ForTheDoers Blog

Understanding how the power market creates social welfare and utilises flexibility is essential for the implementation of a carbon-free future

Mikko Kattelus  ·  21 July 2021

What keeps me motivated, curious, and forward looking is that I’m working in a social welfare business. Power market participants all have their individual priorities, but they can only thrive by constantly adapting to the needs of society and helping society to renew. For me, working on short-term markets and mostly in the spot market, the meaning of social welfare is also much more tangible. It is matter of fact for each day and for each hour.

windpower sky and flowr

In the previous MI articles, my colleagues have presented the expected changes in electricity demand, highlighted the importance of system integration in renewable energy growth, and addressed the expectations from the power system by looking at the Texas case. As a short-term analyst my focus is on the current functioning of power markets and my story is based on related observations.

Social welfare is at the core of the market

In the Nordics the vast majority of electricity is traded via day-ahead auction of energy, often called the spot market. Everyday buyers and sellers tell the marketplaces how much volume they are able and willing to offer or purchase, and this information is given to an algorithm, EUPHEMIA, Pan-European Hybrid Electricity Market Integration Algorithm. What the algorithm is doing is selecting offers from Finland to Portugal so that “The social welfare [...] generated by the executed orders is maximal.” This quotation is from Euphemia public description (nordpoolgroup.com), the introductory chapters are an essential read for anyone interested in the power markets, and the latter chapters provide information also for the more mathematical enthusiasts. The point is that social welfare in the power market is not just an ideal and a long-term strategic thing for the power market participants, it’s also a matter of fact – hour by hour. And, suitable to the spirit of our time, algorithm-driven.

Flexibility is the key enabler for power market to serve society efficiently

Flexibility is the key enabler for power market to serve society efficiently

Just as with social welfare, the viewpoints to energy system flexibility are many – from cost-efficient adaptability to demand fluctuation, security of supply and the power system, and predictability enabling planning on both the supply and demand side. What I want to highlight is that the main part of flexibility is produced and consumed in the wholesale market. There are two figures of note here. First, in the Nordics the size of the day-ahead auction is well proportional to consumption, Nordic electricity sold via Nord Pool was 358 TWh in 2020*. Second, the predictability of the next-day market level demand is over 97%. These figures show that even as the discussion around flexibility often concentrates around very short-term needs related to security of system and balancing the unpredictable deviations of e.g. wind, the vast majority of the market is still sufficiently predictable to be traded in auctions based on social welfare optimisation.

*) Besides Nasdaq and Nord Pool, Nordic derivatives are traded at EEX and ICE, and physical power at EPEX Spot. In 2020, the combined (buy and sell) EPEX Spot Nordic volumes were 12 TWh for day-ahead and 1.7 TWh for intraday.

Who drives the wholesale market?

The discussion around electricity prices is often concentrated on production. When there are price peaks, the focus of the analysts and the public is often on producers’ pricing. For me, this is just a part of the story. When understanding the market mechanism and EUPHEMIA, it can be concluded that the buy-side behaviour is just as significant. During winter 2009-2010 in Finland, the spot price reached 1400€/MWh for several hours. I still remember that market analysts quite quickly concluded that this was very unlikely to happen again under similar conditions. Why? Because the demand side could have more efficiently adjusted their processes and bidding to the market. Since 2010, when the extreme daily average price in Finland was ~500€/MWh, we have seen only a few days over 100€/MWh; this is a clear indication that market and participants together increased the flexibility. We will surely see similar changes in market behaviour in future – e.g. when further electrified industry and RES producers need to adjust actions to their exposure to market prices.

The market has absorbed the huge wave of renewable production into it since 2010 – in the Nordics mainly in form of wind. This new capacity has been more intermittent than the production it has replaced. Looking at the data, so far the inclusion has been successful, in my opinion. As an example, we can look at two days in February and see how flexible hydro balanced the day-to-day change equivalent to Swedish nuclear production!

Hydro peaks

Source: SvK Kontrolrummet

The increased price fluctuation in 2020 and 2021 still is not directly hinting at any major problems. BUT, there are signs that the inclusion of new supply and demand having a different profile and geographical distribution is not getting easier. On June 29th we saw 10 different area prices for 13 Nordic price zones which highlights the challenges.

Naturally, social welfare in the transition towards clean energy is much more than short-term energy prices – where my focus is. Nevertheless, I strongly believe that maximal utilisation of a well-functioning energy market creates the best conditions for innovative and efficient solutions for CO2 reductions and utilisation of flexibility. And this applies to both demand and supply. The story of day-ahead auction is so far a success story and it is developing.

 

MI Monthly is a blog series produced by Fortum’s TAO (Trading and Asset Optimisation) unit. In this monthly LinkedIn blog, we explore the various aspects of energy markets and the balancing of energy systems through the lens of our market intelligence. Each monthly blog will be published in the writer’s profile: please feel free to take the conversation forward and share these blog posts.

Mikko Kattelus

Manager, Short-term Analysis
mikko.kattelus@fortum.com

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