18

CHAPTER 2

RESTRUCTURED POWER MARKET

2.1 INTRODUCTION

Restructuring of the electricity supply industries is a very complex

exercise based on national energy strategies and policies, macroeconomic
developments and national conditions, and its application varies from country
to country. It is important to point out that there is no single solution
applicable to all countries and there is a broad range of diverse trends

Liberalization, deregulation (or reregulation) and privatization are all

processes under the general label of market reform. Liberalization refers to
the introduction of a less restrictive regulatory framework for companies
within a power sector. This could imply deregulation, which is the
modification of existing regulation. It can be argued that reregulation is a
more accurate term than deregulation. Since new law are being imposed on
the industry with regulatory watchdogs appointed to protect consumer
interests. Ideally, then, a true liberalized energy market would work within a
set regulatory framework, overseen by a regulator and with no external
political influence upon the participants regarding plant size or fuel choice.

Privatization is the sale of government assets to the private sector, by

itself, privatization is not sufficient to introduce competition into a reformed
sector. Competition will be the result of careful regulation of the privatized
entities allows new entrants access to the market. Competition is fundamental
to most of the market reforms and it is introduced in order to reduce costs and
increase efficiency. There is considerable variation in the extent of the
 19

competition which is introduced, for example competition could be

introduced just for the addition of new generating capacity and referred to as
competitive bidding where the existing generating company invites
contractors to tender to build, operate and sell electric power to the monopoly
at a specified price. Alternatively all licensed generators could be allowed to
compete the supply wholesalers or retailers throughout a short term market
(spot market) or via longer term contracts; this is called competitive
generation. The next level is wholesale competition, i.e, competition in the
sale of electricity to wholesale companies for resale to a retail level or directly
to final customers. This is usually allows the larger consumers to choose their
own suppliers. Competition at final consumer level, including household
consumers, is called retail competition. This is usually very last step of the
reforms as it requires a complex information technology system because of
the large number of small users involved. Retail competition is usually
introduced gradually starting with the larger industrial consumers, then the
medium consumers and finally including smaller consumers

Many electricity markets around the world are currently in transition

towards more deregulated and competitive markets. The charges were
initiated by

 A realization that generation and distribution functions need not be

monopolies
 A feeling that public service obligation are no longer necessary
 The cost reduction potential of competition
 Increased fuel level availability and fuel supplies stability
 The development of new technologies in power generation and
information technology
 20

2.2 REFORM MOTIVATION FOR POWER SYSTEM

Having looked into the traditional central utility structure, it is not

difficult to envisage that the high prices of electricity due to monopolies could
drive some societies to resort to reform. For instance, some governments
favour privatization because they wish to increase the net state revenue
through asset sales and divestiture of physically draining state enterprises.

The UK pioneered privatization and has been introducing full

competition in its energy market. This is based on the belief that the regulated
utilities know better how to make efficiency improvements when they are
given the incentive to make them. The other motives of privatization included
the reduction of central government’s role in economic decision making,
forcing privatized companies to become more accountable to owners and
encouraging the criterion of a share holder society through widespread stock
ownership.

The rise of independent power producers has resulted in the

exploitation of different resources as the fuel of power generation in small
plants. Studies done by an independent consultant company specializing in
services regarding renewable energy reveal that there have been significant
improvements in cost efficiency in the electricity produced by wind power.
Nevertheless, wind energy is already competitive today, provided that bit can
be implemented without adding backup capacity from traditional generating
technology.

2.3 SEPARATION OF OWNERSHIP AND OPERATION

One of the main issues concerning electricity reform is the unbundling

of electricity assets. Competition starts with the selling of all the
government’s generators to several private companies. Natural monopoly
 21

refers to a situation where one firm can produce a given level of output at a
lower total cost than can any combination of multiple firms. Economies of
scale exist where the industry exhibits decreasing average long-run cost with
size. According to economic theory, a public monopoly governed by
regulation is justified when an industry exhibits natural monopoly
characteristics.

The idea of separation of ownership and operation applies to the

transmission sector. This central body, often called the system operator, is
responsible for matching demand with supply. This ensures that the system is
utilized in the most efficient way.

2.4 COMPETITION IN THE ENERGY MARKET

Competition is the main goal of energy privatization. Ideally, from an

economist’s point of view, perfect competition is the most desirable market
structure. It is classified according to these criteria: independence, product
substitutability and energy criterion. The performance of a market is
measured by its social welfare. Social welfare is a combination of the cost of
the energy and the benefit of the energy to society as measured by the
society’s willingness-to-pay for it. Maximum social welfare is achieved in a
perfect market.

Wholesale competition has been introduced in most deregulated

markets. Retail competition is being introduced and already some residential
consumers are able to select their own supplier. This competition has been
complicated by the issue of direct access and the necessity for sophisticated
information technology. In some countries, solid regulations are yet to be set
up for wheeling.
 22

In some countries, e.g. the UK, the issue of energy subsidies and the
deposition of stranded costs have also complicated efforts on energy
privatization. One form of energy subsidies refers to those given to generators
to purchase highly priced coal in order to sustain the local coal industry.
Stranded costs are related to the capital investor in the installation of a plant
before deregulation. Generators built at that time were supposed to produce
electricity at a higher price than the market price set by a competitive market
to cover, in the long term, the cost spent on installation. Because of
privatization, the huge investment has become less worthy and investors
could end up the bankrupt. Therefore, electricity reform often involves the
determination of the degree of recovery of stranded costs. In some markets,
e.g. the Californian Pools, the stranded costs are compensated by embedding
on additional charges in the electricity bill.

2.5 AUCTION MECHANISM AND DIFFERENT TYPES

The success of competition is partially determined by the auction

mechanism employed in the market. This section briefly describes different
potential auctions for the energy market.

2.5.1 Sealed –Bid Uniformed Price Auction

In the uniform price auction, sellers submitted a price and the

maximum number of units they would be willing to sell at that price.
Submitted offers are ranked lowest to highest, and the lowest price units are
purchased to the point where supply equals demand. The uniform price paid
for purchase units is either the price or last accepted offer (LAO) or the price
of the first rejected offer (FRO); in either case, the price is called the reigning
price. The UK pool is an example of an non discriminatory auction that
handles the cost of transmission constraints by an ‘uplift charge’ and uses a
uniform price for settlement purpose. It has also been shown that participant
 23

can exploit opportunities for market power in load pockets. A load pocket or a
load centre refers to a geographical area the large amount of power is drawn
by end users. Indeed, the two largest generators in the UK have used their
market power successfully to rises price this way. In general, market power
will make prices more volatile when a uniform price auctions is used.

2.5.2 Discriminatory Auction

A discriminatory auction, in which participants received their actual

offers, is shown by evidence from economic theory and experimental
economics not to be provide incentives to reveal true costs. Despite that, it is
argued that the discriminatory price auction is better form of auction for
electricity markets since the price volatility associated with errors in
forecasting the load will be smaller than using uniform price auction even
when there is no appreciable market power.

2.5.3 English Auction

In English auction, each seller initially submits an offer indicating the

maximum numbers of units they are willing to make available from each
generating facility. The auctioneer begins the auction by starting a ‘clock’
which sweeps down from the reservation price. The supplies withdraw
facilities whenever they wish and the clock stopped supply falls to, or below,
the quantity demanded. If supply equal demand, the price is paid as a uniform
price to all remaining sellers.

However, the English auction has a problem when implemented in the

electric power frame work: it is the need for the costs of all participants to be
known by the system operator. The English auction fails to reveal the entire
supply curve for suppliers who remain in the market, which is necessary
 24

computing the least cost dispatch. Also, real-time natural of the auction also
imposes relatively high transaction cost compared with a sealed-bid auction.

2.5.4 Bilateral Models

Bilateral models promote free market competition and therefore are a

good way to achieve competition in an electricity market. In this model ,
suppliers and consumers independently arrange trades, setting by themselves
the amount of generation and consumption and the corresponding financial
terms, with no involvement of interference by the system operator, e.g. Nord
Pool. However, the unique characteristic of electric power networks makes it
difficult to utilize the model. Problems are caused by the lack of coordination
among the independent trades, leading to the violation transmission networks
constraints such as congestion and transmission system losses. These
objectives can range from a least cost formulation to one that results in the
minimum possible adjustment of two schedules.

2.5.5 Multilateral Trades

A multilateral trade is generalization of a bilateral trade this is

operating paradigm allows suppliers and consumers primarily to seek profit
on their own while independent system operator ensures security. This model
has minimal role for system operator who has no data on costs or financial
arrangements. The duties include verifying feasibility of trades 24 hours
ahead, dispatching and monitoring trades in real time and eliminating
imbalances and charging commitment violation. Trades are arranged by
brokers a broker can be a generator or a consumer involved in the trade, but
can also be an unrelated third party.

The drawback of this paradigm is that the congestion charge is

shouldered by all participants and therefore it does not give any signals for
 25

locating or installing new transmission facilities. The concern of fairness

arises about how curtailment of trades is done initially. Furthermore, in
reality, power system networks are complex, it will be difficult for
participants to find the best trade and therefore it is unlikely that the optimal
operating point will be achieved within a reasonable period.

2.6 ADVANTAGES OF DEREGULATION

Cost Savings: At any given moment, power is supplied to the

transmission grid by the firm with the lowest marginal cost. Dispatch
according to merit saves resources and reduces the cost of generating
electricity. Because the different plant may have different load
characteristics, peak and load duration curves, generating capacity can be
fully utilized and additional capital resources saved.

Generator’s Flexibility: Spot market increases the generator’s

flexibility in scheduling production. The presence of a spot market means
that less idle capacity must be maintained in order to provide a given level of
service reliability. Shortfalls and emergencies can be met by purchasing
power on the spot market. Demand and supply are equilibrated by flexible
spot prices.

Consumer Services: The markets will provider an array of service

standards that more closely match consumer preferences. Consumers could
be offered priority service with a schedule of electricity rates increasing with
the level of reliability. Priority service offers significant efficiency gains over
random rationing with the fixed electricity rates. A competitive market in
electricity generation would offer a much broader array of services than do
state monopolies or regulated generators. It is not surprising that 70% of
USA private utilities, facing new competitive pressure at the generation stage,
now offer some form of voluntary interruptible service.
 26

Innovation: Competition not only leads firms to be more responsive to

consumer demands, monitor costs more closely, and compete on the basis of
price but also provides an incentive to be innovative. Developing a new
consumer service a better method of reducing costs, or a faster way of dealing
with problems promises the innovator a competitive edge.

2.7 UNBUNDLING OF ELECTRIC UTILITY

Electricity Supply Industry (ESI), throughout the world, is undergoing

restructuring for better utilization of the resources and for providing quality
service and choice to the consumer at competitive prices. The privatization
and deregulation of electricity markets has a very large impact on almost all
the power systems around the world. Restructuring of power system has
become more attractive as supplies tighten, prices climb and markets seek
way to mature. This aims at balancing the simplifying assumptions required
for creating a liquid market with the reality of power system operation This
balancing phenomenon termed ‘deregulation’ resulted in risk less and
efficient power system operation. The deregulation of electricity utility
industry insisted and initiated the unbundling of the three sectors viz
generation, transmission and distribution. Hence, a completely unbundled
electric power market will consist of Generation Companies (GENCOS),
Distribution Companies (DISCOS), Transmission Companies (TRANSCOS),
Energy Brokers as well as Independent System Operator (ISO).

In a competitive environment, all GENCOS and DISCOS will have

equal right to access the transmission network. GENCOS will compete in a
free market to sell electricity and DISCOS will attempt to choose the cheapest
sellers. The TRANSCOS will ensure the availability of the transmission
system to all the entities in the system. The Independent System Operator
(ISO) is a regulating entity independent from the electric companies and
 27

optimizes the overall system operation. The task of ISO is to ensure full
dispatch of the contracted power. Much of the complexity arises from the
limitations of the transmission systems and the fact that supply and demand
must be in balance at all times.

Many electricity markets around the world are currently in transition

towards more deregulated and competitive power markets. The changes were
initiated by a realization that generation and distribution functions need not be
Monopolies and competition in generation services has the potential of
reducing the cost. Hence, restructuring has been designed to faster
competition and ensure the optimal dispatch of power in a more secured
manner.

In India, till 1990, the power sector was evolved as a public monopoly.
The power sector was governed by the Indian Electricity Act 1910 and the
Electricity Supply Act 1948. In India, a limited level of competition, since
1991, has already been introduced at generation level by allowing
participation of Independent Power Producers (IPPs). In view of the
increasing requirements and the shortage of resources inhibiting public sector
power distribution, the government has decided to encourage greater private
sector participate provided the private sector brought in additional flow of
resources. The government has also encouraged the participation of foreign
investment and foreign private company investment in this sector and
liberalizing the provisions of export-import policy for inviting flow, of
foreign exchange towards boosting the field of power generation.

Notwithstanding the variations discussed above the experiences of

restructuring have reached similar patterns in certain respects:

 The generation subsystem has a high degree of freedom in the selection

of energy sources, ranging from capital-intensive low-operation cost
 28

resources to others with low capital and high operation costs. Hence,
significant economies of scale or natural monopoly features, except in
the case of large scale hydro-electric potential, are not an impediment
to competition in generation.

 There are no clear economies of scale, but there is a geographic

monopoly, in the distribution subsystem, and therefore some form of
regulation is needed. The distribution business has, however, been
further unbundled into a wires business, which maintains the
distribution network and provides facilities for electricity delivery.

 A retail or supply business, which provides electric energy to end

consumers.

 The transmission subsystem is a natural monopoly in the economic, the

geographic and the technical (control) sense, and therefore must
continue to function as an integrated and regulated entity. However, to
implement competition in the generation and retail sides, it is necessary
to unbundle these two from the transmission system and ensure that the
latter offers open access on an equitable basis to all power suppliers
and consumers. The transmission system thus becomes the focus of
attention in organizing competition and must act as a ‘level playing
field’, and the rules for managing access by all participants must be
transparent and non-discriminatory.

2.8 COMPONENTS OF RESTRUCTURED POWER SYSTEMS

The structural components representing various segments of the

electricity market are generation companies (Gencos), distribution companies
(Discos), scheduling coordinators (SCs), transmission owners (TOs), an
independent system operator (ISO), and a power exchange (PX). Depending
 29

on the structure and the regulatory framework, some of these components

may be consolidated together, or may be further unbundled. In Asian
countries various regional, state, provincial or independent generators coexist.
In these cases the financial and technical interrelationships are murky and are
in a process of rapid evolution. Figure 2.1 shows the unbundling of electrical
utility

1
G1 G2 G1 G2

Unbundled
2

L1 L2 L3 L1 L2 L3
@
2 3

1. Generation 2. Transmission 3. Distribution

Figure 2.1 Unbundling of electric utility

2.8.1 Gencos

Gencos are responsible for operating and maintaining generating plant

in the generation sector and in most cases are the owners of the plant. Open
transmission access allows Gencos to access the transmission network
without distinction and to compete.
 30

2.8.2 BOT Plant Operators and Contracted IPPs

Build, operate and transfer BOT; (or build, operate and own) plant or
IPPs who have long-term contracts with surrounding, usually national,
utilities play an important role in providing additional generation in many
fast-growing systems. Take-or-pay power purchase agreements are often in
force as an economic incentive to investors.

2.8.3 Discos and Retailers

Discos assume the same responsibility on the distribution side as in a

traditional supply utility. However, a trend in deregulation is that Discos may
now be restricted to maintaining the distribution network and providing
facilities for electricity delivery while retailers are separated from Discos and
provide electric energy sales to end consumers. Another trend in developing
countries is to sell to an investor, or to corporatize, portions of the distribution
system so that investment for reinforcement can be raised and better operating
practices implemented.

2.8.4 Transmission Owners (TOs)

Where the transmission network was state owned before restructuring,

obviously this integrity will be retained and a distinction between owner and
operator is redundant. In cases like the USA, former electric utilities may sell
off their other assets and become regulated T&D companies. a basic premise
of open transmission access is that transmission operators treat all users on a
non-discriminatory basis in respect of access and use of services. This
requirement cannot be ensured if transmission owners have financial interests
in energy generation or supply. A requirement, therefore, is to designate an
independent system operator to operate the transmission system.
 31

2.8.5 Independent System Operator (ISO)

The ISO is the supreme entity in the control of the transmission

system. The basic requirement of an ISO is disassociation from all market
participants and absence from any financial interest in the generation and
distribution business. However, there is no requirement, in the context of open
access, to separate transmission ownership and operation. For example, the
National Grid Company (NGC) in England and Wales (E&W) is both the
transmission owner and the operator. The roles of and responsibilities of ISOs
varying widely and this issue will be discussed in responsibilities of ISO. In
countries such as India and China where regional grids are owned by regional
are state governments, and system interconnections is only now growing and
growing rapidly towards national grid status, the protocols of future
ownership and operation are still being evolved.

2.8.6 Power Exchange (PX)

The PX handles the electric power pool, which provides a forum to

match electric energy supply and demand based on bid prices. The most usual
is the day ahead market is also useful since it provides additional
opportunities for energy trading redress short term imbalance. In the E&W
system the ISO and PX functions growth exist within the NGC. In evolving
Asian systems the arrangements for the future are still under intense
discussion. Example China, India, Thailand, Indonesia and also most of
Africa.

2.8.7 Scheduling Coordinators (SCs)

SCs aggregate participants in the energy trade and are free to use
protocols that differ from pools rules. In other words, market participants may
enter an SCs market under the SCs rules and this could give rise to different
 32

market strategies. In some markets such as E&W, SCs are not allowed to
operate. In many new situations such as California, SCs are an integral
component of the market.

2.8.8 PX Function and Responsibilities

A PX of some form is essential for efficient trading in electricity. The

PX establishes an environmental in which generators and consumers bid to
sell and buy energy. Parties to bilateral contracts can operate their own
separate energy trades and schedule their transaction outside the PX’s market.
The primary function is to provide forums to match electricity energy supply
and demand in the current and forward energy markets. As mentioned before,
the market horizon may range from a half hour to a few months but the most
useful situation is a day-ahead market. Depending on the market design, the
day-ahead market may be preceded by a longer term market and
supplemented by an hour-ahead market. The so called ‘hour ahead ‘ provides
energy trading opportunities up to one or two hours before the operating
hours.

In its simplest form a PX provides bulletin board types of environment

for energy suppliers and energy customers to engage in bilateral forward
contractors. The MCP is the basis for the settlement of forward market
commitments. Regardless of asking prices all selected bidders are paid the
MCP. This approach encourages bidders in a competitive market to price
energy close to their marginal production cost.

Depending on the market design and activity rules the energy bids may
include several price components or a single price component. A multi market
bid may include separate price unit startup, no-load operation and energy. A
single part bid is an energy price inclusive of fixed and variable cost in either
case the energy bid may included several energy price segments depending on
 33

the amount of energy; that is, the bid may be take the form of a separate
Rs./MWh quotation for each block of energy from the same unit are a
portfolio of units.

The market design, bidding protocols and bid section process, impacts
on the computer applications needed to support the PX. In the case that the
market on single part bids a simple market clearing of supply and demand bid
curves is sufficient to determine the winning bids, MCP and schedules for
each hour. However, if the market design is based on multi part bids, unit
commitments software, possibly with enhancement to take into account
security constraints, may be needed.

The complexity of the bidding infrastructure and system is also

dictated by the market design and the protocols used. If iterative bidding is
allowed the bidding infrastructure and supporting software may have stringent
performance requirement. Since multi part bid system do not require bidding
iterations performance requirements may be less stringent then for single part
bids.

Basically, the working process of the PX is: (1) receive bids from
power producers and customers. (2) match the bids, decide the MCP prepare
scheduling plan. (3) provide schedules to the ISO or transmission system
operators; (4) adjust the scheduling plan when the transmission system
congested.

2.9 ISO FUNCTIONS AND RESPONSIBILITIES

The system operator plays a critical role in both traditional utility

environment and the emerging unbundled system, although some activities
and responsibilities have a change considerably. In the traditional utility take
over the entire business so for as operating the physical system is concerned.
 34

In vertically integrated traditional utilities the range of operator

responsibilities. In the new market structures there are a variety of
arrangements for system operator and since the operator must be disassociated
from all participants the name independent the system operator (ISO) is a
natural choice. The ISO has three objectives: security maintenance, service
quality assurance and promotions of economic efficiency and equity. Figure
2.2 shows the Role of ISO

To achieve these objectives the ISO performance one or more of the

following functions

Reactive Power
Spinning/ Non-
Separate spinning Reserve
markets
Losses

Maintaining Load
system security Forecasting

Roles of ISO

Instantaneous matching of Ensuring Fair Use of

load and supply Power Exchange Transmission Network

Bids Matching

Setting system price Transmission Congestion

charging charging

Loss
compensation

Figure 2. 2 Roles of ISO

 35

2.9.1 Power System Operation Function

The fundamental function includes the operation planning function and

real time control
 Perform power system scheduling
 Coordinate with energy markets
 Perform power system dispatch
 Determine available transfer capabilities(ATCs)
 Determine real time ATCs
 Pre-calculate short-run costs and prices for transmission-related
services
Real-time control includes
 Monitor power system operation status
 Monitor system security
 Conduct physical network operations and network switching
 Deal with outages and emergencies
 Coordinate real-time system operation

2.9.2 Power Market Administration Function

There are two types of energy markets: the pool market and the contract
(bilateral and multilateral transactions) market. The further could be run by
the PX or an ISO-PX combine while the latter may be coordinated by one or
more SCs. The pool market includes

 Run a power parties can bid to buy and sell energy

 Develop a preferred schedule for the pool
 Submit the supply and load schedule to the ISO according to pre-
specified protocols
 36

The contract market includes

 Manage bilateral and multilateral transactions
 Manage and coordinate submissions from SCs
 Submit preferred schedules to the ISO according to pre-specified
protocols

2.9.3 Ancillary Services Provision Function

 Own certain ancillary services for satisfactory grid operation

 Purchase ancillary services transactions from market participants
according to pre-specified protocols
 Provide ancillary services to transmission users
 Allocate costs of ancillary services among all users

2.9.4 Transmission Facilities Provision Function

 Maintain the transmission network

 Provide transmission facilities for all supplies and loads
 Plan transmission, reactive power and FACT’s expansion and ensure
that resources for future investment are generated
 Plan and commission own ancillary services

2.10 POWER SYSTEM RESTRUCTURING MODEL

Modern power industry operation is particularly difficult to understand
because of the dichotomy between electricity’s business and physical
manifestations. From the business perspective, electric power is an
exchangeable commodity that can be traded much like any other commodity
like oil, wheat, etc. and for which futures markets and hedging systems do
exist. But, in its physical manifestation, electricity is quite unlike all other
traded commodities. The fundamental difference is that it cannot be stored to
 37

any significant degree. This greatly affects how to must be managed as a

business asset, and greatly constraints its present and future market prices do
or don’t interact, as compared to other commodities. In large part due to its
‘ storage-less’ nature, electricity can be transported only on a real-time basis,
and in a manner heavily constrained by myriad physical laws that are
complicated in their interactions but nearly instantaneous in their impact.
The net effect of all of these differences in the modern electricity
trading and wholesale transportation systems are quite different from the
practices existed previously. Restructuring has been accompanied by a variety
of new problems, which have given rise to controversy between many
governmental organization and private companies. The changing nature of
electricity utility industry has brought many new practices to power system
operation. The philosophy and techniques of planning and operation well
established over past decades have begun to change and it is needed to
recognize and meet these challenges. To create the competition in power
market there may be different ways of restructuring the power industry. But
considering the organizational set-up, financial condition, control structure
and their coordination, different reform models are categorized.

2.11 CLASSIFICATION OF POWER SYSTEM RESTRUCTURING

MODEL

This topic aims at describing various market models. Various markets all
around the world can be classified on different basis. The classification can be done
in the following manner.

1. Classification based on energy trading

2. Classification based on contractual models
3. Classification based on operational mechanisms of different ISOs.
4. Classification based on ownership transmission network
5. Classification based on number of suppliers
 38

2.12 MODELS BASED ON ENERGY TRADING

This type of classification is based on the level of competition, i.e. the

on which side and competition exists, wholesale level or retail level.

2.12.1 Monopoly Model

In the model as shown in Figure 2.3, a single entity is taking care of all
the business such as generation, transmission and distribution of electric
power to the end users. Usually (but not necessarily), in this kind of model the
monopoly lies with the government. It is quite natural that this kind of model
should have strict regulation in order to protect and consumers against
monopoly. Most of the electric power systems obeyed this model prior to
deregulation.

Generator

Wholesaler /
Transmitter

Distribution
company

Customer

Figure 2.3 Monopoly energy market

2.12.2 Single Purchasing Agent Model

In this model, as shown in Figure 2.4, there is a competition in the

wholesale sector, i.e. generation. Here, independent power producers (IPPs)
are permitted. All generators sell their power to the central pool or power
purchasing agency, which is turn sells, it to state distribution utilities or
distribution companies in the service area. All power generated by generating
 39

companies (GENCOs) must be sold only to a purchasing agency and not to

any other agency. Distribution companies (DISCOs) are only able to purchase
from the purchasing agency. They do not have a choice of choosing their
power supplier.

In this model, sales from power pool to retailers take place at a pre-set
tariff price efficiency considerations suggest that this tariff should follow the
marginal cost of the system while at the same time covering total costs to the
purchasing agency. This tariff should then be modified appropriately from
time to time. Retail tariffs, in a competitive retail market, would inevitably
tend to follow the cost of purchasing at the purchasing agency wholesale
tariff. This model accommodates the social obligation policies to be
implemented by the government.

Gencos Gencos IPP IPP

Power Pool S.T.U

Discos Discos Discos

C C C C C C

Figure 2.4 Purchasing agent model

In this model transmission and distribution network can be owned and

operated by state and regional transmission utilities, inter-state tie line should
be sufficient to maintain a loose regional power pool.
 40

2.12.3 Wholesale Competition Model

This model has shown in Figure 2.5, provides the choice of supplier of
DISCOs together with competition in generation. DISCOs can purchase
energy for their customers from any competing generator. These distribution
companies maintain a monopoly over energy sales to the final consumers and
each of them has a franchise to serve a given set of customers. In requires
‘open access’ to the transmission network, and the development of a spot
market. The purchasing agency concept has come to the low-voltage level
rather then at the high voltage level but now it is not a simple buyer model.
Generators may sell directly to any distribution company but open access to
low-voltage wires is not permitted.

Since this model permits open access to the transmission, wires, it

gives the IPPs to choose an alternative buyer. However, customers within a
service area still have no choice of supplier. These will be served by a DISCO
in their area. With this model the ‘obligation to supply’ will move to the
DISCOs which still have a monopoly over the customers. They own and
operate the distribution wires.

Gencos Gencos IPP IPP

Disco Disco Disco Disco

C C C C

Figure 2.5 Wholesale competition model

 41

The transmission network can be owned and maintain by government

and private transmission companies. System operators should manage the
operation and control

2.12.4 Retail Competition Model

In this model as shown in Figure 2.6 all customers have access

competing generators either directly or through their choice of retailer. This
would have complete separation of both generation and retailing from the
transport business at both transmission and distribution levels the
transmission and distribution wires provide open access. There may be free
entry to generation markets and free exit. This means there should be no
regulation over ‘need for new plants’ and no requirement to maintain capacity
in production when it has passed its economic life. There would also be free
entry for retailers. Retailing is a function in this model, which does not
require the ownership of the distribution wires although the owner of
distribution wires can also compete as a retailer.

This model is not a single buyer model and the power pool in this
model is not like purchasing agency, it is like auctioneer. They never own the
power, they do not take the market risk, and they cannot discriminate the
price. It should behave like a single transporter, moving power to facilitate
bilateral trading. All the trading of power will be done through an integrated
network of wires. The operator of wire should measure and account for the
power trades. In this pooling arrangement, there should be provision for
bidding into a spot market to facilitate merit order dispatch. The pool will
match the supply and demand and determine the spot price for each hour of
the day. It collects money from purchasers and distributes it to producers.

The advantage of this model over monopoly utilities is that

competition is introduced in both wholesale and retail areas of the system.
 42

This model is a kind of truly deregulated power market model. In wholesale

competition model, with relatively few customers all of them regulated
DISCOs, a spot market can be preferable but essential, since contractual
arrangements customers and producers are carried out over a network owned
by a third party. The network owner must ensure that there are commercial
arrangements that allow for the settlement of imbalances between contracted
amounts and actual flows. If different parts of the network are operated
separately, inter-area payment schemes will also have to be devised.

In retail competition model, metering becomes a major problem.

Metering by time of use is no longer merely a useful way of promoting
efficient usage but it is a commercial necessity. Each customer needs to be
metered on hourly basis, if this settlement period. Since the price may change
every hour, it is necessary to know how much the customers of each
competing retailer used in each settlement period, in order to bill the right
customers and to settle accounts properly. If the customers have adequate
metering, there will be no problems. But if the numbers of customers are
increasing and metering capability for all the customers is not sufficient, it
may create logistical problem and provoke disputes.

Genco Genco IPP IPP

Retailer Disco Retailer Disco

Customer Customer Customer Customer

Figure 2.6 Retail competition model

 43

2.13 MODELS BASED ON CONTRACTUAL ARRANGEMENTS

2.13.1 Pool Market

The pool market as given in Figure 2.7 is comprised of competitive

power providers as obligatory members of an independently owned regional
power pool, vertically integrated distribution companies, vertically integrated
transmission companies and a single and separate entity responsible for:
establishing bidding procedures, scheduling and dispatching generation
resources, acquiring necessary ancillary services to assure system reliability,
administering the settlements process and ensuring non- discriminatory access
to the transmission grid. The pool operator does not own any generation or
transmission components and centrally dispatches all generating units within
the service jurisdiction of the pool. Pool-co controls the maintenance of
transmission grid and encourages an efficient operation by assessing non-
discriminatory fees to generate and distributors to cover its operating costs.

In a pool model sellers and buyers their bids to inject their power into
and out of the pool. Sellers compete for the right to inject power into the grid,
not for specific customers. If a power provider bids too high, it may not be
able to sell its power, as his bid may not get selected. On the other hand,
buyers compete for buying power and if their bids are too low, they may not
be getting any power. In this arrangement, low cost generators would
essentially be rewarded. Power pools would implement the optimal power
flow (OPF) and produce a single (spot) price for electricity, given participants
a clear single for consumption and investment decisions. Winning bidders are
paid the spot price that is equal to the highest bid of the winners. Since the
spot price may exceed the actual running of selected bidders are encouraged
to expand their market share, which will force high cost generators to exceed
 44

the market. Market dynamics will drive the spot price to a competitive level
that is equal to the marginal cost of most efficient firms.

Pool model is practiced in Chile, by the national grid company (NGC)

in England and Wales till 2000, and in Argentina and Stands at the core of all
deregulated systems so far.
Contracts for
Differences

Pool

Pool purchase Price Pool selling Price

Grid
Generators Suppliers
MWh MWh

Figure 2.7 Pool energy market

2.13.2 Bilateral Contracts Model

Bilateral contracts model has two characteristics that would distinguish

it from the pool model. These are: the ISO’s role is more limited; and buyers
and sellers could negotiate directly in the market place.

This model permits direct contracts between customers and generators

without entering into pooling arrangement. By establishing non-
discriminatory access and pricing rules for transmission and distribution
systems, direct sales of hour over a utility’s transmission and distribution
systems are guaranteed. Wholesale suppliers would pay transmission charges
to a transmission company to acquire access to the local distribution grid. In
 45

this model, a distribution company may function as an aggregator for a large

number of retail customers in supplying a long-term capacity. Also, the
generation portion of a former integrated utility may function as a supplier or
other independent generating companies, and transmission letters would serve
as a common carrier to contracted parties that would permit mutual benefits
and customers’ choice. Any two contract parties would agree on contract
terms such as price, quantity locations, and generation providers would
inform the ISO on how its hourly generators would be dispatched. The ISO
would make sure that sufficient resources are available to finalize the
transaction and maintain the system reliability if there is no violation of static
and dynamic security the ISO simply dispatches all requested transactions and
charges for the service.

2.13.3 Hybrid Model

The hybrid model combines various features of the previous two

models. The hybrid model differs from the pool model as utilizing the power
exchange (PX) is not obligatory and customers are allowed to sign bilateral
contracts and choose suppliers from the pool. The pool would serve all
participants (buyers and sellers) who choose not to sign bilateral contracts.
The California model is an example of this model. This structure has
advantages over a mandatory pool as it provides end users with maximum
flexibility to purchase from either the pool or directly from suppliers.

As in the pool case, if generators to compete through the pool, they

would submit competitive bids to power exchange (PX). All bilateral
contracts would be scheduled to meet their loads unless they would constrain
transmission lines. Loads not provided bilaterally would be supplied by
economic dispatch of generating units through bids in the pool.
 46

This existence of the pool cans efficiently individual customer’s energy

requirements and simply the balancing process of energy supply. The hybrid
model would enable the participants to choose between the two options based
on provided prices and services. The hybrid model is very costly to setup
because of separate entities requirement for operating the power exchange
(PX) and the transmission system.

2.14 BASED ON DIFFERENT SYSTEM OPERATOR (SO) MODELS

The ISO is the supreme entity in the control of the transmission

system. The basic requirement is an ISO is disassociation from all market
participants and absence from any financial interest in the generation and
distribution business. However, there is no requirement, in the context of open
access, to separate transmission ownership and operation. The roles and
responsibilities ISOs vary widely. In India were regional grids are owned by
regional are state governments and system interconnection is only now
growing, and growing rapidly towards national grid status, the protocols of
future ownership and operation are still being evolved.

There are various models of ISO, the functioning and operation

methodologies of which differ from market to market. There are 5 different
models of ISO available. These are California, Pennsylvania-new, Jersey-
Maryland (PJM) interconnection, New York ISO, electric reliability council
of Texas (ERCOT) and New England ISO. All these models have advantages
and shortcomings of their own.

2.14.1 California ISO

The ISO concerned with the reliability of the grid, balances the
operation of grid in real time. The real time market is operated by the ISO,
which uses ancillary services bids and supplement energy bids submitted
 47

through power exchange (PX) and schedule coordinators (SC). The ISO also
determines the real time market price after the fact (ex-post price) based on
actual metered data.

The ISO guarantees a non-discriminatory open access to transmission

for all users, manages the reliability of transmission system, acquires ancillary
services as required, approves day-ahead and hour-ahead schedules, maintains
the real time balancing of load and generation, maintains frequency of the
system and does the congestion management. The ISO also stands as the
operator of control area operators, which balances inter-tie schedules with
actual flows across inter-ties. The ISO balances the system demand with the
power output of local generating units, plus purchases from external electric
power systems, minus the energy sold to external systems. California ISO
model is shown in Figure 2.8.

Figure 2.8 California ISO

 48

2.14.2 New York ISO

The 8 members of New York power pool (NYPP) decided to break

down the pool and proposed to form a substitute represented by an ISO and
other institution such as the PX to comply with FERC rules, maintain
reliability in the competitive environment and facilitate a competitive
wholesale electricity market.

The ISO is responsible for bulk power system operations, including

coordination of maintenance outage schedules and provision of transmission
services on non-discriminatory basis. The ISO will also administer and
maintain an OASIS (Open Access Same time Information System) for the
New York state bulk power system. What distinguishes NYPP is the highly
meshed characteristics and frequent congestion, and what distinguishes this
model is its clearing energy and ancillary service markets at the same time,
which is an advantageous feature over other proposals where separation of
markets is implemented.

Participants choosing bilateral contracts are required to submit

decremented price bids for congestion purpose. A real time (balancing)
market is operated by the ISO using a centralized five-minute security
constrained optimal dispatch, where buyers and sellers can participate in this
market up to 90 minutes ahead with flexible bids or submit bilateral schedules
for energy as well as some ancillary services. NY ISO model is shown in
Figure 2.9.

The NYISO uses security constrained unit commitment (SCUC)

software for scheduling day-ahead and hour-ahead to dispatch energy, load,
results and regulation taking into account network constraints and schedules
outages. The same software is used for calculation of locational based
marginal prices (LMP).
 49

Figure 2.9 New York ISO

2.14.3 PJM Interconnection

The main responsibilities of the PJM ISO are maintaining the

reliability of transmission grid, operating the spot market, transmission
planning, unit commitment, operating real time (balancing) market and
settlement and billing functions. The PJM ISO scheduling operation and
dispatching would include the day-ahead and hourly process. The day-ahead
scheduling would take place on the day prior to operating day, and the hourly
scheduling would take place within 60-minute leading to the operating hour.
On a least-cost basis, the ISO would manage to serve the hourly energy and
reserve requirements of the control area. PJM ISO model is shown in Figure
2.10.
 50

Figure 2.10 PJM ISO

2.14.4 ERCOT ISO

This ISO does not represent a poolco function and is not concerned
with or responsible for any activities as those of power pool such as
generation dispatch, matching of buyers and sellers, or providing ancillary
services. The ISO does not have any direct control of transmission network or
generation facilities, whereas this control is the responsibility of the ERCOT
control areas.

The ISO’s 3 primary areas of responsibilities include security

operations, transmission access/market information and coordinated regional
transmission planning and engineering service.

Even though the first priority of the ERCOT ISO is to maintain system
security, this ISO has the authority and responsibilities toward the system,
which include functions such as real time system monitoring, response to
 51

system contingencies, administration of OASIS, transmission traffic

administration, ancillary service verification and coordination of regional
transmission planning for feature planned transactions.

2.14.5 New England ISO

The organization of this ISO is composed of two major areas:

System operations and reliability: responsible for daily dispatch of

resources assuring the reliability of the system and the administration of the
open access transmission traffic, short-term and long-term demand
forecasting and reliability planning.

Market operations: directs wholesale electricity market place to ensure

fairness to all market participants and full competition that could lead to the
lowest price for electricity, provides customer services and training support
and performs the settlement function in the market place by ensuring that
sellers in the spot market are paid by purchasers, and tracks bilateral contracts
between market participants.

The New England ISO proposed seven markets to be run under the
ISO directions. These markets are one energy market, four ancillary service
markets and two capacity markets. The ancillary service markets are:

 Ten Minute Spinning Reserve (TMSR) Market

 Ten Minute Non-Spinning Reserve (TMNSR) Market
 Ten Minute Operating Reserve (TMOR) Market
 Automatic Generation Control (AGC) Market
 52

2.15 MARKETS BASED ON NUMBER OF SUPPLIERS

2.15.1 Perfectly Competitive Markets

There are many suppliers and consumers. The selling or purchasing

behavior adopted by one market player will not influence the market price
ideally, the market price is at its marginal cost of production.

2.15.2 Oligopoly Market

There are few suppliers the selling behavior adopted by one supplier
has great influence on the market price. The market price may not necessarily
reflect the production cost. There exists market power.

2.15.3 Monopoly Market

There is one only supplier. The market price is controlled by the

supplier and sometimes with limitations from other organization such as
governments. The market price generally does not reflect the production cost.

2.16 MARKETS BASED ON THE OWNERSHIP OF

TRANSMISSION NETWORK

2.16.1 ISO Model

The technical responsibilities of ISO are discussed earlier in detail.

ISO model is practiced in those countries in which transmission companies
are also providing the generation and distribution services in their area of
operation and secondly, sufficient numbers of equal sized transmission
companies exist in the market and it is not possible to club the system
operation with any of these companies for commercial reasons.
 53

Therefore separation of ownership of the transmission assets from the

system operation function is considered necessary to avoid any preferential
treatment for dispatching its own generation.

2.16.2 Transmission System Operator (TSO) Model

In TSO model, operation of the grid and ownership of the grid and
integrated in single entity, which is responsible for development of
transmission system and to provide non-discriminatory open access to all
eligible market participants? It is also responsible for system operation
functions. Neutrality is an important aspect of the TSO to ensure an efficient
market. This model is prevalent in whole of the Europe.

Electricity Supply Industry (ESI), throughout the world, is undergoing

restructuring for better utilization of the resources and for providing quality
service and choice to the consumer at competitive prices. Restructuring of the
power industry aims at abolishing the monopoly in the generation and trading
sectors, thereby, introducing competition at various levels wherever it is
possible. Electricity sector restructuring, also popularly known as
deregulation is expected to draw private investment, increase efficiency,
promote technical growth and improve customer satisfaction as different
parties compete with each other to win their market share and remain in
business. Electricity markets throughout the world continue to be opened to
competitive forces. The underlying objective of introducing competition into
these markets is to make them more efficient. In competitive environment, the
price is determined by stochastic supply and demand functions. As a
consequence of increased volatility, a market participant could make trading
contracts with other parties to hedge possible risks and get better returns.
Congestion occurs when transmission lines or transformers are overloaded
 54

and this prevents the system operators from dispatching additional power
from a specific generator.

2.17 MARKET EFFICIENCY

The theory that we developed at the beginning of this chapter suggests

that if two parties put different values on the same good, a trade should take
place. If such transactions are to happen quickly and easily, the market must
be liquid. This means that there should always be enough participants willing
to buy or sell goods. The mechanism through which the market price is
discovered should also be reliable.

Good mechanisms for disseminating widely comprehensive and

unbiased information about the market conditions are indispensable to this
price-discovery process. Participants will also have more confidence in the
fairness of the market if its operation is as transparent as possible.

Finally, the costs associated with trading (fees, administrative expenses

and cost of gathering market information) should represent a small fraction of
the value of each transaction. These transaction costs are considerably
reduced if the commodity being traded is standardized in terms of quantity
and quality. A market that satisfies these criteria is said to be efficient.