Privatization of generation, retail price caps, a power exchange, locational pricing for congestion management, real-time markets for energy and ancillary services, the “works.” That’s how a high-ranking energy official described his developing country’s plans for restructuring its state-owned electricity industry to a friend of mine who heads up a software business serving participants in energy markets around the world.
My friend asked him why he thought he needed all of these things. The answer: because that’s what the markets in developed countries had.
the British experiment with restructured markets
Electricity market restructuring began in the United Kingdom. In 1990, the British government privatized its state-owned generation companies (except for its nuclear operations), splitting them off from its T&D organization. The new gencos sold power to local distribution companies through a single buyer known as the Pool. This was a cost-based market in which each generation company submitted bids based on their operating costs and the system-wide market price was determined by the bid of the last unit accepted by the Pool to meet the projected demand for a given half-hour period.
Buyers and sellers could enter into bilateral contracts, but these were limited to so-called contracts for differences, or CfDs. Under these arrangements, the buyer or seller would make a payment to the other party based on whether the market price was above or below the contract price. The scheme essentially provided a price floor for generators and a price ceiling for utilities and other customers, allowing each to hedge its exposure to market fluctuations.
Britain’s cost-based Pool remained in place until 1992 when a price-based system was introduced. Under this scheme, the process worked the same way except that the bids generators made now contained a markup, and the system-wide demand estimate was replaced with actual bids from load-serving utilities. This created supply and demand curves, with the market clearing price indicated by their intersection. CfDs were still used, and they took on more importance in light of the potential for wider price variations.
Policymakers and industry participants around the world watched the U.K.’s experiment with competitive power markets closely. In the United States, the natural gas industry had been recently deregulated-along with telecom and the airlines-and as events unfolded in Britain, the push for restructuring American power markets gained momentum.
But trouble was brewing in the United Kingdom. Power prices in the mid-90s were increasingly volatile, and British policymakers began to take steps to mitigate the situation. They imposed price caps and forced the two previously state-owned gencos to divest more of their plants. They also began to reconsider the overall market structure of the Pool and decided to do away with the single-buyer model in favor of an open trading market where buyers and sellers were free to enter into private contracts. In 2001, the aptly named New Electricity Trading Arrangements (NETA) took effect.
Power prices stabilized in the U.K. following NETA, and continued on a downward trend that actually began in 1998. Interestingly, though, the change in market structure alone may have had relatively little to do with the price trend. According to one study by a pair of British academics, NETA had little or no impact on wholesale prices, aside from the savings realized by the abolishment of capacity payments. The primary driver was much more basic: competition, fostered by more market participants, each wielding a lower concentration of market power.
the South Korean plan
Just as the United States watched the U.K. market’s development, so too has the California experience, among others, become an object lesson for other power markets undergoing restructuring. One of these is South Korea, a country that in the span of a few decades has made the transition from developing economy to global industrial player. Through the 1990s, Korea sustained a mind-boggling 9 percent annual growth rate in electricity demand. To keep up this blistering pace, the Korean government realized it would need an infusion of private capital to build the necessary capacity and set out to restructure the nation’s state-owned power industry.
In 1999, the government published its restructuring plan. The national utility, KEPCO, would divest its generation portfolio, except for its nuclear and hydro plants, and form five new generation companies. These gencos would then bid into a cost-based pool modeled on the U.K. example, but with a provision for large (>50MVA) customers to buy directly from the pool. Later stages of the plan called for the cost-based model to be replaced by a price-based pool.
In 2001, KEPCO’s generation units were parceled out to create the five new wholesale power suppliers. Each of these firms operated independently but remained a subsidiary of KEPCO, which also operated a sixth wholesaler, the Korea Hydro & Nuclear Power company. The Korea Power Exchange (KPX) was also created at this time to operate the market.
The Korean market clears two prices for each time interval, one for base load plants and the other for all other resources. According to data published by KPX, wholesale prices remained relatively stable following the introduction of the new market scheme. There has been more volatility recently, which may have contributed to the Korean government’s decision to halt the restructuring of its distribution business.
There does not appear to be anything standing in the way of a fully realized wholesale market in Korea, and information on KPX’s website indicates that the market is still moving in that direction. KPX reports that generation companies have improved operations (e.g., shorter maintenance outages), and have enhanced their profitability. In addition, policymakers are now evaluating a variety of market mechanisms to address concentration of market power, locational prices, price stability and other issues. If Korea can find workable solutions to these questions, the resulting price-based market may eventually become the new model for other emerging markets.
Fesmire is a communications manager in ABB’s power technologies division, and writes regularly on transmission and distribution, IT systems and other industry topics. The opinions expressed here are his own and do not necessarily represent those of ABB. Bob can be reached via email at email@example.com.