Balancing power supply and demand is becoming ever more challenging for transmission system operators (TSOs) across Europe, and the growing penetration of wind and other variable renewable energy supply in the electricity mix requires a fundamental rethink of market design.
What is needed is more flexible trading arrangements, with wind-energy trading across Europe, throughout the day, every day, in a fluid, transparent market. Specialised wind-energy traders with well-developed market models, fine-tuned forecasting services and advanced data are set to play a fundamental role, helping to maximise generators' revenues and keep consumer prices low.
In wind-energy sales, traders have largely been confined to the sidelines, and only about half of all EU member states are geared up for higher wind penetration with intraday markets. Belgium, Denmark, Estonia, Finland, France, Germany, Italy, Poland, Portugal, Romania, Spain, Sweden and the Netherlands do have intraday power markets while within the UK, Great Britain has an intraday power exchange but Northern Ireland does not. Norway, not an EU member state but tightly integrated in the Nordic power market, is also among those with an intraday market.
Rigid fixed-price-protected markets for wind, including those with feed-in-tariffs (FITs), in several European countries have provided little incentive for small producers, or even large producers, to seek the benefits and take on the risk of negotiating better selling prices on the open market, where they deal directly with wholesale suppliers or go through power trading exchanges. In some cases, the existing regulatory structures, which most often oblige TSOs to buy all green energy, have not allowed producers to sell their power directly to market.
Yet there are signs of change. In Germany, the government is easing wind, solar and biomass towards full market integration through an interim structure, Direktvermarktung, or direct to market, with a premium payment. The new system has led to a boom in wind power operators bypassing TSOs to trade on the Franco-German Epex Spot exchange. This is similar to the many small Danish wind producers trading wind power on Scandinavia's Nord Pool Spot exchange, which traces its experience to integrating wind back to 2000, when Denmark was included in the Nordic/Baltic common power market.
European energy regulators are beginning to push for the market integration of renewable energy at the same time as cash-strapped governments scale back financial support to green-energy generators. Further market integration and wind energy trading will be a huge trend in the medium to long term, predicts Luca Pedretti, senior manager for energy ventures at Switzerland-based European energy trader Axpo Trading. Most of the FIT-remunerated wind-power stations will end up selling their power on the free market one day, he says.
Germany's market premium
In the German Direktvermarktung model, introduced at the start of 2012, renewable-energy generators are economically rewarded for directly selling electricity on the power exchange. When they do this, they are entitled to claim from distribution system operators an extra payment - the difference between the FIT and the monthly average price of electricity on the exchange - in addition to revenues from electricity sales. A management fee is also paid to the wind power producers to cover the costs of forecasting and other expenses arising from actively managing electricity sales, costs that TSOs are saving.
This new system represents progress towards integration of wind on the market in Germany, following on from the country's four TSOs selling power purchased directly from generators on the Epex spot market since 2010. The Direktvermarktung system allows generators to test the waters with trading in wholesale electricity markets and to begin the transition away from fixed-price incentives, said a recent Deutsche Bank report.
Given that the low marginal costs of wind and other renewable sources are pushing down wholesale electricity prices, one question Deutsche Bank analysts raise is how long it could take for wind energy to compete on an even footing with conventional energy on price without incentives. Achieving a level playing field, as the European Wind Energy Association (EWEA) stresses, also requires the removal of subsidies for coal, gas and nuclear generation.
Under the Direktvermarktung system, TSOs can offload balancing risks on to traders. When there is a difference between scheduled and actual power generation or demand, TSOs must buy or sell power in the balancing, or reserve, market to ensure that supply and demand match up in real time. This can be an expensive proposition, particularly as power generators can exacerbate the long or short positions of the TSOs to maximise their own profits - with the balancing costs usually being passed on to consumers.
"The market solution is cheaper than having four TSOs doing all the trading because balancing costs are reduced," says Anders Kring, head of renewables at energy trader Danske Commodities, a pioneer in wind trading in Europe."I can't pass over my costs to consumers so I have to do everything I can to minimise my portfolio risk. If all traders are working to minimise their portfolio risk then the risks of the whole German portfolio are also much lower."
By seeking the highest price, traders also help consumers across Europe. When traders offer more of their power supply to higher price zones, this helps bring the price down and pave the way for price convergence. Cross-border transmission bottlenecks, however, can be a problem, blocking the way for efficient trade, and demand for grid capacity from traders indicate where long-term investments in the grid could be most beneficial.
Towards free market
The German premium payment system is clearly an intermediate solution; renewable producers have not been thrust into a completely free market yet. While the mechanism basically ensures FIT-equivalent revenues, it introduces a variable, because the payment is based on average German electricity prices while the actual prices, locked in through trading, perhaps in dealings outside of Germany, may be higher or lower. Producers choose on a monthly basis to operate through FITs or direct to market.
Since January, the number of market participants taking the direct-to-market option has grown, and wind farms representing more than 75% of German installed wind capacity are now in the system. This has meant more work for wind energy traders, whether they hail from independent commodities trading firms or trading divisions of utilities. It may make sense for large as well as small wind producers to hire a trading house, which can hedge risks through a diverse portfolio of wind and other power assets. "We can supply wind farms with power purchase agreement contracts," says Kring. "We can take on the risk because we can minimise it in the market by trading."
A sign of the system's success is that the management fee component of the purchase price is to fall faster than initially foreseen as traders and producers have been managing the process well and making a profit. Germany's parliament last month agreed to reduce the fee to EUR6.5/MWh next year, down from this year's EUR12/MWh and significantly below the EUR10/MWh fee originally planned for 2013.
From 1 January, an additional payment will be introduced in the market premium model for wind-energy producers that can curtail production when supply exceeds demand. This could start at EUR1/MWh rising to EUR2/MWh by 2015. Trading houses will install remote-control systems to issue curtailment orders directly on the trading floor when the wind is blowing but demand for power is low and prices dip below zero.
Curtailment often indicates a market failure, namely a lack of transmission capacity to send wind power to places in Europe where there is demand, and grid investment is needed to alleviate such congestion points. Yet, even though there is more renewable energy on the exchange there has been relative price stability and a reduction in negative price occurrences, according to Epex Spot, thanks to the liquidity already on the market and the day-ahead market coupling between Germany, France and the Benelux countries - exchange connections that help bring price convergence.
As an increase of wind power comes online from new offshore wind farms in northern Europe, the potential for negative prices remains a critical issue. With a track record of less than a year, there are also some kinks in the system that need to be worked out. Traders note that German TSOs have rarely, if ever, informed them of wind power curtailments, making it more difficult for them to balance power portfolios. And turbine manufacturers have sometimes balked at releasing wind farm supervisory control and data acquisition (Scada) reports and vital data collation, complicating wind forecasting - something that is vital for wind energy traders.
Indeed, wind traders are also wind forecasters. "Much data, time and money can be invested to improve the quality of the forecast," notes Pedretti, "for example, by improving the calibration of the forecast, by providing historical production data from neighbouring wind farms, having instant updates regarding unplanned outages or enabling a short-term production data feedback to improve hourly forecasts."
The timing of wind energy forecasts is key to lowering costs and requires trading systems to be flexible. "We know that the closer we are to trading real time, the more accurate forecasts are and the better you are able to integrate wind in a cost-efficient manner by minimising balancing requirements," notes Paul Wilczek, senior regulatory adviser at EWEA. The Epex Spot exchange has helped set the stage for more wind-energy trading with the addition last December of contracts under which power is sold in 15-minute slots, in addition to the existing contracts covering one-hour periods. In the German TSO zone, these power contracts can be traded on the exchange until 45 minutes before delivery begins, the shortest lead time in Europe.
Germany, although not going as far in opening the market, is following the lead set by Nordic countries and in particular Denmark, which paved the way for wind energy trading more than a decade ago with full market liberalisation. Denmark has consolidated experience trading wind portfolios in the Nord Pool-operated day-ahead auction market - Elspot; and the intraday market - Elbas. Trading houses that started in Denmark are using that experience in Germany.
"Management of wind-power production on a traded market is only possible and required where the regulation allows for it," says Pedretti. "Wind-energy trading is most sophisticated in Germany, Scandinavia, Spain and, increasingly, Romania and Poland."
Spain's six a day
Emerging wind markets Romania and Poland have introduced incentive systems based on green certificates, which exposes producers to more power price risks than a FIT system. Spain, Europe's second largest wind-power producer after Germany, represents a mixed-bag for traders. While Spanish wind producers are responsible for balancing costs, and have invested heavily in forecasting and participate in intra-day trading to correct imbalances, the market is made up of six consecutive intraday auctions for power rather than the continuous trading preferred by most traders.
In a recent report on furthering development of Europe's internal energy market, EWEA calls for the extensive use of commercial power trading, advocating a regulatory framework that promotes commercial power exchanges and adopting market rules that facilitate their use. "Market rules should be established that draw from best practices, particularly those from the Nordic power markets," says Wilczek. "One of the best practices is simply the sheer level of co-operation and communication between Scandinavian countries. Their TSOs are co-operating and communicating, and are quite transparent when it comes to anything related to energy exchanges." Another best practice, Wilczek adds, involves implementing measures at a European level for market liberalisation and creating an internal energy market with common rules for cross-border trading and network access.
The most progress has been made on integrating day-ahead markets across Europe. But for intraday power markets, even among those European countries that do have them, the gate closure - the moment ahead of delivery when generation schedules must be finalised - varies between Germany's 45 minutes and the 22-hour lead time required in Romania. Nonetheless, while Europe looks set to miss the 2014 deadline for achieving an internal energy market, most member states are moving in the right direction.
Wind is expected to be increasingly less sheltered from the European market as it evolves. "If the general direction is towards more market integration of wind energy - for example through certificate systems, direct to market and bonus (price) elements - then wind producers will be increasingly faced with the problem of what to do about the risks inherent in wind production," points out Pedretti. Handling that risk is prime material for wind energy traders.
HOW IT WORKS - A DAY AT THE TRADING DESK
"A trading day starts before the day actually arrives," says Anders Kring, head of renewables trading at Danske Commodities, a Danish energy trading house that includes electricity from wind turbine owners as a commoditity that it sells. "The day before delivery we have to tell the TSO (transmission system operator) what power we plan to feed into the system, and that afternoon we start making updates and monitoring to see if we need to buy or sell more power for the next day."
Adjusting trading positions continues through the night, as production forecasts are updated. These adjustments could entail buying or selling power in the domestic market or across Europe, both on power exchanges and by dealing directly with other trading houses in the 28 countries in which the trading house is active.
"We have internal price models indicating where we think prices will increase or decrease and, based on our trading positions, will start trading out (selling) when we think we'll get the best prices," says Kring.
While traders are on hand 24 hours a day, seven days a week, liquidity can be a problem during the night and at weekends, he says, although experience with Germany's new market premium system on the Epex Spot exchange (see main feature) is encouraging. Having stimulated trading of wind power, liquidity has improved month by month.
Along with buying and selling of power, dealing in transmission capacity rights for cross-border trades is also part and parcel of a trader's day. "It is a very big part of our job to make sure we have flexibility on the power grid," says Kring. "Sometimes transmission capacity can be very expensive and other times it can be free, but the expensive capacity can end up being worth nothing and other times the free transmission rights can be worth a lot."
As with other elements of risk inherent in trading wind energy, trading houses have developed market models on transmission capacity. The strength of their models is one way in which trading houses can compete.
For a variable source of power such as wind, hedging is particularly important - a broad portfolio of assets provides a natural hedge. "We have wind assets in northern Germany, others in southern Germany, some in Sweden and Denmark and others throughout Europe," says Kring. "Maybe we are expecting wind in northern Germany and it comes in the south, but our overall position is the same so it really doesn't matter. We also trade in options and are developing virtual power plants in which you place different assets together in a portfolio that you balance."
Both hydroelectric and solar assets are good to combine with wind. Solar, notes Kring, fits well with wind "because the correlation between wind and solar is negative, meaning that when the wind is blowing the sun tends not to be shining".
The job of a wind energy trader can be stressful. Reams of information have to be managed, including sending extensive information on dispatching to TSOs throughout Europe. The market is also developing quickly. "Prices are changing all the time," he says.
REAL-TIME TRADING - STEP-BY-STEP GUIDE
Danish green-energy trader Danske Commodities buys wind production in Europe under power purchase contracts, selling it on to power exchanges and wholesale market suppliers for onward purchase by retail suppliers of electricity and large end users. This buying and selling of electricity by traders is continuous over a range of timescales and each trading house has its own approach and systems. Power is mixed and amalgamated into larger and smaller blocks to create the right product for the best deal at any given moment, whether that is months before it is required or within the hour. Typical for real-time trading of power from a Danske Commodities customer portfolio is the simplified process described below.
Day before delivery
- Weather specialists and traders prepare wind-farm production forecast for next day
- Traders prepare curves for day-ahead auctions and offer to exchanges or bilateral counterparties such as utilities. In Germany the deadline is 12noon
- Exchange publishes results of auction at 12.40pm and winning renewable energy traders who submitted the lowest offers sell forecast production to market at prices set by the auction
- Traders and dispatchers notify the relevant TSOs - there are four in Germany
- TSOs signal acceptance of the nominated power
- Weather specialists and traders continuously update wind-farm production forecasts and trade the expected imbalances in intraday markets
- All trades are notified to TSOs
Day of delivery
- Weather specialists and traders continuously update wind-farm production forecasts and trade the expected imbalances in intraday markets (exchanges and bilateral counterparties across Europe)
- All trades are nominated to TSO and production plans are updated
After delivery (days or months)
- Traders receive notification of actual production sold and calculate imbalances
- Cash-flow settlement theoretically occurs within the following month plus 20 days within the framework of the European Federation of Energy Traders
- Traders continuously secure cross-border transmission capacity through yearly, monthly, daily and hourly auctions to have maximum flexibility when power is sold.