/kw-yr) (% of Net CONE) $34 (25%) $14 (10%) $7 (5%) *Base case assumptions throughout analysis assume supply curve and demand curve consistent with Brattle demand curve analysis for AESO. Demand curve with price cap of 1.6x Net CONE and zero crossing point at 125% of reliability requirement. Assumed clearing price of Net CONE before withholding. Assumed smooth supply curve shape; actual supply curve made up of discrete offers would exhibit more variance. Notes: Portfolio size includes withheld capacity. For further discussion see Taylor, Gary, et al. Market Power and Market Manipulation in Energy Markets: from the California Crisis to the Present. Public Utilities Reports, Inc., 2015. 4 brattle.com
Sensitivity to Demand Curve Shape The capacity market demand curves being considered for Alberta are relatively flatter than in other markets, reducing incentives to withhold. Proposed Demand Curves Supply Curve Much Steeper Demand Curve (PJM Shape) Steep Curve: Larger price increase per MW withheld Flatter Curve: Smaller price increase per MW withheld Notes: Dark blue curve is used for base case analyses: 1.6x Net CONE Cap and floor at 125% of reliability requirement. Other proposed curves have caps/floors as a percentage of Net CONE/reliability requirement of 175%/121% and 190%/117%, for the medium and lightest blue, respectively. The Much Steeper Curve is PJM-shaped demand curve: 1.5x Net CONE Cap and floor at 108% of reliability requirement. 5 brattle.com
Sensitivity to Demand Curve Shape Participants with very large net long positions stand to benefit from withholding, especially with steeper demand curves. Steeper Demand Curve Medium Demand Curve Flatter Demand Curve 6 brattle.com
Sensitivity to Demand Curve Shape Under steepest proposed Alberta curve, participants with net long positions >1,500 MW may have an incentive to withhold. Smallest Net Seller with an Incentive to Withhold (MW) Market Clearing Price Increase ($/kw-yr) 550 MW Withheld 225 MW Withheld 110 MW Withheld Flattest Alberta Curve Middle Alberta Curve Steepest Alberta Curve 2,790 MW $34/kW-yr 2,310 MW $43/kW-yr 2,020 MW $52/kW-yr 2,440 MW $14/kW-yr 1,980 MW $18/kW-yr 1,690 MW $21/kW-yr 2,310 MW $7/kW-yr 1,840 MW $9/kW-yr 1,560 MW $11/kW-yr Steeper demand curves may incentivize smaller net sellers to withhold and increase effect of withholding on prices Steeper demand curve PJM shape 1,650 MW $70/kW-yr 1,030 MW $39/kW-yr 910 MW $19/kW-yr Withholding smaller quantities requires a smaller net long position but has a smaller effect on prices 7 brattle.com
Sensitivity to Capacity Auction Clearing Price Low capacity market prices, e.g. due to oversupply, may increase or reduce incentives to withhold. Low prices reduce foregone revenues from withheld capacity, but flatter supply and demand curve shapes reduce sensitivity of prices to withholding. High Clearing Price (Base) Low Clearing Price Steeper curves: larger price changes High withholding cost Flatter curves: smaller price changes Low withholding cost Notes: Plotted demand curve is the flattest proposed demand curve (1.6x Net CONE cap, 125% of reliability requirement floor). See subsequent slides for analysis showing extent to which the two factors shown above will cancel during low clearing price sensitivity. 8 brattle.com
Sensitivity to Capacity Auction Clearing Price Incentives to withhold increase as prices fall, resulting in smaller breakeven portfolio sizes. This effect is somewhat mitigated by the shallower demand curve shape at lower prices. Trends are consistent across withheld quantities, we show a 550 MW withholding. Steeper demand curve segment Flatter demand curve segment decreases revenues from withholding Flatter demand curve segment The cost of withholding falls at lower prices 9 brattle.com
Risks of Physical Withholding Incentives may be greater for participants to physically withhold (e.g. retire) resources with high net avoidable going forward fixed costs. However, majority of existing supply likely to submit price taker bids or offer at near zero. Withheld Supply Net Avoidable Going Forward Fixed Costs 550 MW Withheld Min Net Long Position (MW) 225 MW Withheld 110 MW Withheld Base Case (price taker) 2,790 2,440 2,310 50% Net CONE 1,670 1,340 1,200 75% Net CONE 1,110 780 660 90% Net CONE 770 450 330 10 brattle.com
Takeaways Large net long participants may have an incentive to withhold supply Physical withholding via uneconomic retirement or mothball of supply Economic withholding by offering supply above net going forward cost Indicative screening suggests a net long position >2,000 MW is required for economic withholding to increase net revenues under proposed demand curves Larger net long positions increase incentives to withhold Incentives may be greater to physically withhold (e.g. retire) resources with high net going forward fixed costs We do not assess how other financial instruments may affect incentives More than 225 MW must be withheld for prices to rise by more than 10% of Net CONE The proposed, flat demand curve shape reduces incentives for withholding as compared to steeper demand curves 11 brattle.com
Contact Information KATHLEEN SPEES Principal Boston Kathleen.Spees@brattle.com +1.617.234.5783 JUDY CHANG Principal Boston Judy.Chang@brattle.com +1.617.234.5630 JOHANNES P. PFEIFENBERGER Principal Boston Hannes.Pfeifenberger@brattle.com +1.617.864.7900 ROGER LUEKEN Associate Washington, DC Roger.Lueken@brattle.com +1.202.419.3321 The views expressed in this presentation are strictly those of the presenter and do not necessarily state or reflect the views of The Brattle Group. 12 brattle.com
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