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You are here: Home > Investors > ... > Power > The power business in Portugal
     
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The power business in Portugal  
 

Following the European trend, the electricity markets in Portugal and Spain were deregulated

Until a few years ago, the electricity business in Portugal was dominated by a sole operator that produced and sold electrical power in the regulated market at a tariff set by ERSE, the market regulator. The tariff remunerated the several activities of the value chain, from electrical production to the end customer, and contained deviation adjustments from previous years and general economic interest costs (energy efficiency measures and renewable energies).


Following the European Union Directive 2003/54/CE, the Portuguese government set goals in 2005 for the Portuguese energy sector through the cabinet resolution nº 169/2005. Goals included the diversification of primary energy sources, higher environmental concerns and the promotion of competitiveness.


In 2006, the decree-law nº 29/2006 adopted the strategic guidelines of the European Union Directive 2003/54/CE and the cabinet resolution RCM nº 169/2005. In 2006, the European Union Directive 2006/32/CE set the guidelines to implement a more rational use of energy and energy services, with a view to increase energy efficiency in the European Union.


In 2006, the decree-law nº 172/2006 set the licencing procedures for ordinary production regime, the concessions of the National Transportation Network and the distribution and marketing networks.


Besides following the decree-law nº 29/2006, the proposals are in accordance with the sector's deregulation intentions, which established common rules for the internal electricity market as in the European Union Directive 2003/54/CE, and with the workings of the Iberian electricity market, after the agreement signed between Portugal and Spain on 1 October 2004.

In this context arised the need to constitute a deregulated market in Portugal, alike markets in Europe and at the same time of the Spanish deregulation process. The creation of the Portuguese electricity market arised jointly with the creation of the MIBEL market.

Creation of the MIBEL market

The MIBEL market is an Iberian market with a common platform that may be used by Portuguese and Spanish operators since 1 July 2007. Throughout the first decade of the XXI century, the Portuguese government and the Spanish government showed interest in constituting a common electricity market but difficulties emerged.


There were issues such as the connection capacity between both countries, which was developed, the acquisition of a certain amount of electrical power in one country and the sale in another country or the harmonisation of the legal framework that rules the market negotiation and the subsequent operation.


To have an adaptation period to the new market model and create the Iberian Market Operator, two operators were created to manage the organised markets:

 

  • OMEL, the Spanish hub, is responsible for managing the spot market (daily and intra-day);
  • OMIP, the Portuguese hub, is responsible for managing the forward market.


The MIBEL's spot market started on 1 January 1998 just for the Spanish market. The derivatives market was started on 3 July 2006.

 

From the energy acquisition contracts to the maintenance costs of the contract equilibrium

Before market deregulation, there was an energy acquisition system based on energy acquisition contracts.

 

With energy acquisition contracts, producers received a payment for availability, which included fixed operation and maintenance costs, depreciation and the remuneration of capital employed at a determined rate, and the variable costs they had with energy production.


This annual remuneration was updated by inflation and adjusted by deviations of the plant's availability against the contracted availability. It did not depend on the amount of electrical power produced by each plant.
The energy acquisition contracts ended in different periods at each plant, ranging from 2007 for the Tunes plant to 2027 for the Frades dam.


With the commitment of the Portuguese and Spanish governments to promote the MIBEL market through the creation of liquidity conditions, the existence of an energy acquisition system in which 58% of demand would be satisfied through plants with energy acquisition contracts was not sustainable. If 20% from the special production regime is added to 58% of demand, there will be difficulties forming an Iberian market that would only satisfy 20% of consumption needs.

 

There was a proposal to replace energy acquisition contracts by maintenance costs of the contract equilibrium.

The advantages of the maintenance costs of the contract equilibrium are the maintenance of the net present value with energy acqusition costs in the market, with assumptions being reviewed annually from 2007 to 2017, since the conditions to maintain the net present value with low risk, supply liquidity to the market, have the permission of the European Commission and allow a decrease in power tariffs is contracted.


The difference between the contracted net present value with the energy acquisition costs and the net present value of future cash flows are the basis of the maintenance costs of the contract equilibrium, according to the outcome of the negotiations between the energy acquisition costs and the state. Since the maintenance costs of the contract equilibrium assumed the annual assumptions review during the first 10 years, producers had contracted remuneration guarantees during that period.


After 2017, there will be no more revisions. The rent will be constant until the end of 2027.

After the creation of the MIBEL, the regulated market was not extinguished in Portugal and Spain

The regulated market in Portugal is based on the principle that the sector's several activities are included in the tariff: electrical production, ultra-high pressure transportation, distribution in high, medium and low pressure and sales.

 

In Portugal deregulation occurred in production and marketing, ie both activities may be freely operated under licence. The transportation and distribution activities were kept regulated.

The transportation of electrical power is managed by REN (Redes Energéticas Nacionais), while the distribution activity is made by EDP Distribuição, a company of the EDP group.

Marketing companies may acquire electrical power: 

  • Through the spot market (OMEL);
  • Through future contracts (OMIP, the Iberian Energy Market Operator, or auctions);
  • Through bilateral agreements.


The supply chain of the electricity sector may be synthesized as follows:

 

Cadeia de valor do sector da electricidade

At the same time, the technical management of this system, which is performed by REN, guarantees the reliability of the system.

 

The tariff

Since only production and marketing of electrical power were deregulated, the sale tariff for end customers in Portugal has three components:

  • Access tariff;
  • Energy tariff;
  • Marketing tariff.


The access tariff includes the regulated activities paid by every electricity end user in Portugal, both in the regulated and liberalised market. This tariff includes activities of the electricity sector that were not deregulated and adjustments following negative balances from past years or structural changes, namely:

  • Tariff for using the transportation network;
  • Sale tariff of the concessionaire of the National Transportation Network (RNT);
  • Use tariff of the distribution network;
  • Tariff of the global use of the system.


The access tariff allows competition: every marketing company has free access and in equal conditions to transportation and distribution networks under a marketing licence.


The energy tariff and the marketing tariff is reflected in the tariff of the customers that choose to stay in the regulated market. For clients of the deregulated market, the energy cost is agreed with the marketing company. The marketing margin is decided by the marketing company.

The tariff for using the overall system is the component of the sale tariff to end customers that includes the adjustments of the energy costs which arise from the additional cost with the energy acquired to special regime producers.

Tariff deficit and deviations

Each component of the tariff must reflect the costs with the activity that aims to remunerate. In the market, the final price of the energy component is generated by the matching of supply and demand. Therefore, the energy price must reflect marginal costs for producing electrical power. However, the price of the energy tariff does not reflect the production costs due to motives external to the market.

 

Two factors contribute to the mismatch between the price of the regulated tariff and the price for the client of the deregulated market:

  • Tariff deficit;
  • Deviations.

The tariff deficit is based on the regulator's assumption that the price it will propose for the energy tariff, which is the component of the sale tariff to end customers that expresses the cost with energy acquisition, is not enough to cover production costs. It is not possible to reflect that price in the tariff. A deficit is created that, according to the regulations, will be diluted in the tariff in the following five years. The 2006 and 2007 deficits were diluted throughout time in order to be paid in 10 years, according to the legislation.


The deviation occurs when, at the end of the year, the regulator realises that the planned component of the energy tariff was not enough to reflect market costs or that it caused a discount, if the price of electricity was high. The additional cost, or the lower cost, is diluted or discounted in the tariff in the following two years.


The defficit and the deviation with negative balances are different, since the defficit is calculated ex ante, while the deviation is checked ex post. Both are an additional cost with the acquisition of energy that customers will have to pay in the future. The deviation with positive balances is, alike deviation with negative balances, checked ex post. In this case, there is a discount in the following years in order to make the adjustment.


2008 was an atypical year in the evolution of the price of commodities and the price of electricity was no exception. Since the sale tariff to end customers did not include a control mechanism to face extreme variations of the price of energy in the market, the decree-law 65/2008 extended the payment period of deviations occurred in extreme years. The deviation occurred in 2008 will be paid in 15 years starting in 2010 by every consumer.

 

Special regime production

Special regime production is a type of electrical production that is environmentally advantageous and in certain cases more efficient. The special regime production status is in accordance with the goals to diversify primary energy sources that were defined in 2005.

 

Special regime production are electrical production sources recognised as renewable along with cogeneration:

  • Wind power;
  • Mini hydro plants (hydroelectric recycling with installed capacity lower than 30 MW);
  • Solar energy;
  • Biomass;
  • Biofuels.

Cogeneration is an electrical power production process that uses natural gas as a fuel and from which heat (water steam or hot water) is generated. The heat is recycled by the industry that is generally located close to the cogeneration plants. Thanks to this heat recycling, the efficiency of the cogeneration process is close to 80%.


These technologies are favoured in two ways:

  • They are the first to be used, having priority in the come into stream. Its production starts before other technologies, such as coal, gas (Combined Cycle) and fuel plants or large hydro plants. The electricity produced by cogeneration plants has priority accessing the network;
  • They are remunerated through a tariff higher than the regulated tariff, which reveals the benefits of less poluting and more efficient technologies for Portugal.

Energy produced through special regime production is remunerated above the marginal costs of production. The special regime production does not enter the market to set the daily price.

 

However, since the last-resort marketing company is enforced to acquire the entire production of the special production regime in accordance with article 49 of the decree-law nº 29/2006, a lesser amount of electricity is acquired in the market. The supply curve of the market is shifted so the matching of supply and demand occurs at a lower point of the demand curve. Therefore, the energy price arising from the daily market is lower.

The additional cost with special regime production, which is included in the access tariff, is the difference between the value paid by energy produced through the Special Regime Production and the price arising from the matching of supply and demand in the daily market.

The spot market started in 1998 and the forward market started in July 2006

The final price of power at each hour of the day arises from the matching of supply and demand. Within a day, there are 24 prices for the asset, one for each hour of the day, instead of a sole price. There are 24 supply and demand curves. Sale orders are placed by producer companies, while purchase orders are placed by distribution and marketing companies.


The Iberian power market has some specificities in the capital markets related to both the asset and the price formation:

  • The contract size is equivalent to one MWh for each hour of the following day. Within a day, there are 24 prices arising from the Daily Market session;
  • Every offer is made until 10h00 (Spanish time) of the previous day in the so-called negotiation of the daily market (09h00 in Portugal). The hour prices are published at 11h00. Baseload is the average of the hour price for each MWh arising from the daily market;
  • Subsequently, there are six adjustment sessions in order to match supply to demand in the Intra-Day Market.
  • Marketing and distribution companies place purchase orders, while producers place sale orders in the market. Each order is composed of an amount-price pair. For each hour, the market price arises from the matching of supply and demand curves. The power matched in the daily market will be sold at the matched price;
  • The purchase and sale orders in Portugal and Spain are initially placed in a commom platform to both countries. As long as there is capacity to transfer power MWh between Portugal and Spain in both directions, the prices of Portugal and Spain are just one;
  • When the connection capacity is saturated in the Portugal-Spain direction or the Spain-Portugal direction, there is a market split (market separation) and the offers of sellers and buyers of each country are bounded by the national borders;
  • In addition to the market, there are bilateral agreements between producer companies and marketing companies, whose energy is off the market. However, the entity that manages the market must be informed of the characteristics of the transactions: the amounts that were transacted, price per MWh, periodicity, etc.

 

    Technologies and costs

Ranking order

The final market price of energy arises from the matching of the supply and the demand of producers and marketing companies, the two activities of the chain that were deregulated.


Besides special regime production, the other production technologies enter the network through the ranking order, which is the ascending ordination of the several technologies by marginal cost of production. The most expensive technology that is able to match its sale offer in the market at each hour sets the market price, ie it sets the hourly price at which other technologies with lower marginal costs of production will sell energy.

 

At each hour of the day, the entry in the network is made in the following order, starting by the special regime production:

 

 

Coal and combined-cycle gas have changed position in the mérito curve due not only to the volatility of the price of raw material in the international markets, which is reflected in marginal costs, but also to the costs of CO2 licences. Besides special regime productions, there are other distortions to the entry in network by the pure ranking order, namely:

  • Technical limitations of each type of plant. Plants cannot be turned on or off on a hourly basis and are limited to a certain amount of launches per week/month or year. One technology may be injecting energy in the network whose marginal cost is higher than other technology that is stopped. However, it is not possible to switch off the first one and turn on the second technology.
  • The marginal cost of energy production in dams is very low. A lagoon is the only viable way of storing large amounts of electrical power. Therefore, it has an additional value during consumption peaks and when a fast injection of electrical power in the network is needed. There is high flexibility to enter and exit the network, since technical restrictions to hydroelectric use are lower than those of other technologies.

This applies to hydroelectric uses with regularisation capacity, that is, uses that have lagoons able to store enough water to arbitrage (turbinating when the electrical power is more expensive).


A dam without the regularisation capacity must turbinate the water when it arrives, since it has a low control on the hours in turbine. The use has a water-stream exploration. Therefore, they come into stream before other technologies, which are more expensive but whose come into stream is controllable.

 

Dams have several advantages:

  • Energy storage capacity, which allows the satisfaction of demand during consumption peaks by taking advantage of the regularisation capacity;
  • Flexible entry and exit of operation;
  • Low marginal costs of production;
  • The possibility of articulation with the wind technology in the cases of hydroelectric use with reversibility (turbination and pumping). 

 

Wind production and the pumping and turbination cycle

Wind production that occurs during the night is used. It is injected in the network when the consumption is lower, since electrical power cannot be stored. The price of this power is lower.

 

A dam with reversibility, or pumping capacity, allows the turbination of water and the pumping of the water that was turbined into the lagoon. Wind energy is used to pump water.

 

The importance of hydroelectric use increases: they satisfy the energy consumption of wind turbines, thereby avoiding the energy waste of wind, and consume energy when it is cheaper through pumping, so that water turbination is made in consumption peaks when energy is more expensive. Hydroelectric use is also made out of peak hours. Hydroelectric generation may be used when other technologies are unavailable.

 

Nuclear energy and the PT-SP premium

Some of the electric power produced in Spain comes from nuclear plants, which have low marginal costs of production. Considering that the order of the come into stream of the technologies is made according to marginal costs, nuclear energy is one of the first to come into stream. Nuclear energy, which has a restricted connectedness capacity, explains the price difference per MWh between Portugal and Spain.


The market split generally occurs against the interests of the Portuguese consumer, since the price per MWh that arises from the matching of supply and demand in the daily market in Spain is lower than the final price in Portugal. The Portugal – Spain premium is formed, ie the difference between the hourly price in Spain and Portugal, which has been higher than Portugal.


The connection capacity in the Spain-Portugal direction is low. It is limited to 1500 MW per hour. Portugal is a power importer, since electrical power is cheaper in Spain.


The higher premium in the off-peak hours when the production of nuclear plants is higher shows that nuclear energy is one of the main responsibles for the existence of a PT-SP premium.

 

CO2 licences

With environmental concerns in the agenda of the European governments and after the Kyoto Protocol, goals related to the CO2 emissions by country and business sector were established. A certain amount of licences is awarded to each company based on the production planning and the operation period (load factor) and the emission planning. If the emissions surpass the amount of carbon dioxide tonnes covered by the licences, the company will have to acquire more licences to cover the additional amount.


For the 2008-2012 term, the number of licences awarded by the Portuguese government and several foreign governments decreased. In the previous term, which was an exceptional term, too many licences were awarded. Consequently, the price of these licences in the carbon market plummeted from 20€/ton to marginal costs of 0.02€ or 0.03€ per tonne. The companies acquired more licences, since the impact of the cost of licences on marginal costs was low.


With licence prices of 20€/ton, the impact on costs is no longer irrelevant. It caused the inversion in the ordem de mérito between coal and gas technologies: without licences or with their price at marginal values, the marginal cost of production of a coal-driven plant is lower than a gas-driven combined-cycle plant. However, with prices of 20€/ton, the order is reversed and the combined cycle enters the network before coal.



Last update: 09 Jun 2011

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