Colombias ForwardEnergy MarketPeter Cramton University of Maryland 5 November 2007

Purpose of marketImprove efficiency of bilateral market for forward energyLimited competition and high transaction costsLocal, fragmented marketsNon-standard contractsSelf-dealing between utility and affiliate supplierCentralized market with standard product

Two products, one auctionRegulated customers (68% of load)Small customers without hourly metersPassive buyers in auction

Nonregulated customers (32% of load)Large customers with hourly metersActive buyers in auction

Regulated product:Energy share of regulated loadPay as demand contractSupplier bids for % of regulated loadSupplier that wins 10% share has an obligation to serve 10% of regulated load in each hourDeviations between hourly obligation and supply settled at the spot energy price

Price coverageof regulated customerOld market New marketBilateral energy contracts and spot market$260>$500$0$0>$500Forward energy marketFirm energy marketPrice riskMarket powerHigh transaction costsLow transaction costsLittle market powerFull price hedge

Price coverageof nonregulated customerOld market New marketBilateral energy contracts and spot market$260>$500$0$0>$500Forward energy marketFirm energy marketPrice riskMarket powerHigh transaction costsLittle market powerFull price hedgeAs bid

Low transaction costs

Regulated demand participationParticipation is mandatory and passive (no active bidding of demand)Regulated customer may decide to become a nonregulated customerPurchase hourly meterActively participate in auctionBut switch to nonregulated status is permanent

Nonregulated demand participationNonregulated demand participates in the same auctionSingle nonregulated productProduct: expected energy, not actual energyHourly, but based on expected energy demandHedges expected energy demand, but exposes customer to spot price on the marginRequires hourly meter (and demand management)Participation benefits both regulated and nonregulated customers, as well as suppliersImproved liquidity and price formation

Quarterly 2-year contracts, annual rolling

Descending clock auctionPrice$120.0 = P0P1P2P3QuantityDemandRound 5Round 4starting priceclearing priceAggregate supply curveP4P5 $61.7 = P6Round 3Round 2 Round 1 excess supply $60.0 = P6Price$120.0 = P0P1P2P3QuantityDemandRound 5Round 4starting priceclearing priceAggregate supply curveP4P5 $61.7 = P6Round 3Round 2 Round 1 excess supply $60.0 = P6Descending clock auction

Activity ruleA bidder can only maintain or reduce its aggregate quantity as price falls (aggregate supply curve upward sloping)Allows full substitution between Regulated and Nonregulated productsBidders can express any linear substitution between productsAny price separation reflects difference in serving regulated load and nonregulated load

Handling differences among nonregulated customersCustomer forecasts demand for every hourCustomer rate is auction clearing price scaled by quality factor of each nonregulated customerQuality factor reflects expected cost difference (at spot price) for particular customerEach supplier receives its share of paymentsSupplier obligation is its share of aggregate nonregulated expected load

Demand curve for nonregulated product is submitted before auction by each nonregulated customerPriceQuantityNonregulated demand12.5%10.0%Demand target0.0%$50$60$70$75Determined by summing bids of all nonregulated customers

Administrative demand curve for regulated product addresses insufficient competitionPriceQuantityRegulated demand12.5%Demand target0.0%$60$9090% chance price in this range99% chance price in this rangeDemand curve determined by two prices:High price: Only 1/10 chance clearing price is higher.Very high price: Only 1/100 chance clearing price is higher.

Market design is importantSimplify, improve liquidityAddress potential market failuresMotivate demand response with forward contracts that hedge expected loadCustomer exposed to spot price on marginYet enjoys all the risk benefits of forward contracting