In the current electricity market reform in China, the electricity trading promoted by various provinces and regions mainly involves direct transactions between power generation enterprises, large users, and electricity sales companies, including bilateral negotiations and centralized bidding forms. There have been many discussions about whether the electricity market must establish a spot market and when to establish a spot market. Here we will introduce and analyze the relevant concepts, and share some of my views.

one

The goal of power system reform

Direct trading, bilateral negotiation, centralized bidding, and spot market are all methods for achieving electricity trading and are reform paths. To discuss the path of reform, the first thing to consider is the goals of the reform.

For the reform of the power system, restoring the commodity attributes of electricity and establishing a market-oriented trading mechanism are the specific paths of the reform, while optimizing the resource allocation of the power system and even the entire energy system, providing safe and reliable energy supply with minimal resource, environmental and other costs, is the ultimate goal. The design of all reform paths and plans should first consider the goals of the reform, and then combine them with the current situation and constraints of actual resources, environment, society, and other aspects.

The goals of resource allocation in the power system include two major aspects: efficiency and fairness, and efficiency goals include two aspects on a time scale: long-term efficiency and short-term efficiency.

1) Long term efficiency

Mainly manifested in the effectiveness of investment and planning in the power system. The electricity market mechanism needs to ensure sufficient, effective, and reasonable investment, and lead to optimization planning of power sources, grids, and loads to support the safe, stable, and economical operation of the power system. Firstly, the investment level should not be too low to affect the safety of the power system; Secondly, excessive investment should not increase the cost of the power system; Finally, the structure of the power supply and grid should be reasonable and matched.

2) Short term efficiency

Mainly manifested in the effectiveness of real-time economic operation (scheduling) of the power system. The electricity market mechanism needs to be able to derive the optimal real-time operation plan. During the operational phase, investment costs have become sunk costs, and decision-making mainly depends on variable costs and marginal costs. The market mechanism needs to be able to derive the maximum operational mode for overall social welfare. Simply put, it means letting the power plants with the lowest variable cost of electricity generation generate electricity first, and letting the users with the highest electricity efficiency consume electricity first. Due to the continuous fluctuations in the supply and demand of electricity over time, and the need to maintain real-time balance in the power system, the economic dispatch of the power system must be carried out on a relatively small time scale. In the early days, scheduling plans were generally formulated with a cycle of 1 hour or half an hour, and power imbalances during the scheduling period were resolved through auxiliary services such as frequency modulation; With the development of related technologies, the scheduling cycle has gradually shortened, and now many countries and regions formulate scheduling plans with a 5-minute cycle.

3) Fair Goal

The main consideration is the allocation of social welfare among different market entities. The fairness of the electricity market should consider the allocation of social welfare among different business entities such as power generation, power grid, and users, as well as among different geographical and administrative regions. The reform plan needs to consider the changes in welfare among different entities after the reform.

two

Spot market in the electricity market

In economics, the spot market generally refers to real-time or quasi real time transactions of "one hand payment, one hand delivery". In the electricity market, different literature, institutions, or scholars have different understandings or definitions of the spot market.

One method is to divide transactions over a certain period of time, calling them medium to long term transactions (or forward transactions), and calling transactions before or within a certain period of time spot transactions. China's Document No. 9 and related supporting documents are defined according to this. On the other hand, strictly according to the definition in economics, only the market closest to the operating time is the spot market, and the rest are forward markets. In the subsequent description of this article, for the sake of convenience and clarity of concept, the spot market refers to the latter meaning of the spot market, which is the electricity market closest to the operating time. The specific time can be the day before, two hours before, or hour before, and the manifestation can be the day before market, real-time market, balanced market, etc.

three

Medium and Long term Trading in the Electricity Market

Forward contract, futures, and options trading are all types of medium - to long-term trading, in which trading parties agree to trade a certain quantity of products at a certain price at a certain point in the future. The main difference between these types of transactions lies in whether they are standardized. Forward trading is a non standardized contract where both parties determine the trading location, quantity, and price. Futures and options are standardized contracts that must be traded on a futures exchange, with strict regulations on the quantity, price, delivery location, and credit management of market members. At present, direct trading and generation rights trading in China's electricity market are essentially forward trading, and relevant futures and options trading varieties have not yet been established. Most countries or regions that implement electricity markets abroad have established several futures and options markets, which can increase trading liquidity and reduce market risks.

four

Settlement of forward contracts

Electricity forward contract is a financial contract in which the seller and buyer of electricity agree in advance (five years, one year, one month, one week, or one day, etc.) to trade a certain amount of electricity at a certain price in a future market (day ahead market or real-time market). A common form or term for it is a price difference contract, in which the buyer and seller do not need to have actual electricity production or consumption needs, and can settle in the agreed market based on the difference between the market price and the contract price.

For example, power plant A and user L signed a transaction contract on November 20, 2016 for a real-time market of 220000 kWh of electricity at 2:00 pm on December 15, 2016, with a price of 0.4 yuan/kWh. On December 15, 2016, based on the real-time bidding results, the electricity price at 2 pm was 0.35 yuan. The settlement between power plant A and user B needs to be based on the "price difference" between the contracted electricity price of 0.4 yuan and the real-time electricity price of 0.35 yuan: 200000 * (0.4-0.35)=10000 yuan, which means user L needs to pay a price difference of 10000 yuan to power plant A. On the contrary, if the real-time electricity price at 2 pm on December 15, 2016 is 0.42 yuan, power plant A needs to pay the price difference of 200000 * (0.42-0.4)=4000 yuan to user L. Note that neither the buyer nor the seller who signs a price difference contract need to have actual power generation or consumption capabilities. If both parties to the transaction have physical electricity generation and consumption in the real-time market, settlement will be based on the actual electricity generation and real-time market prices. For example, on December 15, 2016 at 2 pm, the actual power generation of power plant A was 210000 kWh, and the actual electricity consumption of user L was 190000 kWh. If the real-time electricity price during this period was 0.45 yuan/kWh, power plant A could obtain a sales revenue of 94500 yuan in the real-time market, and user L would need to pay an electricity fee of 85500 yuan in the real-time market.

For the settlement of contracts for difference, it can be settled by both parties outside the real-time market through over-the-counter methods, or it can be submitted to the operating agency of the real-time market for settlement. At present, most regions and countries settle their transactions through market operating agencies in their markets.

It can be considered that the buying and selling of forward contracts is a spread, or price index, which refers to the difference between the contract price and the price of a predetermined market (day ahead market or real-time market). Power plants and users can avoid price risks through forward contracts, while traders can make profits through arbitrage.

five

Realizing the goals of the electricity market through different trading modes

As mentioned earlier, the goals of the electricity market include multiple aspects such as long-term efficiency, short-term efficiency, and fairness, which can be achieved through a combination of various transaction types to achieve these comprehensive goals.

1) Realize long-term market goals through capacity markets, government signed contracts for difference, and other means

In the long run, market design needs to consider multiple objectives, such as the adequacy of long-term capacity investment; The historical issue is that some investments approved by the government before the reform were able to recoup their costs; Possible bankruptcy issues of enterprises caused by reforms; The implementation of energy policies such as the development of renewable energy.

These goals can be achieved through mechanisms such as capacity markets and price difference contracts, which are characterized by being independent of the actual supply and demand of enterprises and not affecting the real-time operation of the power system.

For example, through the capacity market, power generation companies can obtain certain profits even if they do not generate electricity, thereby ensuring the adequacy of power investment. For example, using government led differential contracts to ensure certain returns for relevant market entities. In fact, many countries such as the UK and Canada achieve some of their government policy goals through price difference contracts or similar mechanisms. The base electricity consumption in Guangdong Province, China can also be achieved through the mechanism of price difference contracts.

2) Realize short-term optimal resource allocation through the spot market

In the spot market, all power generation companies and users adopt full electricity bidding and clear the market according to the principle of maximizing social welfare (when users do not quote, it is the minimum cost of power generation). In the context of sufficient competition and effective control of market power, power generation companies quote based on the short-term marginal cost of electricity generation, with lower cost power plants being given priority in winning the bid.

According to the Coase theorem, as long as the free trading of medium and long-term contracts is allowed and the transaction costs are low, the efficiency of the spot market will not be affected by the previously signed medium and long-term contracts. You can understand this conclusion with a simple example. The system has two power plants A and B, both with a capacity of 500MW. The variable cost of generating electricity per kilowatt hour is 0.2 yuan and 0.5 yuan, respectively. The load during a certain trading period (one hour) is 700MW. Below are the scheduling results under two scenarios.

Scenario 1: The government has signed base electricity contracts for 400MWh and 300MWh with power plants A and B respectively. Trading of power generation rights is not allowed. The actual power generation of A and B is 400MWh and 600MWh respectively, with a total power generation cost of 0.2 * 400000+0.5 * 300000=230000 yuan=230000 yuan.

Scenario 2: There is no base electricity contract. According to the principle of economic dispatch, A generates 500MWh of electricity, B generates 200MWh of electricity, and the total social power generation cost is 0.2 * 500000+0.5 * 200000=200000 yuan=200000 yuan. Compared to situation 1, the total cost of power generation has decreased by 30000 yuan, which means that social welfare has increased by 30000 yuan.

Scenario 3: The government has signed base electricity contracts for 400MWh and 300MWh with power plants A and B respectively. Allow trading of power generation rights. Due to the significantly lower power generation cost of A compared to B, A and B reached an agreement to transfer the 100MWh power generation rights of B power plant to A at a price of 0.15 yuan/kWh. This means that A can generate an additional 100MWh of electricity, but needs to provide B with a certain subsidy: 0.15 * 100000=15000 yuan. In this way, A will generate 500MWh of electricity and B will generate 200MWh, with a total social power generation cost of 200000 yuan, the same as Scenario B. But due to the base electricity contract, compared to scenario 2, A has an additional cost of 15000 yuan, while B has an additional revenue of 15000 yuan. But compared to situation 1, A increased its profit by 15000 yuan by generating 100 MWh more electricity, while B received a subsidy of 15000 yuan for generating 100 MWh less electricity. The total social welfare increased by 30000 yuan, mainly due to a reduction of 30000 yuan in power generation costs.

Scenario 4: The government has signed base electricity contracts for 400MWh and 300MWh with power plants A and B respectively. Trading of power generation rights is not allowed, but power plants are allowed to declare price increases or decreases in the spot market. Assuming that A declares that a price per kilowatt hour higher than 0.35 yuan can increase power generation by 100MWh, and a price lower than 0.1 yuan can reduce power generation by 250MWh; B declares that if the price per kilowatt hour is higher than 0.6 yuan, an additional 200MWh of electricity can be generated, and a subsidy of 0.35 yuan per kilowatt hour will be provided. They are willing to reduce their electricity generation by 150MWh. In the spot market, trading institutions clear up and down quotes, resulting in A increasing by 100MWh and B decreasing by 100MWh. The increased power generation of A is settled at 0.35 yuan per kilowatt hour, and the reduced power generation of B is subsidized at 0.15 yuan per kilowatt hour. Ultimately, the power generation cost in the market is the same as Scenario 2, at 200000 yuan. The profit levels of A and B are the same as Scenario 3.

From the above example, it can be seen that in the case where forward contracts (base electricity contracts) are allowed for trading (such as power generation rights trading in scenario 2 or spot market regulation trading in scenario 3) with low transaction costs, the existence of base electricity contracts does not affect social welfare and can still achieve optimal resource allocation. However, the existence of base electricity contracts affects the distribution of social welfare among different market entities (power plants A and B). But if the transaction cost is high (such as not adjusting the market upward or downward, and lacking an effective power generation rights trading mechanism), and the actual dispatch is based on the base electricity contract (Scenario 1), social welfare will be compromised.

six

Suggestions for the Design of Trading Models in China's Electricity Market

1) To achieve the goals of investment effectiveness, energy conservation and emission reduction in the power system through medium and long-term contract forms such as price difference contracts.

2) Establish an effective and convenient mechanism for the transfer and trading of medium - and long-term contracts, including government signed base electricity contracts, market negotiation contracts, and centralized bidding contracts.

3) The spot market conducts full electricity bidding, and the scheduling period in the spot market is half an hour or shorter.