Mar­kets of elec­tric­ity vs other prod­ucts

Financial Mirror (Cyprus) - - OPINION - By An­dreas Poul­likkas

The de­vel­op­ment of elec­tric­ity mar­kets is based on the as­sump­tion that elec­tric­ity can be treated as a prod­uct and obeys the rel­e­vant the­o­ries re­gard­ing the de­mand and sup­ply curves.

But if elec­tric­ity was a sim­ple prod­uct, kilo­watt hours would be on shelves just like ap­ples and pears, ready for con­sump­tion when the con­sumer turns on the light. So that is why, the anal­y­sis is far more com­plex as there are sig­nif­i­cant dif­fer­ences be­tween elec­tric­ity and other prod­ucts. These dif­fer­ences have a pro­found im­pact on the or­gan­i­sa­tion and rules of elec­tric­ity mar­kets.

The main dif­fer­ence is that elec­tric­ity is con­nected to a com­pli­cated nat­u­ral sys­tem that op­er­ates much faster than any other mar­ket. In this nat­u­ral elec­tri­cal sys­tem, sup­ply and de­mand, pro­duc­tion and con­sump­tion must be bal­anced on a per se­cond ba­sis. If this bal­ance is not main­tained, the elec­tri­cal sys­tem col­lapses with dis­as­trous con­se­quences. Such an in­ter­rup­tion is un­ac­cept­able as it does not only in­ter­rupt the trad­ing sys­tem but also a whole re­gion or even a coun­try can be left with­out elec­tric­ity for sev­eral hours.

Restor­ing an elec­tri­cal sys­tem to its nor­mal oper­a­tion af­ter a com­plete col­lapse is a very com­plex process and can take up to 24 hours or even more in ma­jor in­dus­trial coun­tries. The so­cial and eco­nomic con­se­quences of such a wide­spread dis­rup­tion in the oper­a­tion of elec­tri­cal sys­tems are so in­tense that no rea­son­able na­tional en­ergy reg­u­la­tor and / or gov­ern­ment would agree to the im­ple­men­ta­tion of a sim­pli­fied elec­tric­ity pur­chas­ing mech­a­nism that would sig­nif­i­cantly in­crease the like­li­hood of such an event.

Thus, the re­li­a­bil­ity of the elec­tri­cal sys­tem has two as­pects: (a) ad­e­quacy, that is the abil­ity of the sys­tem to meet the re­quire­ments of its cus­tomers in both elec­tri­cal ca­pac­ity and en­ergy, and (b) safety, the abil­ity of the sys­tem to re­main in oper­a­tion af­ter sud­den dis­tur­bances that may oc­cur. To­day, the re­li­able sup­ply of spe­cific quan­ti­ties of elec­tric­ity re­quires large power plants con­nected to con­sumers via trans­mis­sion and dis­tri­bu­tion net­works.

An equally im­por­tant but less fun­da­men­tal dif­fer­ence be­tween the elec­tric­ity mar­ket and those of other prod­ucts is that the en­ergy gen­er­ated by a gen­er­a­tor can­not be di­rected to a spe­cific con­sumer. And vice versa, a con­sumer can­not re­ceive en­ergy from just one gen­er­a­tor. In­stead, elec­tri­cal en­ergy pro­duced by all gen­er­a­tors is con­cen­trated in the course of con­sump­tion. This con­cen­tra­tion is pos­si­ble be­cause the units of elec­tric en­ergy gen­er­ated by dif­fer­ent gen­er­a­tors are sim­i­lar. Con­cen­tra­tion is de­sir­able be­cause it leads to sig­nif­i­cant en­ergy sav­ings. Max­i­mum pro­duc­tion ca­pac­ity should be pro­por­tional to max­i­mum ag­gre­gate de­mand rather than to­tal max­i­mum in­di­vid­ual re­quire­ments. On the other hand, an in­ter­rup­tion in a sys­tem where prod­ucts are con­cen­trated has an im­pact ev­ery­where and not just on par­ties in­volved in the trans­ac­tion.

Given that it is cur­rently not eco­nom­i­cal to store large amounts of elec­tric­ity, this en­ergy should be pro­duced around the same time it is con­sumed. There­fore, elec­tric­ity traders al­ways re­fer to a cer­tain amount of kilo­watt-hours sold dur­ing a cer­tain pe­riod of time. The du­ra­tion of this time pe­riod is typ­i­cally set to one hour, half an hour or a quar­ter of an hour de­pend­ing on the coun­try or re­gion where the mar­ket is lo­cated. Since elec­tric­ity sold dur­ing a pe­riod is not the same prod­uct as elec­tric­ity sold dur­ing an­other pe­riod, the price will usu­ally be dif­fer­ent for each pe­riod.

Fi­nally, de­mand for elec­tric en­ergy re­flects pre­dictable daily and weekly cycli­cal changes. How­ever, it is not the only prod­uct for which de­mand is cycli­cal. For ex­am­ple, cof­fee con­sump­tion has two or three spikes ev­ery day and pe­ri­ods of lower de­mand. Cof­fee trade does not re­quire spe­cial mech­a­nisms be­cause con­sumers can eas­ily store it in solid or liq­uid form. On the other hand, elec­tric­ity must be pro­duced at the same time it is con­sumed.

Since short-term price volatil­ity is ex­tremely short, balanc­ing pro­duc­tion and de­mand re­quires pro­duc­tion fa­cil­i­ties that are ca­pa­ble of adapt­ing to the large and rapid changes in con­sump­tion that oc­cur over a day. Not all units will be pro­duc­ing dur­ing a 24-hour pe­riod. When de­mand is low, only the most ef­fi­cient units are likely to be com­pet­i­tive and all oth­ers will be shut down tem­po­rar­ily. Feed from less ef­fi­cient units is only needed to feed at the peak of de­mand. As the mix of power plants changes fol­low­ing the fluc­tu­a­tions in con­sump­tion, the cost of elec­tric­ity gen­er­a­tion changes over the course of the day. Sharp cycli­cal changes in the cost and price of other prod­ucts are very un­usual.

In con­clu­sion, given the com­plex­ity of the elec­tric­ity mar­ket, as well as the re­li­a­bil­ity of an elec­tri­cal sys­tem for un­in­ter­rupted sup­ply to con­sumers, no mat­ter how much we would like to sim­plify mar­ket rules gov­ern­ing the elec­tric­ity mar­ket, the re­sult will al­ways be com­plex.

Dr. An­dreas Poul­likkas is Pres­i­dent of the Cyprus En­ergy Reg­u­la­tory Au­thor­ity (CERA)

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