STRUCTURAL VOLATILITY & AUSTRALIAN ELECTRICITY MARKET Ghazaleh Mohammadian Thesis submitted for the degree of Doctor of Philosophy (Mathematics) School of Computer Science, Engineering and Mathematics Faculty of Science and Engineering Flinders University December 2015 To my parents For unconditionally providing their love, support, guidance and encouragement. CONTENTS TABLE OF CONTENTS ............................................................................................................ I LIST OF FIGURES ................................................................................................................. IV LIST OF TABLES ................................................................................................................... VI SUMMARY ............................................................................................................................ VIII DECLARATION ....................................................................................................................... X ACKNOWLEDGEMENTS ...................................................................................................... XI 1 INTRODUCTION ................................................................................................................. 1 1.1 NATIONAL ELECTRICITY MARKET ................................................................................. 2 1.1.1 Main responsibilities of NEM ................................................................................ 4 1.2 ELECTRICITY GENERATION IN NEM ............................................................................. 4 1.2.1 Generation technologies in NEM ......................................................................... 6 1.2.2 Climate change policies ....................................................................................... 9 1.2.3 Ownership arrangement in electricity generation .............................................. 10 1.2.4 Regulation and deregulation .............................................................................. 11 1.3 REGULATORY ARRANGEMENTS ................................................................................. 13 1.3.1 National electricity law and rules ........................................................................ 13 1.3.2 Australian Energy Market Commission (AEMC) ................................................ 14 1.3.3 Australian Energy Regulator (AER) ................................................................... 14 1.3.4 Australian Competition and Consumer Commission (ACCC)............................ 14 1.3.5 National Electricity Market Management Company (NEMMCO) ....................... 14 1.3.6 Australian Energy Market Operator (AEMO) ..................................................... 14 i 1.4 ELECTRICITY NETWORK ............................................................................................ 15 1.4.2 Ancillary services ............................................................................................... 17 1.5 ELECTRICITY SUPPLY AND DEMAND IN NEM .............................................................. 18 1.5.1 Demand .............................................................................................................. 18 1.5.2 Submitting offers to supply ................................................................................. 21 1.5.3 Supply and demand balance ............................................................................. 21 1.6 SPOT MARKET ......................................................................................................... 24 1.6.1 Setting the spot price ......................................................................................... 26 1.6.2 Trends in the electricity spot price ..................................................................... 28 1.7 FINANCIAL RISK MANAGEMENT IN NEM ..................................................................... 29 1.8 THE RETAIL ELECTRICITY MARKET ............................................................................ 30 1.8.1 Retail price ......................................................................................................... 31 1.9 COMPETITION IN NEM .............................................................................................. 32 2 PRICE VOLATILITY AND MARKET POWER IN ELECTRICITY MARKET .................... 34 2.1 INDICES AND MODELS OF DETECTING MARKET POWER .............................................. 36 2.1.1 Structural indices ................................................................................................ 36 2.1.2 Behavioural Indices ............................................................................................ 40 2.1.3 Other indices ...................................................................................................... 42 2.2 PRICE VOLATILITY IN THE AUSTRALIAN ELECTRICITY MARKET ..................................... 43 2.2.1 Spot price volatility in South Australia ................................................................ 45 2.3 STRUCTURAL VOLATILITY .......................................................................................... 49 2.3 ALLEVIATING MARKET POWER.................................................................................... 50 3 STATISTICAL APPROACH ............................................................................................... 51 3.1 CORRELATION OF ELECTRICITY DEMAND AND PRICE .................................................. 52 3.2 STRATEGIC BIDDING STRUCTURE IN THE AUSTRALIAN ELECTRICITY MARKET .............. 54 3.3 DISTANCE MEASURES .............................................................................................. 56 3.4 CLUSTERING ANALYSIS ............................................................................................. 60 3.4.1 Ward’s minimum variance method ..................................................................... 63 3.5 BIMODAL BIDDING BEHAVIOUR BY GENERATORS ......................................................... 66 3.6 LOTTERY MODEL ...................................................................................................... 70 3.7 AUCTION & BID TO COVER RATIO ............................................................................... 76 3.8 RISK TO CONSUMERS ............................................................................................... 79 4 PARAMETRIC OPTIMISATION PROBLEMS AND MARKET POWER .......................... 83 4.1 DISPATCH PROBLEM IN GENERIC FORM ..................................................................... 84 4.2 SIMPLIFIED DISPATCH PROBLEM ............................................................................... 87 4.3 COMBINED MODEL .................................................................................................... 87 4.3.1 Three generators examples ............................................................................... 90 4.3.2 South Australian size examples ......................................................................... 93 4.4 DEPARTURES FROM BEHAVIOURAL ASSUMPTIONS ...................................................... 94 ii 4.4.1 Extreme antagonistic and altruistic scenarios .................................................... 95 4.4.2 Illustrative examples ........................................................................................... 97 4.4.3 South Australian size examples ......................................................................... 99 5 DISINCENTIVES TO STRATEGIC BIDDING ................................................................. 106 5.1 BACKGROUND ........................................................................................................ 107 5.2 AUMANN-SHAPLEY INSPIRED PRICING MECHANISM .................................................... 108 5.2.1 Average price based on (AP1): ........................................................................ 111 5.2.2 Average price based on (AP2). ........................................................................ 112 5.2.3 Average price based on observed distribution of demand............................... 115 5.3 EXTENSION TO MULTI-REGIONAL MEAN VALUE PRICING ............................................. 118 6 CONCLUSION AND FUTURE WORK ............................................................................ 120 APPENDIX ........................................................................................................................... 125 BIBLIOGRAPHY.................................................................................................................. 131 iii LIST OF FIGURES FIGURE 1.1. TRANSPORT OF ELECTRICITY ................................................................................... 2 FIGURE 1.2 ELECTRICITY CONSUMPTION BY SECTOR .................................................................... 3 FIGURE 1.3. LARGE GENERATORS IN NEM .................................................................................. 5 FIGURE 1.4. GENERATION BY FUEL TYPE IN NEM, 2010 ............................................................... 7 FIGURE 1.5. TOTAL MONTHLY SOUTH AUSTRALIAN WIND GENERATION. ......................................... 8 FIGURE 1.6. MARKET SHARES IN ELECTRICITY GENERATION CAPACITY BY REGION, 2013 ............. 11 FIGURE 1.7 INTERCONNECTORS IN NEM ................................................................................... 16 FIGURE 1.8. VICTORIA – SOUTH AUSTRALIA ELECTRICITY