Day Ahead Markets: A new hope or a phantom menace?

The Independent Review into the Future Security of the National Electricity Market[i] chaired by Dr Alan Finkel AO recommended that by mid-2018, the Australian Energy Market Operator and the Australian Energy Market Commission should assess “the suitability of a ‘day-ahead’ market to assist in maintaining system reliability”.  So what’s a “day-ahead market” and will it help?

Principles of Day-Ahead Markets

A day-ahead market is a voluntary, financially-binding forward electricity market, in which buyers and sellers bid to trade volumes of electricity for the coming day.  From these bids a dispatch schedule for each of the day’s intervals is prepared (subject to network security and other constraints), which is adjusted on the day for actual supply and demand and real-time constraints.  This actual supply and demand is handled by a separate, real-time balancing market (like the existing National Electricity Market).  Although participation in day-ahead markets is voluntary, typically a large proportion of the day’s volumes is covered by the trades.

The day-ahead market has the characteristics of both a financial market and a physical market.  It is a financial market in that participants can buy and sell electricity on the market with no obligation for physical delivery, and a physical market in that the trade of electricity can be settled by the physical transfer of electricity.

Since it’s a forward market, it can help generators and loads to hedge against exposure to pricing and scheduling risks, and demand-side participation is also facilitated by having clear price signals well in advance of the time needed to act.

Overseas Examples

Day-ahead markets have been implemented in most European and North American markets.  In Europe it is part of the “Price Coupling of Regions” project which is developing a harmonised European electricity market with a single price coupling solution used to calculate electricity prices across Europe on a day-ahead basis, respecting the capacity of the relevant network elements.  The integrated European electricity market is expected to increase liquidity, efficiency and social welfare[ii].

In North America, day-ahead markets are present in most major markets, including California, New York, PJM (which coordinates electricity for 61 million people in 13 states and the District of Columbia) [iii] and the Electric Reliability Council of Texas (ERCOT), which manages around 90 per cent of the state’s electricity load.

Benefits of a Day-ahead Market

The benefits of a day-ahead market are that it:

• Allows generators to schedule slower-start units better to meet forecast demand;
• Increases system reliability by providing sufficient notice for plants to be scheduled;
• Provides market signals to demand-side management providers, encouraging greater participation, and providing the benefits of enhanced system reliability, cost reduction, improved market efficiency, better risk management, environmental benefits, customer service improvements, and market power mitigation[iv];
• Reduces the impact of uncertainty in real-time market prices, because a smaller proportion of generation is exposed to real-time price volatility;
• Increases liquidity, as trades can be financial contracts rather than for physical delivery;
• Creates an arbitrage opportunity between the day-ahead market and the balancing market, again increasing liquidity; and
• Allows market-based redistribution of risk.

Disadvantages of a Day-ahead Market

The disadvantages are that:

• Predispatch already telegraphs expected market outcomes therefore any scheduling improvement may be limited;
• If the proportion of fast-start generation increases, the market signals for slower-start generation may not be needed;
• The implementation cost for the new market may be significant;
• The day-ahead market still requires a real-time balancing market; and
• The new market won’t be needed if the real-time market has minimal volatility.

Conclusion

Day-ahead markets are becoming increasingly common around the world, and provide a valuable means of improving the match between supply and demand.  Although there will be costs involved in establishing and participating in the market, opportunities to enhance price discovery and increase market efficiency are to be embraced.

[i] Independent Review into the Future Security of the National Electricity Market: Blueprint for the Future, Commonwealth of Australia 2017

[ii] https://www.epexspot.com/en/market-coupling/pcr

[iii] PJM operates a wholesale electricity market that spans all or part of Delaware, Illinois, Kentucky, Maryland, Michigan, New Jersey, North Carolina, Ohio, Pennsylvania, Tennessee, Virginia, West Virginia and the District of Columbia.

[iv] Peak Load Management Alliance (2002) Demand Response: Principles for Regulatory Guidance