Things always come in threes. TWO thousand €/MW is the standard deviation typically observed between the different auction prices for the 2020 supply year, THREE is the number of times that we discussed the capacity mechanism in our Newsletter in 2019. It’s clearly our preferred subject, since it always has its share of surprises in store for us.
Since 15 December 2016, the date of the first EPEX Spot auction, this fairground for capacity guarantees can be interpreted as a pileup where the various strategies of the participants are beginning to take shape and solidify over the course of the twenty-one auctions that have been held. Lessons can be drawn from each of them, allowing us to gain a better understanding of the way prices are formed and the manoeuvres of the different players around the table.
It is important to remember that capacities certificates are exchanged either via bilateral contracts or via auctions organised by Epex Spot, the number of the latter being theoretically fixed at 18 for a given supply year [AL] (Point 11.1.2 of RTE´s [the French Transport System Operator] rules). These auctions are spread out over seven years. Fifteen of them are held over the four years preceding the supply year. In the final year preceding the supply year, six auctions are scheduled: these are the most important ones.
It is over the course of these AL-1 auctions that the greatest portion of certified capacities is traded, due to provision 126.96.36.199 of the capacity mechanism rules which more or less mandates that players holding 3 GW or more of certified capacity are to offer up to at least 25% of their total certified capacity to the market during AL-1. Furthermore, at the end of this supply year, all of their remaining capacity must be offered to the market.
This provision aims to increase the market’s liquidity by requiring large producers, who are often strongly integrated players, to participate in auctions.
Capacity mechanism: bets are placed, nothing is alright
Let’s note straight away that the former market reference price (PRM) of the capacity mechanism, which provided the average guarantee trading price for a given supply year, has evolved since the mechanism began, following the upward trajectory aimed at by the Programmation Pluriannuelle de l’Energie [multi-year energy programme] (PPE). This price climbed from €9,999.8/MW for AL 2017 to €9,342.7/MW for AL 2018, then to €17.365.3 /MW for AL 2019, and ended up at €19,458.3/MW for the 2020 supply year.
Not to worry! In January 2019, our assessment would have probably ended there. The organisation of auctions according to a clearing system, and the ability of the price elicited by this clearing to reflect the true state of the system would, of course, remain topic issues.
But…in this market, which is still under construction, the changes will continue to come.
Missing money: missing in action?
It was under these circumstances that two decisions taken by the Energy Regulatory Commission (CRE) – the purpose of which was to increase the liquidity of the auctions, particularly for the most recent auction – changed the face of the market. First, decision N°2019-040 of 28 February 2019 set the Reference Price for Imbalances (PREC) at the result of the most recent auction. Then, decision N°2019-133 of 20 June 2019 noted that, for AL 2020 and the years following it, interconnection capacities would be sold at the December auction. All of this offers us a glimpse of the modified intervening auctions and a fairly special upcoming end-of-year auction (see our Newsletter N13 from July 2019).
Indeed, the sale of cross-border capacities at zero price via the simplified procedure is a method of pushing obligated actors to make ‘at-any-cost’ offers, as a means of forcing the capacity mechanism to adhere to its theoretical framework (which, according to the CRE, should allow us to observe ‘at-any-cost’ offers and capacities being offered at prices corresponding to the missing money from their technologies).
The CRE, in its decision of 20 June 2019 on cross-border capacities, also recognises that, ‘the volume of [cross-border] capacity guarantees sold being high, the level of prices could have an impact on the market’s equilibrium. The PREC was defined based on the most recent auction in order to increase its liquidity and reinforce its ability to reflect the equilibrium of the capacity market. Offering […]these cross-border capacities sold at zero price at the last auction therefore increases the chances of recording a price that represents the supply-demand balance.’
AL 2020: the equilibrium test
Before summarising the results of these regulatory acrobatics, let’s take a look at the AL 2020 auctions in 2019. Before the auctions began, the market appeared slightly unbalanced, with a higher estimated level of obligations than that seen nowadays.
At the beginning of the year, we offered our vision of the market, in which we estimated a capacity price of €20,000 per megawatt for this one, the 2020 supply year. The average for the 2020 supply year, with the former PRM, was €19,458.3/MW. The graph below shows the changing capacity price over the course of the different auctions. Prices fluctuated between €22,382/MW (in June) and €16,583.9/MW (in December), at an average price of €19,458.3/MW.
Now let’s make a recap. In December 2019, the level of aggregated obligations set by RTE was 90.6 GW whereas the certified capacities amounted to84.2 GW. By adding the 6.5 GW of cross-border capacity to these certifications, we can see that, before the final auction of the year, the market was in perfect balance (or up by 4.3 GW of obligations if we consider RTE’s reference case: steady consumption, which takes into account a level of obligations of 94.3 GW).
As of this same date, according to the transaction register, obligated actors had purchased 67 GW of capacity. If we take into account the amounts [12.9 GW to 13.7 GW] that we estimate for ARENH (Regulated Access to Historic Nuclear Electricity) demand, slightly less than 10.5 GW of obligations remained to be covered, out of the 90.6 GW of obligation estimated so far.
AL 2020 Auctions: Spot the difference
At the end of the 12 December 2019 auction, where 94,884 MW were traded, there would thus be less than one GW of obligations to be covered after AL-1.
Thus, if we took time to dwell on the curves of previous auctions, they could almost be superposed! The results, published by EPEX Spot on Thursday 12 December 2019, show how this auction differed from the others, if only in that the quantities traded more than doubled.
Add to the above those players holding capacities who place their offers to ensure that they complete their transactions, and this liquid auction should be the closest to the theoretical framework ever imagined by legislators.
As we have been emphasising in our previous Newsletters, we feared that multiple players – particularly those holding capacities – would desert the final auction of the year. The very high quantities traded may lead one to think the opposite. In reality, and excluding any cross-border capacity, only 2.99 GW were traded eventually, versus the 5.91 GW traded during the December 2018 auction (where cross-border capacities were not offered). As a basis for comparison, during the five previous AL 2020 auctions, between 4.1 GW and 4.7 GW had been traded.
This CRE provision seems to have produced rather the opposite effect of that counted on, since we notice a decrease in the actual liquidity – contributed by players other than RTE. This leads us to wonder how representative the auction clearing price is as the irrefutable equilibrium price reflecting the players’ different amounts of missing money.
How was the supply curve affected?
A long ‘nuclear’ threshold, which we have now become used to, was noted. Its length, in the end, set the price.
Furthermore, we noted that approximately 6.6 GW – including the 6.5 GW of cross-border capacity – were offered at zero price.
How was the level of demand affected? Were certain players at fault?
We noted a nearly ‘at-any-cost’ demand of 6.2 GW. In principle, according to the theoretical framework of this latest auction, demand should have been fixed in its whole or partially at the pricing level given, which was €60,000/MW for AL 2020. However, a higher level of demand at a low price was observed (the demand curve appeared flatter and longer than in previous cases). As future AL 2020 auctions will, in principle, only be used for rebalancing, a higher overall ‘at-any-cost’ demand should have been noted.
In this case, why would certain players have risked finding themselves out of balance by making low-price purchase offers when this was the last auction of the year? Certainly, because this year-end auction determines the reference price for imbalances. In this case, a player who is short may prefer to count on a low imbalance price rather than placing an ‘at-any-cost purchase’ offer, which would risk increasing the auction clearing price and therefore the readjustment price during the supply year.
Certain low-price demand bids observed were probably there to seize market opportunities and/or to help lower the PREC.
Historically, most trades that take place after December of AL-1 are made at prices similar to the PRM, and therefore similar to the PREC payable between 20 March and 20 April of the year AL+3. For obligated actors, this auction was thus a clash of two strategies, a deciding match between:
- Offering a higher purchase price to ensure that an obligation which is, by its nature, uncertain, is covered (the temporal reconciliation of profiled consumers taking place in AL+1) by making the reference price for imbalances increase.
- Or offering a lower price, at the risk of not covering one’s entire obligation, but while counting on a more moderate imbalance price; this could cover, in particular, increases in the consumption profile during AL20.
Moreover, it is probable that a question of liquidity and payment deadlines are taken into consideration in the players’ game (with the imbalances being payable in AL+3).
Those who have waited until this latest auction in order to purchase will have benefited from the best possible price for this supply year.
A more marginal rebalancing
Historically, we have noted that trades (excluding internal trades between strongly integrated players and transfers relating to the ARENH) that take place after AL-1, particularly via bilateral contracts or via rebalancing auctions, only concern, against all expectations, a very small portion of the guarantees traded for a given supply year and hover around the PRM for the year.
Consider, by way of example, for AL 2019, after 31/12/2018, where 22 GW were traded (including internal trades between strongly integrated players and transfers relating to the ARENH) with 85% of these transactions settling at prices centred around the 2019 PRM or slightly below it. However, true exchanges of capacity (excluding internal trades between strongly integrated players and transfers relating to the ARENH) only involved around 7.6 GW, 5 GW of which were acquired by obligated actors. These latter transactions thus allowed obligated actors to adjust their position.
It’s time to take stock
EPEX auctions still bring together a substantial portion of capacity guarantee exchanges. By way of example, for the 2020 supply year, out of the 76.5 GW that were traded from AL-4 to 13 December 2019, 31.4 GW (41%) were exchanged via the auction sessions organised. With the variations or even just the risk of variations in the prices observed, the EPEX market is still the right place for successful operations…or for missteps.
With the low auction prices observed in December 2019 and the various changes happening that we have tried to explain, in the course of the coming years we are likely to see:
- Those holding certified capacity selling their guarantees at auctions preceding the December AL-1 auction and avoiding transactions in December and in the AL.
- Obligated actors who pass on the cost of capacity to their customers would need to participate to a lesser extent in all auctions, to protect themselves against the risk that the year-end auction elicits a very high price, and more actively in the last auction in order to tip the scales in favour of a low price.
- Obligated actors, who directly bear the cost of capacity, being primarily present at the last auction.
We therefore expect to see a strong presence of capacity sellers at the intermediate auctions. However, the obligated buyers would be more reluctant to participate.
What changes should we expect?
In its monitoring report on the capacity mechanism (July 2019), the CRE concluded that ‘the simulations presented […] show that the prices stemming from the different auctions having taken place for the 2017 and 2018 supply years seem compatible with the fundamentals of the capacity mechanism.’ However, it ‘notices that the mechanism’s architecture does not allow for an efficient interaction between supply and demand and leads certain players to avoid offering their capacity guarantees at a level corresponding to the missing money of their capacities.’
Several directions can be envisioned, all the more so as ‘the CRE therefore considers that a reflection must be conducted in order to help the design of the capacity mechanism evolve, for example by turning towards a mechanism which includes more centralisation, modelled on the British, Irish and Polish mechanisms.
For its part, RTE will engage in early 2020 in dialogues and create working groups to reflect upon the design of the capacity mechanism. In mid-2020, the TSO [Transmission System Operator] will be provided with some initial feedback, after which there will probably be some slight changes in design and regulations.
The architecture of the capacity mechanism should take effect starting in the 2023 supply year.
Prior to this, we will see several more capacity auctions in which strategies must be established: The next auction session will be held on 05/03/2020. It will focus on the 2021 supply year and rebalancing for AL 2017. In addition to the six auctions for AL 2021, four are planned for the 2022 supply year. For the first time ever, auction sessions will be organised in AL-2.
Let the game begin!