Improving the Capacity Allocation: Supply Options

Auctions represents a powerful tool to detect the willingness to pay of the buyers (or sellers) when there is scarcity of a good or service, pro- vided that the auction is well designed and cannot be manipulated by the subject involved. Auction mechanisms have been applied for the al- location of the peak and uniform capacity described in Section 3.4. The

theory in support of the use of auctions for the allocation of gas storage capacity has been provided by (16; 17). The main idea is that auctions improve social welfare whenever the final allocation is output maximiz- ing. In particular, the paper indicates the conditions under which an ad- ministrative allocation must be preferred to an auction mechanism and viceversa, in a market characterized by a dominant firm and a fringe of competitors. The strategy of introducing imperfect competition has the intent of capture some of the real features of the current European gas markets, where big players are at stake and new entrants are appear- ing38_.

If the advantages deriving from the adoption of market mechanism for the allocation of the capacity are clear, the drawbacks linked to the security and stability of the system have not been widely discussed. In fact, it can occur that shippers are not able to predict price peaks due to the excessive volatility of consumption and accumulate an amount of gas lower than the social optimal level. Whenever this happens, the market design approach enters in conflict with the target of assuring the secu- rity of supply to end users. An example can be represented by a low seasonal price differential expected by the shippers. This may reduce the attractiveness of gas stockpiling, with the risk of generating scarcity for limited periods in time, causing prices to jump up. Again, the price peaks may reflect not necessary the lack of an adequate amount of gas for seasonal modulation but, rather, the lack of flexible resources for daily or intra-daily instantaneous variations. The risks of extreme revenues fluc- tuations may than generate instability on the spot market and constrict TSOs to adopt emergency operations. As such concern is expected to be- come more serious due to renewable penetration and the relegation of CCGT to a “back-up” role, the spot market design should be accompa- nied with additional instruments.

38_{The work leaves an open discussion regarding the interaction between the allocation}

and productive efficiency of the shippers and the effect of introducing a secondary markets where renegotiation of storage capacities can occur. If renegotiation is allowed than it is essential to guarantee enough liquidity to the system and avoid attempts of monopoliza- tion and market foreclosure behaviors. This issue is more relevant the more the market is concentrated.

The introduction of supply option may serve to this scope. This instru- ment would provide the TSO with the additional amount of capacity for managing the daily modulation. This is achieved by purchasing from the shippers an obligation to supply, on TSO request and in the real time, the spot market with a certain amount of stored gas. This amount is determined by the TSO as the result of the maximization of a social func- tion that includes, among the others, the reduction of the probability of scarcity events as a function of the total stock available39_.

The shippers commit themselves40_{to provide resources at a price that} cannot exceed a given cap, predetermined when the option is bought by the TSO. The remuneration for the gas offered in the real time follows the balancing price up to the cap. If the balancing price exceeds the lat- ter, the shippers is required to pay back the extra-revenue he received. Therefore, the cap acts for limiting the earnings of the shippers and con- trolling market power in the case of scarcity of reserves for short-term modulation.

To conclude the design, the shippers offer the options in a non dis- criminatory way through auctions and the TSO selects the offers accord- ing to the price ascending order. Practically, this may be conducted with a Descending Uniform Price auction, where the TSO (or the SSO as defined in the previous section) starts the auction calling a very high price and keep reducing it at each step as far as the demand equalizes the offer and a single option price (the “premium”) comes out41_.

The advantages of this approach reveals to be manifold. First, the TSO is endowed, in the fullness of time, with the additional storage ca- pacity for the real-time balancing of the grid. Second, the price of this additional capacity is “capped” at some determined level in the event of scarcity, permitting to control shippers market power. Third, the market approach gives to the shippers the possibility to diversify the risk associ-

39_{This mechanism can be thought as an adaptation of the capacity market from the}

electricity sector to the gas industry. The elicitation of additional capacity, diversely from electricity, is not based on the increase of gas production but, instead, on its accumulation.

40_{A penalty should be inflicted to the shipper who do not respect the obligation.} 41_{The auction may include also a reservation price (lower bound) to cover part of ship-}

ated with price volatility. Indeed, those shippers who are more risk ad- verse towards future prices may stabilize the supply of their reserves by receiving a premium in exchange of gas accumulation. On the other side, the shippers who expects prices to raise up in the long term would prefer accumulate gas when prices are lower and exploit consumption peaks. Finally, the incentive to stabilize gas storage furniture for seasonal and daily modulation comes at a cost for the system represented, in the mech- anism just described, by the premium paid by the TSO for the acquisition of the options. Accordingly, the difference between the revenues for the selling of storage (uniform and peak) capacity and the premium is re- versed on final users, according to consumption. The timetable of the new market design is summarized in the Appendix.