Power Economics in Liberalised Electricity Markets

Power Economics in Liberalised
Electricity Markets
Lecture at Aachen University of Technology
- 1. lecture, chapters 1 and 2 -
Dr.-Ing. Jochen Kreusel
1. Introduction
2. Basics in Power Economics
Power Economics
in Liberalised Electricity Markets T1_03_E.ppt / p1 / 03-04-25
1. Introduction - Why This Lecture?
Education in electrical engineering

• strong in methodology
• mainly restricted to technical issues
Professional experience
• strong interference between technology, organisation and economy
• combined with strong demand for technical expertise
Power industry
• key industry for all countries
• important employer for electrical engineers
Liberalisation
• radical change of this key industry
• cross-border challenge
Power Economics
1. Introduction - Goal of the Lecture
Introduction to a very important subject

• currently and during the next years
• in Germany
• but also in many other countries world-wide
Effective introduction to economical methods

• of course not a detailed lecture on this subject
• but raising awareness for the way of thinking and its business impact
Discussion partner working in the industry
Power Economics
1. Introduction - Dr.-Ing. Jochen Walter Kreusel
Personal data
• born in 1963
• married, one son
Education
• Abitur (university entrance certificate) 1982
• studies of electrical engineering at Aachen Univ. of Technology, 1982-1988
• scientist at IAEW 1988-1990 (Ph. D., research group System Structures)
• senior engineer at IAEW from 1991 to 1994
• ABB Calor Emag Schaltanlagen AG (1994-1998)
– head of marketing department 1995-1997
– head of research and development 1997-1998
• ABB Energy Information Systems GmbH, managing director, 1999-2001
• division manager Innovisions, ABB New Ventures GmbH, 2001/2002
• marketing and communication manager, ABB Power Technologies, Germany
Power Economics
1. Introduction - Dipl.-Ing. Fernando Olsina
Education
• studies in Mechanical Engineering at the Engineering Faculty,
National University of San Juan, Argentina, 1995-2000
• PhD Candidate at Institute of Electrical Energy (IEE), National University of
San Juan, since September 2000
• PhD visiting student at Institute of Power Systems and Power Economics,
Aachen University of Technology, DAAD Fellowship, since April 2002
• member of the scientific staff at IEE, 2000-2001
• member of IAEW Research Group “Generation and Trading”, April 2002
Focus of scientific work

• modelling of long-term development of power markets by means of System
Dynamics simulation methods
• economics of large scale wind power generation in power systems
• dynamics of generation capacity investments
Power Economics
Facts about ABB
n leading power and automation

n headquarters: Zurich, Switzerland
technology company with strong
n about 139,000 employees in
more than 100 countries market positions in its core
n orders in 2002: US$ 18.1 billion businesses
n revenues in 2002: US$ 18.3 billion n two core divisions: Automation
n listed on stock exchanges in Technologies, Power Technologies
London/Zurich, Stockholm, Frankfurt n non-core activities:
and New York
Oil, Gas and Petrochemicals,
Building Systems
Power Economics
Who we are
n ABB is a leader in power and automation

technologies that enable utility and industry
customers to improve performance while
lowering environmental impact.
n Our aim is to create value for all our

stakeholders. We seek to meet the needs
of our customers, our employees and the
communities where we do business, and
create value for our shareholders.
Power Economics
What we offer
n leading-edge power and automation

technology products, systems, solutions
and services for
n utilities
n industries
n the oil, gas and petrochemicals sector
n world-class collaborative business

platforms and solutions based on
IndustrialIT open architecture software
Power Economics
ABB Power Technologies - Our Portfolio
High Voltage Medium Power Distribution Utility Power

Products Voltage Transformer Transformer Automation Systems
Products Systems
n ABB is no. 1 in Power Technologies

n in total
n in each of its business areas
n globally present with about 42.000 employees in more than 70 countries
Power Economics
Customer Oriented Organisation
C U S T O M E R S
external product account management product external

sales sales sales sales
channels channels
Power Technologies Automation Technologies
B u s i n e s s A r e a s
Power Economics
Revenues 2002
in bio. US Dollar (nominal change in % to 2001)
non-core activities
Utilities
4,186
4,826 (-14 %)
19% 21%
Automation 21%
Technology 19% Power Technology
Products Products
5,035 (+6 %) 4,355 (+10 %)
20%
Industries
Power Economics
4,412 (-12 %)
in Liberalised Electricity Markets T1_03_E.ppt / p11 / 03-04-25 ABB
Central Market Systems with ABB Participation
StattNet
(Scandinavia)
Power
Pool NE ISO NGC
(Alberta) (New England) (England) RWE Balancing Market
Vattenfall Europe Balancing Market
NY ISO (Germany)
(New York)
CA ISOCA ISO
(California)
(Kalifornien)
Korea Power Exchange

(South Korea)
ISA
(Columbia)
PUB
(Singapore)
National
ESKOM Market
(South Africa) (Australia)
Power Economics
1. Introduction - Organisation
Scope of lecture
• lecture (V2), optional tutorial (Ü1), summer semester
• seven lessons, three tutorials, each 3 hours
Oral Examination
• DPO 1987 Wahlfach V2 (Wahlfach/Leistungsnachweis)
• DPO 1998 Wahlfach V2Ü1 (Wahlfach/Leistungsnachweis)
• MPO 1998/2000 elective subject 3 SWS
• examination at the end of summer semester
(or at the beginning of summer lecture period on request)
Referees
• Dr.-Ing. Jochen Kreusel, lecture
• Dipl.-Ing. Fernando Olsina, tutorial and contact partner for lecture:
Tel. 0241 / 80-9 67 34, E-Mail: fo@iaew.rwth-aachen.de
Power Economics
1. Introduction - Organisation
Handouts / References
• paper copies of slides shown in lecture and tutorial
– in English (lecture also available in German on request)
– distribution before lecture or tutorial
• slides are also published on the lecture’s web site in pdf format
• references to latest literature
• glossary (English-German including explanations),
will be distributed at the end of the semester
• manuscript available in German (latest update end of 2002) on request
Power Economics
1. Introduction - Contents and Dates of Lecture (1/2)
Date Content Referee

25.04.03 1. Introduction Dr. Kreusel
2. Basics of Power Economics
09.05.03 3. The Liberalised Electricity Market Dr. Kreusel
3.1 Introduction
3.1.1 Motivation for Privatisation and Liberalisation
3.1.2 Tasks and Roles
3.1.3 Overview of International Deregulation Status
3.1.4 International Examples
23.05.03 Tutorial: Capital Budgeting Olsina
06.06.03 3.1.5 Germany Dr. Kreusel
3.2 Tasks in the Different Market Roles
3.2.1 Technical Organisation of Power Systems
3.2.2 The Service Market
13.06.03 Tutorial: German Associations Agreements Olsina
Power Economics
1. Introduction - Contents and Dates of Lecture (2/2)
Date Content Referee

20.06.03 3.2.2 The Service Market (cont’d) Dr. Kreusel
3.2.3 Competitive Market
3.2.3.1 Generation and Bilateral Wholesale Market
3.2.3.2 Power Exchanges
27.06.03 Tutorial: Power Exchanges Olsina
04.07.03 3.2.4 Competitive Market (cont’d) Dr. Kreusel
3.2.3.3 Energy Service Provider
3.2.3.4 Balance Circles
3.3 Market Communication
11.07.03 4. Pricing in Liberalised Markets Dr. Kreusel
4.1 Tariffs for Commercial and Industrial Customers
4.2 Pricing in the Wholesale Market
25.07.03 5. Experiences with Liberalisation, Summary and Perspective Dr. Kreusel
Power Economics
2.1 Introduction
What means Power Economics?

• power
• economics
Power industry in this lecture

• electricity industry
• dealing with energy
– starting with primary energy
– ending with secondary energy (first conversion level acc. fig. 2.1)
Power Economics
2.1 Introduction
scope of lecture Primary energy:

primary energy
− solar energy
− fossil energy
conversion at
generator − nuclear energy
secondary 1. conversion:
energy − coke
non-energetical − gasoline
end energy − electrical energy
consumption
− district heating
losses at exploration and conversion at 2. conversion:
conversion consumer − heating
auxilliary services − process heat
at conversion − light
energy − mecanical energy
losses at consumer for usage
fig. 2.1: conversion chain from primary energy to final usage [1]
Power Economics
2.1 Introduction
System of market economy

• numerous self-responsible individuals (personal and legal)
• all acting according rules (laws and norms) of the society
Economical behaviour from an individual’s perspective
• maximising output by given input
• minimising input by given output
• considering
– risk
– chance
• regarding all relevant time horizons
– short-term
– mid-term
– long-term
Power Economics
2.1 Introduction
simple task or good performance
output O O
→ Max ∧ O ≥ O
required
I
O required
difficult task or poor performance

competitive advantage ∆I (assuming that the blue
lines represent the same task)
input I of rare resources
fig. 2.2: input-output optimisation as basic principle of economical activities
Power Economics
2.1 Introduction
Problem of mid- and long-term strategies
• time horizon is defined by the individual
⇒ economical activity does not need to sustain longer than the individual needs it
• mid- and long-term events are more stochastic than short-term ones
• human tendency to short-term thinking
Example 1: examinations
• three examinations
– Electromagnetic Theory: beginning of March
– Communications Engineering: mid of March
– Operating Systems: early April
• strategy A:
– first 1 week Communications Engineering
– three weeks Electromagnetic Theory
– short break, 1 further week Communications Engineering
– normal preparation for third examination
• strategy B: postpone Communications Engineering 1 semester
Power Economics
2.1 Introduction
Example 2
• replace “Electromagnetic Theory” by “risks from nuclear energy”
• replace “Communications Engineering” by “global warming because of the
greenhouse effect”
Power Economics
2.1 Introduction
Additional expectations regarding economical activities

from the society
• different time horizon (e.g. greenhouse effect)
• protection of society members from too high risk (e.g. insolvency)
• ensuring tasks of public interest
– safe and reliable supply with electrical energy
– regional development support
– ...
• limitation of economical power
Consequence
• theoretical solution space of optimising individual benefit is constrained
• with this pattern all models of electricity markets can be explained
Power Economics
2.1 Introduction
solution space for

pure individualistic
optimisation
accepted solution
space for market
participants
constraints resulting
from expectations of
the national economy
fig. 2.3: constraints of individual solution space resulting from societal requirements
Power Economics
2.2 Selected Topics from Financial Theory
Task: assessment of economical situations

• decisions on investment projects
• calculation of average costs
• ...
Problems
• cash inflows and outflows at different times
– single events
– continuos flows
• various utilisation and depreciation periods
• value of a single cash flow depends on time
– inflation
– interest rates
Power Economics
Solution
• transformation of cash flows using the opportunity cost of capital
• two methods:
– net present value (NPV) method
– annuity method
• these are equivalent and can be transformed into each other
3 basic operations
• net present value method
– equivalent shift of cash flows in time
– transformation of a series of constant cash flows into one equivalent cash flow
• annuity method: transformation of single cash flows
into a series of constant cash flows
Power Economics
Basis operations of net present value and annuity method
original value
cash cash cash
flow C flow C flow C result
t0 reference time
t0 t t0 t t0 t
operation 1: operation 2: operation 3:

equivalent shift in time net present value annuity
fig. 2.4: basic operations of net present value and annuity method
Power Economics
Equivalent time shift (operation 1, net present value)

Task
• calculation of the net present value of a single cash flow at k units of time
before/after the reference time
• given:
– interest rate in percent per unit of time T0
– reference time t0
Case 1: cash event before reference time

NPV = C ⋅ (1 + i ⋅ T0 ) k = C ⋅ q k
with : NPV : net present value C : cash flow
i: interest rate per unit of time T0
k: number of units of time between t 0 and t k , k > 0
Power Economics
Equivalent time shift (operation 1, net present value)

Case 2: cash event after reference time
C −k
NPV = = C ⋅ q
(1 + i ⋅ T0 ) k
with : k : units of time to shift, k > 0
General:
C −k
NPV = = C ⋅ q
(1 + i ⋅ T0 ) k
with : k: units of time to shift
(k < 0 : event before reference time)
q -k : discount factor
Power Economics
Net present value of a series of events (operation 2)

Case 1, task
• net present value of a constant series of cash flows
• same cash flow in each unit of time (inflow I, outflow O, O < 0)
• first outflow one unit of time after reference time
Solution
NPVtot = (I + O ) ⋅ (q −1 + q −2 + ... + q − n ) with: NPVtot: net present value of
n series
= (I + O ) ⋅ ∑ q − k q: interest factor
k =1
qn −1 n: duration of time series

= (I + O ) ⋅ n in units
q ⋅ (q − 1)
β: NPV factor
= (I + O ) ⋅ β
Power Economics
Net present value of a series of events (operation 2)
Case 2, task
• net present value of a series of events
• outflows O increasing per unit of time with rate a (e.g. salaries), inflows I
increasing per unit of time with rate e (e.g. because of increasing prices)
• series O, I start at time t=t0+T0
Solution −k −k
O1 n  q  I1 n  q 
O k = O k −1 ⋅ (1 + a ⋅ TN ) = O k−1 ⋅ q a , for k ≥ 2 = ⋅∑  + ⋅ ∑ 
q a k =1  q a  q e k =1  q e 
I k = I k −1 ⋅ (1 + e ⋅ TN ) = I k −1 ⋅ q e , for k ≥ 2
O1 I
this means : O k = O1 ⋅ q k −1
, I k = I1 ⋅ q k −1 = ⋅ βa + 1 ⋅ βe
a e qa qe
O1
NPVtot = ⋅ (q 1a ⋅ q −1 + q 2a ⋅ q −2 + ... + q na ⋅ q − n )
qa
I1
+ ⋅ ( q1e ⋅ q −1 + q 2e ⋅ q − 2 + ... + q en ⋅ q − n )
qe
Power Economics
Annuity of a single event (operation 3)
Task
• distribution of a single event at time t = t0 over a period of n units of time of
length
• the net present value of this series shall be equal to the original single event
Solution
n
The formula for the NPV is still given: NPV = C = ∑ A k ⋅ q − k = A ⋅ β
k =1
This time the single cash flow C is the NPV of a series of regular cash flows Ak. We are
looking for A as cash flow per period. If the length of the period is one year, A is called
annuity. It is obvious that the transformation from a single event to an annual value
(annuity) has to be done by dividing the single cash flow B by the NPV factor β. β is given
for a chosen length of the series and the appropriate interest rate. We define
1
α=
β
as annuity factor.
Power Economics
2.3 Cost Structure of Power Generation, Transmission, Distribution
Objectives of Cost Calculation

• determination of running costs of existing assets
• e.g. as a basis for pricing
Fix cost, independent from use of assets
• capital expenditures for investments
• personnel expenditures
• insurance
• maintenance
Variable cost, dependent from use of assets
• material (resources, fuel)
• further cost depending on operation
Power Economics
Cost Structure in Generation

Fix, capacity dependent cost Variable, energy dependent cost
• capital expenditures • fuel cost
• further fix cost • simple relation when constant fuel
consumption rate (i.e. constant
& P = ( α + b& ) ⋅ K H = ( α + b& ) ⋅ k P ⋅ Pn
K
efficiency) assumed
& P : annual capacity & W = kW ⋅ W
K & = k W ⋅ T& m ⋅ Pn = p W ⋅ ν ⋅ T
& m ⋅ Pn
with: K
dependent cost
K H : investment & W : annual energy dependent cost
with: K
α: annuity factor k W : energy rated,
b&: mark up for other fix cost energy dependent cost
k P : capacity rated W& : delivered annual energy
investment cost & m : annual time of use at full capacity
T
Pn : installed capacity p W : fuel price (primary energy)
ν: fuel consumption rate
Power Economics
Cost Structure of Generation
Total cost of generation
& =K
& +K& = ( k& + k ⋅ T& ) ⋅ P
&
K k& P
K P W P W m n k= = + kW
&
W T& m
Typical data
type Pn own cons. KH(Pn) kP α + b& k& P kW
[MW] [MW] [mio €] [€/kW] [%/a] [€/(kW·a)] [€/kWh]
nuclear 1270 50 2.750 2.150 350 0,005
coal 720 45 1.000 1.400 16,2 225 0,035
gas turbine 100 <1 30 300 50 0,135
(from [2], assuming i=8%/a, depreciation period 20 a)
Important criteria for differentiation between power stations

• ratio between fix and variable cost
• volatility of fuel cost
• payback period
• operational flexibility
Power Economics
Cost Structure in Generation
0,80
0,70 nuclear station

hard coal station
0,60
gas turbine station
0,50
k in €/kWh
0,40
0,30 NOTE: figure does not show

differences in utilisation period!
0,20
0,10
0,00
500 2500 4500 6500 8500
annual time of use at full capacity (h/a)
fig. 2.5: costs per unit of energy of different types of power stations depending on the utilisation
Power Economics
Cost Structure in Transmission and Distribution

Parts of costs
• fix: capital expenditures, personnel, insurance, maintenance etc. ⇒ dominant
• variable: losses (load depending part)
Typical capacity depending cost of electrical networks

k& P EHV grid HV grid MV grid LV grid
[€/(kW·a)]
voltage level 40 35 75 250
total down to 40 75 150 400
current
voltage level
(source: [2], medium and low voltage grids in addition to voltage level
strongly depending on local circumstances (e.g. urban or rural environment)!)
Power Economics
Comparison of full cost of generation and transport for supply at

different voltage levels
NOTE: grid cost strongly depending
0,3 on differences in utilisation!
grid
0,2
€/kWh
generation
0,1
0
household mid size industry large industry
(2 kW, LV) (10 kW, MV) (100 kW, HV)
fig. 2.6: full costs of electricity supply for typical users at different voltage levels
Power Economics
2.4 Full Cost and Contribution Margin
So far
• capital budgeting: planning tool
• full costing
– for control of long-term cost coverage
– assumes that business can be planned
Examples: limitations of full costing

• example 1: costs depend on utilisation
& k& P + k& Ü / V
K
& =K
&P+K
& & & & &
K Ü / V + K W = ( k P + k Ü / V + k W ⋅ Tm ) ⋅ Pn k=
&
= + kW
W T& m
Revenue R depending on a planned utilisation period T& m0 can be calculated

as: R = ( k + e) ⋅ P ⋅ T& = K + E
n m0 0
with : e : earnings rated to energy

E0 : absolute earnings at planned utilisatio n
Power Economics
If we now replace k by the sum of its capacity and energy dependent parts and
let the utilisation be variable we get:
& + k&
k T& m
&
R (Tm ) = ( P Ü/ V &
+ k W ) ⋅ Pn ⋅ Tm + E 0 ⋅
T& m0 T& m 0
The difference of expected income based on the utilisation and cost caused by
the utilisation gives the expected earnings:
E (T& m ) = R (T& m ) − K
k& P + k& Ü / V T& m

=( + k W ) ⋅ Pn ⋅ T& m + E 0 ⋅ − (k& P + k& Ü / V + k W ⋅ T& m ) ⋅ Pn
&T T& m0
m0
T& m T&
= E0 ⋅ − (1 − m ) ⋅ (k& P + k& Ü / V ) ⋅ Pn
T& m 0 T& m 0
Deviations from the planned utilisation lead to an over or under absorption of fix
cost!
Power Economics
• example 2: differentiating distribution of fix costs to several products:

The tariffs for low voltage customers normally do not cover the full costs of
this customer group. Therefore a direct costing approach is used:
 R1   k f 11 k f 12 ... k f 1n   V1   k v11 0 ... 0   V1 

         
R 2   k f 21 k f 22 ... k f 2 n   V2   0 k f 22 0   V2  r
:  = : ⋅ + ⋅ +E
: :  :  : : :  : 
         
R  k k fn 2 ... k fnn   Vn   0 k fnn   Vn 
 n  fn1 0 ...
r r r r r r
= ( k f ) ⋅ V + (k v ) ⋅ V + E = Kf + K v + E
with : (k f ) : contribution margin matrix (fix cost coverage)
(k v ) : matrix wit h variable cost parts
r
V: volume vector
n
Constraint : ∑K
i =1
fi = K fix
Power Economics
Contribution Margin
Consequences of dependency of fix cost coverage on utilisation:
• need to react in case of missing utilisation (under absorbed cost normally
can not be compensated later)
• possibility to adapt prices if fix costs are covered already
• both cases in particular important in case of high share of fix costs
(factories, power generation, energy networks)
Contribution margin to increase transparency

sales price
additional var. cost Contribution margin
full cost according plan prices between covering variable and full cost may
indirect fix cost be reasonable if
(e.g. sales & administration) • otherwise under absorbed cost will occur
direct fix cost (e.g. factory) • fix cost are covered already
variable cost prices below variable costs usually are not economical,
as these costs are caused by additional business.
cost pricing
Power Economics
2.5 Literature to Chapters 1 and 2
[1] Edwin, K. W.
Mensch und Technik. Grundgesetze systemtechnischer Planung.
Aachener Beiträge zur Energieversorgung, Band 68, Aachen, 2000
[2] Haubrich, H. J.
Elektrische Energieversorgungssysteme Technische und wirtschaftliche Zusammenhänge.
Manuscript of lecture „Elektrische Anlagen I“ (Power Systems I) at Aachen University of
Technology, 1998
Power Economics

Power Economics in Liberalised Electricity Markets

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Power Economics in Liberalised Electricity Markets

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Power Economics in Liberalised

Dr.-Ing. Jochen Kreusel

Education in electrical engineering

Introduction to a very important subject

Effective introduction to economical methods

Discussion partner working in the industry

Focus of scientific work

n leading power and automation

n ABB is a leader in power and automation

n Our aim is to create value for all our

n leading-edge power and automation

n world-class collaborative business

High Voltage Medium Power Distribution Utility Power

n ABB is no. 1 in Power Technologies

external product account management product external

Power Technologies Automation Technologies

Korea Power Exchange

Date Content Referee

Date Content Referee

What means Power Economics?

Power industry in this lecture

scope of lecture Primary energy:

System of market economy

simple task or good performance

difficult task or poor performance

input I of rare resources

fig. 2.2: input-output optimisation as basic principle of economical activities

Additional expectations regarding economical activities

solution space for

Task: assessment of economical situations

Basis operations of net present value and annuity method

operation 1: operation 2: operation 3:

Equivalent time shift (operation 1, net present value)

Case 1: cash event before reference time

Equivalent time shift (operation 1, net present value)

Net present value of a series of events (operation 2)

qn −1 n: duration of time series

Objectives of Cost Calculation

Cost Structure in Generation

(from [2], assuming i=8%/a, depreciation period 20 a)

Important criteria for differentiation between power stations

0,70 nuclear station

0,30 NOTE: figure does not show

Cost Structure in Transmission and Distribution

Typical capacity depending cost of electrical networks

Comparison of full cost of generation and transport for supply at

Examples: limitations of full costing

Revenue R depending on a planned utilisation period T& m0 can be calculated

with : e : earnings rated to energy

k& P + k& Ü / V T& m

• example 2: differentiating distribution of fix costs to several products:

 R1   k f 11 k f 12 ... k f 1n   V1   k v11 0 ... 0   V1 

Contribution margin to increase transparency

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