Emerging new energy trading platforms are mushrooming and are set to challenge Eskom’s energy generation and supply monopoly.
Last month, it was announced that renewable energy company Scatec, Standard Bank and asset management firm Stanlib had established Lyra Energy to offer a low-risk, flexible commercial proposition.
This new renewable energy platform is poised to change the South African energy landscape.
Pretty soon the market will be generating and supplying more than Eskom's share of energy.
Trading and liberalisation of energy trading is not a new phenomena. Globally the model has been tried and tested.
These firms are planning a major takeover of the energy trading business. With their combined capacity in capital, human resources and customer reach expertise they will offer an unparalleled energy service trading platform.
This as South African private companies are launching a new trading platform to compete with Eskom’s energy trading platform. This is not new except that there have been a series of previous proposed initiatives like the REDS initiative.
According to research this is how the Lyra Model will work:
- It offers distributed access to high-quality, affordable and predictable utility-scale renewable energy to medium and large commercial and industrial players.
– Lyra’s aggregator model will fund, build, own, and operate generation assets. The energy from these projects will be transmitted or wheeled, to multiple off-takers, across the national grid. Private sector customers or off-takers can expect increasing savings over time.
– Lyra Energy’s objective is to offer private power supply to the previously unserved segment of the commercial and industrial power users in South Africa. More specifically, users with significant electricity demands, which in itself does not justify the procurement and implementation of a dedicated large renewable energy project. This will also provide clients with green energy certifications that are key to achieving individual and global net zero goals.
Each private sector customer will sign a standardised, fixed-tenor Power Purchase Agreement (PPA) with Lyra which has been developed and tailored taking into account market trends, and seeks to address traditional risks and frictions associated with bi-lateral PPA’s and wheeling of energy.
Scatec CEO Terje Pilskog, said: “Underpinned by Scatec’s extensive, well-established development pipeline, including market-leading technical and operational services, the Lyra platform is in a strong position to leverage economies of scale, minimise risk, and ensure successful, consistent generation of clean electricity.”
“As with other Scatec projects, the platform’s new utility-scale projects will be supported by an Integrated business model, with a strong focus on long-term community impact, and sustainable job creation,” added Terje.
I will keep tabs on this exciting venture as it develops in South Africa!
Discovery Green
Lyra Energy already has competition, with a head start. Last year Discovery CEO Adrian Gore unveiled Discovery Green, a renewable energy platform, which opened for business yesterday, that will unlock an investment of roughly R20 billion to R25bn in South Africa’s energy infrastructure.
The platform, developed with the support of RMB, Discovery’s investment banking partner, connects businesses across South Africa to affordable, renewable power generated by utility-scale renewable plants.
Energy platforms are exposed to commodity risks and are energy traders:
Energy trading and risks
The volatility of energy and commodity prices increases the pressure on companies.
Energy suppliers and traders are exposed to extensive risks, which result in particular from the procurement, distribution and trading of raw materials in the form of energy carriers and certificates.
The type and level of risks depend on the individual corporate strategy, for example the type of procurement, the decision on own market access, and especially the selection of an optimal opportunity/risk profile. As a minimum, the following tasks should be dealt with as part of the management of the resulting opportunities and risks:
These include:
– Regular review of the trading and hedging as well as the risk management strategy.
– Review of trading and compliance guidelines
Game theoretic-based energy trading mechanism:
The game theory-based energy exchanging strategy is typically used for developing energy trading models that enable market participants for energy interactions under game theory techniques. This mechanism is more suitable for members who participate in competitive energy environments, and are looking for high-quality and affordable energy interactions
In addition to the aforementioned energy trading mechanisms, there are other mechanisms that are useful for developing effective energy exchanging models in line with the objectives of the related problem.
Trading Electricity
To understand the difference between wholesale energy markets and traditional financial markets, it's important to grasp the nature of trading electricity, compared to financial assets like equities, bonds, and commodities. The most important difference is that electricity is produced and consumed instantly.
At the wholesale level, electricity cannot be stored, so demand and supply must constantly be balanced in real-time. This balancing leads to a significantly different market design compared to common capital markets.
It has also restricted access to the wholesale markets because while the markets are open, their intimidating technicalities have kept less-experienced traders away. Regulators encourage traders to join the markets, but potential participants must show financial strength as well as technical knowledge to be granted access.
Market Organisation and Design
Energy markets are also much more fragmented than traditional capital markets. The day-ahead and real-time markets are managed and operated by Independent System Operators (ISO). These non-profit entities are organized on a physical grid arrangement commonly referred to as network topology.
There are currently seven ISOs in the US. They also act as exchanges and clearing houses for trading activities on different electricity markets.
Regulation in the electricity market
Regulation plays a crucial role in the wholesale electricity market. Governments set policies and regulations to ensure the market is competitive, to promote the development of renewable energy, and to protect consumers from price gouging. Regulators also oversee the market to ensure that energy providers follow the rules and that prices are fair.
The bottom line
The wholesale electricity market differs significantly from traditional financial markets because electricity cannot be readily stored, and supply and demand must constantly be balanced in real-time.
The market is operated by ISOs, which perform tasks like power plant dispatch and real-time power balance operations, acting as exchanges and clearing houses for trading activities on different electricity markets.
The price of electricity is influenced by factors that affect supply and demand equilibrium, with economic activity, weather, and general efficiency of consumption on the demand side and fuel prices and availability, construction costs, and fixed costs on the supply side being the main drivers of the price of energy.
The lack of storage and other complex factors lead to high volatility of spot prices, so market participants try to hedge their exposure to risk using derivatives products like energy futures and forwards. All ISOs use locational marginal pricing, which is the price for delivering one more unit of power, usually a megawatt.
Volatility and hedging
The lack of storage and other more complex factors lead to very high volatility of spot prices. To hedge some of these inherent price volatility generators and load-serving entities look to fix the price of electricity for delivery at a later date, usually one day out.
This is called the Day-Ahead Market (DAM). This combination of Day-Ahead and Real-Time markets is referred to as a dual settlement market design. The Day-Ahead prices remain volatile due to the dynamic nature of the grid and its components.
Energy prices are influenced by a variety of factors that affect the supply and demand equilibrium. On the demand side, commonly referred to as a load, the main factors are economic activity, weather, and general efficiency of consumption. On the supply side, commonly referred to as generation, fuel prices and availability, construction costs and fixed costs are the main drivers of the price of energy.
There are a number of physical factors between supply and demand that affect the actual clearing price of electricity. Most of these factors are related to the transmission grid, the network of high voltage power lines, and substations that ensure the safe and reliable transport of electricity from its generation to its consumption.
The spark spread is the difference between the wholesale market price of electricity and its cost of production using natural gas. Energy traders and investors look to this spread to understand the profitability of utilities companies.
The Highway System Analogy
Imagine a highway system. In this analogy, the driver would be the generator, the highway system would be the grid, and whoever the driver is going to see would be the load. The price would be considered as the time it takes you to get to your destination.
Notice that I mentioned the highway system and not simply roads, which is an important nuance. The highway system is the equivalent of high voltage power lines while local streets are analogous to the retail distribution system.
The retail distribution system is made up of the poles you see on your street while the grid is made up of big electricity pylons holding high voltage lines. ISOs and the general market are mainly concerned with the grid while retailers or Load Serving Entities (LSE) get the power from substations to your home.
So let’s remember this, cars are power, people are the generators, the destination (a highway exit and not someone else’s home) is the load, and price is time. We’ll use this analogy from time to time to explain some more complex concepts but remember that the analogy is imperfect, so treat each reference to the analogy independently.
Locational Marginal Pricing
All ISOs use a form of pricing called locational marginal pricing (LMP). This is one of the most important concepts in electricity markets. The locational refers to the clearing price at a given point on the grid (we’ll get to why prices are different at various locations in a moment). The marginal means that the price is set by the cost of delivering one more unit of power, usually one megawatt.
Therefore, the LMP is the cost of providing one more megawatt of power at a specific location on the grid. The equation for an LMP generally has three components: the energy cost, the congestion cost, and losses. The energy cost is the compensation required for a generator to produce one megawatt at the plant. Losses are the amount of electric energy lost while zipping along the lines.
These first two components are simple enough, but the last one, congestion, is trickier.
Congestion is caused by the physical limitations of the grid, namely transmission line capacity. Power lines have a maximum level of power they can carry without overheating and failing. Losses are usually considered to be heat losses as some of the power heats the line instead of simply transiting through it.
Returning to our analogy, congestion could be considered to be traffic jams, and losses would be the equivalent of the wear and tear on your car. Just like you don’t worry about wear and tear on your car when visiting a friend, losses are fairly stable across the grid and are the smallest component of the LMP. They also mainly depend on the quality of the road you are driving on.
Looking to minimise costs
So, given that LSEs are looking to minimize their costs, they rely on the ISO to dispatch the lowest cost generator to supply them with electricity. When a low-cost generator is willing but unable to deliver power to a given point because of congestion on the line, the dispatcher will instead dispatch a different generator elsewhere on the grid, even if the cost is higher.
This is similar to having someone else drive to the destination even though they live further away, but because traffic is so bad, the person living closer cannot even get on the highway!
This is the main reason prices differ by location on the grid. At night, when there is low economic activity, and people are sleeping, there is plenty of room on the lines and therefore very little congestion.
So referring to our analogy, when there are few people on the road at night, there is no traffic, and therefore the price differences are mainly caused by the losses or wear and tear on your car. You may ask: “But not everybody will take the same time to drive from their home to their destinations, and you said price is the same as driving time, how can that be?”
Setting prices
Remember that prices are set at the margin, so the price is set as the next unit to be produced, or the time it would take for the next person to drive to their destination. You would get paid that “time” regardless of how long it took you to get to your destination. So is living close to your destination the best way to get rich? Well, not exactly. Sticking to the analogy, building close to the destination takes much longer and is much more costly.
Key Takeaways
– Electricity is a key component of modern society, and the price of electricity is a key factor for many other parts of the economy.
– Electricity markets tend to be more fragmented than other commodities markets and managed by independent operators.
– The electricity market is mainly used by utilities companies, energy providers, and professional or institutional traders.
Crown Prince Adil Nchabeleng is president of Transform RSA and an independent energy expert.
* Disclaimer: Views and inputs to this article are derived from content extracted from research on the topic.
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