The value of flexibility in power markets

The concept of flexibility is not one you find in standard microeconomics textbooks, yet it already plays a major role in the remuneration of the resources that generate and consume electricity every day and is likely to play an even larger role with the penetration of large intermittent renewable capacities. In this paper we attempt to quantify the net revenues that can be captured by a flexible resource able to react to the short term price variations on the day-ahead and intraday markets in Germany. We find that the difference between day-ahead and intraday revenues for a flexible resource has been increasing (although the profitability has been decreasing on both markets). This difference is more pronounced once 15 mn price variations can be captured by a flexible resource. The net revenues from the local 15 mn auction (which is held 3 h after the hourly “coupled” day-ahead auction) are more than eight times higher than the day-ahead hourly auction but below the net revenues that can be captured with the high prices from the continuous market. The results of the backward-looking empirical estimations allow us to distinguish and quantify two components of flexibility: (1) the “immediacy” value as we are approaching real-time and the urgency of the delivery increases (this value is revealed during the continuous intraday process and is highly linked to the stochastic nature of power supply and demand (i.e., wind/solar forecasts, forced outages of thermal generation,…) forecast error risk), and (2) the “ramping capability” component based on the technical characteristics as a resource can react to variations of shorter granularity (15 mn vs. 60 mn). We model and quantify the ramping capability component using a geometric brownian motion with jumps.