Electricity Markets Pricing Structures and Economics by Chris Harris

Electricity Markets Pricing Structures and Economics

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Preface to Electricity Markets Pricing Structures and Economics PDF

I have had much assistance from my friends and colleagues, who are experts in the many fields covered in this book.

I have consistently found disapproval at the inevitable oversimplification of their disciplines, coupled with an appreciation of accessible explanations of other disciplines.

Whilst I believe that I am justified in my obstinacy in maintaining this compromise in order to pursue the multidisciplinary approach that I believe to be essential in constructing a market design,

I do apologize for the compromises to depth and purity and request that the reader views the descriptions as introductory and explanative, rather than definitive, and invite her and him, when requiring further knowledge, to read the excellent textbooks available, some of which are included in the references.

Introduction to Electricity Markets Pricing Structures and Economics

In the last part of the twentieth century, electricity had moved backstage after its supporting role in the ‘white heat1 of the technological revolution’. With the technology apparently solved and delivered, the Electricity Age2 was a forgotten age, surpassed by the Information Age.

It has been suggested that the age we are entering now is the age of Natural Capital, in which resource depletion and environmental impact become key drivers.

Given that electricity delivers almost all energy that is not muscle power or used directly by the combustion of organic and fossil material, electricity may again play center stage.

The Electricity Supply Industry (ESI) market solutions must match the big picture policy solutions and contend with complex and interactive issues.

Buchanan, in ‘the Power of the Machine’, published in 1991, stated that ‘One way or other, it is probable that the comparative stability of power technology enjoyed in the present century cannot be maintained much longer’, citing the energy crisis which begins to loom, and the insufficiency of the pace of technological change (particularly in this case in relation to nuclear fusion power and renewable technology).

Indeed it is a common, if not universal, view, that in the interval between the fossil world and the new renewable (and possibly nuclear) world, the economics of providing fossil fuel-fired generation at a similar price to today, will not stack up in the 21st century in the circumstances of source depletion and increasing costs of environmental impact abatement.

The question is the extent to which the industry can bridge this gap without substantial and sustained state intervention in consumption.

Perhaps the most universal change in the ESI in the ten years either side of the millennium has been and will be, the increase in market orientation, caused by the general increase in market activity in other commodities and products, the pressure on the industry, and the organizational response of the ESI in facing new challenges.

Whilst the overall paradigm to which the ESI is evolving, in response to policy change is broadly similar in almost all countries, the pace and stages of development differ widely, and ideal ESI structures are highly dependent on local factors such as political ideology, climate, and indigenous energy endowment.

This book is about markets, and how the structure of markets and behavior of participants can and do cause prices to respond to drivers such as consumer needs, energy endowment, capabilities of physical installations, regulatory impositions, and policy objectives.

It is intended to inform, rather than promote, attack, defend or apologize for markets, but undoubtedly any textbook is colored by the background and opinion of the author.

I believe in the potential of competitive markets to deliver an industry performance that is aligned to energy policy with a socially determined tradeoff between costs/disbenefits and benefits.

I believe that the challenge, albeit a great challenge, is essentially a technical one, which can be achieved by better communication to stakeholders of the interdependencies of issues and better design of the whole marketplace of which electricity is a part.

There are three reasons for this belief in the potential of competitive markets to deliver a policy solution;

Firstly, markets are efficient vehicles for clearing quantitative information concerning preferences of diverse and interdependent issues for a multitude of participants, at least at the margin.

Where whole markets fail, it is largely because the market structure is such that specific important information, such as the impact of production on society, is absent, and therefore the market is incomplete.

The challenge is to make the market complete enough to capture all of the important signals (such as environmental costs) without making it too complicated to understand and administer.

Whilst the inter-relationship between produced goods (electricity) and simultaneously produced bads (e.g. emissions) has added a whole new layer of complexity, the gradual increase in commoditization is making these tractable.

In addition to this, we will show that the increasing use of traded options can overcome some of the greatest problems of market incompleteness for single commodities, namely the capture of preferences not just for certain conditions at the margin, but for a variety of scenarios, with different probabilities.

Secondly, through the profit motive, markets create the incentive for efficiency, particularly if the market signals (which become manifest as prices) are clear, strong, stable, and visible in the long term.

Where market power occasionally causes ‘excess’ rent to some participants, it is largely because the long term signals have been ineffective and therefore that a market scarcity could not be addressed by the timely new entrances.

When this occurs, it is a result of poor market structure, poor communication, unstable policy, or poor regulation. These two reasons are well known, and much discussed. It is the third reason that has excited me so much during my years in the industry.

A proper functioning market, with efficient signals, has a third benefit, and that is to reward innovation, and specifically ‘routinised3 innovation’ at a day-to-day operational level.

This is, in my view, a feature that is more important in the ESI than in any other industry, and the reason arises from the physical nature of electricity.

Main Contents of Electricity Markets

  • The Basics
  • Structure, Operation, and Management of the Electricity Supply Chain
  • Policy – Issues, Priorities, Stakeholders, Influencers
  • Liberalization, Deregulation, and Regulation
  • Market Structures for Electricity
  • Power Capacity
  • Location
  • Environment, Amenity, Corporate Responsibility
  • Price and Derivatives Modelling
  • Economic Principles in Relation to the ESI
  • Financial Modelling of Power Plant
  • Security of Supply

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