RISK

1
RISK CAPACITY INVESTMENT INCENTIVES IN
ELECTRICITY MARKETS

• Peter Jackson
• Department Of Management
• University Of Canterbury

2
Outline

• My research topic/motivation
• Investment
• Optimal Plant Mix
• Hydro/Strategic concerns
• Contracts/Portfolios
• Market Structure/Solutions

3
My research..

• Evaluate the impact of investor risk on
  investment decisions
• Explicitly deal with impact of
• Hydro risk
• Strategic behaviour
• Deterrence
• Outcomes, Solutions
• Investment/Entry
• Pricing/Efficiency
• Market structure
• Is not finished (hardly started!!!)

4
Motivation - Do electricity markets deliver
appropriate security?

• Security concerns were to the fore with central
  planners
• Central planning proved uneconomic, and often
  over-investment resulted
• Electricity markets have been created in an
  effort to capture economic efficiency
• But private investors wont invest unless it is
  economically justified
• Private investors face different risks and are
  investing into a spot market that is susceptible
  to strategic behaviour

5
Investment and Prices Why Invest?

• Generation plant can be valued (equivalently) as
  a call option
• Option value is dependent on pricing
• Could discount or model risk more explicitly

6
Basic Screening Curve Analysis

• Optimal Plant Mix
• Risk Free
• Not Strategic
• Some energy limited plant
• With shortage costs, fixed costs are recovered in
  equilibrium

7
Investment Risk

• My research focus is
• Hydro risk
• Strategic risk
• But there are significant other risks for
  investors
• Reliability
• Regulatory/Political
• Demand growth
• Input prices
• Technological/Resource
• Transmission
• To a greater or lesser extent all plant faces
  risks but peaking plant is most vulnerable.

8
Energy Limited Hydro

• Energy must be/should be used
• Inflow quantities determine total energy
  available
• Reservoir size and plant rating determines
  flexibility
• Inflow sequences are also important
• Peaking plant may never operate for its true
  purpose.
• Being in the optimal plant mix is not the same as
  being in the dispatch.

9
Energy Limited Hydro

• Notional revaluation of fuel and capital cost
  based on energy available
• All plant is impacted but peaking plant is worst
  off

10
Peaking Plant Cautious Entry

• Given hydro variability, how much peaking plant
  is required?
• Apart from other issues the investor need to know
  inflow distribution.
• What is really important is the PDC, and this can
  vary for a variety of reasons eg hydro inflows
• But what if PDC is a result of gaming? (And
  gaming and hydro inflows are probably related)
• What is the true underlying PDC? It may be
  impossible to estimate, especially for an entrant

11
The Impact Of Risk On Adequacy
12
Peaking Plant Investment

• Price and quantity risk from a variety of sources
• Natural
• Strategic
• Hydro generation makes forecasting particularly
  difficult
• Not suitable for many standard forms of contract
• Finance difficult to obtain given risks
• So how do we get any peaking plant built at all?

13
Wider considerations.

• Standalone entry very difficult
• But firms have multiple generation plants, and
  contracts in place lower risk
• The impact on the portfolio of assets and
  obligations is more relevant than the performance
  of the individual asset
• Spot market gaming may increase returns above
  SRMC and incentivise investment
• Strategic firms will not want to settle contract
  shortfalls with competitors
• Deterrence
• Market structure may (or may not) help

14
NZ - Market Structure

• LP Clearance
• Market design goals
• Allocative efficiency
• Productive efficiency
• Dynamic efficiency
• NZ Market
• S.O.Es Private investors
• Energy only market
• Vertical Integration
• Hydro influence
• Few Large customers

Wolak Report, 2009
15
Potential Solutions

• Tolerate gaming
• Two part markets
• Capacity ticket systems
• Current proposals from taskforce

16
Contracts and Risk I

• Consider increasing risk on generators who are
  unable to cover contractual obligations

17
Contracts Risk II

• Increasing cost of over contracting improves
  adequacy but this analysis assumes contracts are
  exogenous
• What if contracts are endogenous? Equilibirum
  contract prices will be higher for higher risk
• Customers will get more security (but pay for it)
• What is the relative performance of other
  solutions?
• Market power (18 - Wolak)
• Capacity payments (25 - Initial market study)
• Evaluation required

18
Future Work required

• Energy limited plant
• MW limited
• Dynamic analysis
• Plant retirement
• Demand growth
• Investment
• Strategic interactions
• Spot market
• Cautious Entry
• Deterrence
• Complementarity Formulations
• Evaluate remedies