Effi. Market For As

Proceedings of the 34th Hawaii International Conference on System Sciences - 2001

The Design of Efficient Market Structures for Ancillary Services Hugh Outhred University of New South Wales [email protected] approaches to the design problem, with particular emphasis on the issue of ancillary services.

Abstract The electricity industry has particular characteristics that create barriers to its successful commercialization. Electrical energy is instantaneously transmitted from generators to end-use equipment according to physical laws rather than commercial contracts. Any blueprint for commercialization must be compatible with these characteristics. The main commercial activities in a restructured electricity industry assume that electrical energy behaves as a commodity. Ancillary services play a crucial role in underwriting that assumption. Therefore, it is even more complex to achieve economically efficient outcomes in ancillary services than in the main commercial activities. This paper discusses approaches to this problem, with particular emphasis on recent proposals for changes to the implementation of ancillary services in Australia. It will be several years before the success of these proposals can be measured.

1. Introduction The electricity industry has particular characteristics that create barriers to its successful commercialization: • Electrical energy is instantaneously transmitted from generators to electricity consuming equipment and no third party, such as a retailer, has intermediate physical ownership of the product. • Physical laws rather than commercial contracts determine the flow of electrical energy. Thus generators, network operators and consumers all share responsibility for whether electrical energy arrives at consumers’ equipment and, if it does, whether it is of “merchantable quality”. • The lack of cost-effective storage of electrical energy implies that supply/demand balance can change instantaneously. Imbalance between supply & demand places security of supply in jeopardy and must be corrected promptly by technical means (ancillary services) rather than waiting for a market to clear. Any blueprint for commercialization must be compatible with these characteristics. This paper discusses

2. Models of the electricity industry In developing a design for commercialization of the electricity industry, it is useful to keep four perspectives in mind: • Physical (near term “reality”) • Mathematical-engineering • Economic • Commercial The physical perspective on the electricity industry is concerned with the actual behavior of the set of electrical equipment that comprises the electricity industry. This very large set of equipment includes all generator and consumer equipment, network equipment and all control systems. Under most circumstances, this equipment behaves as intended. However unexpected events such as equipment failures can cause unintended behavior to occur with little warning. The mathematical-engineering perspective on the electricity industry is concerned with models of physical behavior that are both sufficiently accurate and sufficiently tractable to be useful for simulation and design purposes. Low-order approximate models must be used because of the complexity of the industry. Different approximate models are used depending on the phenomena that are to be simulated. These models are abstracted in important ways from the actual behavior that they represent. Also, engineering analysis assumes that no data provided by participants for use in these models will be deliberately misleading. The economic perspective on the electricity industry is concerned with maximizing the benefits of trade between generators and consumers. Ideally, trading platforms should incorporate mathematical-engineering models of network losses and flow constraints. Trading platforms should also be forward-looking, determining prices while they are still avoidable. The commercial perspective on the electricity industry is concerned with nature of the commercial interactions between the industry participants and, in particular, the

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Proceedings of the 34th Hawaii International Conference on System Sciences - 2001

ability of individual market participants to exercise market power. Design of trading platforms should assume that participants may provide data with intent to mislead where that might improve their commercial outcomes.

3. Main commercial activities The main commercial activities in a commercialized electricity industry are as follows: • Real-time trading (physical or spot trading) • Forward trading in financial instruments Real-time, spot or “physical” trading is intended to approximate physical behavior. Thus it should take account of network losses and flow constraints, and it should be forward-looking to allow participants to make decisions based on prices that are still avoidable. Realtime trading should have a short trading period to allow rapidly changing physical conditions to be tracked. However it should allow adequate time for participant decision making. While there is no consensus on the appropriate time frame for real-time trading, a half-hourahead spot market may be regarded a good compromise. Electricity spot markets are extremely volatile and commercially risky. Forward trading in financial instruments related to future spot prices assists in managing these risks and providing guidance about likely future spot-market conditions. Both spot and forward trading assume commodity-like behavior for electrical energy, possibly at specified locations in the electricity network. Therefore separate steps must be taken to ensure that the energy traded is of merchantable quality.

4. Ancillary service definitions & categories Ancillary services can be defined as a set of activities undertaken by generators, consumers and network service providers and coordinated by the system operator that have the following objectives: • Implement the outcomes of commercial transactions, to the extent that these lie within acceptable operating boundaries. That is, ensure that electrical energy production and consumption by participants match the quantities specified by the outcomes of spot markets. • Maintain availability and quality of supply at levels sufficient to validate the assumption of commoditylike behavior in the main commercial markets. This can be achieved by keeping the physical behavior of the electricity industry within acceptable operating boundaries defined by planning studies in conjunction with operator experience.

Ancillary services can be divided into the following three categories that are described in more detail below: • Related to spot market implementation, short-term energy-balance and power system frequency. These will be labeled Frequency Control Ancillary Services (FCAS). • Related to aspects of quality of supply other than frequency (primarily voltage magnitude and system security). These will be labeled Network Control Ancillary Services (NCAS). • Related to system restoration or re-start following major blackouts. These will be labeled System Restoration Ancillary Services (SRAS). Spot-market implementation involves ensuring that participating generators and loads achieve their energy targets specified in the market solution for the current spot market interval. However market model imperfections or incompleteness (such as a lack of demand-side bidding or inadequate representation of network losses) mean that the spot market solution may not deliver an overall balance in electrical energy flows in actual operation. Also, unexpected phenomena (such as the failure of a generating unit) during a spot market interval may create a mismatch between the spot market solution and physical behavior. The overall balance in the electrical energy flows in a power system is not monitored directly because of its complexity. It depends on the operating states of all generators and loads as well as on network losses and can vary instantaneously. However power system frequency is a useful surrogate for energy balance because it is a measure of the stored kinetic energy in the rotating masses of generating units and loads. Imbalances in electrical energy flows that persist for more than a few seconds will be reflected in a change in the stored kinetic energy and thus in power system frequency. Moreover, for time scales longer than a few seconds, frequency may be considered to be uniform across a power system. Thus ancillary services that control frequency may be used to manage short-term imbalances in overall electrical energy flows. Most generating units are fitted with active speed control devices (speed governors) and many motor-driven loads vary passively with frequency. Thus both generators and loads can contribute to managing energy-flow balance. At any particular time, the operating power level of each spot market participant will combine a power level designed to achieve its spot market energy target with that responding to frequency deviations. It is by no means straightforward to separate, monitor and account for these activities appropriately. Unlike frequency, voltage cannot be thought of as uniform across a power system under any circumstances. Voltage drops occur across network elements due to current flows. Tap-changing transformers, shunt

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Proceedings of the 34th Hawaii International Conference on System Sciences - 2001

capacitors and other control devices are used to control voltages at selected locations. Network losses and the power consumption of many loads vary with voltage. Thus there is interaction between voltage levels and spot market quantities and some coupling between frequency and voltage related ancillary services. The operating state of a power system that has suffered a major blackout may be very different from its normal range of operating states. Power system restoration or restart requires at least some generating units that are capable of self-starting and may require some special network equipment. Commercial contracts can ensure that such capability is made available.

5. Boundary issues for ancillary services There are overlaps between the management of rapid variations in energy balance by FCAS and the management of slow variations in energy balance by the spot market. Information theory suggests that spot markets can only manage energy imbalances with periodicity more than twice the spot market interval. Therefore FCAS must manage energy imbalances with faster periodicity than this. Also, physical constraints such as ramp-rate limits may at times prevent participants from achieving their anticipated energy for a particular spot market interval. This may leave energy imbalances that must continue to be controlled by FCAS. Some ancillary service and spot market related activities are conducted in parallel. For example, acquiring ancillary service resources for future operation, projecting system security for the purposes of setting network flow constraints, and trading in financial instruments concerned with future spot market operation. Some NCAS actions (which can affect network losses and load power levels) may interact with energy balance management by NCAS or spot markets. Inefficiencies may arise unless these boundary issues are identified and undesirable interactions minimized at the design stage.

6. Potential for economic efficiency Economic efficiency can be defined in terms of technical, allocative and dynamic efficiency. Here, technical efficiency implies using the best available means to achieve a specified ancillary service task, allocative efficiency implies delivering an appropriate level of each ancillary service, and dynamic efficiency implies timely development and adoption of new ancillary service technologies. Technical efficiency is the easiest of these three measures to address, by avoiding technological bias in the

definition of ancillary services and by adopting competitive procurement processes. However it may still be difficult to ensure sufficient competitive pressure for ancillary services that are location specific, such as NCAS, or that require specialized functionality, such as SRAS. In broad terms, it appears easier to achieve technical efficiency with FCAS. Allocative efficiency is more difficult to achieve because it requires the beneficiaries of ancillary services to reveal their willingness to pay. Traditionally, targets for quality and availability of supply have been set and monitored by regulators and commercial alternatives are as yet immature. Again, the prospects seem brighter with FCAS than the other ancillary service categories. This is because of the close relationship between frequency and supply-demand balance and the uniformity of frequency throughout a power system, apart from rapid fluctuations. However the uniformity of frequency also implies publicgood characteristics and thus “free-rider” problems might emerge. A partial answer to this concern is that a passive response to frequency is built-in to many items of electrical equipment. As electricity spot markets mature, it may become possible to introduce voltage-value functions into bids and offers. Assuming adequate local competition, this would cause market participants to reveal willingness to pay for voltage regulation, facilitating the achievement of allocative efficiency in voltage-related NCAS. Dynamic efficiency is likely to be achieved through facilitating active involvement by consumers (and electrical equipment designers) in the delivery of ancillary services. Traditionally, consumers have had relatively little involvement in the delivery of ancillary services, however the value provided by ancillary services is greatest if they are located within or close to consumer premises. This is because the problems that consumers experience with supply availability and quality are usually due to phenomena associated with their local distribution network.

7. Australian treatment of ancillary services Australia has implemented a wholesale electricity market with rules that apply uniformly across the interconnected transmission network that covers the southern and eastern mainland States (South Australia, Victoria, New South Wales and Queensland) and the Australian Capital Territory (ACT). This market is called the National Electricity Market (NEM) and it covers about 85% of Australia’s total electricity consumption. It employs a “hub and spoke” approximation to nodal pricing that is expected to evolve towards increasing accuracy with time. The Australia approach to electricity restructuring is discussed in more detail in [1].

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Proceedings of the 34th Hawaii International Conference on System Sciences - 2001

The rules that govern NEM design and operation are called the National Electricity Code (NEC). The NEC contains rules that deal with the provision of ancillary services at the wholesale market level, including the transmission network that supports the market. Responsibility for acquiring and controlling these ancillary service resources rests with the National Electricity Market Management Company (NEMMCO). Distribution-level ancillary services are dealt with by the individual jurisdictions requiring distribution network service providers to set and report against targets for availability of supply. Australian standards apply to quality of supply at consumers’ points of connection. Currently there is a proposal to change the treatment of wholesale market ancillary services within the NEC. This section describes the current arrangements and the following section discusses the proposed changes and their motivations. The NEC uses the category definitions given in Section 5 for wholesale market ancillary service– FCAS, NCAS and SRAS. The FCAS category is further divided as follows: • Continuous and contingency services, distinguishing between small disturbances associated with normal operation from large disturbances due to the loss of significant amounts of generation or load. • Fast, slow and delayed response services specifically defined as six-second, sixty-second and five-minute responses. These services are assumed to be independent and are acquired separately. Targets have been set for tolerable frequency excursions following large disturbances. These distinguish between the loss of the single largest generator and the loss of multiple generators. Normally, sufficient FCAS contingency resources are procured to cover the loss of the single largest generator. At present, NEMMCO has responsibility for determining the quantity and location of wholesale market ancillary services. It procures them through one of three procedures depending on the service: • Tender process • Regulated acquisition • Provision under a direction Initially, market customers (retailers and direct consumers) paid for all ancillary services. However, from July 2000 the costs have been shared equally between market generators and market customers. The costs of wholesale market ancillary services presently amount to approximately A$150 million per year, split roughly onethird each between FCAS contingency services, FCAS continuous services and the remainder (NCAS and SRAS).

8. Proposed changes to wholesale market ancillary services in Australia A recent report by NECA’s Code Change Panel [2] has recommended further changes to the rules associated with ancillary services in the National Electricity Code. The Australian Competition and Consumer Commission (ACCC) will now assess the proposed changes according to criteria of competitiveness and public good prior to their implementation. In particular, the Code Change Panel recommended that: • A statement of principles for ancillary services should be incorporated into the NEC. These principles give preference to reliance on competition rather than on regulation in determining levels and provision of ancillary services. • A review should be undertaken of the scope for further development of arrangements for NCAS. These should incorporate an arbitration process for the elements of those services that don’t satisfy a competition criterion. • There should be a staged introduction of competitive arrangements for FCAS that tests the extent to which efficient markets in ancillary services can be established. In reaching these recommendations, the Code Change Panel largely accepted the findings of a previous review undertaken by NEMMCO [3], which adopted the following hierarchy for ancillary services: • Implement two-way markets where practical, to trade services between “causers” and “providers”. • Where two-way markets are impractical, implement one-way markets with NEMMCO as buyer. Cost allocation is to be in accordance with the principle of “causer pays” or “beneficiary pays” where these can be identified. Otherwise, costs are to be shared equally among market participants. The NEMMCO review proposed a staged introduction of competition for FCAS that will be discussed in Section 8.1. It proposed deferring consideration of NCAS pending further development of network representation in the NEM spot market. However, it did identify a “Light on the Hill” for NCAS, to be achieved in 3 to 5 years. This envisages a nodal active and reactive power dispatch that would implement spot markets for NCAS provision at participants’ connection points. The costs of NCAS provision would then be borne by the beneficiaries of the increased spot market settlement residue that would accumulate due to improved network transfer capability.

8.1. Frequency control ancillary services

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Proceedings of the 34th Hawaii International Conference on System Sciences - 2001

The NEMMCO review recommended retention in the NEC of mandatory capability of governor response but proposed removing the current mandatory provision of governor response to large frequency deviations. Instead it proposed a set of FCAS spot markets [3]: • Two spot markets for small deviation FCAS enablement (raise and lower). • Six spot markets for large deviation (contingency) FCAS enablement (raise and lower) for fast (6 second), slow (60 second) and delayed (5 minute) response. Solutions to these markets would be co-optimized with solutions to the spot market and FCAS prices would be set accordingly. They would account for the cost of having capacity withheld from the energy market as well as its use to provide FCAS. Initially, NEMMCO would be the sole buyer of FCAS services and would determine the requirements needed to achieve the frequency control standards set by the Reliability Panel. NEMMCO would assign costs to causers where possible, for example by using SCADA and AGC data to assess the performance of participants against their spot market energy targets. In time, NEMMCO envisages that a two-sided market in energy deviations (from spot market targets) would largely replace the FCAS enablement markets. Also, NEMMCO anticipates that it could include the requirement for large deviation FCAS as an optimized variable in the spot market. The cost of acquiring matching large deviation FCAS would be taken into account in determining the dispatch level for the market participant identified as the largest single contingency.

In response to these concerns, a staged implementation has been proposed, in which the effectiveness of the changes implemented and the desirability of further changes will be assessed at each stage. Another important issue has yet to be addressed. That is the relationship between ancillary services in wholesale and retail market design. Most consumers and some generators are connected to distribution rather than transmission networks. For them, distribution-level impacts on availability and quality of supply are of much greater significance than transmission-level impacts. Retail market design is still evolving in Australia and as it matures, it is likely that retail markets will take on greater responsibility for maintaining availability and quality of supply. That, in turn, will have implications for the treatment of ancillary services at the wholesale market level.

9. Concerns about the proposed changes

11. References

The following kinds of concerns have been expressed with regard to the proposed changes to the treatment of wholesale market ancillary services in Australia: • Excessive complexity – for example, eight separate markets in FCAS. • Doubts about the effectiveness of competition – particularly with regard to NCAS and SRAS, where requirements are localized and/or specialized. • Doubts about the feasibility of implementing commodity markets in what are technically challenging services.

[1] H. R. Outhred, “The Competitive Market for Electricity in

10. Conclusions The introduction of competition in the electricity industry is a complex process. The main commercial activities in a restructured electricity industry assume that electrical energy behaves as a commodity. Ancillary services play a crucial role in underwriting that assumption. Therefore, it is even more complex to achieve economically efficient outcomes in ancillary services than in the main commercial activities. This paper has described work in progress in Australia to improve the economic efficiency of the delivery of ancillary services. It will be several years before the success of these proposals can be measured.

rd

Australia: Why it Works so Well”, Proceedings of the 33 Hawaii International Conference on System Sciences, January 2000.

[2] Code Change Panel, Ancillary Services Report, National Electricity Code Administrator, Australia, August 2000. [3] National Electricity Market Management Company, Ancillary Service Review, Final Report, October 1999.

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