The start of the single Iberian electricity market presents new challenges for market players. The benefits of the new market will eventually be seen, however, including increased competition, reduced transaction costs and greater coordination between system operators.
By July, Mibel – Mercado Iberico de Electricidad, the Iberian electricity market – should be up and running, the anticipated start date being 20 April 2004. However, given the ambitious timetable, coupled with the change in the Spanish government, will there be the political will to drive the changes through? If the necessary changes are made, what benefits might there be for consumers, energy companies and government?
The timetable for the introduction of Mibel was such that many commentators questioned whether it was realistic – especially when the Spanish elections were due in the interim. The elections duly took place in March and the result gave a surprise victory to the socialist party, Partido Socialista Obrero Español (PSOE). The emerging energy agenda of PSOE is far from clear. There are reports which suggest conflicting directions: PSOE is said to be pro-competition; there are also reports that the possibility of large mergers and acquisitions, which were stifled under the conservative government, is back on the cards.
Figure 1. Timeline for Mibel
Assuming Mibel does thrive despite the uncertainties, its introduction could result in a number of changes for players in the Spanish and Portuguese markets.
Background to Mibel
On 14 November 2001 the governments of Spain and Portugal signed a cooperation protocol where both administrations agreed to introduce the ‘Iberian Electricity Market’ (Mibel) on 1 January 2003. The objective of the Iberian market was to guarantee market participants in both countries access to a new Iberian market operator and to interconnection with other countries under equal conditions, and freedom to engage in bilateral contracts.
Matt Brown, Principal Consultant, ILEX Energy Consulting Ltd., Oxford, UK
In May 2002 the regulatory bodies of both countries presented a prototype model to their respective ministries for the organization of the market together with an implementation plan. The model was reported to envisage a four-year initial regulatory stage (2003-2006) during which both regulators would work towards a common regulatory system. OMEL, the Spanish market operator, would become the Iberian market operator and the two system operators (REE in Spain and REN in Portugal) would co-ordinate their actions.
In October 2002 the heads of state of both countries agreed to delay the formal start of the regulatory stage until March 2003, when the single market operator and the co-ordination mechanisms of the two system operators would be in place, and it was agreed that OMEL should operate the spot market, with OMIP (the Portuguese operator) running the long-term futures market.
Further delays occurred in early 2003, and it took until November of that year for the two governments to sign a Memorandum of Understanding agreeing the broad principles of the market.
Finally on 20 January 2004, the Prime Ministers of both countries (at the time Jose Maria Aznar and Jose Manuel Durao Barroso) ratified the agreement for Mibel, specifying a start date of 20 April 2004.
Design and structure
The latest market information suggests that the market will have two market operators, one in Portugal and the other in Spain, to be fused together after two years. There will be three types of market contracts:
- spot markets for daily trading
- a forward market for trading up to one year
- bilateral trading for contracts of over a year.
How the demarcations of forward contracting will be ‘policed’ is less clear. It is also not clear yet whether Mibel will have a single Iberian market price with socialization of resulting Spain-Portugal constraints costs, much like the BETTA model for Great Britain, or whether Mibel will have two price zones for Spain and Portugal, with market splitting carried out within the Pool, much like Nord Pool.
One possible change will be with the power guarantee in Spain, as there may be a new capacity payment mechanism for Iberia as a whole. It appears unlikely that the current integral tariff in Spain will be changed as a result of Mibel.
A major difficulty on the road to fusing the two markets has been Power Purchase Agreements (PPAs) in the Portuguese market, or Contracts to Acquire Electrical Energy (CAEs). These long-term contracts have to be renegotiated. It is the CAEs that form the bulk of the stranded costs in liberalizing the Portuguese market, referred to as the Costs required to Maintain the Contractual Equilibrium (CMECs). According to recent press reports, Electricidade de Portugal’s (EDP) PPAs have been negotiated successfully, but Tejo and Turbogas (two project financed power stations) are both having difficulty due to negotiations with their large syndicates of lending banks.
Overall, the Iberian market initiative has triggered a wave of reviews of the markets in both countries, where all sides would like to address their problems while protecting their positions at the same time.
Each of the participants in the new market has been aiming for very different outcomes depending on whether they are a regulator or market participant; a supplier or generator; an incumbent or new entrant. The regulators are looking for ways to make the market more competitive, such as:
- addressing market concentration and the vertical integration of the participants – to reduce the potential for market dominance or manipulation
- introducing new wholesale market rules
- introducing market-based mechanisms to guarantee sufficient generation capacity
- giving more publicity to producer prices
- modifying the rules for bilateral contracts
- introducing a market-based system of incentives to support the construction of new renewable generation capacity, to replace the current systems of fixed subsidies in both countries.
Incumbent generators in Spain would like to take this opportunity to review the current tariff system that they (rightly) consider insufficient to cover the total generation costs of building new capacity and may not allow the recovery of the outstanding balance of stranded costs – the Costs of Transition to Competition (CTCs). They also want to protect the very favourable terms under which they have invested in renewable generation during the last four years.
Figure 3. Generating capacity split by type across Iberia
Both Spanish and Portuguese commercial players want to ensure that the conditions for doing business will be identical in both countries, so that there are no unfair advantages to any one side of the border. They would like to see harmonised tariffs on both sides and greater certainty in the tariff setting mechanisms.
Portuguese generators are concerned that the price of Algerian gas for generators in Portugal may be higher than in Spain, representing a competitive disadvantage, and would like to see a single Iberian market for gas. They are also concerned by the prospects of their current long-term PPAs being terminated, and the possibility of a difficult negotiation for the recovery of stranded costs.
Consumer groups on both sides would like to see more competition and lower prices but, at the same time, better security and quality of supply. They would welcome the replacement of fixed subsidies for renewable energy generation with more competitive market-based mechanisms, such as renewable certificates trading, as well as competitive arrangements to guarantee sufficient reserve capacity for generation. They would also want the single market to be one where the rules are the same for any participant on either side of the border, including those relating to tariffs and service levels.
Fusing the two markets together does not make Mibel much bigger than the Spanish market, due to the comparatively small size of the Portuguese market.
Spain and Portugal are interconnected with about 600 MW of capacity on average, which varies through the year. This capacity is due to increase over time, initially to stabilise at around 1000 MW and then to grow to around 1800 MW, on average. This is in the context of a combined market of 44 000 MW peak demand with growth projected at around four per cent per annum in both countries.
Historically, the interconnector flows have been two-way, although greater from Spain to Portugal. Our modelling of the Iberian market would suggest that, in the medium-term, flows would be predominantly in the same direction, dependent on hydro availability. However, the extent over time of new generating capacity additions in each of the countries will determine the direction of flows in the longer-term.
The mix of generation types in Spain and Portugal is shown in Figure 3. Both countries have a dependence on hydro. Portugal’s hydro production is more volatile than Spain’s, although Spain has a high degree of variation also. The combined mix of generation types does not appear to afford a higher degree of either fuel mix security or reliability. Portugal has no nuclear plant but otherwise has a similar fuel mix to that of Spain.
The ownership of generating plant is given in Figure 4. The marked difference between Endesa and Iberdrola’s generation mix is evident. It is this that has led to the different stances assumed by these two companies over the introduction of emissions trading. In Portugal the two IPPs, International Power’s Tejo and Turbogas (whose main shareholder is RWE) provide some competition to EDP. It should be noted that EDP has a 40 per cent stake in Hidrocantabrico.
Herfindahl-Hirschman indices (HHIs) for the generation markets and for the supply markets are shown Table 1. HHIs of around 1500-2000 are usually considered to denote a reasonably competitive market. On the face of it the combination of the markets would appear to ameliorate concentration concerns in both markets.
It is against this backdrop that Mibel can be judged. In the Portuguese market EDP’s position is one of dominance. If the Portuguese market were to remain in isolation, calls for EDP to be broken up would inevitably be considered. In the context of the Iberian market, however, EDP’s size brings some real competition to Spain’s incumbents.
However, in practice the benefits to competition in generation will be limited by the size of the interconnection. The benefits in supply, certainly at the small customer end of the market, may be difficult to realise, especially in Portugal where there may be resistance to supply by Spanish companies.
It is generally expected that prices in Portugal will fall as a result of Mibel. This may well be true at the wholesale level if, for instance, there is a single price for Iberia. If there is a two-zone model then price differentials will continue to exist giving a result similar to that if there were a separate market in Portugal with explicit auctioning of the interconnector capacity.
In terms of retail prices the impacts will depend largely on the tariffs in both countries. In Spain the integral tariff gives customers fall-back insurance against an increase of retail prices. In Portugal, the timing of full liberalization, the way in which tariffs are dealt with, and how these interact with the Spanish position, will be key. This is doubly true in the light of the impact of the EU emissions trading scheme on the costs of electricity from January 2005.
The benefits of Mibel
At the heart of Mibel is the liberalization of the Portuguese electricity market. This market could have been restructured along different lines to that used in Spain, and in a way that could have given similar results in terms of competition and price impacts, perhaps with less cost.
The ability of Portugal to argue for keeping its national champion, EDP, whole, while at the same time giving a perception of bringing greater competition to Spain, would seem to be a main driver behind the form that Mibel and liberalization in Portugal has taken.
However, benefits may well accrue. Having similar trading systems on both sides of the border will no doubt reduce transaction costs and may lead to greater competition in Iberia in the long-term, as a result of making it easier for utilities to trade. At the same time restructuring the generation market in Portugal and dealing with legacy contracts will have benefits for competition. Prices may fall in Portugal due to this increased competition, and greater coordination between the system operators may reduce transmission costs.
If Mibel does come through a difficult birth and is given support by government and regulators to flourish, then tangible benefits are sure to be seen in the longer-term.