The Geographical Structure of the Electricity Market: Some Frequent Misconceptions
Date: June 19th 2020
Author: Alberto Pototschnig
The geographical structure of the electricity market – i.e. the bidding zone configuration – should mostly be a technical aspect in market design, however, at times it has received significant political attention, and the debate is overshadowed by some misconceptions.An appropriate geographical configuration is key for a well-functioning electricity market to the benefit of consumers, as it should allow congestion in the network to be dealt in the most efficient way. However, across most of Europe the geographical configuration follows the political borders, with bidding zones corresponding to countries rather than reflecting network congestion. Norway, Denmark, Italy and Sweden are notable exceptions, each of which are split into a number of sub-national zones.
The issue has received significant political attention in recent years when ACER proposed a split of the former Germany-Luxemburg-Austria bidding zone by separating Austria in an attempt to address the increasing volume of unscheduled flows (mostly loopflows) affecting neighbouring jurisdictions and reducing the commercial capacity on many borders. The political opposition to splitting countries into different zones stems from concerns about having different electricity prices in different parts of the same country. Interestingly, this seems to be a concern for electricity, but not for other public services – e.g. local public transport. Moreover, with the liberalisation of electricity supply, consumers will be offered, and will be able to choose between, various electricity tariff plans, so the idea of them all paying the same price is somewhat outdated. In any case, the splitting of one country into different price zones does not necessarily have to result in consumers facing different wholesale electricity prices depending on their geographical location, as has been demonstrated in Italy, which has a single national price for purchases from the power exchange.
The first and only bidding zone review conducted so far by a number of TSOs in 2018 delivered an inconclusive outcome. No alternative configuration emerged as decidedly superior or inferior when compared to the status quo. This was due to the many assessment criteria provided for in the relevant regulation and the lack of any structure or priority among them. The same problem may arise again with the current bidding zone review, launched by all TSOs in October last year, in compliance with the provision of the recast Electricity Regulation. Although the governance of the process has been improved, with the European Commission deciding as a last resort, there is a risk that ultimately, as was the case in the previous review, the comparison of the performance of alternative bidding-zone configurations will once again boil down to the perceived trade-off between the efficiency of the market outcome and operational security on the one hand, and market liquidity on the other. As a first approximation, any configuration characterised by smaller bidding zones should improve operational security as it makes more flows subject to congestion management procedures and, consequently, makes managing congestion easier. By delivering a market outcome that is more likely to be feasible, such configurations will also reduce the need for economically inefficient remedial actions, thus improving the overall efficiency of the market. At the same time, it is often claimed that smaller bidding zones reduce market liquidity.
In reality, the evidence from Europe and the U.S. seems at least to question that a bidding-zone split and, in general, smaller bidding zones necessarily reduce market liquidity. In fact, liquidity seems to be determined more by the design of the market and the structure of the sector. While liquidity can promote competition, the latter may impact liquidity more than the dimension of bidding zones.
What in fact seems to be more relevant for the well-functioning of the electricity market is the structure (concentration) of the sector with respect to the structure (congestions) of the network. Different bidding-zone configurations do not change the physical ability of the network to transmit electricity from generators to loads, but rather how the underlying physical limitations of the network can be imposed on market participants trading across large areas or regions. This affects the efficiency at which the network is used, as well as the behaviour of market participants. Larger bidding zones might appear to support greater competition in the market by allowing a larger group of market participants to compete among themselves. However, if the larger bidding zone does not reflect the actual capabilities of the network, local market power will inevitably emerge, particularly as real time approaches.
This was also the conclusion reached in an online workshop organised by the Florence School of Regulation (FSR) on 18 June, where the implications of different bidding zone configuration on market liquidity and competition were assessed, including on the basis of the available evidence from Europe and the U.S.
The workshop was introduced by Alberto Pototschnig, a part-time professor at the FSR, who has recently written a policy brief on this very same topic. The academic perspective was provided by Prof. Frank Wolak, from Stanford University, and Prof. Carlos Batlle, from the Massachusetts Institute of Technology. Policy makers and regulators were represented by Oliver Koch from the European Commission, and Clara Poletti, Christophe Gence-Creux and Christine Materazzi-Wagner, respectively chair of the Board of Regulators, head of the Electricity Department and chair of the Electricity Working Group of ACER.
This article is available also in Slovene.