Are Marginal Based Electricity Markets Coming to an End?

  ⁽¹⁾Senior Researcher, INESC TEC & Associate Professor, Faculty of Engineering of the University of Porto

Traditionally, power systems were organised in terms of vertically integrated companies, i.e., companies that provided all the services along the value chain of electricity: from generation to the relationship with end consumers. Since the 1980s and 1990s, power systems underwent a restructuring process in several countries and geographical areas, leading to their organisation according to generation, network transmission and distribution, and retailing activities. In Europe, electricity can be usually traded in day ahead markets typically operating in a marginal basis or by bilateral contracts. In addition, the governments of several European countries decided, early on, to adopt policies to boost the investment in renewable technologies, or to start using endogenous resources to increase the energy self-sufficiency. This was done, for instance, through the adoption of specific tariff regimes, as it was the case of the feed in tariffs still in use in Portugal to pay the Special Regime Generation (SRG).

Portugal and Spain integrate the Iberian Electricity Market (MIBEL) since 2007. The Iberian Market Operator receives, on day d-1 (the day before operation) buying and selling bids for each hour of day d. The generation bids are ordered by the ascending order of their price, leading to the aggregated selling curve. On the other hand, the buying bids communicated for each hour of day d are organised by the descending order of the bid price, leading to the aggregated buying curve. The intersection of these two curves determines the traded quantity, the accepted bids, and the market price. This price is interpreted as the marginal price of the Iberian system, admitting that the limit constraints of the interconnection lines are not active. It is still important to mention that these are uniform price auctions, that is, the price that each accepted buying bid will pay and that it will be paid to each accepted selling bid is not their bidding price, but in fact the system marginal price.

This uniform price rule has been discussed frequently because it means that any dispatched power unit is paid at the price of the last accepted bid, frequently coming from a thermal unit, even if its operation cost is reduced. Meanwhile, the SRG installed capacity increased along time and this evolution - together with the priority given to this generation - contributed to fuel this discussion. In fact, in mainland Portugal, SRG included, by 2021, 9 000 MW of (wind parks, solar PV units, small hydro and cogeneration, waste and biomass units) out of 19 200 MW installed capacity – with the Iberian Market Operator estimating the generation through said technologies on each hour of d day according to the aggregated selling curve, through zero price segments.. As a result, the presence of a large SRG generation at a certain hour of day d contributes to reduce the market price at said time the revenues of the Ordinary Regime Generation units.

For many years. this model was applied in the Iberian Market without major problems, namely because the market prices were much more reduced than they currently are. In fact, between 2007 and 2020, the average annual market price ranged from 69.68 €/MWh in 2008 to 33.99 €/MWh in 2020 (in this case, largely because of the demand reduction determined by the COVID 19 pandemic). However, since February 2021, the market prices are increasing; initially, because of the demand and natural gas price increases caused by the economic recovery at a global level, and then because of the increase of the CO2 licence prices in Europe. Since February 2022, the electricity market prices all through Europe escalated frequently to values above 200 €/MWh due to the increase of the natural gas prices.

Considering this evolution and the changes that are likely to occur in the Iberian generation systems until 2030, we will now explore some topics and try to address the question that we present in the title of this text:

• i. in the first place, and until the end of 2000, the organisation of MIBEL in terms of a marginal based day ahead market was not questioned, namely because the average market prices were relatively low;
• ii.in this period, the value of the feed in tariffs was larger than the average market price, which determined the payment of subsidies to the SRG that were internalised in the Tariff for the Global Use of the System, paid by end consumers. These subsidies were perceived as an incentive to new investments in these technologies, some of them not entirely mature;
• iii.since 2021, the average market price increased, and it is now higher than the feed in values paid to most of the SRG technologies; so, feed in generation contributes to reduce the final energy price paid by consumers;
• iv.in both cases, either before the end of 2020 or since the beginning of 2021, it is true that the price paid by end consumers for the active energy has a distant relation with the average market price;
• v.for instance, in 2019 - and taking as an example a Portuguese average low voltage end consumer -, the Energy Tariff was responsible for about 40% of the electricity bill before taxes and the Tariff for the Global Use of the System accounted for 25%. A closer look at this tariff indicated that most of this value was related with the subsidies assigned to SRG, i.e., they were in fact related to generation costs. This means that the amount used to remunerate generation almost corresponded to 2/3 of the total, while the market prices only determined in a direct way 40% of the total;
• vi.this increasingly distant relation tends to increase given the targets included in the National Energy and Climate Plan 2020 – 2030. According to this plan, the wind capacity is planned to increase from 5 400 to about 9 000 MW; the solar photovoltaic capacity from 1 400 to about 9 000 MW; and the hydro capacity from 7 200 to about 9 000 MW. This evolution will determine, for instance, that in periods with large wind and hydro generation or with large solar photovoltaic generation, the market prices will be reduced or even reach zero in many hours;
• vii.this means that the energy prices paid by end consumers will be increasingly decoupled from market prices, while the revenues obtained by the surviving thermal units (namely natural gas units) will decrease. These units, together with hydro stations, will certainly play a crucial role in the system in terms of providing reserve services and inertia. Under these conditions, an important part of the revenues of these units will be increasingly associated with the provision of ancillary services;
• viii.as a result, it will become increasingly difficult to explain to an end consumer the relevance of the day ahead market operating under a marginal basis, given that the final active energy price in €/kWh that is billed to him/her shows an increasingly indirect and decoupled relation with the market prices operating under a marginal basis.

Considering these comments, it seems clear that, by 2030, the electricity generated and effectively paid according to the day ahead market price will be increasingly reduced, since a larger amount of generation will be associated with other remuneration regimes. In addition, the annual number of hours with zero or close to zero market prices will tend to increase, so that the surviving Ordinary Regime Generation will have to get revenues by providing other services, namely reserves or signing contracts to provide inertia that will most likely be established in the coming years.

Therefore, having in mind this evolution and the difficulties and deficiencies associated to the current marginal based markets, we admit as very likely that the day ahead markets as we know them today will be eliminated and replaced by bilateral contracts - or even by marginal based intraday markets with a more reduced gate closure regarding the physical delivery, mainly used to trade small quantities of electricity or to adjust generation or demand pre-existent positions.