Having successfully completed the second of five virtual power plant (VPP) auctions last week, Spain's Iberdrola and Endesa look set to meet their target of freeing up a maximum of 3,825MW capacity. As Germany's E.ON follows suit with its 250MW base-load offering for today's auction, Verity Ratcliffe considers the future for capacity auctions and whether the technique will succeed in opening up the market to smaller power buyers and boosting the market's liquidity.
VPP capacity means that buyers have the right to negotiate power generation from sellers' plants without owning them. The buyer can produce power on the basis of an exercise price that is set in advance.
VPP auctions aim to adjust incentives to promote the participation of smaller buyers of electricity. They achieve this by offering different-sized chunks of capacity owned by a seller or a group of sellers (like Iberdrola and Endesa together for example).
The companies can buy small amounts of capacity with relatively low risk. In turn, this increases the buying pool and promotes greater forward contracting.
The technique has been used in France, Belgium, Netherlands, Denmark and Norway.
The Spanish situation
Liberalisation of the Spanish electricity market has been in the 'development stage' for over a decade. Between 1998 and 2001 the initial steps resulted in a period characterised by a relatively competitive but non-sustainable electricity market with wide price fluctuations.
By 2006, the government saw the need to respond to the market's deficit peaks. The increase in regulation implicit to this process impacted on the perceived viability of the market for new entrants. In addition, some saw this stage as a step back from liberalisation.
Independent power companies abandoned the market as the climate was deemed unfeasible for players without generation assets - so the government decided to counteract the trend. A new tariff methodology and VPP auctions were introduced with an end date of 2009 in mind for the completion of the liberalisation process.
The government mandated the two main utilities - Endesa and Iberdrola - to hold a series of five VPP auctions, thus commencing Spain's first capacity auction.
The VPP auction response
The auctions are conducted on the internet using the 'ascending clock' method with two different products on the auction block - peak and base-load capacity - and with the option to purchase durations of 3, 6 or 12 month units. Indifference curves are used to allow the bidders to switch between the different product durations within the base and peak products. Bidders must be production agents in Spain to qualify.
The main players:
CNE - Supervisor of the auction
Endesa and Iberdrola - Sellers in the auction
MEFF - The central counterparty and nomination aggregator
IBM - The auction organiser
Deloitte - The monitoring trustee
The first auction was held on 13th June. The base-load exercise price was set at 17€/MWh and the peak-load at 52€MWh.
The second auction was held on 13th September. The base-load exercise price was set at 22€/MWh and the peak-load at 51€MWh.
E.ON's first VPP auction
The stage is now set for E.ON Energia's first VPP auction. 250MW of power generation capacity is on sale today with a maximum of 30MW per bidder. Should this prove a success, E.ON intends to continue selling capacity in this way.
The company has been drawn to the method as it supports active energy exchange that will assist it in the long-run as it should bring more participants to the electricity market. This will be good for competition and should prove to be a stabilising influence on electricity prices.
The future for VPP auctions
In many ways, Spain's starting point for the auctions is unique. As a result, the success of the auctions will be determined by their ability to remedy previous problems and their capacity to meet the liberalisation agenda too.
A recurring criticism of the pre-VPP auction era was that so-called forward markets - OMIP (Iberian energy spot market) and OTC - had not evolved in Spain as in other European countries. The development of these markets will prove to be the overriding litmus test for the project.
Having completed only two of the five VPP auctions, it is still not clear whether they will prove a success - but interest from bidders seems good. The first auction - which was held in June - represented a tentative step into the unknown. A total of 15 bidders took part on this occasion.
The second auction was significantly larger both in terms of energy volume - which was 50 per cent greater - and the number of participants. 17 bidders participated - 13 of which were foreign - and Endesa expects this figure to rise for the final three auctions.
Juan Ignacio Gonzalez Ruiz (partner) and Maco Descalzo (associate) from Spanish law firm Uria Menendez advised on the legal issues associated with the auction. Commenting on the possibility for more capacity auctions in Spain in the near future, Gonzalez Ruiz says: 'While in the beginning Endesa and Iberdrola may have been resigned towards having to carry out the auctions, the success of the auctions may mean others will want to join in the future.'
Germany's auction today suggests a tentative step into the world of capacity auctions with just a small slice on the auction block. Should this prove successful, follow-up auctions should be expected.
Certainly, experience in other countries would suggest that auctions breed more auctions - Dong's offering pattern in Norway is indicative of this. In 2006, the company offered 250MW capacity. This year the figure stands at 500MW which is to be stepped up next year to 600MW.
At present, pressure is coming from national governments, consumers and the European Union to increase fair competition between providers - only today the Commission announced plans for controversial market liberalisation.
At the same time, power producers are becoming fully aware of the long-term benefits from opening up the purchasing market to a greater pool of buyers. As it stands there appears to be very little in the way of a continued stream of VPP auctions.