Iberia’s Spot Electricity Market: Behind the Curtains

Today we will attempt to explain the pricing system of the electricity spot market, known as the “pool”. The purpose of the pool is to establish an energy exchange between producers and consumers, defining the prices of every specific hour for the following day. Not as simple as it seems.

The power pool takes place in the virtual platform OMIE which is an independent agent. Every morning an auction happens in the pool where all consumers buy the electricity needed for the next day to power generators. In the daily market auction, the energy price in the peninsula for each hour is established through a matching process.

OMIE, as the market operator, receives all ask and bid offers submitted to the pool. Usually, these offers come from representative agents of central producers and suppliers, responsible for supplying to final customers.

Hourly and for every session, OMIE sorts the producer bids received from lower to higher prices and the supplier purchase orders from higher to lower prices listing a price range from 0 € /Mwh to 180.30 / MWh (known as instrumental price) . The daily market matching is marginal and the price for one hour in a day occurs at the intersection of the two curves. That price will be allocated to all producer bids which were under the crossing spot as well as to all the purchasing offers that were above.

The following chart shows the matching at the hour X on the daily market time:

What are the factors that influence the price value?

In order to explain this, we need to introduce the concept of the composition of the demand and, in particular, of the electricity production mix.

Demand, both residential and industrial, is often not manageable and it is represented by:

– Referenced supplier and other supplier who purchase at the maximum price of 180 € / MWh in order to ensure electricity for its customers.

– Hydraulic Pump stations, industrial consumers who go directly to the market and other traders who buy electricity in the liberalized market if a certain value is reach.

Demand pushes upward or downward the price of an hour, depending on the need for electricity. The variables that often determine the increase or decrease in demand are: working hours, temperatures and economic activity.

The relationship between price and demanded looks simple but it gets complicated by adding other variables such as the behaviour of the interconnections. These are primarily needed for two reasons:

– Contribute to security of supply, providing support functions between neighbours’ systems. The interconnections are the most significant security of supply instant support.

– Facilitate trade in energy, increasing competition by taking advantage of differences in prices of energy in the interconnected power systems. Interconnections play a fundamental role in the so-called Internal Electricity Market in Europe (MIE), which seeks to integrate all existing markets today in the European Union in a single market.

Moreover, with the vacant capacity in lines not use for supply security, electricity trade are set daily using differences in energy prices between interconnected electrical systems. These exchanges allow electricity generation to be carried out with the most energy efficient technologies flowing from where it is cheaper to where it is more expensive.

Currently trading capacity (MW) in February 2016:

An example of the commercial interconnections flow is the France-Spain interconnection. As mentioned, the flow of electricity depends on the price difference between the neighbour and the peninsular pool (we will import if our pool is more expensive and we will export otherwise). In fact, we can see how to:

– In April 2014, with an average price of € 26.44 / MWh in Spain and an average price of € 33.73 / MWh in France, the balance of the interconnection was Exporter.

– In April 2015 an average price of € 45.37 / MWh in Spain and an average price de39.45 € / MWh in France was importing the balance.

On the production side, the relationship between price and the technologies used to generate the electricity are more complex. This complexity increased since the market liberalization, resulting in a more diverse energy mix. However configuration of producers offers continues to build on the opportunity cost: the avoiding cost when opting to produce (as the turn on cost of the plant) and the income not perceive because of producing (in the case of a thermal power plant would be the resale of its fuel to a third party). Meaning producer offer base not on variable costs but on the opportunity cost (alleged optimal use of available resources by the producer agent).

This approach to design offers leads to a high price volatility between meals. On day 11/02/2016 there was a variation of 55% between the lowest and the highest price:

This is because based on the opportunity cost philosophy in the context of a marginal system, technology entry order does not prioritize the cheapest it would be:

1- NUCLEAR	Despite the high fixed costs, they have a very low operational cost so their opportunity cost is almost zero. Usually they are a price taker (i.e. bid 0 € / MWh) to ensure they get in because of its lousy capacity to stop generation.
2- WIND, SOLAR RENEWABLE AND HYDRO FLOWING	They leverage in an inexhaustible natural sources which cannot be stored. They have low operating cost and help to lower the price of the pool (usually they are price taker). They also improve the distributed generation.
3- COGENERATION	They are associated to an industrial production process so their participation is more predictable. They have the disadvantages of fossil power plants. But they are more energy efficiency by taking advantage of the residual heat and by reducing energy losses in the network (better distributed generation).
4- COAL & COMBINED CYCLE	Burning plant of fossil resources (coal, gas and oil) which are expensive because they depend on the fossil price subjected to the international markets volatility.
5- ADJUSTABLE HYDRAULIC AND OTHER OBSOLETE CENTRAL	Plants with water reservoirs which have a high opportunity cost, because they can always reserve the water to produce in another time when price would be higher.

Besides, it must be added the existence of complex bids like conditions ramp between hours, minimum income or indivisible blocks offers, among others. These conditions are considered by OMIE and may cause the intersection of the curves to occur at a different point than originally planned (see first figure).

Based on this technologies entry order and the demanded behaviour it could be argued that:

– A lower demand for electricity would have a lower price because the market expelled the most expensive plants from participating.

– As the latest technologies to enter are the ones setting the price, generation by fossil fuels plants and large hydro plants are the ones which frequently having the last word.

– An increase in renewable production may involve a sharp drop in the electricity price in the daily market.

Here are the composition of the energy mix in the mainland system, where it is observed that there was a share of renewable nearly 43% and annual daily market price of € 42.23 / MWh compared to 2015 in 2014 with a share of almost 37% and an annual daily market price of € 50.52 / MWh. A Behaviour that reinforces the last hypothesis mentioned earlier.