POTENTIAL CONSEQUENCES OF CAPACITY

MECHANISMS ON THE PLANNED NORDLINK

CABLE

Berlin, October 23rd 2012

Arndt von Schemde,

Partner, THEMA Consulting Group

European integration in electricity

Markets Investments

3

Key questions

1. What are the effects of market integration?

2. What are the effects of new interconnections?

3. How could capacity markets have an impact of the

effects of market integration and on interconnections?

4

Key questions

1. What are the effects of market integration?

2. What are the effects of new interconnections?

3. How could capacity markets have an impact of the

effects of market integration and on interconnections?

5

Effects of market coupling (1) – efficient utilization

Flow vs. price on

German-Danish border

prior to market coupling

Flow vs. price with

market coupling

Wrong

direction

Capacity not

utilized

Wrong

direction

Capacity not

utilized

6

Effects of market coupling (2) – social welfare

• Model estimates

for North-West

Europe

• EU 27 results

obtained by

scaling up

results

• Value of market

integration likley

to increase with

increasing

shares of RES

105

164175

273

0

50

100

150

200

250

300

"Small mistakes" "Large mistakes"

€m

ill p

er

an

nu

m

North-West Europe EU 27

Low estimate High estimate

Source: THEMA Consulting Group

7

Effects of market coupling (3) – consumer benefits

• Clear benefits for

consumers,

driven by overall

lower prices (up

to € 1.6 bill p.a. if

scaled up for EU

27)

• TSOs lose cable

income: price

convergence

• Nordic countries:

water values

increase – similar

effect as cables

728

961

-552

-731

-71 -66

-1 000

-800

-600

-400

-200

0

200

400

600

800

1 000

1 200

"Small mistakes" "Large mistakes"

€m

ill p

er

an

nu

m

Consumer surplus Producer surplus Congestion rent

Low estimate High estimate

Distributional effects for Northwest Europe

Source: THEMA Consulting Group

8

Effects of market coupling (4) – non-quantifiable

Competition

• Capacity is optimized taking into account all bids and offers in all markets

participating in the market coupling, creating larger markets and more

competition – promoting price conversion across borders and regions.

Forward markets –

the need and the

ability to hedge

• Reduced need to hedge – larger markets absorb uncertainties/risks

• Improved ability to hedge – integration promotes more liquid forwards

Security of Supply

• More efficient utilization of the resources in the power system promotes security

of supply. This is becoming more important with the inclusion of more RES.

• Expected improvements in algorithm will further promote SoS

• More money to invest – improved ability (and reduced need) to hedge

• More efficient investments – better price signals / incentives

• Reduced need to invest – more efficient utilization of existing resources Investments

• Implicit auctions across regions promotes efficient optimization of a more

complex power system

• Efficient market coupling is thus key in promoting efficient inclusion of RES and

the in the transition towards a carbon neutral future

RES integration

9

Key questions

1. What are the effects of market integration?

2. What are the effects of new interconnections?

3. How could capacity markets have an impact of the

effects of market integration and on interconnections?

10

Expanding the geographical scope

11

Security of supply

Efficiency

Nature conservation

Integrating the markets Integrating the power system

Grid in Norway

Nordic interconnections

POLITICAL AMBITIONS

TRADITIONAL FOCUS

… EXTENDED AGENDA

FOR EUROPE

Climate change

Independence from

import of fossil fuels

Energy transition

Growing need for grid and

interconnections

Regional, interregional and

European market integration

and cooperatioon

National and regional market

development and cooperation

Value created by differences

12

Annual variations Peak/off-peak Intermittency

Value creation along several variables

13

Cable income Effects for consumers

and producers Other effects

Arbitrage via hourly price

differences

Flat prices in Norway, due

to hydro

Volatile prices Germany,

due to thermal capacities

and RES

Cables have price effect

Price decrease benefits

consumers, price increase

benefits producers

The sum of effects is

positive

Germany: likely lower

peak prices

Norway: In surplus

slightly higher prices,

in deficit lower prices

Same effects as market

integration

Competition

Security of supply

Climate and RES

integration

….

Effects of interconnections - congestion rent (CR)

To Germany

from Norway

To Norway

from Germany

Hour

Po

wer

pri

ce

(€/M

WH

) CR – from

NOR to GER

CR – from

GER to NOR

Price Germany

(historic)

Price Norway

(historic)

Historic prices (a typical Monday)

14

Price volatility

in Germany

Price differences between Germany and Norway

Low

Medium High

Very high

Effects of interconnections - congestion rent (CR)

2002

2003

2004

2005

2006

2007

2008

2009

2010

4

Scenarios:

1. Nordic power balance - low value of flexibility

2. Nordic power balance – high value of flexibility

3. Nordic surplus – low value of flexibility

4. Nordic surplus – high value of flexibility

2 3

1

15

Key questions

1. What are the effects of market integration?

2. What are the effects of new interconnections?

3. How could capacity markets have an impact of the

effects of market integration and on interconnections?

16

Do we need capacity mechanisms?

Market coupling

Integration of

intraday market

Integration of

balancing markets

NordLink

Internal German

connections

Flow based

market coupling

Other European

grid investments

More demand flex

Market integration

and development

Grid and

interconnections

Is this enough, or do

we need capacity

markets?

Make sure capacity

mechanisms act

neutral w.r.t. other

measures and

incentives

• Capacity markets

should resolve a

form of market

failure

• Make sure capacity

markets do not

create new market

failures

17

Will a capacity market distort the effects of integration?

Reduce value by

“cutting the price

peaks”?

The energy transition need

interconnections and more

flexible demand/generation

…but capacity markets may

reduce their income,

including the income of

NordLink

Reduced

competition by

blocking market

access

• Flexibility is traded outside

the regular markets

• Limited (or no) access for

Norwegian generators

• Reduced incentives to

develop competitive flexible

sources in Norway and to

build interconnections to

Germany

• Costs to German

consumers

• Income to German

generators

• Lost opportunities to

Norwegian generators

?

18

Price volatility

in Germany

Price differences between Germany and Norway 0

Local capacity markets could impact revenues

2002

2003

2004

2005

2006

2007

2008

2009

2010

4

Scenarios:

1. Nordic power balance - low value of flexibility

2. Nordic power balance – high value of flexibility

3. Nordic surplus – low value of flexibility

4. Nordic surplus – high value of flexibility

2 3

1

19

Low

Medium High

Very high

Capacity mechanisms should not be local solutions

Not taking account of

X-border capacities

would increase cost of

solution

• Short-term: Higher

costs associated

with utilization of

existing resources

• Long-term: Higher

costs in addition

due to different

investments

Local solutions Cross-border solutions

High cost

Low cost

Short-term Long-term

Ideal

Cap.mrkt.

20