TA - 8772 PAK: Strengthening the

Central Power Purchase Agency

BRIEF NOTES ON ELECTRICITY
MARKETS
Principal Concepts and Guidelines

Prepared for ASIAN DEVELOPMENT BANK

Beneficiary CENTRAL POWER PURCHASING AGENCY

01/12/2017

MRC Consultants and Transaction Advisers

General Moscardo 32, 1-A, 28020 Madrid (Spain)
www.mrc-consultants.com
 MRC Consultants & Transaction Advisers

Disclaimer
This report was prepared by MRC Consultants and Transaction Advisers at the request of CPPA
G. MRC Consultants and Transaction Advisers has based its work on publicly available
information and proprietary data provided by CPPA G and from MRC Consultants and
Transaction Advisers’ database. Changes in these facts or underlying assumptions could change
the results reported in this study. Any other party using this report for any purpose, or relying
on this report in any way, does so at their own risk. No representation or warranty, express or
implied, is made in relation to the accuracy or completeness of the information presented
herein or its suitability for any particular purpose.

CPPA G: CTBCM DETAIL DESIGN - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 i
 MRC Consultants & Transaction Advisers

Document Status
Title: Strengthening the Central Power Purchase Agency
Notes on Electricity Markets

Reference: ADB Project Reference - TA 8772 - PAK

ADB Contract Reference – 123782-S52827
Issue:
Date: 01/12/2017

Authorization

Name Position Signed Date

CPPA G Project Director

Inoue Yuki ADB Project Manager

John Swinscoe MRC Team Leader

Document Versions

Issue Date Author(s) Description

0.0 Name First Draft V 0.0
1.0 Second Draft V 1

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 2

 MRC Consultants & Transaction Advisers

Table of Contents
1. INTRODUCTION ................................................................................................................................. 6

2. GENERAL CONCEPTS AND MARKET MODELS ON ELECTRICITY MARKETS........................................................... 6

2.1. How Many (electricity) Markets Models Exist in the World? .................................................... 6
2.2. How does Markets Work in Centralized Dispatch Model? ........................................................ 6
2.3. How does Markets Work in Self Dispatch Model? ................................................................... 7
2.4. From Balancing Mechanisms to Spot Market .......................................................................... 7
2.5. Trading Platforms................................................................................................................... 8
2.6. What in Terms of Efficiency .................................................................................................... 8
2.7. Are there Mixed Models)? ...................................................................................................... 9
2.8. Which Countries Use Each Approach ...................................................................................... 9
2.9. The European Model - European Power Exchange ................................................................... 9
2.10. How the Transactions Carried Out In The Market Finally Consolidate In The Real (Physical)
World? ....................................................................................................................................... 10
2.11. How Often These Markets Operate? ................................................................................... 11
2.12. Are the Settlements Creating Financial Obligations? ........................................................... 11
2.13. What About Long-Term Contracts (Hedging)? ..................................................................... 12
2.14. Should Capacity Be Considered As A Different “Product” Than Energy? ............................... 12
2.15. How Capacity Requirements Are Usually Handled? ............................................................. 14
3. THE PROPOSED MARKET MODEL FOR PAKISTAN...................................................................................... 14

3.1. Pillars for the Proposed Model ............................................................................................. 14

4. POTENTIAL (FUTURE) EVOLUTION OF THE MARKET MODEL ........................................................................ 16

5. TRADING PLATFORM IN PAKISTAN (POWER EXCHANGE?) .......................................................................... 18

5.1. Numerical Example .............................................................................................................. 20

5.1.1. Data for the example ................................................................................................................ 20
5.1.2. Case 1: The SO has to Perform The Dispatch (SCED) Using The Prices Approved by NEPRA ... 20
5.1.3. Case 2: NEPRA does not Set Prices For The Generators (Any Generator Or, Alternatively, A
Group Of Generators) ......................................................................................................................... 23
6. CONCLUSION AND REMARKS ............................................................................................................... 24

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 3

 MRC Consultants & Transaction Advisers

Table of Figures
No table of figures entries found.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 4

 MRC Consultants & Transaction Advisers

Acronyms
BMC Balancing mechanism for Capacity
BME Balancing mechanism for Energy
BPC Bulk Power Consumer
BST Bulk Supply Tariff
CDP Commercial Delivery Points
CPPA-G Central Power Purchasing Agency (Guarantee)
CTBCM Competitive Trading Bilateral Contract Market (competitive wholesale electricity market
for Pakistan)
Discos Distribution Companies successors of WAPDA restructuring
EPA Energy Purchase Agreement
MO Market Operator
NEPRA National Electric Power Regulatory Authority
NTDC National Transmission and Dispatch Company
PPA Power Purchase Agreement

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 5

 MRC Consultants & Transaction Advisers

1. INTRODUCTION
The purpose of these notes is to have a guide and discussions about general concepts of market models
used around the world and how they translate to the Pakistani situation in the Power Sector and in the
elaboration of a Market Model for the implementation of the CTBCM, according to the mandate given by
the ECC.

2. GENERAL CONCEPTS AND MARKET MODELS ON ELECTRICITY MARKETS

2.1. HOW MANY (ELECTRICITY) MARKETS MODELS EXIST IN THE WORLD?

Many. Very many. Seeking for simplification, we can group them in two broad market model
categories (although many “grey areas” exist.
o Centralized economic dispatch market models in which the SO runs an optimization
software to determine the merit order list, which also takes into consideration regulated
security limits..

o Self dispatch market models in which the SO only takes care of the congestion and
through different mechanisms adjust the operation to make it feasible within the
regulated security limits.

2.2. HOW DOES MARKETS WORK IN CENTRALIZED DISPATCH MODEL?

o In the case of centralized dispatch models (sometimes referred as Gross Pools) all
generators and all the demand have to declare to the Market Operator or System
Operator or M&SO, etc. their available capacity and with regard to prices, there are
essentially two versions: (1) what is declared is the generation variable costs (mostly heat
rate and fuel price) and (2) what is declared is an offered price for the produced energy
(with certain restrictions). In the second case, this declaration can be segmented in pairs
of quantities and prices1 . The demand, in most of the cases, is “price taker” (when the
demand is inflexible). In cases when the demand is flexible (specially large consumers)
there are mechanisms in which the demand can also offer to buy in the market depending
on the market price, in the form of pairs of MWh trenches and associated prices2

In the case of a Gross Pool, all participants sell and buy all their production and
consumption in the market. The settlement is done at the marginal cost or price of the
market by the MO. Payments are normally done through a centralized mechanism,
although there are also cases in which, the settlement made by the MO also includes the
instructions of how much each seller has to pay to each buyer.

1 E.g. for the first trench of T1 MWh, the price is P1 $/MWh, for the trench above it of T2 MWh, the offered price is P2 $/MWh,
etc.
2 In some cases the demand sells reserve, in the form of interruptible demand, that the SO has available for operation, which can

be dispatched according to offered prices.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 6

 MRC Consultants & Transaction Advisers

However, there could also be bilateral contracts between sellers and buyers. These
contracts are mostly to hedge prices and to ensure that in moments of scarcity, the buyers
have their supply secured. The SO does not take into consideration those contracts for
dispatch, the system is dispatched according to the optimization software. In these cases
there is a balancing mechanism to trade the deviation between the contracted quantities
and the actual quantities, either produced or consumed. So, while the contracts are
settled by the contracting parties, the deviations are settled in the market by the MO at
a price which calculation is established by the regulation (for instance as established in
the Commercial Code or Market Rules)

2.3. HOW DOES MARKETS WORK IN SELF DISPATCH MODEL?

o In the case of self dispatch models, the sellers and the buyers agree bilaterally quantities
and prices (also for different periods of time). All the agreed contracts (only the
quantities) are informed to the SO to dispatch the generators according to them. The SO
verifies if all contracts put all together in the available network can be dispatch as
requested without violating the security limits. If the limits are not violated, then the
operation is done according to the requests of the contracting parties. If the limits are
violated, the SO uses mechanisms to accommodate all the generation and the demand in
the available network3. The same mechanism is used to settle deviations between the
contracted and the actual quantities. So it is also a balancing mechanism

2.4. FROM BALANCING MECHANISMS TO SPOT MARKET

o In cases where the parties are not forced to sell and buy through contracts, or at least a
significant part of their production and the consumption can freely be decided by the
participants, then potentially the balancing mechanisms will become the environment
where these selling and buying can be made. So in those cases, the balancing mechanisms
is not anymore only a tool to settle differences but it becomes a trading environment
where parties can sell and buy, part or all their quantities. When this happens, it is not
called anymore balancing mechanism, but either balancing market or directly spot
markets.

The pricing mechanisms for the balancing mechanisms/markets, can also evolve from
simple (at the start) to more complex ones (once the trading environment is getting more
mature). For instance, a balancing mechanism at the start up of a market, could be set as
the annual, monthly, daily average prices, which are simple to determine and pretty
stable. Later on, it can evolve to marginal cost or even marginal prices, depending on the
evolution of the maturity of the market, conceptually measured through the abilities
acquired by the operators to operate in such environment, the maturity of tools, including
data availability, the solutions of restrictions of all kind, such as network restrictions,

3 Increasing or reducing generation and demands, typically using increasing prices for increasing quantities, in the chase of
increasing generation or decreasing demand and decreasing prices for decreasing quantities in case of reducing generation or
increasing demand.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 7

 MRC Consultants & Transaction Advisers

collection restrictions and others, and the capacity of the market players to do their own
selling/purchasing planning to optimize their business.
However, when the balancing mechanisms becomes a more relevant trading
environment, where market participants sell and buy, the pricing mechanism should also
evolve to a marginal costs or prices one.

2.5. TRADING PLATFORMS

o In both markets it is possible to implement platforms through which the parties can sell
and buy. There even are cases in which for regulated demand is mandatory to purchase
through this platform. When the trading parties are eligible consumers and generators
with no long term contracts, these platforms normally are not regulated, i.e. the parties
can establish the trading mechanisms freely.

The result of this trading are a number of bilateral contracts between the sellers and the
buyers that have participated in it for a certain trading period.
At the moment of the actual operation of the system, depending on the type of market,
this bilateral contracts are converted into:
 In centralized economic dispatch market, the contracts are informed to the MO4
for settlement of the deviations, and the SO dispatches the market regardless
these contracts (the merit order list is determined based on cost or prices, as
discussed earlier). It could be said that in this case, the trading platforms are
essentially financial instruments to optimize the commercial operation in the
market, however not affecting the physical dispatch.

 in self dispatched markets, the contracts are informed to the SO to be dispatched

as per the parties requests.

2.6. WHAT IN TERMS OF EFFICIENCY

o The centralized economic dispatch model, if properly implemented, obtain the optimal
solution for the operation, this is the least cost operation for the short and medium term,
taking into consideration all possible restrictions (security limits) that may exists in the
system. All other types of dispatch, are either less efficient (higher total costs) or at best,
the same total costs as obtained with the centralized economic dispatch model.

o Dispatch model other than centrally dispatch ones have arisen in power sector in which,
due to existing conditions (like ownership, etc.) didn’t allowed to implement the most
efficient model. One typical case is when generators don't want to disclose their prices,
as it happens in centralized dispatch models.

4 Can be informed by the trading platform or by the trading parties, it is not relevant.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 8

 MRC Consultants & Transaction Advisers

2.7. ARE THERE MIXED MODELS)?

In principle, nothing precludes that some part of the generation is subject to centralized dispatch,
while some part is self-dispatched. “Mixed approaches” are normally used when dealing with
international (or inter-regional) transactions. In these cases, there is no need to have the same
model everywhere, but some way of coordination among markets. This kind of approach was (and
still is) used in Europe, regional markets in Latin America, etc. India can be considered also a mixed
approach, since part of the generation (belonging to the federal state) is dispatched in a
centralized way, while other generation can be considered “self dispatched”
In any case, when applied to a single country, there is a natural evolution, which, at the end, after
some time, leads to the application of one or the other more “pure” model.

2.8. WHICH COUNTRIES USE EACH APPROACH

o As said, there are many approaches. In general, it can be said that (with exemptions):

o the “centralized dispatch” approach has been used in America (both US and Latin-
America) and several other countries. Spain used it during many years until it changed to
the “non-centralized” model.

o The “non-centralized” approach is mainly used in Europe. India could be another example
(with some specific particularities5). Several other countries also follow this kind of
scheme.

2.9. THE EUROPEAN MODEL - EUROPEAN POWER EXCHANGE

It is important to understand the context. Most of the utilities have been in the past vertically
integrated. At the time of the reform most of them were privately owned. Also, the EU is as a
whole an economic environment that promotes intra community transnational transactions, such
as mergers and acquisitions, included power companies. Also physically the power systems are
strongly interconnected, allowing cross border trading. In this context, due to the origin of the
utilities, the threat that governments perceived of loosing sovereignty if energy companies are
taken over by foreign companies and the heavy interconnection of all countries, imprinted on the
reform process particular features responding to those facts. Only transmission and system
operation were split from the utilities, and in each country the TSO were created. There are
specific rules for the use of the transmission system, very much influenced by the cross border
trading; most the utilities own generation and distribution, and the figure of voluntary power
exchanges was created. To these power exchanges go trading participants who want to optimize
their internal costs by selling or purchasing in the market.
Here it is important to remark that this kind of demand can be very flexible what enables the
trading participants to offer for instance to purchase different quantities depending on the trading
price. Any other type of demand, such as a Disco without generation or even many of the eligible

5 In India, part of the generation, which belongs to the federal state, is dispatched by PGCL in a centralized way.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 9

 MRC Consultants & Transaction Advisers

consumers are not that flexible, especially if they don't have how to replace whatever is not
purchased from the market.
The power exchange has a day ahead market and an intra-day market. The trading platform
accept offers to sell and offers to buy and has a matching algorithm that finds the optimal solution
for all the transactions proposed by the trading participants. Afterward the TSO checks its
technical feasibility. Once the final solution is found, the physical selling and purchasing arising
from the trading platform become binding for all the trading parties.
The TSOs also run a balancing mechanisms based on a Balancing Agreement, in which a deviation
is defined as a volume difference between physical scheduled nominations informed to the hub
operator or transmission system operator (“nomination”) and the contractual delivery volume
established in the trade confirmation (“deviation”).
The implementation is quite complex, for all the stages of the daily (day ahead) and intraday
processes, for the standard information that has to be submitted, the mechanisms to introduce
corrections if the physical dispatch is not feasible, the settlement process, the guaranteeing
entities that give assurance, for a fee, to the participants that payments will be done, etc. In the
EU has taken many years to reach to the present situation. Several power exchanges are
operational.

2.10. HOW THE TRANSACTIONS CARRIED OUT IN THE MARKET FINALLY CONSOLIDATE IN
THE REAL (PHYSICAL) WORLD?
After all the transactions of the market have been done (regardless the type of market model),
somebody has to operate the system in a safe and reliable way. This institution is the System
Operator (SO) or the Transmission and System Operator (TSO) in some cases. The balance
generation-load should be maintained at all times, reserves need to be scheduled, transmission
constraints eliminated, etc. The way this is done is different in any country but, in general, it is
done under following rules:
o In the case of centralized dispatch, the SO uses a Security Constrained Economic Dispatch
to determine which generators shall be running, taking into account the necessary
reserves and the transmission constraints. In order to do that, it needs to know the
operating cost (or prices) of each generator. For consistency, it uses the same values
which have been offered in the market (when the market is based on bids), although this
is not necessary so and the SO may use different offers which are received specifically for
this purpose. So, the balancing mechanism is “naturally” done. And the result of these
calculations is the marginal price (which may be different at different points of the
system). This (these) prices is (are) the spot price(s) of the system/region. For that reason,
people use to refer to it as the “market spot price(s)” or, simple, market price(s).

As the models used for balancing the system are the same (or similar) to those used to
settle the market, the normal tendency of this kind of approach is to consolidate the
“market” and “operation” functions only in one institution (the market and system
operator).

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 10

 MRC Consultants & Transaction Advisers

o In the case of self-dispatch approach, the SO needs to know (in advance) what is the
expected dispatch of all generators (in mixed approaches, remember that the market only
clears part of all the generation or demand). This obtain this information directly from
generators and suppliers. The usual word for this process is “nomination”. Once the SO
receives all the nominations, it has to conduct security analysis, check necessary reserves,
etc., etc. This process is carried out under the assumption that nominations should be
respected as much as practicable. In any case, under these schemes, the SO needs to
receive additional offers to balance the system. These offers, which may have very
different names, are, at the end, offers for increasing/decreasing generation/demand.

The SO uses these offers to adjust the system and, the result, is always a new price which
is normally known as the balancing price. It is usual to refer to this process of system
adjustment as to run a “balancing market”.
So, in these cases, there are always two prices: The price cleared in the market before
actual operations (day ahead, or shorter) and the balancing price. This is so because the
two processes (before and after SO adjustments) are carried out by different institutions.

2.11. HOW OFTEN THESE MARKETS OPERATE?

o Usually, practically in all world, at least a day ahead market is run, regardless of the market
approach used. Also, in all cases, an ex-post price exist, which is the result of the balancing
adjustments and/or real time operations (balancing market). In between these two
“moments” there could be as many markets as wished. In some cases, several intra-day
markets of the same type of the day ahead market are run with different durations (i.e. Spain)
while in other cases, once the day ahead market is closed other markets are open with,
sometime different rules6. In any case, the international experience shows that the volumes
operated/traded in the day ahead market are, by far, more important than those traded
afterwards (the relation is 90/10 at maximum).

2.12. ARE THE SETTLEMENTS CREATING FINANCIAL OBLIGATIONS?

In general, yes. Energy traded at the day ahead, intra-day or balancing markets involve financial
obligations for both sides, and they have settled/cleared within prescribed times. There are some
exemptions, however, to this general rule. In some Latin-American markets (gross pools) the day
ahead sanctioned price is only for informative purposes. All the energy is traded using the ex-post
operations prices only. In these cases, it is similar to consider that all the energy is actually traded
at a real-time balancing market. This, in turn, simplifies the settlement process, but, in any case,
there are no “conceptual” differences.

6 Inpractically all cases the day ahead market is conducted under marginal approach (offers are received during some period and
at the gate closure a single price is determined which apply to everybody which has participated) while many intra-day markets
operate under a continuous approach (offers of buying/selling are received at any time and they are cleared in a bilateral case.
Like the stock exchange).

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 11

 MRC Consultants & Transaction Advisers

2.13. WHAT ABOUT LONG-TERM CONTRACTS (HEDGING)?

Short term market prices (day ahead, balancing, etc.) are by nature volatile. They permanently
vary due to changes in load, generation availability, etc. Market participants need instruments to
hedge this volatility, either to predict future payments (loads) or to obtain financing in the case
of generators. These instruments are the contracts (sometimes called long term contracts).
These contracts are similar whether the model chosen is a centralized dispatch or not. They
initially take the form of delivering a certain amount of electricity at a certain date for a specified
price, although, with time, more complex agreements may be developed. These contracts may be
negotiated bilaterally (OTC) or through organized markets. In general, many market operators
(usually after some time of establishment) start developing some kind of organized financial
instruments (usually futures and forwards) which are used by some market participants to hedge
their operations. In any case, all these products are financial instruments without any significant
impact in daily operations (day ahead, intra-day or balancing markets).
Usually, market participants may sign the contracts they wish (both OTC or in organized markets).
The regulator, however, may limit this capacity in the case of suppliers serving non eligible
customers (or captive customers who cannot choose their suppliers and have to procure from a
pre-designed supplier). The reason is not exposing these captive customers to undue (or
perceived as undue) risks. In other cases, there is more flexibility but the regulator informs in
advance which prices will be used to determine the tariffs for these customers. [usually the short
term (day ahead) prices or some specific dedicated auctions for these suppliers procure their
electricity].
It’s sometime argued that the net-pools (voluntary pools) gave a (slightly) more friendly
environment to develop such contracts. In the case of centralized dispatch the market operator
need to know (in advance) at least the quantities bilaterally agreed to produce the settlement
while in the net pools (or power exchanges) the settlement is produced without any reference to
the contracts signed. Said that, the international experience shows that in all the cases long term
contracts develop and that these contracts can be enough flexible as to fulfil the requirements
required by market participants. Even more, while market develops, the financial market (by
itself) starts creating and trading a bunch of derivative financial products which can be used by
market participants to hedge their operations (futures, options, structured products, etc.).
One important pre-requisite for this is the existence of a clear short term market with enough
liquidity and a transparent price, which can be used as a market index and can’t be challenged.
Implementation also poses a hard challenge, most of all due to the required maturity of the
operator and of the IT systems.

2.14. SHOULD CAPACITY BE CONSIDERED AS A DIFFERENT “PRODUCT” THAN ENERGY?

All the markets explained above relates with energy transaction. The question, therefore, is if it is
necessary to introduce (or not) other mechanisms/markets related with available capacity to
encourage long range adequacy in the system (capacity required not only to serve the load today
but also to serve the load in the near-medium-long range).
There is no a single answer to this question. There are defenders in both sides.
o Energy only defenders, based in the economic theory, indicate that if the market
(whichever the model selected) is “efficient” there is no need to introduce any other

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 12

 MRC Consultants & Transaction Advisers

mechanism to encourage long term adequacy. If the market is “short”, that is, the
available capacity is limited, the prices will go up and this would be the signal that market
players would use to develop additional investments. This, in turn, requires that there
won’t be any kind of limitation on the market prices (so, it would be expected that market
price have relatively frequent spikes.

Taken from the CPPA training course.

o Defenders on the other side, argue that the market is imperfect (there is no clear
undoubted price when there is no enough generation available and the SO is forced to
shed load) and, therefore, some kind of “cost of unserved energy” need to be used for
settling the transactions.

Regardless of this debate, there is some empirical experience that clearly suggest the convenience
of treating capacity as a different product than energy, at least in developing countries. The
reasons behind this includes:
o New generation requires time to develop (several years at minimum). So, the participants
in the market should have a clear perception of future risks (i.e. the possibility of very
high prices 2-3 years in advance) to take appropriate decisions. Market participants,
especially if belonging to the private sector, tends to minimize this risk and, therefore,
their decisions are taken based on a relatively short term view, opening the possibility of
unwanted situations in the future.

o There is a natural reaction against price spikes. When these situations appear, the
regulator intervenes, either cancelling the market and/or imposing caps to the bids
received7. This, in turn, eliminate the signals required for developing additional
generation (especially peak oriented additional generation).

o In developing countries, many generation projects are carried out by developers which
requires external financing to materialize them. It is extremely difficult (almost
impossible) to obtain financing for a project which expected incomes depend on the
(random) appearance of price spikes.

As a result, it can be concluded that some mechanism is needed to assure future adequacy8.
Therefore, capacity needs to be treated as a “different product” than energy and justified to
guarantee the security of supply.

7 One of the reasons of this behaviour is that, sometimes, it is extremely difficult to separate price spikes due to “natural”
objective reasons from spikes created by market manipulation (due to the existence of market power).
8 It is interesting to note that some European countries, which could be considered as champions of the “energy only market”

option start reconsidering their position. The reason is that the massive incorporation of non-controllable renewable energy

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 13

 MRC Consultants & Transaction Advisers

2.15. HOW CAPACITY REQUIREMENTS ARE USUALLY HANDLED?

A bunch of options:
o In some cases, it was decided that a capacity payment that would be received by all (or
some kind of) generators. These payments are defined by the regulator and spread
among all suppliers in the system (regardless they trade in the market or not).

o In some others (i.e. UK at the initiation of the market) an add-on was incorporated to the
market price. The value was calculated as the probability of failure (LOLP) times the value
of lost load (VOLL). So, all market participants have to, slightly, contribute to long term
adequacy.

o In many other cases (specially in developing countries) all suppliers have the obligation of
having enough capacity contracted for the following “x” years. Suppliers are penalized in
case of non-compliance. The model is sometimes (although not always) complemented
with some kind of organized auctions where the suppliers can obtain the capacity they
need to comply with their obligations.

o An important number of hybrid (or ad-hoc) mechanisms.

In any case, it needs to be taken into account that the mechanisms/models that are implemented
to assure long range adequacy and security of supply are relatively independent of the model
selected for the short term (gross pool, net pool, others) market. Any market model comprises
both elements: short term market – long term adequacy (market or not). They are usually treated,
however, as two (relatively) decoupled problems.

3. THE PROPOSED MARKET MODEL FOR PAKISTAN

3.1. PILLARS FOR THE PROPOSED MODEL

The current situation in Pakistan can be characterized, among others, by the following facts:
 All existing generation is contracted through long term PPAs with the 10 ex-WAPDA Discos. These
PPAs are characterized by “take or pay” capacity payment and energy payments which are a
function of the actual energy generated, decided by the System Operator (NPCC). Both the prices
of capacity and energy are determined by NEPRA. Part of the contracted generation is assigned
to KESC, due to a transitory agreement which will end in next years (2020?).

facilities (which can’t guarantee capacity) increases the requirements of reserve. Assuring these reserves remains in the system
for those moments in which they are necessary to be dispatched requires some kind of payment decoupled from the market
results.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 14

 MRC Consultants & Transaction Advisers

 The price for all existing generation, both in terms of capacity and energy, is decided by NEPRA
(based on the signed PPAs or through a cost analysis in the case of ex-WAPDA Gencos.

 All demand is served by the 10 Discos. Although the regulation allows to some bulk power
customers (BPC) to procure their electricity bilaterally from generators, practically there are no
BPCs that have exercised this possibility, basically because there is no generation available which
has not been contracted.

 The payment discipline is weak (at least in the case of some Discos).

 There has been significant lack of generation to supply the total load for many years. Currently
the situation is (approximately) in equilibrium. Due to the large amount of additional capacity
already contracted or currently under construction, there is a significant risk of overcapacity in
the near future9. All these generation will enter in the system with long term PPAs with take or
pay conditions, regardless the size of the demand (additional burden for the demand).

In an environment with such restrictions is extremely difficult (in fact practically impossible) to rapidly
create a competitive electricity market, in which significant amount of energy could be traded. Instead of
this, the market model envisaged can be considered as a first stage of a market implementation roadmap,
a “seed” for the gradual market development, with rules and procedures which:
 Are simple and robust, properly functioning under the current sector structure (take or pay
PPAs) but working also well when in the near-medium future additional generation is installed
without inflexible long term PPAs and/or with part of the demand free to choose supplier; and

 Can easily evolve towards different market structures in the future, provided there is more
generation available to be traded in the market and eligible demand which procures there its
required energy.

It is important to emphasize the key aspects over which the proposed market model was designed (the
“Pillars”). These “pillars” constitute the backbone of the design. Of course, there are different ways to
implement it and detailed design possibilities exist, but while preserving such “pillars” nothing will affect
the core of the proposed model.
Considering the ongoing of the whole design of the market done by the Special Committee formed by
BoD to make recommendations about it and ensure a wide stakeholders consultation, we consider that
is important to clearly insist in the importance of preserving the Pillars of the mode, provided that there
is a clear consistency between real situation, future strategic objectives and possibilities of
implementation. If there is global consensus about them, the particular details can be easily worked out.
If there is no global agreement in such “pillars”, obviously the challenge will be harder.
These main pillars (and their reasons) include:
 The market model should be compatible with existing (and envisaged) power sector structure.
Not all market models existing in the world can be translated to the Pakistani environment under
the circumstances that characterize it, such as that all the existing generation (and, also, the new
generation envisaged for the next 4-5 years) is already contracted through long term inflexible
PPAs. That requires that the market model to be implemented in the short term should be capable

9The actual amount of overcapacity will significantly depend on the future load growth. In any case, the simulations performed
shows that even in the optimistic scenarios of demand growth this overcapacity will not be absorbed before 2025.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 15

 MRC Consultants & Transaction Advisers

to properly handle this situation. This reason justifies our proposal to assign the existing PPAs to
the Discos with a balancing mechanism. However, as the expectations are that this market should
gradually increase competition and become more efficient, its design is such that in the near
future and as the conditions are met, with very simple regulatory adjustments, the market can
become more and more sophisticated, up to the point that the level of the transactions match
the decision makers expectations.

 The market model should assure long-range adequacy of the power sector. Pakistan has
experienced cycles of overcapacity, followed by prolonged cycles of insufficient capacity. The
proposed model assures that, in the future, enough generation capacity will be available, as well
as minimizing, as far as practicable, the installation of excessive capacity that should be paid by
the consumers. This objective justifies the proposal of imposing capacity contracting obligations
to all the participants which represent demand (Discos, large customers, wholesale suppliers,
retail suppliers, etc.). It also envisaged a mechanism to balance such capacity obligations.

 The market model should encourage short term efficiency in the generation side. Maximum
short-term efficiency is obtained if, in the market, all participants (in particular generators) make
offers which are equal to their variable costs. To comply with such objective, the proposed model
prescribes that the dispatch (to be performed by the SO) should be made through an optimization
tool: The Security Constrained Economic Dispatch and that this tool will use the variable prices,
determined by NEPRA, as inputs10. The balancing mechanism, which will settle the differences
between the contracts and the actual generation/consumption will use the prices determined
through such tool. Therefore, maximum efficiency is obtained.

 The market model should be capable to adequately operate in the medium-term future, when
the power sector structure and weaknesses may be different from today. The proposed model
should be capable to handle future situations in which, for example, some generators may be
installed without long-term inflexible PPAs, or some consumers decide to procure their supply
outside the current Discos. The market model perfectly adapts to such kind of situations and the
balancing mechanism would be the “tool” for the operation of such kind of generators and/or
loads. The proposed model allows many forms of transactions, which may be used to hedge the
positions of these generators or loads. Nothing in the proposed model precludes its evolution
according to other market requirements, either intra power sector or including financial market
or a combination of several connected commodity markets, such as gas, coal, emissions, etc. All
of this can be done through regulatory changes, without requiring costly structural changes, both
in terms of money or in terms of consensus building..

4. POTENTIAL (FUTURE) EVOLUTION OF THE MARKET MODEL

As it was mentioned above, the market model proposed could easily evolve towards more open (and
eventually more complex) structures, while preserving its basic concepts (the “pillars”). This evolution
should be guided by the changes that may happen in the power sector structure, maturity of stakeholders,
technological changes, different gaps within reasonable margins, etc. . In this regard, it needs to be

10 The energy prices determined by NEPRA are, actually, the variable costs for generation.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 16

 MRC Consultants & Transaction Advisers

emphasized that the market model implemented articulates enough features and figures that will allow
it to “adapted” to the structure of the power sector and not the opposite11.
It is possible to make hypothesis about how the power sector evolution could be. Following paragraphs
show how the proposed market model could evolve as changes arise in the sector (this evolution matrix
is under construction, so it will be updated shortly):

1 New generation is installed in Pakistan, No changes required. The proposed market model
with or without long term contracts with envisaged this situation.
(some) participants.
2 NEPRA does not fix prices for (some) of At some point in time, the SCED (and determining
the new generation installed. the associated marginal prices), will be able to be
based on prices offered by participants.. New
procedures will be needed to determine how these
offers would have to be formulated/received
(monthly, weekly, hourly?).
The Balancing Mechanism will be transformed into
a Balancing Market or, eventually, into a Spot
Market (it’s only a matter of names). No substantial
changes are required in the conceptual design,
3 NEPRA reduces the capacity obligations The Balancing Mechanism transforms, practically
(more generation can be bought through immediately, into a Spot Market. Procedures need
competitive procurement “in” the to be implemented to receive offers from
market. This also means that NEPRA generators (and eventually demand), and the SO
stops deciding prices for generation (all, has to run the SCED using these offered prices.
or a significant part of total generation) Again, no significant changes in the conceptual
design.
4 Demand start to be more “active” and a In principle, no changes need to be introduced in
significant part want to trade their energy the proposed model. However, is highly probable
through independent suppliers. [The that this demand (represented by the suppliers) will
same may happens with new generators be keen to join trading platforms to hedge the
that eventually will be installed in contracts they would sign, without being required
Pakistan]. to permanently negotiate bilaterally.
Trading Platforms (TP) are part of the proposed
market model. We can call them TP or Power
Exchanges (PX). In principle, there is no need to
regulate these TP, leaving its creation to the market
forces (financial market). There would be one, or
more than one of such TP.
. In this case, as it is done in several other countries,
they run a bunch of relatively standardized

11Despite the fact that the market model implemented could foster (or, alternatively, be a barrier to) changes in such power
sector structure, since some models could be perceived by potential investors as more (or less) “friendly” than others.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 17

 MRC Consultants & Transaction Advisers

products (i.e. day ahead, week ahead, futures,

forwards, etc.).
There would be no restrictions for the Financial
Sector to create other products (other platforms)
they consider better serve the requirements of
their potential customers.

5. TRADING PLATFORM IN PAKISTAN (POWER EXCHANGE?)

We have been suggested to evaluate a different “model” for the market. The basic elements of this
“model” are:

 A trading platform (call it a PX) is created. In such platform, part of the demand and generation
will trade their energy.

 The “demand” which may trade energy in such platform would be some large customers and part
of the demand currently served by Discos (to be decided in which amount), which will be detached
from them and transferred to new suppliers;

 Some generators, which are not covered by long term PPAs and, eventually, new ones would also
trade in such PX.

 The physical dispatch will continue being performed by the NPCC (SCED) and imbalances will be
settled through a Balancing Mechanism similar to what it is described in the proposed market
model.

With this assumptions, the model proposed for the CTBCM may perfectly host a trading platform like this,
there are no impediments to do it with the different figures the market will contain. For instance:
 A Wholesale supplier could purchase the generation not committed in PPAs from generators

 The Wholesale Supplier would resell it to a Retail Supplier through market contracts

 And the Retail Supplier will sell the purchased power to its clients, that could be either discos or
BPC or exporters

 The Wholesale Supplier could also be generator or a group of generators, and the Retail Supplier
could also be a group of BPC12

 In order to may it more dynamic, the Wholesale Supplier could perfectly organize a Trading
Platform, in which organize reverse auctions between the generators and the demands, and out
of this auctions a number of contracts will arise, which, will have the same treatment in the
market as any other contract (the SO will dispatch the system regardless the contracts) and the
Balancing Mechanisms will settle any difference between the contracted amounts and the
dispatched amounts.

12Discos could also purchase through a Retail Supplier, if the NEPRA procurement rules (for generation costs pass through) treat
this possibility appropriately

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 18

 MRC Consultants & Transaction Advisers

 Gradually, and as soon as the operators and the systems have reached the required maturity,
physical transactions could also be implemented, although for the time being it is not clear what
kind of benefits this could bring altogether

 Another consideration is that in order for a reverse auction to be effective, it is necessary to

have at both ends (sellers and buyers but mostly buyers) enough elasticity. This is not easily
achievable:

o A retailer selling to households, small industries and commerce, etc. Most probably will
find that is customers cannot modify significantly its demand: it is what it is. It could also
invest in storage or other demand side management techniques, but this is an entirely
different business

o If the retailer is selling to BPC, perhaps the demand is a little more elastic, but not much,
with the exception of industries that can shift production or can run their own
generation

o In case of a wholesaler for exports, in that case perhaps the elasticity could have a larger
degree of manoeuvrability

 The fact that at least in the short term the complexity of reverse auctions seems not to be
necessary is an advantage: the trading platform could start as a normal auction platform which
over time could evolve towards a higher level of complexity

 All of this could be done from day one according to the proposed market model, even it could
be prepared before the starting date to be launched together with the rest of the market. The
preconditions to be able to do it are:

o To have secured generation not committed in PPAs, totally or partially

o To have either

 independent distribution companies (as the NERPA Act is today, i.e. holding a
licence for both, distribution services and sale of electricity) with a license
allowing them to be market participants; or

 according to the NEPRA Act Amendment (2017) to have a licensed company

providing distribution services and one of more retail companies selling
electricity to end customers (regulated or captive); or

 BPC willing to leave the Discos that are supplying them now (or new ones) and
eager to become market participants, willing to be part of this trading platform

o Probably this TP should have different time horizons for different type of either sellers
or buyers, what, as in the end, the results of the trading are bilateral contracts, for the
system and specially for the SO, there will be no conflicts

o Probably one of the hardest points to solve will be the guarantees. A wholesale or retail
supplier could not be as the CPPA today, and agent with limited liabilities, therefore the
risks are different and for sure will make the eligibility of trading participants more
restricted

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 19

 MRC Consultants & Transaction Advisers

o This platform shall not be considered a public service, it is crucial to let the parties to
take their own risks and manage them with their own resources. If a TP like this is born
under the public tutelage, it will never fly as a dynamic driver for the growth of the
competition in the market.

o We have also to say that our preference has always been to go gradually according to a
roadmap that all parties should adhere to. It has been proven that to go faster than
what the stakeholder, operators and systems can mange, in the end produces more
damages than benefits.

5.1. NUMERICAL EXAMPLE

5.1.1. DATA FOR THE EXAMPLE

Following example shows how this Trading Platform would work in the proposed market eventually
function.
In this example there are 4 generators and 4 loads, with the following data:
Generator Price approved by NEPRA Maximum capacity
G1 5 PKR/MWh 10 MW
G2 6 PKR/MWh 15 MW
G3 7 PKR/MWh 40 MW
G4 7.5 PKR/MWh 30 MW

Loads Demand
L1 10 MW
L2 15 MW
L3 30 MW
L4 30 MW

5.1.2. CASE 1: THE SO HAS TO PERFORM THE DISPATCH (SCED) USING THE PRICES
APPROVED BY NEPRA
 Assume G1 and G3 goes to the PX (G2 and G4 decides not to go, since it is a voluntary market).
G1 offers 7 PKR/MWh; G3 offers: 8 PKR/MWh. Assume also that L2 and L4 goes to the same
market.

o The PX settles the market:

 Offers received:

 To sell: 10+40 = 50 MW

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 20

 MRC Consultants & Transaction Advisers

 To purchase: 15+30 = 45 MW

 Quantity settled: 45 MW

 Cleared Price: 8 PKR/kWh

o Results:

 G1 receives: 10 MW * 8 PKR/MWh = 80 PKR

 G3 receives: 35 MW * 8 PKR/MWh = 280 PKR

 L2 pays: 15 MW * 8 PKR/MWh = 120 PKR

 L4 pays: 30 MW * 8 PKR/MWh = 240 PKR

 In turn, the SO prepares its SCED. The eventual results (without taking into account transmission
constraints & reserves) would be:

o Total demand: 85 MW

o Total generation: 95 MW

o The result of the SCED are:

 G1 generates 10 MW, G2 generates 15 MW; G3 generates 40 MW and G4

generates 20 MW (it generates less, since it is the most expensive one).

 L1, L2, L3 and L4 were totally supplied.

o Marginal Price is 7.5 PKR/kWh.

 The settlement process (done by the Market Operator) performs the following calculations [It is
assumed that no generators / loads have any existing long-term contract. However, the
calculations can be done similarly in presence of other contracts of this type. It is irrelevant for
the analysis make here]

o The PX communicates the transactions made in such platform:

 G1 sold 10 MW and G3 sold 35 MW.

 L2 purchased 15 MW and L4 purchased 30 MW.

o The settlements are:

 G1

 Generated 10 MW.

 Sold 10 in the Px.

 Result in the balancing mechanism (or market) BM: 0

 Settlement: 0 PKR

 G2

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 21

 MRC Consultants & Transaction Advisers

 Generated: 15 MW

 Result in the BM: +15 MW

 Settlement: 15 * 7.5 PKR/MWh = 112.5 PKR

 G3

 Generated: 40 MW

 Sold 35 in the Px.

 Result in the BM: 40-35 MW = +5 MW

 Settlement: 5 MW * 7.5 PKR/MWh = 37.5 PKR

 G4

 Generated: 20 MW

 Result in the BM: +20 MW

 Settlement: 20 MW * 7.5 PKR/MWh = 150 PKR

 L1

 Consumed: 10 MW

 Result in the BM: -10 MW

 Settlement: -10 MW * 7.5 PKR/MW = -75 PKR

 L2

 Consumed: 15 MW

 Purchased in the PX: 15 MW

 Result in the BM: 15 – 15 = 0

 Settlement: 0 PKR

 L3

 Consumed: 30 MW

 Result in the BM: -30 MW

 Settlement: -30 MW * 7.5 PKR/MW = -225 PKR

 L4

 Consumed: 30 MW

 Purchased in the PX: 30 MW

 Result in the BM: 30 – 30 = 0

 Settlement: 0 PKR

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 22

 MRC Consultants & Transaction Advisers

The final results, considering both the PX and the BM are:

PX [PKR] BM [PKR] Total [PKR] Price [PKR/MWh]
G1 80 0 80 8.0
G2 0 112.5 112.5 7.5
G3 280 37.5 317.5 7.94
G4 0 150 150 7.5
L1 -75 -75 -7.5
L2 120 0 -120 -8.0
L3 -225 -225 -7.5
L4 240 0 -240 -8.0

This example shows how the two markets (the PX and the BM) can, actually, co-exist. Nothing in the
model we have designed is contrary to such transactions.
In particular, in this example, G1 and G4 benefiting from the results in the PX (if they have not traded
there all the energy had been traded at the BM at a price of 7.5 PKR/MWh) and L2 and L4 paid a higher
price for the energy.
This is not always so. If, for example, G2 had participated in the PX (or L4 has not participated), the results
had been different. In such cases, the generators that had participated received a lower price for their
energy and the loads benefited from this.
However, the question to be answered is if there is some “real” benefit of having a PX like this described.
There will be a very short time between the closing of the PX and the moment at which the SO performs
the SCED (with the associated BM results). So, the PX (the PX described in this example) could not work
as a “real” hedging mechanism, nor for the loads neither for the generators. The prices at the BM will be
actually volatile. But, in principle, it can also be expected that the prices at the PX will be, even, more
volatile. For the simple reason that, being a voluntary market, the volumes traded there will be smaller.
Therefore, the incentives to trade there will be relatively small. There would be gain and losses, but, as
mentioned, the PX can’t act as a genuine hedging mechanism, basically because the closing gates for the
two markets are only few hours.
Which is the “actual” market price. Undoubtedly, the “market price” is the BM. This price is formed taking
into account all the generators and loads (at the SCED), and therefore, all market participants will use this
to take their decisions. At the end, it is quite probable, that this PX (if no other products are traded there)
will gradually vanish…

5.1.3. CASE 2: NEPRA DOES NOT SET PRICES FOR THE GENERATORS (ANY GENERATOR
OR, ALTERNATIVELY, A GROUP OF GENERATORS)
In this case, the generators can decide about the prices to offer in the PX, exactly as in the case of the first
case.
The SO, to carry out its functions of centralized dispatch, will require offers from all generators (or,
alternatively, the group of generators for which NEPRA has not sanctioned regulated prices.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 23

 MRC Consultants & Transaction Advisers

Of course, the SO has to require such offers some time in advance of the actual operations. So, in actual
terms, there would be two “markets” at which (all or a group of) generators have to make their offers.
One voluntary (the PX) and the other mandatory (for the SO to perform the SCED). Both offers
simultaneously or, at maximum, separated by few hours. Again, it is quite hard to imagine that a strong
PX can actually develops…

6. CONCLUSION AND REMARKS

In summary, a Trading Platform like this, referred as a PX (as described in this example) it is totally
compatible with the market model envisaged. However, it is hard to imagine that it would have a strong
development, basically because it would be “competing” against the BM, which is in the core of our model
envisaged (since it is directly related with the centralized dispatch).
Of course, it is possible that the PX “evolves” making trading not only the day ahead (as per the example)
but also week ahead, year ahead or any kind of other financial instruments. In such a case, the PX would
be an actual “place” to hedge about volatility in the BM prices and, therefore, it could have significant
growth.
There is nothing against such issue and, in fact, it was envisaged in our market model, although with a
different name: We call them “Trading Platforms” and they can be developed as the “market” (that is, the
participants in the market) would require it.

CPPA G: Detail Design - Notes on Electricity Markets – TA 8772-PAK CPPA-G - 01/12/2017 24