Two-settlement system for the Brazilian electricity market

Highlights

• The Brazilian cost-based market employs the single-settlement system to clear electricity.

• Electricity cleared is measured in real-time, but the price is set in the operation schedule.

• Economic failure: the electricity price is not set by intersection between demand and supply curves.

• Opportunity to market participants exercise unilateral market power.

• The two-settlement system corrects the economic failure and mitigates the use of market power.

Abstract

The Brazilian cost-based market employs the single-settlement system to clear electricity. Besides single, this system adopts a hybrid mechanism in which the amount of electricity measured during production and consumption in the real-time market is cleared with the electricity price set during the operation's schedule in the day-ahead market. The result is that the intersection between demand and supply does not set the electricity price neither in the day-ahead market nor in the real-time market. This work studies the flaws of the Brazilian settlement system. The study demonstrates that the two-settlement system is a better option for this market because it prices the electricity correctly at the moment of production and consumption, encourages the market participants to furnish accurate data for the system operation, mitigates anti-competitive practices, and induces market efficiency.

Introduction

Electricity markets have been put in place in many regions worldwide as an alternative to the traditional vertical structure in which the same company is responsible for producing, transmitting and distributing electricity to the end consumers (Joskow and Schmalensee, 1983; Hunt, 2002). The objective of the electricity market is to bring efficiency to electricity production and trading, resulting in system adequacy, suitable payback to investors, and fair price to consumers.

However, the electricity market is not organic, naturally emerging among people or companies willing to sell and purchase goods or services. It is a market that must be designed (Cramton, 2017; Wolak, 2019a). The Regulator, or the policymaker (called the Regulator in this paper), is responsible for designing the market.

When the Regulator designs the market, it has to manage two conflicting targets: supply reliability and low prices to consumers. They are conflicting targets because the more the investment made, the more reliable the system is. In theory, absolute reliability leads to infinite investment. If there is too much investment, the price of electricity rises. It is necessary to raise funds to match the investment. However, low electricity prices may not be sufficient to provide reliability.

In pursuit of the best market design, the Regulator must satisfy both the short- and long-term efficiencies. They make the best use of existing energy resources, and foster the economic signals and incentives for efficient investments in new sources by expanding the installed generation capacity or replacing the existing generation plants with more efficient ones with low-cost electricity supply.

To address both conditions, the Regulator must ensure that the competitive activity is effective, and that the rules of the proposed design eliminate, or at least mitigate, any anti-competitive market participants’ strategy that may artificially raise the electricity prices for extraordinary profits using unilateral market power.

In Brazil, the electricity market was designed considering the huge integrated power system that is responsible for delivering more than 99% of the country's electricity consumption; the hydro-dominated supply, that provides about 70% of the electricity consumption depending on the hydrological conditions of the year; and the electricity demand that increases by about 3% per year (Munhoz, 2017).

An Independent System Operator (ISO) is responsible for scheduling and operating the integrated power system in the Brazilian market. The ISO uses a cost-based dispatch model based on a stochastic dual dynamic algorithm (Pereira and Pinto, 1991) to support its decisions and schedule, for each period, all thermal power plants with a marginal cost lower than the marginal operation cost (MOC) of the system calculated by the model. Hydropower plants and other renewables supply the remaining demand.

Hence, in the Brazilian market, the market participants do not define the short-term price by their willingness to purchase and sell electricity. Computational algorithms set the short-term price, formally called Differences Settlement Price (PLD, in Portuguese), based on data of demand, supply, and system constraints. Therefore, it is a cost-based centralized market design.

Normally, the PLD is equal to MOC. However, the PLD and MOC may have different values for the same period because (i) the PLD has a regulatory cap and a floor and (ii) the PLD calculus does not consider internal transmission constraints of each market in the four Brazilian zones, since each zone must have the same short-term price in all-electric nodes. Nonetheless, when the MOC is between the PLD cap and floor, and there are no internal transmission constraints inside the zones, the PLD value equals the MOC value.

The short-term electricity price in Brazil was set week-ahead in three load levels (light, intermediate and heavy) for each of the four electricity zones in the Brazilian market until the end of 2020. Each week, the Brazilian market had three prices in each zone (Munhoz, 2017). However, from January 1st, 2021, the market changed the temporal price granularity. The electricity price is set day-ahead on an hourly basis (MME, 2019).

The Brazilian cost-based market employs the single-settlement system to clear the electricity. This system adopts a hybrid mechanism in which the amount of electricity measured during production and consumption in the real-time market is cleared with the electricity price set during the operation's schedule in the day-ahead market. The result is that the intersection between demand and supply does not set the electricity price neither in the day-ahead market nor in the real-time market.

This paper proposes a regulatory improvement in the Brazilian electricity market design by modifying the electricity settlement system. The objective is to improve the market efficiency given by the relationship between independent power suppliers and large consumers who may trade in the wholesale market, which, for simplicity, are called generators and demand. The retail market, in which small consumers participate, is not addressed in this work.

The paper demonstrates the flaws of the Brazilian settlement system and how the use of the two-settlement system enhances the competitiveness of the Brazilian market, prices electricity correctly at the moment of production and consumption, encourages market participants to furnish accurate data for the ISO, and mitigates anti-competitive practices like the use of unilateral market power.

A concrete case of the possible use of unilateral market power in the Brazilian electricity market and how the two-settlement system can avoid these problems is presented at the end of the paper. It uses real data that measures the frequency that the thermal-plant companies modified their availability information to the Brazilian ISO.

The organization of the paper is as follows. Section 2 describes the main concepts regarding short and long-term efficiency. Section 3 explains the consequences for the electricity prices when market participants exercise unilateral market power. Section 4 describes the two-settlement system and the Brazilian electricity market settlement system. Section 5 presents the proposal of the paper. Section 6 provides an analysis of the possible use of market power in the Brazilian market, and section 7 concludes the paper.