An assessment of the Danish–German cross-border auctions

Abstract

This paper presents an analysis of the auction prices at the cross-border auction between West Denmark and Germany and between East Denmark and Germany (the Kontek cable). Monthly and annual transmission capacities appear to be more highly valued than daily transmission capacity on average. The two cross-border auctions show different trends: the auctions between West Denmark and Germany exhibit a higher level of prices in the southbound direction, and between East Denmark and Germany, higher prices in the northbound direction. We find a relatively strong correspondence in the pricing of products over different time frames (daily, monthly and annual auctions) between West Denmark and Germany and a weak correspondence for the products between East Denmark and Germany. In the daily auctions, market players can decide whether to use their capacity after the clearing of the day-ahead market, while in the monthly and annual auctions they must decide whether to use their capacity prior to clearing. If they choose not to use their capacity, the use-it-or-lose-it principle applies. The capacity is then subsequently released to the daily market. Since the daily cross-border auctions are free of commitment, they should be valued as options. Likewise, in the monthly and annual auctions market players can choose not to nominate their capacity but as this must occur before the clearing of the day-ahead market, they will not know the directions of the power flows a priori. If they nominate the capacity they must use it; if the direction turns out to be “wrong,” it is then possible to purchase capacity in the opposite direction in the daily auctions. If market players can accurately predict the outcome of the spot markets day ahead, the value of monthly and annual capacity should more closely reflect the value of an option. Thus, one would expect the value of the monthly and annual capacity to be between the value of an option and an obligation. Although this suggests that the average price of daily capacity should be greater than monthly and annual capacity, our data do not support this hypothesis. The daily, monthly and annual capacity auctions do not reflect the value of the underlying asset as specified by the appropriate valuation of the energy price differentials between West Denmark and Germany and East Denmark and Germany. Therefore, market players are exposed to substantial variation in fees for congestion management on the cross-border. We study whether arbitrage improves over time and discern no obvious trend. Since the explicit auction procedure has not been cost-efficient, a better approach appears to be the new market coupling arrangement introduced on the Kontek cable and on the border between West Denmark and Germany, with the result that market players will pay a congestion management fee (i.e. area price difference) equal to the energy price differential resulting from the market coupling mechanism.