Market coupling: looking at the
future of the Italian Power
Exchange
Anna Creti, Eileen Fumagalli
IEFE Università Bocconi
Elena Fumagalli
Politecnico di Milano
Giusi Squicciarini
Autorità per l’energia elettrica e il gas
I mercati energetici in Italia - Dip. Matematica, MIP, AIGET
20 Novembre 2008
Outline

Introduction
Literature review
The international context

The Italian electricity market




Problem definition
Conclusions
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
2
Introduction


Existing electricity markets in Europe are national in scope
Market integration




Potential benefits: economic efficiency (decrease in market
concentration) and security of supply
Market integration in Europe is a reality (only in some
restricted areas)
Strong commitment at institutional level (ERGEG Regional
Initiatives)
Italy: no economic debate on this major policy decision
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
3
This work

Is market integration a good choice for the Italian
electricity market?


Eliminate inefficiencies in cross-border exchange
Modification of the market design


Feasibility of the arrangement
Net efficiency gains from coupling
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
4
Literature review (1)


Relevant economic concepts regarding electricity market
integration: literature on nodal pricing and transmission
congestion
Market integration has the potential to increase economic
efficiency and to mitigate market power




Ehrenmann and Neuhoff, 2003
Neuhoff, 2003
Gilbert at al., 2004
Willems, 2002
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
5
Literature review (2)

Nordic market


Belgian-Dutch market, ex-ante evaluation




Kube and Wadhwa (2007) ex-post evaluation (+)
Neuhoff (2003) Cournot-Stackelberg (+ Belgian consumers, - Dutch
consumers)
Petrov et al. (2003) supply function equilibrium, no transmission
constraints (+)
Hobbs et al. (2005) Cournot model (+, with caveats)
Neuhoff et al., (2004)

Differences in the treatment of transmission allocation and pricing
models can make a significant difference in the conclusions of different
models, even if they all are Cournot in energy sales
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
6
Literature review (3)

Simple market models


Extension of the same conclusions to national markets
should be considered with some caution
More sophisticated models

Real markets: results are likely to be effected by several
factors, including market architecture, technical
characteristics of the production industry, market structure,
institutional aspects
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
7
The international context:
market model

Prevalent market model



Separate bilateral markets
Separate clearing of the day-ahead auctions
Explicit auctioning for the allocation of crossborder capacities: transmission rights are
allocated separately and independently from
energy (by TSOs)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
8
The international context:
integration methods

Integration of day-ahead markets: implicit auctions

Market splitting: Based on the bid/offer information, the PX
establishes both flows across and prices in the different market
areas.
 In case of network congestion, the PX separates the market in
two or more price areas, while utilizing the available capacity
between congested areas.

Market coupling: the co-operation between two or more PXs
ensures that during every hour of operation the available trading
capacity is utilised with power flowing from low price areas to
high price areas
 Price or volume coupling
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
9
The international context:
Nordpool, TLC, ERI

Nordic Power Market (Nord Pool)


TriLateral market Coupling (TLC) started in 2006



Started as the Norwegian power exchange in 1995, extended to
Sweden in 1996, Finland in 1998, Denmark in 2000 and partly
also to Germany in 2005 (Kontek area)
Powernext in France (2001) and APX in The Netherlands (1999)
Belpex in Belgium (2006), at the same time as TLC
MIBEL started in 2007

Spain (OMEL) and Portugal (OMIP): OMI (Iberian Market
Operator)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
10
The Italian electricity market

On Italian borders: explicit auction


Harmonized Auction Rules: Italy, France, Switzerland,
Austria, Slovenia and Greece
Day-ahead timeframe, “implicit auctions are more
efficient than explicit auctions and should be the
target mechanism for all regions” [ERGEG, 2008]
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
11
Inefficiencies of an explicit
auction: findings

Studies have found different types of inefficiencies






Incorrect utilisation (wrong sign nominations): imperfect
arbitrage
Underutilisation of interconnector capacity
Firmness of capacity
Compensation, in the event of curtailment
Operational risk
Trading risk and costs
Newbery and McDaniel (2002); Tornquist (2006); Kristiansen (2007);
EC (2007); Meeus (2008); GME (2008)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
12
Inefficient flows: FR-NL (2005)
Nominated cross-border net exchange: French-Dutch border (2005) [Meeus, 2008]
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
13
Problem definition

Inefficiencies arise when transmission capacity is
allocated through explicit auctions
?
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
14
Inefficient flows: FR-IT (2007)
Inefficient flow direction
Data from: GME, (2008)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
15
Problem definition


Inefficiencies arise when transmission capacity is
allocated through explicit auctions
Market integration is the preferable choice for the
Italian electricity market
?
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
16
Problem definition


Inefficiencies arise when transmission capacity is
allocated through explicit auctions
Market integration is the preferable choice for the
Italian electricity market
?

Modification of the market design


Feasibility of a coupling arrangement
Identify the net efficiency gains that might be achieved with
market integration
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
17
Problem definition


Inefficiencies arise when transmission capacity is
allocated through explicit auctions
Market integration is the preferable choice for the
Italian electricity market
?

Modification of the market design


Feasibility of a coupling arrangement
Identify the net efficiency gains that might be achieved with
market integration
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
18
Feasibility: day-ahead markets

Day-ahead markets in the Central South
region (Austria, France, Germany, Greece
Italy, Slovenia)



Markets with physical delivery (no France)
Bilateral trading (no Greece)
Common rules for explicit auctions (no Germany)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
19
Feasibility: products traded

Traded products



Italy and Slovenia: hourly products
Austria, France and Germany: hourly and block orders
Block orders:



Clearing mechanism based on iterations between the
central auction office and the different PXs (as in TLC)
Implementing of block constraints in the central solver
algorithm (more efficient)
Implement volume coupling
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
20
Feasibility: timing

Heterogeneity in gate closure times and computation time
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
21
Feasibility: algorithms

Market clearing algorithms

Market splitting (Italy and Greece)


Uniform purchasing prices (Italy and Greece)



Coherence of cross-border flows
Time to run the local market clearing algorithms
Implement volume coupling
Coordination with other coupling mechanisms
(TLC includes France)
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
22
Feasibility: settlements and
liquidity

Settlements


Harmonization to the shorter time frames would require
PXs in Italy, Austria and Greece to settle cross-border
trades in advance of domestic trades: PXs would have to
take non zero net financial positions
Market liquidity


Slovenian market: extremely low liquidity
Market coupling is going to increase the liquidity of the
involved markets
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
23
Conclusions

Implicit auctions are more efficient solutions than
explicit auctions for the day-ahead allocation of
cross-border transmission capacity ≠
≠ Efficiency gains in market coupling

Harmonization of day-ahead market design



Practical difficulties need to be carefully addressed
Assuming volume coupling: they do not appear so
critical as to prevent a progressive integration of the
Italian market with neighbouring markets
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
24
Work ahead
Analysis of potential efficiency gains from
coupling of the day-ahead Italian market



Include structure and technical features of the
markets involved
Empirical studies and simulations rather than
theoretical work
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
25
Open questions

As regional markets are becoming a reality in
Europe, open questions are numerous






Creation of regional TSO or PX
Inter-regional coordination
Choice of the capacity model
Flow-based models
Coupling of intra-day and integration of balancing markets
…
IEFE Università Bocconi - Politecnico di Milano - Autorità per l'energia elettrica e il gas
26