Value of lost load (VoLL) - the only rein for wholesale electricity prices
Internal Electricity Market Glossary

 

 


 

 

Value of Lost Load (VoLL) has been traditionally defined as the value attributed by consumers to unsupplied energy. It represents the maximum price that consumers are willing to pay to be supplied with energy, and at that price they will be indifferent between, on the one hand, being supplied and paying the price and, on the other hand, not being supplied (and pay nothing).

 

voll

The so-called 'Winter Package' defines the VOLL as 'an estimation in €/MWh, of the maximum electricity price that customers are willing to pay to avoid an outage' (Article 2(2)(h) of the Proposal for a Regulation of the European Parliament and of the Council on the internal market for electricity (recast), 30.11.2016, COM(2016) 861 final 2016/0379 (COD)).

 

Pursuant to Article 10 of the said draft Regulation by one year after the Regulation's entry into force the EU Member States must establish a single estimate of the VoLL for their territory, expressed in €/MWh (different VoLLs per bidding zone may be established if Member State has several bidding zones in its territory).

 

Member States must update their estimate at least every five years. 

 

The European Commission must be kept informed of the above estimates, which will also be available to the general public. 

 

The methodology for establishing VoLL will be determined (Article 19(5) - the ENTSO-E is required to submit to the ACER a draft methodology for the VoLL's calculating by six months after entry into force of the Regulation).

 

The crucial provision of the Winter Energy Package lies in Article 9(1), which defines maximum wholesale electricity price at the VoLL's level.

 

This rule applies, inter alia, to bidding and clearing in all timeframes and include balancing energy and imbalance prices.

 

Recital 10 of the draft Regulation argues that it is "critical to ensure that, as far as possible, administrative and implicit price caps are removed to allow scarcity prices to increase up to reflecting the value of lost load.

 

VoLL is typically quite high (e.g. several thousands of euros per MWh) and not necessarily the same for each (group of) consumer, thus enabling voluntary demand side management (DSM) activation by consumers before the VoLL is reached (ACER/CEER Annual Report on the Results of Monitoring the Internal Electricity and Natural Gas Markets in 2014, November 2015, p. 217).

 

Pursuant to the Agency for the Cooperation of Energy Regulators (ACER), in a well-functioning electricity market, prices should be allowed to vary unhindered in a way which optimises EU generation schedules in the short term and efficiently determines the optimal composition of the energy mix in the long term, including during shortage situations.

 


"The demand for electricity is typically insufficiently responsive to prices because currently prevailing technical features of electricity delivery do not allow most customers to respond to price variations in real time. As a consequence, there may be situations when the wholesale energy market cannot clear, because demand remains above available generation capacity independently of the price level. In such circumstances, some kind of regulatory intervention is needed to bring supply and demand in balance, e.g. by rationing demand and administratively setting a price.

 

Economic theory indicates, under certain assumptions, that during periods of rationing it is optimal to set a price at the level of the value of lost load (hereafter, 'VOLL'). VOLL is equal to the marginal consumer surplus associated with a unit increase in electricity supplied to rationed consumers. In other words, it expresses the value attached by consumers to uninterrupted electricity supply. A regulated price at the level of VOLL when the market does not spontaneously clear would in theory provide incentives to invest in generation capacity that reflect consumers' average willingness to pay for security of supply.

(...)

In most Member States price caps currently exist which are not based on estimates of average VOLL, but often on the technical bidding limits used by power exchanges. The maximum price may also be limited by the rules by which imbalance settlement is calculated, since market participants will never choose to pay more for electricity in the market than they would be charged for a deficit after gate closure. Although VOLL has not been calculated in many Member States, those Member States that have calculated it, report values that are well above their price caps in the day-ahead market.

(...)

There are several reasons why in practice prices are often capped significantly below VOLL level. In practice it is a challenge to accurately estimate the VOLL to ensure that prices are set to incentivise investments in generation capacity up to a level that reflects consumer willingness to pay for additional security of supply.

(...)

Alternative emergency measures (like activating operating reserves, dispatching emergency demand response or implementing voltage reductions, for instance) are used to balance markets that suppress price signals, instead of implementing involuntary curtailments of demand and VOLL pricing."

 

Commission Staff Working Document, Accompanying the document Report from the Commission, Interim Report of the Sector Inquiry on Capacity Mechanisms {C(2016) 2107 final}, 13.4.2016 SWD(2016) 119 final, p. 28, 29


During such shortage situations, the margin between available capacity and (peak) demand may tighten, and electricity prices will rise above marginal operating costs to include a 'scarcity premium', potentially up to the VoLL.

 

During these hours, all generating plants in the merit-order (e.g. base-load, intermediate and peaking plants) receive a price which contributes to the recovery of their fixed costs.

 

Even in the absence of scarcity, most dispatched plants receive an "infra-marginal rent" (i.e. the difference between the market price and the variable cost of the plant) which can be used to cover fixed costs.

 

The above ACER Report of November 2015 further observes, in a well-functioning electricity market, the occurrence and magnitude of scarcity prices should be sufficient to attract the required level of investment.

 

In the absence of such price spikes and without any other revenues (e.g. from the provisions of ancillary services), existing peak plants might exit the market without being replaced.

 

This would simultaneously increase the frequency of scarcity conditions and scarcity prices, while reducing the market's ability to respond.

 

Where demand is sufficiently price responsive, a well-functioning electricity market will deliver full adequacy, albeit at the cost of some demand 'voluntarily' reducing consumption when, during (rare) shortage situations, prices are allowed to reach VoLL levels.

 

This is because, given the definition of VoLL, no consumer is willing to pay a price for energy higher than VoLL.

 

Commission Staff Working Document, Accompanying the document Report from the Commission, Interim Report of the Sector Inquiry on Capacity Mechanisms {C(2016) 2107 final}, 13.4.2016 SWD(2016) 119 final, p. 28, 29 refers to literature (Cramton P., Ockenfels A. and Stoft S. (2013)), according to which the market responds to VOLL by building additional capacity up to the point where a MW of capacity costs just as much as it earns from being paid VOLL during blackouts.

 

So at this point the cost of capacity equals the value of capacity to consumers, and beyond this point, consumer value per MW can only decline as the system becomes more reliable.

 

Hence, the VOLL pricing rule causes the market to build the second-best, 'optimal' amount of capacity.

 

This solves the adequacy problem – with help from a regulator.

 

A first-best solution can only be obtained by enabling a fully responsive demand-side allowing the market to clear at all times on the basis of individual consumers' preferences.

 

The said Commission Staff Working Document of 13.04.2016 estimates that the VOLL for the EU Member States ranges from EUR 11,000/MWh to EUR 26,000/MWh, so significantly higher than existing European price caps.

 

The aforementioned document also reads:

 

"Moreover, a majority of countries does not calculate a VOLL for their market, nor use it in setting a market price cap or a reliability standard.

 

This results in a situation in which the necessity and the size of a capacity mechanism are not always based on a proper economic assessment. As a consequence, there is a risk that interventions in the market become subjective and hence sub-optimal. Objectivising the need for and degree of interventions can be done by adopting a well-defined VOLL as a key indicator in determining an appropriately maximum level of protection."

 

 


 

 

 

 

"To determine their reliability standard, a number of Member States make use of a calculation of VOLL. Where a Member State calculates and applies VOLL, it estimates the value an average consumer places on secure electricity supplies at any point in time. In other words, it is the price point at which the consumer is indifferent between paying for electricity and being cut off. The higher the degree of protection desired, the more (back-up) capacity is needed and therefore the higher the price tag attached to it. In order to determine the cost of additional protection against disconnections through additional capacity investment, some countries calculate the cost of new investment by estimating the cost of a 'Best New Entrant (BNE)' or 'Cost of New Entry (CONE)'. The estimate is usually based on the costs of a new peaking plant (since this represents a cheaper way of providing marginal capacity than a baseload plant). A comparison of VOLL and BNE/CONE can identify the point at which the value for consumers of investment in additional capacity is maximised – at the point at which the incremental cost of insuring customers against power cuts is equal to the incremental cost to customers of power cuts. [...] Linking the reliability standard to the level of capacity that reflects the maximum value consumers place on being supplied with electricity, means that an economic efficient level of protection is set and that expensive overprotection is avoided.

 

Less than half of the countries calculate VOLL and use it as their basis for determining their reliability standard. A possible reason that not all Member States make use of a VOLL to ensure an economically sensible level of protection may be that it is difficult to calculate an appropriate average VOLL. Electricity has a different value for different users and differs over time. An additional complexity [...] is that electricity consumers are not able to individually express their valuation of electricity for every time slot. VOLL calculations therefore attempt to replace the true (but unknown) value of disconnection with an administrative average value. The average VOLL in each Member State or bidding zone may also be different, reflecting the different cost of a MWh of unserved energy to different types of consumers and/or consumers in different parts of Europe."

 

Commission Staff Working Document, Accompanying the document Report from the Commission, Interim Report of the Sector Inquiry on Capacity Mechanisms {C(2016) 2107 final}, 13.4.2016 SWD(2016) 119 final, p. 58


 

 



Last Updated on Sunday, 23 April 2017 22:51
 

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