Power System Restructuring Models

1. Introduction

Modern power industry operation is particularly difficult to understand

because of the dichotomy between electricity’s business and physical
manifestations. From the business perspective, electric power is an
exchangeable commodity that can be traded much like any other commodity
like oil, wheat, etc and for which futures markets and hedging systems do
exist. But, in its physical manifestation, electricity is quite unlike all other
traded commodities. The fundamental difference is that it cannot be stored to
any significant degree. This greatly affects how it must be managed as a
business asset, and greatly constrains its present and future market prices do
or don’t interact, as compared to other commodities. In large part due to its
‘storage-less’ nature, electricity can be transported only on a real-time basis,
and in a manner heavily constrained by myriad physical laws that are
complicated in their interactions but nearly instantaneous in their impact.
The net effect of all of these differences is that modern electricity
trading and wholesale transportation systems are quite different from the
practices existed previously. Restructuring has been accompanied by a
variety of new problems, which have given rise to controversy between many
governmental organizations and private companies. The changing nature of
electricity utility industry has brought many new practices to power system
operation. The philosophy and techniques of planning and operation well
established over past decades have begun to change and it is needed to
recognize and meet these challenges. To create the competition in power
market there may be different ways of restructuring the power industry. But
considering the organizational set-up, financial condition, control structure
and their coordination, different reform models are categorized.
This topic aims at describing various market models. Various markets all
around the world can be classified on different basis. The classification can be
done in the following manner:
1Classification based on energy trading
2Classification based on contractual models
3Classification based on operational mechanisms of different ISOs
4Classification based on ownership of transmission network There are three
different types of electric power markets. These are as follows:

1Physical Market
2Financial Market
3Balancing Market

Physical Market:
Physical market is a market where electrical energy exchange takes place
physically. Energy spot market comes under this market. These markets can
be day ahead hourly, day ahead half-hourly markets. This market is the core
of all markets as major volume of energy is traded on this. In this market,
every customer has to pay the Market Clearing Price (MCP) and every GENCO
gets the MCP (so long as Pay As Bid scheme is not implemented), provided
congestion does not take place. There is a possibility of high price volatility in
this market. So, every participant faces a risk of losing revenue in a market
clearing process. In order to hedge the risk, there is another market called
Financial market where in there are some financial instruments used to hedge
the risk.

Financial Market:
This is the market in which actual energy is not traded, but contracts between
two parties are traded such that both the parties share the risk. Derivatives
like Forwards, Futures, Options, and Swaps are used as risk hedging
instruments. These are discussed in details later.

Balancing Market:
Even though there is a physical market for the energy transaction, the
physical market is a day ahead market in which all calculations are done
based on forecasted load. In the real time operation, there is a mismatch
between forecasted and actual load. Hence there is a need for balancing
market which takes care of load/ generation mismatch. Balancing market
refers to ancillary service management. In most of the power markets there is
a separate provision for creating balancing market. The generators have to
submit separate bids in this market, apart from physical spot market.

2. Models based on Energy Trading

This type of classification is based on the level of competition, i.e. the
on which side the competition exists, wholesale level or retail level.

2.1 Monopoly Model

In this model, a single entity is taking care of all the business such as
generation, transmission and distribution of electric power to the end users.
Usually (but not necessarily), in this kind of model, the monopoly lies with the
Government. It is quite natural that this kind of model should have strict
regulation in order to protect end consumers against monopoly. Most of the
electric power systems obeyed this model prior to deregulation.

2.2 Single Purchasing Agent Model

In this model, as shown in Figure 1, there is a competition in the

wholesale sector,
i.e. generation. Here, Independent Power Producers (IPPs) are permitted. All
generators sell their power to the central pool or power purchasing agency,
which is turn sells, it to state distribution utilities or distribution companies in
the service area. All power generated by generating companies (GENCOs)
must be sold only to a purchasing agency and not to any other agency.
Distribution companies (DISCOs) are only able to purchase from the
purchasing agency. They do not have a choice of choosing their power
supplier.
 Figure 1: Pool as Purchasing Agent Model
In this model, sales from power pool to retailers take place at a pre-set
tariff price. Efficiency considerations suggest that this tariff should follow the
marginal cost of the system while at the same time covering the total costs to
the purchasing agency. This tariff should then be modified appropriately from
time to time. Retail tariffs, in a competitive retail market, would inevitably
tend to follow the cost of purchasing at the purchasing agency, wholesale
tariff. This model can accommodate the social obligation policies to be
implemented by the government.
In this model, Transmission and distribution network can be owned and
operated by State and Regional transmission utilities. Inter-state tie line
should be sufficient to maintain a loose regional power pool.

2.3 Wholesale Competition Model

This model, as shown in Figure 2, provides the choice of supplier for

DISCOs together with competition in generation. DISCOs can purchase energy
for their customers from any competing generator. These distribution
companies maintain a monopoly over energy sales to the final consumers and
each of them has a franchise to serve a given set of customers. It requires
“open access” to the transmission network, and the development of a spot
market. The purchasing agency concept has come to the low-voltage level
rather than at the high voltage level but now it is not a single buyer model.
Generators may sell directly to any distribution company but open access to
low-voltage wires is not permitted.
 Figure 2: Wholesale Competition Model

Since this model permits open access to the transmission wires, it gives
the IPPs to choose an alternative buyer. However, customers within a service
area still have no choice of supplier. These will be served by a DISCO in their
area. With this model the “obligation to supply” will move to the DISCOs,
which still have a monopoly over the customers. They own and operate the
distribution wires.
The transmission network can be owned and maintained by government
and private transmission companies. System operators should manage the
operation and control.

2.4 Retail Competition Model

In this model as shown in Figure 3 all customers have access to

competing generators either directly or through their choice of retailer. This
would have complete separation of both generation and retailing from the
transport business at both transmission and distribution levels. The
transmission and distribution wires provide open access. There may be free
entry to generation markets and free exit. This means there should be no
regulation over “need for new plants” and no requirement to maintain
capacity in production when it has passed its economic life. There would also
be free entry for retailers. Retailing is a function in this model, which does not
require the ownership of the distribution wires although the owner of
distribution wires can also compete as a retailer.
This model is not a single buyer model and the power pool in this model
is not like purchasing agency, it is like auctioneer. They never own the power,
they do not take the market risk, and they cannot discriminate the price. It
should behave like a single transporter, moving power to facilitate bilateral
trading. All the trading of power will be done through an integrated network of
wires. The operator of wire should measure and account for the power trades.
In this pooling arrangement, there should be provision for bidding into a spot
market to facilitate merit order dispatch. The pool will match the supply and
demand and determine the spot price for each hour of the day. It collects
money from purchasers and distributes it to producers.

Figure 3: Retail Competition Model

The advantage of this model over monopoly utilities is that competition

is introduced in both wholesale and retail areas of the system. This model is a
kind of truly deregulated power market model.
In Wholesale Competition Model, with relatively few customers, all of
them regulated DISCOs, a spot market can be preferable but not essential.
However, in Retail Competition Model, spot markets will become essential,
since contractual arrangements between customers and producers are carried
out over a network owned by a third party. The network owner must ensure
that there are commercial arrangements that allow for the settlement of
imbalances between contracted amounts and actual flows. If different parts of
the network are operated separately, inter-area payment schemes will also
have to be devised.
In Retail Competition Model, metering becomes a major problem.
Metering by time of use is no longer merely a useful way of promoting
efficient usage but it is a commercial necessity. Each customer needs to be
metered on hourly basis, if this is the settlement period. Since the price may
change every hour, it is necessary to know how much the customers of each
competing retailer used in each settlement period, in order to bill the right
customers and to settle accounts properly. If the customers have adequate
metering, there will be no problems. But if the numbers of customers are
increasing and metering capability for all the customers is not sufficient, it
may create logistical problem and provoke disputes.
3. Models Based on Contractual Arrangements
3.1 Pool Model
The Pool model is comprised of competitive power providers as
obligatory members of an independently owned regional power pool,
vertically integrated distribution companies, vertically integrated transmission
companies and a single and separate entity responsible for: establishing
bidding procedures, scheduling and dispatching generation resources,
acquiring necessary ancillary services to assure system reliability,
administering the settlements process and ensuring non-discriminatory
access to the transmission grid. The Pool operator does not own any
generation or transmission components and centrally dispatches all
generating units within the service jurisdiction of the pool. PoolCo controls the
maintenance of transmission grid and encourages an efficient operation by
assessing non-discriminatory fees to generators and distributors to cover its
operating costs.
In a Pool model, sellers and buyers submit their bids to inject their
power into and out of the Pool. Sellers compete for the right to inject power
into the grid, not for specific customers. If a power provider bids too high, it
may not be able to sell its power, as his bid may not get selected. On the
other hand, buyers compete for buying power and if their bids are too low,
they may not be getting any power. In this arrangement, low cost generators
would essentially be rewarded. Power pools would implement the Optimal
Power Flow (OPF) and produce a single (spot) price for electricity, giving
participants a clear signal for consumption and investment decisions. Winning
bidders are paid the spot price that is equal to the highest bid of the winners.
Since the spot price may exceed the actual running of selected bidders,
bidders are encouraged to expand their market share, which will force high
cost generators to exit the market. Market dynamics will drive the spot price
to a competitive level that is equal to the marginal cost of most efficient firms.
Pool model is practiced in Chile, by the National Grid Company (NGC) in
England and Wales till 2000, and in Argentina and stands at the core of all
deregulated systems so far.

3.2 Bilateral Contracts Model

Bilateral contracts model has two characteristics that would distinguish
it from the Pool model. These are: The ISO’s role is more limited; and buyers
and sellers could negotiate directly in the marketplace.
This model permits direct contracts between customers and generators
without entering into pooling arrangements. By establishing non-
discriminatory access and pricing rules for transmission and distribution
systems, direct sales of power over a utility’s transmission and distribution
systems are guaranteed. Wholesale suppliers would pay transmission charges
to a transmission company to acuire access to the transmission grid and pays
similar charges to a distribution company to acquire access to the local
distribution grid. In this model, a distribution company may function as an
aggregator for a large number of retail customers in supplying a long-term
capacity. Also, the generation portion of a former integrated utility may
function as a supplier or other independent generating companies, and
transmission system would serve as a common carrier to contracted parties
that would permit mutual benefits and customers choice. Any two contratced
parties would agree on contract terms such as price, quantity and locations,
and generation providers would inform the ISO on how its hourly generators
would be dispatched.
The ISO would make sure that sufficient resources are available to
finalize the transactions and maintain the system reliability. If there is no
violation of static and dynamic security, the ISO simply dispatches all
requested transactions and charges for the service.

3.3 Hybrid Model

The hybrid model combines various features of the previous two
models. The hybrid model differs from the Pool model as utilizing the Power
Exchange (PX) in not obligatory and customers are allowed to sign bilateral
contracts and choose suppliers from the Pool. The Pool would serve all
participants (buyers and sellers) who choose not to sign bilateral contracts.
The California model is an example of this model. This structure has
advantages over a mandatory pool as it provides end users with maximum
flexibility to purchase from either the pool or directly from suppliers.
As in the Pool case, if generators opt to compete through the pool, they
would submit competitive bids to Power Exchange (PX). All bilateral contracts
would be scheduled to meet their loads unless they would constrain
transmission lines. Loads not provided bilaterally would be supplied by
economic dispatch of generating units through bids in the pool.
The existence of the pool can efficiently identify individual customer’s
energy requirements and simplify the balancing process of energy supply. The
hybrid model would enable the participants to choose between the two
options based on provided prices and services. The hybrid model is very
costly to set up because of separate entities required for operating the power
exchange (PX) and the transmission system.

4. Different System Operator (SO) Models

The ISO is the supreme entity in the control of the transmission system.
The basic requirement of an ISO is dissociation from all market participants
and absence from any financial interests in the generation and distribution
business. However, there is no requirement, in the context of open access, to
separate transmission ownership and operation. The roles and responsibilities
of ISOs vary widely. In India where regional grids are owned by regional or
state Governments and system interconnection is only now growing, and
growing rapidly towards National Grid status, the protocols of future
ownership and operation are still being evolved.

4.1 Responsibilities and functions of System Operator

In vertically integrated traditional utilities the range of operator

responsibilities as well as the ownership of the system is maximized in one
corporate entity. In the new market structures there are a variety of
arrangements for the system operator and since the operator must be
dissociated from all participants the name independent system operator (ISO)
is a natural choice. The ISO has three objectives:
a. Security Maintenance
b. Service Quality assurance
c. Promotion of Economic efficiency & Equity

To achieve these objectives the ISO performs one or more of the following
functions.
(i) Power system operations function
(ii) Power Market Administration Function

(iii) Ancillary Services Provisions Function

(iv) Transmission facilities provision functions

There are various models of ISO, the functioning and operation

methodologies of which differ from market to market. In USA itself, there are
6 different models of ISO available. These are:
California, Pennsylvania-New Jersey-Maryland (PJM) interconnection,
New York ISO, Electric Reliability Council of Texas (ERCOT), New England ISO
and Midwest ISO (MISO). All these models have advantages and shortcomings
of their own.

4.2 California ISO

The ISO, concerned with the reliability of the grid, balances the
operation of grid in real time. The real time market is operated by the ISO,
which uses ancillary services bids and supplemental energy bids submitted
through Power Exchange (PX) and Schedule Coordinators (SC). The ISO also
determines the real time market price after the fact (ex-post price) based on
actual metered data.
The ISO guarantees a non-discriminatory open access to transmission
for all users, manages the reliability of transmission system, acquires ancillary
services as required, approves day-ahead and hour-ahead schedules,
maintains the real time balancing of load and generation, maintains frequency
of the system and does the congestion management. The ISO also stands as
the operator of control area operators, which balances inter-tie schedules with
actual flows across inter-ties. The ISO balances the system demand with the
power output of local generating units, plus purchases from external electric
power systems, minus the energy sold to external systems.
Interactions among different entities in California are shown in
Figure 4. Reference Website: www.caiso.com
.
 Figure 4 The California ISO
4.3 New York ISO

The eight members of New York Power Pool (NYPP) decided to break
down the pool and proposed to form a substitute represented by an ISO and
other institutions such as the PX to comply with FERC rules, maintain
reliability in the competitive environment and facilitate a competitive
wholesale electricity market. The ISO is responsible for bulk power system
operations, including coordination of maintenance outage schedules and
provision of transmission services on non-discriminatory basis. The ISO will
also administer and maintain an OASIS (Open Access Same time Information
System) for the New York state bulk power system. What distinguishes NYPP
is the highly meshed characteristics and frequent congestion, and what
distinguishes this model is its clearing energy and ancillary service markets at
the same time, which is an advantageous feature over other proposals where
separation of markets is implemented. Participants choosing bilateral
contracts are required to submit decremental price bids for congestion
purpose.
A real time (balancing) market is operated by the ISO using a
centralized five-minute security constrained optimal dispatch, where buyers
and sellers can participate in this market up to 90 minutes ahead with flexible
bids or submit bilateral schedules for energy as well as some ancillary
services.
The NYISO uses a Security Constrained Unit Commitment (SCUC)
software for scheduling day-ahead and hour-ahead to dispatch energy, load,
reserves and regulation taking into account network constraints and
schedules outages. The same software is used for calculation of Locational
Based Marginal Prices (LMP).
Interaction of the New York ISO with other entities is shown in Figure 5.

Figure 5 The NY ISO

4.4 PJM Interconnection

The main responsibilities of the PJM ISO are maintaining the reliability of
transmission grid, operating the spot market, transmission planning, unit
commitment, operating real time (balancing) market and settlement and
billing functions.
The PJM ISO scheduling operation and dispatching would include the day
ahead and hourly process. The day ahead scheduling would take place on the
day prior to operating day, and the hourly scheduling would take place within
60-minute leading to the operating hour. On a least-cost basis, the ISO would
manage to serve the hourly energy and reserve requirements of the control
area.
Interactions of PJM ISO with other entities are shown in
Figure 6. Reference Website: www.pjm.com
 Figure 6 The PJM ISO
4.5 ERCOT ISO

This ISO does not represent a PoolCo function and is not concerned with
or responsible for any activities as those of power pool such as generation
dispatch, matching of buyers and sellers, or providing ancillary services. The
ISO does not have any direct control of transmission network or generation
facilities, whereas this control is the responsibility of the ERCOT control areas.
The ISO’s three primary areas of responsibility include: Security
operations, Transmission access/ market information and coordinated regional
transmission planning and engineering support. Even though the first priority
of the ERCOT ISO is to maintain the system security, this ISO has the authority
and responsibilities toward the system, which include functions such as real
time system monitoring, response to system contingencies, administration of
OASIS, transmission tariff administration, ancillary service verification and
coordination of regional transmission planning for future planned transactions.

4.6 New England ISO

The organization of this ISO is composed of two major areas:

System Operations and Reliability: responsible for daily dispatch of resources

assuring the reliability of the system and the administration of the open
access transmission tariff, short-term and long-term demand forecasting and
reliability planning.
Market Operations: directs wholesale electricity marketplace to ensure
fairness to all market participants and full competition that could lead to the
lowest price for electricity, provides customer services and training support
and performs the settlement function in the marketplace by ensuring that
sellers in the spot market are paid by purchasers, and tracks bilateral
contracts between market participants.

The New England ISO proposed seven markets to be run under the ISO
directions. These markets are one energy market, four ancillary service
markets and two capacity markets. The ancillary service markets are:
Ten minute spinning reserve (TMSR) market
Ten minute non-spinning reserve (TMNSR) market
Ten minute operating reserve (TMOR) market

• Automatic generation control (AGC) marketThe capacity markets

are:
Operable capability market
Installed capability market

5. Financial Markets

A powerful electricity market should be supported and implemented by

proper trading tools that take into consideration special circumstances of
electricity trading which are different from other commodity trading practices.
A successful implementation of a trading system in electric energy and its
derivative markets could fulfill restructuring objectives, which include
competition and customer choice. A robust trading system could facilitate
capable risk hedging instruments that could capture the risks associated with
price volatility and other unexpected changes.
Financial markets associated with power industry provide risk-hedging
instruments such as derivatives. Various derivative instruments are futures
contract, forward contract and options contract.
Derivative by definition is a financial contract (instrument), written on
an underlying asset, whose value depends on the values of more basic assets.
A derivative is not a security, but an agreement between two parties, with
opposite views on the market, who are willing to exchange certain risks. A
hedger would use derivatives as insurance against market swings, price
increases and funding costs while getting better exchange rates in financial
markets.
The basic derivatives are called plain vanilla, which include forwards,
futures, options and swaps. Many derivatives are used in electricity trading,
but the most common ones applied to energy risk management strategies are
futures, forwards and options.

5.1 Futures Contract

A futures contract is a standardized one to deliver or receive a certain

quantity of a commodity at some stated time in the future. Price, quantity,
grade, location and time of future delivery are all stated in the contract. Note,
however, that the only point of negotiation is the price. All other terms and
conditions are pre-specified, thereby making it a standardized contract. A
futures contract is therefore not specifically drawn to tailor the needs of any
particular set of trader this in effect maximizes transferability and hence
liquidity. That is, other parties, including speculators, can purchase and resell
the contract in the secondary market. Futures contracts relate to a specific
month, several of which are traded at any one time. When the actual month of
delivery arrives, all outstanding contracts must be settled by delivery of the
commodity or by an offsetting contract.
The main justification of the futures contract is that it permits
specialization between two elements of the economic process: the function of
holding commodities (or other assets) and the function of bearing the risk of
price changes. The seller of a futures contract on a commodity does not
normally intend to deliver the actual commodity nor does the buyer intend to
accept delivery; each will, at some time prior to the date of delivery specified
in the contract, cancel out obligation by an offsetting purchase or sale. In fact,
historically, less than one or two percent of futures contracts have been
fulfilled by actual delivery.
The futures (financial market) and spot markets (physical market) tend
to parallel one another and to converge as the delivery date approaches. The
relationship between spot and futures market prices is such that at any point
in time the futures price and spot price should only differ due to the cost-of-
carry. The cost-of-carry of a futures contract comprises interest, insurance,
and commission (cost-of-carry also include storage costs for a commodity
such as wheat) that are incurred from holding the contract until settlement.

5.2 Options Contract

Options contracts are also tradable instruments which grant the holder
the right, but not the obligation, to either buy or sell an underlying security,
such as a futures contract, or commodity at an agreed upon price at some
future point in time. The agreed upon price is known as the strike price and is
established at the time of purchase. The future point in time at which the
option may be exercised is known as the expiration date. The buyer of the
option pays a fee or premium to the seller. A call option gives the holder the
right to purchase the underlying property at some future date, and a put
option gives the holder the right to sell the property at some future date.
Options can be held in isolation. Speculators and hedgers both
participate in the options market. Since options contracts are tradable, the
holder has the flexibility to sell the contract in a secondary market. In the
electricity market, option contracts can also be used to mitigate risks of
supply and price. However, option contracts are financial instruments and are
not directly related to the physical delivery of electricity. The holder does not
have to exercise this right. This fact distinguishes options from futures
contracts.

5.3 Forwards Contract

Forward contracts are in some aspects similar to futures contracts. They
involve an agreement to buy or sell an asset on a certain date for certain
price. Futures contracts are traded on an organized exchange, and the terms
of the contract are standardized by the exchange. By contrast, forward
contracts are private agreements between two financial institutions or
between a financial institution and one of its corporate clients. Usually, in
forward contracts, there is a range of possible delivery date. Forward
contracts are not marked to market daily like futures contracts. The involved
two parties contract to settle up on the specified delivery date. Whereas most
futures contracts are closed out prior to delivery, most forward contracts do
lead to delivery of the physical asset or to final settlement in cash.