Market Coupling and Price Coordination between Power

Exchanges

Marek ADAMEC, Michaela INDRAKOVA, Pavel PAVLATKA

Dept. of Economics, Management and Humanities, Czech Technical University, Zikova 4, 166

27, Praha, Czech Republic

Marek_adamec@seznam.cz, mindrakova@post.cz, ppavlatka@centrum.cz

Abstract:

Market coupling is a frequently used method for integrating electricity markets in

different areas. Cross-border transmission capacity between the various areas is not

explicitly auctioned, but it is implicitly made available for the energy deals on all power

exchanges, which are on the same side of the border. Traders on power exchange therefore

benefit automatically from cross-border exchanges without the need to explicitly acquire the

corresponding transmission capacity. The main idea of market coupling mechanism is to

maximize the total economic surplus of market participants and increase social welfare. It is

obvious that sufficient transmission capacity between networks will enable to equalize or

decrease spread across the different countries. The main idea is to maximize total economic

surplus of all participants, while cheaper generated electricity in one country meets demand

and reduces price in another country. Implicit auctioning offers certain advantages that

promote the development and smooth operation of the market. Market participants are not

required to buy transport capacity without information about its market value. This enables to

reduce risk exposure significantly and makes it much easier for trading participants to benefit

from access to cross-border grid. The market value of the transmission right is equal to the

price difference between the areas. Therefore the income of TSO is arising only when

constraints of transmission exist. Market coupling thus represents a major step towards a

more integrated European market. From our point of view market coupling optimizes the

clearing and settlement of the electric energy orders, which are traded in day-ahead auctions.

All orders from different locations are exchanged to the extent that network capacities allow.

Coordination is necessary for coupled exchanges to support location incentives for network

development, consumption and generation. The revenue redistribution among market

participants of power exchange and TSO is also discussed in the paper.

Keywords: Cross border trading, implicit auction, market coupling, day ahead auction

1. Benefits of Market Coupling Mechanism

Market coupling is one of possible methods for integrating electricity markets in

different areas. In Europe, market coupling stands for a further integration of electricity

trading across country borders. The main idea of this method is the improvement of the

effective utilisation of daily cross border capacities between different areas. With market

coupling the daily cross-border transmission capacity between the various areas is not

explicitly auctioned among the particular market parties, but is implicitly made available

through energy transactions on the power exchanges (PEXs) on either side of the border. This

leads to availability of power exchanges to optimize the clearing of their day-ahead auctions.

The optimal solution can be settled at different prices due to verticals in the aggregated order

curves. Therefore we have to place emphasis on price coordination, which is really important

to give correct locational signals for network developement and correct signals for generation

and consumption.The physical flow on an interconnector is based on market data from the

marketplaces in the connected markets. On the other hand, explicit auction is when the

transmission capacity on interconnector is auctioned separately and independent from the

markets where electricity is finaly auctioned. Explicit auction is considered as a very simple

method of dealing with capacity, but it is not sufficiently effective due to current trends.

Market coupling concept thus leads to the state, where the buyers and sellers on PEX benefit

automatically from all cross-border exchanges without the need to explicitly allocate relevant

transmission capacity. The main goal of this method is to maximize the total economic

surplus of all market participants. The main benefits could be gained by matching bids at

lower price in one country, which meet demand at higher price in another country and the

result is a reduction of prices in another country. Sufficient transmission capacity then enables

to equalize prices across adjacent countries. The concept of market coupling is designed to be

operated in a manner that requires minimal changes to market rules of power exchanges.

2. Available transfer capacitites on interconnectors

Market coupling mechanism is working with the concept of available transfer

capacity, which is very important and necessary for effective trading. In order

to correctly calculate the particular available transfer capacity of particular

crossborder interconnector and the total capacity which is their combination,

the Association of European Transmission System Operators (ETSO)

developed methodology for the needs of Czech power system for the

profiles.Czech power system is specificated by five directions of

interconnection. The formula for calculation of available transfer on profiles

is:

ATCp = NTCp – NTFp = TTCp – TRMp – NTFcp – ( kpi * ci )

Where:

ATCp – available transfer capacity on p-th profile.

TTCp – basic transfer capacity of profile is calculated from capacities

of transfer points in profile and it considers their irregular load and N-

1 criteria.

TRMp – reserve on p-th profile including emergency standby,

blackout of the largest block in each system and a mistake in

regulation of net interchange.

NTCp – it is so called net transfer capacity of p-th profile.

NTFp – typical total physical flow through p-th profile including loop

flow and ratio of all existent trades.

NTFcp – residual flow through profile after subtracting the ratio of

known contracted trades typical for the given period and profile

kpi – coefficient of trade ratio on i- th direction on p- th profile

ci – already included trades from i- th direction

For making values valid for all profiles public in desired lead time it is

necessary to calculate so called tradable capacities which at the same time use

available transfer capacities on all profiles until the first of them is

completely used up. Then this equation applies:

ATCj - (kji * cci) = 0

where

index j – identification of profile at which the available transfer

capacity was first used up; j {p}

kji – coefficient of trade ratio on i-th direction on profile j

cci - available trade capacity in i-th direction

3. Market coupling concept

Market coupling concept is very simple and relies on the obvious principle that the market

with the lower price exports electricity to the market with the higher price. That is of course a

well known principle in economics. There are two cases which may appear: either the

available transfer capacity (ATC) is large enough and the prices and both markets are

equalized (price convergence as we can see on fig. 1) or the available transfer capacity ATC is

too small and the prices cannot be fully equalized (more frequent case, as we can see in fig.

2). Following practical examples show these two cases. First condition is that the price of

market A is lower than the price of market B. Market A will therefore export electricity to

market B. This leads to the fact that the price of market A will increase whereas the price of

market B will decrease. If the available transfer capacity ATC from market A to market B is

sufficiently large, price convergence in the two markets may be reached, so that no market

tends to export or import to the other anymore. In second case the available transfer capacity

isn’t sufficiently large and therefore we can see here price divergence.

Fig. 1: Market coupling without congestion leads to price convergence. (Powernext)

Fig.2: Market coupling with congestion leads to price difference. (Powernext)

Principle of coupling markets involves agregating their respective supply and purchase

curves jointly according to the overall merit order. This method is based on matching the

highest purchase bids and lowest sales bids, regardless of where they have been introduced.

And this method also takes into account the available transfer capacities (ATC), which are

determined by the ETSO methodics. Maximum surplus can be achieved by considering that

one exchange will export to another for as long as the marginal offered price in one is lower

than the marginal bid price in the other one, until moment of prices convergence or available

transfer capacity is exhausted. The marginal offer price for exports from one exchange to

another is represented by a Net Export Curve (NEC). This is derived from the bids and offers

by market participants in the exchange's market. There are two concepts of market coupling

Price based coupling (close coupling)

In price based coupling the power exchanges leave the price calculations to the market

coupling system. The prices derived from the combined price and physical power flow

calculations are used as settlement price on the local power exchanges. The market area prices

and the volume traded are done by one common office.

Volume based coupling (loose coupling)

In volume coupling only the power flow from the coupling mechanism is used as input in

the local price calculations. The flow is then entered on the local PEX as price independent an

(on?) order, which depends on direction of flow. The extent of price discrepancies, which may

occur due to differences in the PEX price algorithm from market coupling algorithm, will

depend on to what degree the coupling algorithm takes local differences into account in the

flow calculation.

4. Net Export Curve (NEC) concept

For each time period, the power exchange can represent its received bids and offers as

agreggated bid and offer curves. An export can be considered as a market bid, moving the

overall bid curve across by the export volume. The market clearing price will then obviously

increase. The relationship between the export volume and market clearing price defines the

NEC. Imports are in this respect considered as negative exports. Next figure shows the

principle diagram of net export curve concept.

Fig. 3: Concept of net export curve (Powernext)

In a two-market scenario (for example Czech and Slovak market coupling), the export from

one market equals the import of the other one. In this respect there can be distinguished two

situations, congested and uncongested situation, which we can see in the next figure 3. First

situation allows market coupling concept to equalize prices of market 1 and market 2 and

therefore we can see price convergence. Second case shows us the case of congested situation

which leads to price difference between these two markets.

Fig.3: Congested and not congested situation of market coupling concept vs. ATC (Powernext)

5. Market coupling optimization problem

This problem involves interaction of supply and demand curves of different power

exchanges, which are matched in order to maximize the total gains from electricity trading.

Optimization of exchanges is solved for every hour of the next day (day–ahead trading

platform). This case is similar to single exchange optimization problem, where the cheapest

supply orders are matched with the highest price demand orders. The only difference in

market coupling is that curves are aggregated from different exchanges and the result of

optimization depends on the limited available network capacity. Topology and capacities of

the network need to be taken into account in every moment of solving this optimization

problem. The goal is to determine which orders will be accepted at particular hourly price at

exchange. The capacities of the network and topology are determined by TSO. Consider three

exchanges PX1, PX 2 and PX3. The submitted orders are listed in table 1.

Tab. 1: Example of three power exchanges

PEX PX1 PX2 PX3

BIDs (Demand Orders)

Price €/MWh 60 60 60

Volume MWh 200 100 200

OFFERs (Supply Orders)

Price €/MWh 45 25 35

Volume MWh 100 300 300

Cleared volume MWh 100 100 200

Cleared price €/MWh 60 25 35

Fig. 4: Demand and supply curves of PEXs separately

Fig.5: Aggregated order curve of PXEs jointly

We can consider following example as we can see in figure 4 and figure 5. If the

exchanges are not coupled, they would have cleared a volume of 100, 100 and 200 MWh at

price of 60, 25 and 35 €/MWh. Total gain from this separated (not coupled) exchanges is

equal to 200MWh x (60 – 35) + 100 MWh x (60 – 25) + 200 MWh x (60 – 60), which is

8,500 €. In other case, where there are no network constraints and exchanges are coupled, the

profit and cleared volume are higher. The cleared volume is in case of coupled exchanges 500

MWh at price 35 €/MWh. The traded volume has increased by 100MWh and the total gain

from traiding has moved to 15,500 € (300 MWh x (60 – 25) + 200 MWh x (60 – 35)). The

increase of gain is caused by replacement of more expensive supply offer introduced at PX1

with cheaper supply offer introduced at power exchange PX2. The difference is thus 7,000 €.

As we can see in previous calculations, equation for maximizing profit from trading is:

ssese

ddede

eq

pqpqMAX ,

Where pde is the price limit of demand order d introduced to exchange e, pse is the

price limit of supply order s introduced to exchange e. Accepted volume of orders are

represented by variables qde and qse. These volume variables are limited due to load flow

network constraints, which make sure that the physical flow is not higher than the available

capacity of transmission lines between different locations. These technical limits of capacities

are determined by real physical capacity of interconnector, its susceptance and also the

voltage angle. The optimal solution of market coupling optimization algorithm is to settle

locational marginal prices (LMP). This locational marginal price corresponds to the shadow

price of its market clearing constraint. Locational marginal prices give efficient locational

signals for network development and support effectiveness of the market. The properties of

LMPs can be derived from the optimality conditions of the market coupling optimization

problem. The shadow price is zero if constraint is non-binding, which is the case when the

interconnector is not fully used.

Fig.6: Net export curves (NECs) of power exchanges

The optimal solution of market coupling is following: we transfer 200MWh from PX2

to PX1. Figure 6 illustrates the possible locational prices and their corresponding export level.

The situation at power exchange PX 3 can be described like this: demand doesn’t want to

purchase electricity for the price higher than 60€/MWh, while supply side wants to supply

fully at such a high price. The corresponding export level for prices higher than 60€/MWh is

300 MWh. No supplier is offering below 35 €/MWh, while demand would be satisfied fully at

such low prices so corresponding import level is 200 MWh. Between 35€/MWh and

60€/MWh demand and supply want to be fully satisfied, so corresponding export for prices

between 35 and 60 €/MWh is 100 MWh. The export from PX3 corresponds to more possible

locational prices at power exchange. The principle of maximizing value of trades among

different exchanges is similar to the behavior of profit-maximizing firms in perfectly

competitive markets. The objective function is therefore formed by maximizing the value of

demand minus the cost of supply in every moment at particular exchange.

6. Importance of price coordination

The best way to coordinate prices is to use the shadow prices of the clearing

constraint. This is represented by local marginal prices LMPs. The value of congested

interconnector is always positive. The final value of a congested interconnector (€/MWh) is

equal to the amount of congestion rents (€) divided by the physical flow in MWh. These

congested rents are the result of different prices between two power exchanges. The question

is which interconnector has to be further expand expanded rather than only the question which

interconnector just only maintains. It is really important how the price ranges are significant

and how often power exchanges face to them. Based od Belpex study, in 80% of hours the

price range is smaller than 20€/MWh.

Belpex experience – Trilateral Market Coupling

This inventive market mechanism linking the Belgian, Dutch and French electricity

markets was launched on 21th November 2006 by Dutch (APX), Belgian (Belpex) and French

(Powernext) power exchanges and TSOs ( TenneT, Elia and RTE). The price coupling

mechanism has been jointly operated with constant success, enabling a coordinated and

efficient day-ahead power price formation on all three markets. Each electricity market

benefits from reduction of short-term price volatility. Prices on APX, Powernext and Belpex

were identical in 65% of the time on an average basis of the 2 first years of coupling. These

results are improving and the convergence of prices is getting stronger. As we can see in

figure 8, price convergence of Belpex prices are relatively high, the highest price convergence

is in January.

Fig.8: Evolution on price convergence – Month baseload (2008), www.belpex.be

7. Conclusion

Compared to the daily explicit auctioning of transmission capacities, market coupling

offers certain advantages that help to the development of the electricity market. Market

participants are then able to trade in one step instead of two steps in explicit auctioning and

this obviously particulary reduces market risk of electricity trading across borders. This

method also supports integration of the European electricity short-term market. The main

condition for this convergence is no transmission constraints. The congestion income exists

only in case when real constraints of transmission capacities exist. Transmission capacity is

automatically used to the maximum extent possible. Market coupling leads to optimization of

clearing orders submitted to their day-ahead auctions at exchanges. Orders at different

exchanges are trade across the borders to the extent that available network capacity allow.

Due to verticals in the aggregated order curves prices they can be settled as a price range.

Coordination among coupled exchanges is necessary in order not to distort the locational

economic incentives for network development and right economic signals for generation and

consumption.

References

[1]ETSO Europeam Transmission System Operator

[2]Training documents of the Department of Economics, Management and Humanities, under

FEE CTU in Prague

[3]L.MEEUS, L.VANDEZANDE, S. COLE, R.BELMANS. Market coupling and the

importance of price coordination between power exchanges, 2008

[4]Belpex, The Belgian Power Exchange, www.belpex.be

[5]M.ADAMEC, M. INDRAKOVA, P. PAVLATKA. Flow-based Allocation, 2008

About Author

Pavel PAVLATKA was born in Ceske Budejovice in 1982. He was awarded a master´s

degree in February 2008. He is currently a doctoral student at the Department of Economics,

Management and Humanities, FEE, CTU in Prague