1) Market integration and new interconnections like the Nordlink cable between Germany and Norway provide significant benefits through more efficient utilization of generation resources, increased competition, and lower consumer prices across Northwestern Europe and the EU. 2) New interconnections create value by exploiting hourly, daily, and seasonal price differences and helping integrate intermittent renewable resources. However, localized capacity markets could reduce this value by limiting cross-border competition and revenue opportunities. 3) Capacity mechanisms should not promote purely local solutions and should not distort the incentives created by market integration and interconnections. Coordinated, cross-border capacity markets are preferable to avoid increased costs over both the short and long-term.

2. Berlin, October 23rd 2012
POTENTIAL CONSEQUENCES OF CAPACITY
MECHANISMS ON THE PLANNED NORDLINK
CABLE
Arndt von Schemde,
Partner, THEMA Consulting Group

3. European integration in electricity
Markets Investments
3

4. Key questions
1. What are the effects of market integration?
2. What are the effects of new interconnections?
3. How could capacity markets have an impact of the
effects of market integration and on interconnections?
4

5. Key questions
1. What are the effects of market integration?
2. What are the effects of new interconnections?
3. How could capacity markets have an impact of the
effects of market integration and on interconnections?
5

6. Effects of market coupling (1) – efficient utilization
Wrong Capacity not
Flow vs. price on direction utilized
German-Danish border
prior to market coupling
Capacity not Wrong
utilized direction
Flow vs. price with
market coupling
6

7. Effects of market coupling (2) – social welfare
• Model estimates
300 North-West Europe EU 27 273 for North-West
Europe
250 • EU 27 results
obtained by
scaling up
€ mill per annum
200 175
164 results
• Value of market
150 integration likley
105 to increase with
increasing
100
shares of RES
50
0
"Small mistakes"
Low estimate "Large mistakes"
High estimate
Source: THEMA Consulting Group
7

8. Effects of market coupling (3) – consumer benefits
Distributional effects for Northwest Europe
Consumer surplus Producer surplus Congestion rent • Clear benefits for
1 200 consumers,
961
1 000 driven by overall
728 lower prices (up
800 to € 1.6 bill p.a. if
600 scaled up for EU
27)
€ mill per annum
400
• TSOs lose cable
200 income: price
convergence
0
• Nordic countries:
-200 -71 -66 water values
-400 increase – similar
effect as cables
-600
-552
-800
-731
-1 000
Low estimate
"Small mistakes" "Largeestimate
High mistakes"
Source: THEMA Consulting Group
8

9. Effects of market coupling (4) – non-quantifiable
• Capacity is optimized taking into account all bids and offers in all markets
participating in the market coupling, creating larger markets and more
Competition competition – promoting price conversion across borders and regions.
Forward markets – • Reduced need to hedge – larger markets absorb uncertainties/risks
• Improved ability to hedge – integration promotes more liquid forwards
the need and the
ability to hedge
• More efficient utilization of the resources in the power system promotes security
of supply. This is becoming more important with the inclusion of more RES.
Security of Supply • Expected improvements in algorithm will further promote SoS
• More money to invest – improved ability (and reduced need) to hedge
• More efficient investments – better price signals / incentives
Investments • Reduced need to invest – more efficient utilization of existing resources
• Implicit auctions across regions promotes efficient optimization of a more
complex power system
RES integration • Efficient market coupling is thus key in promoting efficient inclusion of RES and
the in the transition towards a carbon neutral future
9

10. Key questions
1. What are the effects of market integration?
2. What are the effects of new interconnections?
3. How could capacity markets have an impact of the
effects of market integration and on interconnections?
10

11. Expanding the geographical scope
POLITICAL AMBITIONS Integrating the power system Integrating the markets
 Grid in Norway National and regional market
TRADITIONAL FOCUS  Nordic interconnections development and cooperation
 Security of supply
 Efficiency
 Nature conservation
… EXTENDED AGENDA  Growing need for grid and Regional, interregional and
FOR EUROPE interconnections European market integration
and cooperatioon
 Climate change
 Independence from
import of fossil fuels
 Energy transition
11

12. Value created by differences
Annual variations Peak/off-peak Intermittency
12

13. Value creation along several variables
Effects for consumers
Cable income Other effects
and producers
 Arbitrage via hourly price  Cables have price effect Same effects as market
differences  Price decrease benefits integration
 Flat prices in Norway, due consumers, price increase  Competition
to hydro benefits producers  Security of supply
 Volatile prices Germany,  The sum of effects is  Climate and RES
due to thermal capacities positive integration
and RES  Germany: likely lower  ….
peak prices
 Norway: In surplus
slightly higher prices,
in deficit lower prices
13

14. Effects of interconnections - congestion rent (CR)
Historic prices (a typical Monday)
CR – from
Power price (€/MWH)
NOR to GER
To Norway
from Germany
CR – from
GER to NOR
To Germany
from Norway
Price Germany
(historic)
Price Norway
(historic)
Hour
14

15. Effects of interconnections - congestion rent (CR)
Scenarios:
1. Nordic power balance - low value of flexibility Price volatility
2. Nordic power balance – high value of flexibility in Germany
3. Nordic surplus – low value of flexibility
4. Nordic surplus – high value of flexibility
2008
2006
2007
2 3 2005
2003
2009
2002 1 4
2010
Very high
2004 High
Medium
Low
Price differences between Germany and Norway
15

16. Key questions
1. What are the effects of market integration?
2. What are the effects of new interconnections?
3. How could capacity markets have an impact of the
effects of market integration and on interconnections?
16

17. Do we need capacity mechanisms?
Is this enough, or do
we need capacity Make sure capacity
Other European markets? mechanisms act
grid investments
neutral w.r.t. other
Internal German measures and
connections
incentives
NordLink • Capacity markets
should resolve a
Integration of form of market
balancing markets failure
Flow based • Make sure capacity
market coupling markets do not
create new market
More demand flex failures
Integration of
intraday market
Market coupling
Market integration Grid and
and development interconnections
17

18. Will a capacity market distort the effects of integration?
The energy transition need
? interconnections and more
flexible demand/generation
Reduce value by …but capacity markets may
“cutting the price reduce their income,
peaks”? including the income of
NordLink
• Flexibility is traded outside
Reduced the regular markets
• Limited (or no) access for • Costs to German
competition by consumers
Norwegian generators
blocking market • Reduced incentives to • Income to German
access develop competitive flexible generators
sources in Norway and to • Lost opportunities to
build interconnections to Norwegian generators
Germany
18

19. Local capacity markets could impact revenues
Scenarios:
1. Nordic power balance - low value of flexibility Price volatility
2. Nordic power balance – high value of flexibility in Germany
3. Nordic surplus – low value of flexibility
4. Nordic surplus – high value of flexibility
2008
2006
2007
2 3 2005
2003
2009
2002 1 4
2010
Very high
2004 High
Medium
Low
Price differences between Germany and Norway
0
19

20. Capacity mechanisms should not be local solutions
Not taking account of
X-border capacities
would increase cost of
solution High cost
• Short-term: Higher
costs associated
with utilization of
existing resources
• Long-term: Higher
costs in addition Low cost
Ideal
due to different Cap.mrkt.
investments
Local solutions Cross-border solutions
Short-term Long-term
20