Inna Shcherbyna:  Sales by State Generation Form a Real Commodity Exchange Market with Many Participants

Inna Shcherbyna: Sales by State Generation Form a Real Commodity Exchange Market with Many Participants

The electricity market of Ukraine, its new model, has started working relatively recently, but for the first 9 months there were obvious successes and achievements in this commodity exchange trading, namely on the Ukrainian Energy Exchange (UEEX). Liquidity is increasing, the number of participants grows, and variety of products is increasing. Moreover, the UEEX proved successful sales of electricity produced by the NNEGC Energoatom, and is working with other players to develop new trading instruments and a fixed-term market.

Read more about the achievements of commodity exchange trading in Ukraine, as well as the problems with the operation of the new electricity market, in an interview with ExPro, Deputy Chairman of the UEEX Exchange Committee Inna Shcherbyna.

Translated by: Elizaveta Zavhorodnya

How do you evaluate the first 9 months of the new electricity market and bilateral contracts segment?

In overall, the reform is still ongoing. Every day the market learns how to work under the model we have. While it is difficult to call it a targeted model of reform and to draw an analogy with Western markets, it does not mean that we are going somewhere out there or have chosen the wrong path.

If we look at other the countries, they all had problems during early stages of reform, and they were all perfecting internal regulations until effective models were achieved. The main thing that needs to be done now is a timely, fast and professional response to all bottlenecks. Still, there are difficulties with that, there are problems of interaction.

The market has been operating for 9 months, an age in which children are just starting to walk, and it is normal that not all " teething troubles " have passed, but now these problems are already growing into devastating factors and endangering threats. We are witnessing a situation of rising chain debts in the market: the SE Guaranteed Buyer owes the NNEGC Energoatom and producers of "green" electricity; the NEC Ukrenergo indebted the SE Guaranteed Buyer; consumers do not timely pay to universal service providers and regional power network operators.

The problems entailed by rapid deployment of renewable energy generation badly need rapid political decisions. It is absolutely necessary to take measures to eliminate the shortage of reserves and to launch the ancillary services market. The RES generation is low-predicted and therefore creates high risks disruptions in power system. The NEC Ukrenergo in its Generation Capacity Compliance Assessment Report outlined clear guidance on how to address the problems posed by “green” generation.

The presence of price limitations in the market creates distortions and difficulties for thermal generation, which is forced to work out strategies and, at times, aggressive trading policies to survive in the market. The latter’s approaches are not very successful at a number of CHP plants with a generation cost exceeding the price of electricity in the market.

Confirmation of the immaturity of the market is very significant price fluctuations during short periods of time

The current low market competition is further limited by unreasonable PSOs in the market. The PSO instruments have, in fact, created another heavyweight participant in the market, the SE Guaranteed Buyer, which holds more than 50% of the market with impact on the day-ahead electricity becoming even decisive. When the SE Guaranteed Buyer failed to fulfill its obligations under the power purchase agreement with the NNEGC Energoatom, the latter was forced to dump the unpurchased electricity into the free market making it sag. In that case, it was important to balance the presence of such a large-scale electricity generator in all segments of the wholesale market to avoid market sags. However, we saw positive examples of the realization of NNP-generated electricity in the market for bilateral contracts.

The immaturity of the market was demonstrated by very significant price fluctuations over short periods of time, especially by the fluctuation of prices for the day-ahead electricity. Only unhealthy organisms can fever so. It is necessary to treat the illness itself, not to try to fight the symptoms.

With regard to the bilateral contracts market segment, the UEEX is making considerable efforts to develop this segment in an organized commodity exchange format. There are currently two areas for action: the first is state-owned auctions (specialized section) and the second is focusing on commercial auctions. For the last 9 months the work in the specialized section things went smoothly, we fulfilled all requirements of the Auction procedure, the Auction Committee, all its members (Ministry of Energy, NEURC, Anti-Monopoly Committee of Ukraine, Ministry of Economy) closely oversight our work. They receive daily operational reports on the results of auctions, complaints and violations on us our part were not recorded. We are in constant dialogue with authorities, jointly carry out analysis and search of bottlenecks in order to hone the mechanism of auctions. The UEEX is very responsive to the needs and changes of the market. Thus, for example, the principle of fair distribution of lots under price caps was adhered during auctions. After changes to the PSO occurred, the UEEX was able to reconfigure its work in the shortest time possible.

In early December 2029 we launched a commercial auction section. It was very important to set up a separate commercial session, since we did not aim to be merely a platform for the PSO mechanism sales, as we seek to create an organized market of bilateral contracts in Ukraine with the ability to freely choose counterparties, to conclude contracts in a free form and on terms and conditions bespoke by parties.

The Auction Procedure approved by the Cabinet of Ministers of Ukraine’s Resolution contains a provision that other than state market participants may participate in the auction on voluntary basis. At the same time, there is a rule that only seller can initiate auctions. That is, there is a set of rules that does not encourage private producers or buyers to participate in the auctions of the specialized section. In addition, auctions for state-owned electricity generators are a less flexible tool, since the rules of the auction must clearly comply with the Auction Procedure and be agreed by the Auction Committee.

The main difference of the commercial auction section is that either a seller or a buyer can initiate an auction, and biddings can take place both for raising or lowering the price. The commercial auction section on the UUEX have introduced tools such as formula-based bidding and block bids.

The number of bidders by each auction increases and boosts competition and liquidity

How has the number of bidders volumes of trading changed since the launch of the new electricity market? What positive trends have been since that time?

Currently, there are 224 participants at auctions held on the UEEX. As of April 9, 2020, sales in the specialized auction section amounted to 9 695 521 MWh of electricity including the PSO segment at 58 040 123 MWh. In addition, in the commercial auction section there were another 162 718 MWh sold during the same period. I can say that there are positive dynamics, the commercial auction section is growing. The number of bidders by each auction increases and boosts competition and liquidity.

How do you assess the entry of the NNEGC Energoatom and the Ukrhydroenergo PJSC into the free market segment of bilateral contracts and their sales at market prices? In your opinion, will such sales increase?

State-owned producers are obliged to sell electricity at auction under bilateral contracts. But while the Ukrhydroenergo PJSC had such opportunities, the NNEGC Energoatom was restrained by PSOs.

The NNEGC Energoatom is now trading in volumes that have not been off-taken by the SE Guaranteed Buyer failing to comply with the terms of the contract with the NNEGC Energoatom. That is, the current conditions satisfy the requirements of the normal operation of the NNEGC Energoatom in the market provisioned under the new model.

The state-owned NNEGC Energoatom sold their electricity in a transparent and competitive market with no restrictions or discrimination, and around them the segment of the real bilateral contracts market with many other participants continued its further development.

Today's PSO model has already shown its inability to function properly under increasing electricity generation from RES and massive consumer defaults because of the COVID-19 quarantine measures. Therefore, the current PSO model needs to be changed. However, shifting the burden of problems from one subject to another will not remedy the situation. There is a financial PSO project, but it also has many risks and its format must be further discussed in order to choose the right concept. Therefore, I think the market for bilateral contracts has a potential for growth.

What can you say about the practice of using new exchange instruments such as block trades, coefficient trading? How have those instruments performed lately?

Unfortunately, the participants still badly mastered those instruments. Accurately forecasting volumes and prices, utilizing all markets and tools is what distinguishes effective trading from inefficient one. Those who do not know how to attune to the market will leave it, as it happened in markets of other countries. Of thousands of electricity suppliers in Poland, only 90 active participants remained in business during the first three years of operation of the market.

New instruments are not yet available to government producers, as the auctioning rules in this section should be agreed by the Auction Committee, but they are good tools to hedge against the sharp price fluctuations in all market segments and to increase sales volumes. Block applications are more appealing to traders and electricity suppliers rather than to large-scale electricity generators. The latter may be less interested to work with small bids, but an electricity supplier is the one who should be interested in forming an optimal trading portfolio for purchases in all market segments.

What are the next steps the UEEX plans to take to increase liquidity, to attract new players (private companies), and to provide new services to electricity market participants?

The operator of the transmission system and the regional power distribution networks looking for electricity to cover transmission technological losses should have entered the day-ahead trades on the UEEX. These entities can do so in accordance with Art. 66 of the Law on Electricity Market, and in accordance with the amendments to the PSO, as of January 1, 2020, they are obliged to buy electricity to cover their technological losses in the free market. Somehow, they have not done this in the day-ahead market.

Power distribution network operators have not yet entered the UEEX bilateral contracts auctions to purchase electricity to balance transmission losses

We have now begun to work harder to attract new members. The first thing they encountered was a very low level of awareness. Some were trying to blame everyone and everything, others were urging the UEEX calculate their effectiveness of entering the day-ahead electricity auctions. Of course, we provide advisory support and will expand its scope, but the UEEX cannot do someone's job. To be effective is the task of each individual market participant, since we provide only a tool.

Let's see how a truly competitive electricity market in the EU works. The main segment there is the market of bilateral contracts with its share reaching sometime 90% share in trades. This is the cheapest market segment in which contracts can be traded for a number of years to come. The Ukrainian day-ahead market is not that long-term, the market is just undergoing a stage of formation, participants are still afraid to enter into long-term contracts, forecasts are not so accurate. At the same time and optimization and fulfillment contracts in the short-term market can be risky. To cope with the challenge, by the way, we launched the formula trades.

In the EU an electricity generator sells his schedules during the day-ahead trades, the schedules that are favorable to him, often even the TPP base load electricity is sold at a loss, because for thermal generation the main product is the peak load electricity, and it is important for the electricity generator to stay in the grid. The percentage of generator-consumer direct sales is very scanty and consists only of sales to large industrial giants. The rest of the market is the electricity sales by traders. In the day-ahead electricity market, an electricity generator cares only for secure sales, while a consumer looks for fixed and guaranteed prices. Then every day a long-term contract of the consumer will be accompanied by his supplier at different markets and different prices. The price is higher closer to the time of delivery. The supplier needs to plan and relate his purchases and sales in different markets in order to approach the consumption curve of his consumer, which has already fixed its price, should not sag to a loss as a result. Securing the consumption curve is not the headache of neither of the EU consumer nor the EU electricity generator, it is the task of the trading supplier. What the EU electricity generator heads for is to sell as much as possible.

In future, the share of bilateral contracts will grow

In your opinion, how should the bilateral contracts market develop further? What trends do you predict?

As I noted above, the market will become more standardized. Electricity generators will sell longer contracts of standard electricity loads, and electricity suppliers will become more active, mobile, and inclusive, and will handle block applications and non-standard contracts. Big consumers, who have been engaged in procuring their electricity needs themselves, will eventually leave the market and let electricity suppliers compete for their procurement contracts with them. That is why I emphasize the need for a highly qualified trader and electricity supplier, because they will create a market.

Of course, proper business accounting, good forecasting and planning must be ensured. Once this is ensured, the market for bilateral contracts will increase. And this is not to be feared, so it should be so: 85% - 90% of the market is the bilateral contract market segment, with the remaining percentage distributed among day-ahead, intraday, and balancing market. This is how the market works all over the world. Currently, we are also working a hedge mechanism by launching a trades in futures market.

You’ve mentioned the futures. Recently, the UEEX and the SE Market Operator signed a memorandum on development of fixed-term instruments, including futures, derivatives, options. Could you please elaborate on the development plans of these tools?

A Task Force on launching the fixed-term market is currently in place. We are working together to model possible market development scenarios, and we will further need to find tools that will meet market demands. We focus more on settlements under futures contract. The introduction of futures contracts entailed the need to hedge prices of electricity generation and buys of electricity from a wide range of market participants. This will allow participants to insure themselves against the negative fluctuations in electricity prices, which is extremely relevant under current market conditions.

While we are studying experience of other countries and preparing ourselves for a dialogue on the matter with electricity market participants so that we could provide a truly effective tool for them. This will not be that quick process, usually starting a new tool takes 6 to 12 months.