Exploitation of electricity trading and transmission arrangements
Summary & Background
94.On 30 March 2009 Ofgem launched a consultation on Addressing Market Power Concerns in the Electricity Wholesale Sector – Initial Policy Proposals(10). This initiative reflected the regulator’s observation that the current market structure, coupled with limitations in physical transmission capacity in some areas, allows companies to exploit unduly the market in a way that results in higher bills for the consumer. During a recent investigation Ofgem also found that their existing competition law powers were unlikely to be effective due to difficulties in identifying the market in which a company could be perceived as dominant(11) and the possibility of companies having substantial market power without being dominant as understood in competition law. Their consultation considered a number of ways in which this regulatory loophole could be addressed, including the introduction of a Market Power Licence Condition (MPLC).
95.Under the electricity market arrangements in Great Britain (the British Electricity Transmission and Trading Arrangements) generation companies are entitled to operate power stations without taking into account network limitations. This would not be an issue if the existing transmission network had sufficient capacity to send the required electricity to and from all parts of Great Britain but, in some areas, the existing capacity of the wires does not always allow this. Such scenarios are called transmission-related ‘constraints’ and require action to be taken by the system operator(12), National Grid, to ensure that supply and demand is balanced on both sides of this constraint.
96.Currently, the most significant constraint boundary is that between Scotland and England (known as the “Cheviot Boundary”) and the most common scenario is one known as an ‘export constraint’, where there is too much generation ‘behind’ a constraint (in the smaller region – Scotland) and it cannot be transmitted to the larger region (England). The reverse scenario, where there is too much generation in the larger region, is known as an ‘import constraint’.
97.To balance supply and demand, National Grid can accept, as part of the ‘balancing mechanism’(13), both ‘offers’ to increase generation and ‘bids’(14) to reduce generation at specific plants. They may also have long term bilateral contracts in place with companies, including a category called inter-trip contracts. These involve National Grid paying the company an ‘arming fee’ that, via an automated trip-switch, means a particular plant could be taken off the system if the network becomes overloaded. This ‘tripping’ happens very rarely, nationally less than once a year, but the existence of inter-trip contracts allows National Grid to increase safely the electricity flow on the system and, therefore, is an effective way of expanding the available capacity of the network.
98.Ways in which companies could unduly exploit the above arrangements are by:
manipulation of where electricity is generated in order to achieve excess profit from either ‘offers’ or ‘bids’ in the balancing mechanism. This hinges on whether, because of the limited number of generation plants in particular locations, the company can predict when National Grid would have no choice but to accept an offer or bid from them to be able to balance electricity supply and demand. In this case the consumer may meet costs over and above those expected if power stations operate in economic merit order;
making exploitative ‘bids’ to take advantage of both being behind an ‘export constraint’ and being the only company with which National Grid can arrange balancing actions. For example, they may be the only generator available to reduce output in a particular location and so can name their ‘bid’ price and/or they might use such a locational advantage to extract unduly high ‘arming fees’ for inter-trip contracts with National Grid.
99.These sections will allow the Secretary of State to introduce a licence modification that will enable Ofgem to use its existing licensing powers to monitor and act on any examples of the actions described in paragraph 90 above. The objective is to provide a targeted and proportionate provision that will address the exploitation of market power whilst avoiding unnecessary uncertainty in the electricity wholesale market in Great Britain which could undermine investment in generation and, hence, security of energy supply.
100.The sections will not provide the long-term solution to the problem of ‘constraints’ – this will be resolved by the increased transmission capacity that will be delivered between now and approximately 2015 with additional capacity expected to be delivered by 2018. Reinforcement work on the Cheviot Boundary is already underway. The Energy Network Strategy Group (chaired by DECC and Ofgem) set out a vision for the network for 2020 needed to support a low carbon energy system(15). The sections will, however, give protection to the consumer during a time when the required upgrading of the transmission system may create more potential for exploitation to occur. Using primary legislation to introduce the MPLC will also allow the introduction of a tailored appeals process, which provides the generation companies the right to appeal directly to the Competition Appeal Tribunal (CAT) against enforcement orders or penalties imposed by Ofgem.
Commentary on Sections
Section 18: Power to make modifications
101.Subsection (1) provides the Secretary of State with the power to introduce a modification to electricity generation licences (including standard conditions incorporated in licences and documents maintained in accordance with the conditions of licences (such as industry codes) or agreements that give effect to those documents). When exercising powers under this section, the Secretary of State (and Ofgem) must carry out functions in accordance with the principal objective and general duties set out in sections 3A to 3D of the Electricity Act 1989 (section 30).
102.Subsection (2) limits the power in subsection (1) so that it may only be exercised for the purpose of limiting or eliminating the circumstances in which a generation licence holder may obtain excessive benefits from electricity generation in a particular period. Subsection (3) provides that a licence holder will be taken to obtain an excessive benefit if they have entered into arrangements regarding the generation of electricity with the transmission system operator and one or more of the conditions set out in subsections (4)-(7) is met. These conditions are:
the licence holder does not notify electricity generation that would have been economic to carry out and may receive excessive payments in connection with an increase in electricity generation in the relevant period;
the licence holder may pay an excessively low amount, or may receive an excessively high amount, in connection with a reduction in electricity generation in the relevant period;
the licence holder is paid an excessively high amount for an inter-trip arrangement; or
there is an increase or reduction in the licence holder’s electricity generation in a specific period, compared to their notified generation, as a result of which the licence holder may obtain an excessive benefit.
103.Subsection (8) provides that modifications may include provisions relating to operation of power stations, amounts payable to generation licence holders or offers by the licence holder to pay amounts.
104.Subsection (9) requires the Secretary of State to consult on the detail of any modification made under subsection (1) before it is implemented. Those consulted must include any generation licence holders, Ofgem and such other persons as the Secretary of State considers appropriate. Subsection (10) specifies that this requirement may be satisfied by consultation either before or after the passing of the Act.
105.Subsections (11) to (14) contain definitions and interpretation provisions for the purposes of this section. In particular, subsection (11) specifies the meaning of “notified electricity generation” for a period, and subsection (12) defines references to an increase or reduction in electricity generation in a period.
Section 19: The Authority’s interpretation and enforcement of modifications
106.This section requires Ofgem to publish a document that will set out how they will approach the interpretation and enforcement of the MPLC. Before publishing the document, subsection (2) requires Ofgem to consult generation licence holders, the Secretary of State and any other persons they consider appropriate. This consultation may occur before or after commencement of this power.
Section 20: Final and provisional orders: appeals
107.This section sets out a special process for appealing against any order which Ofgem makes under section 25 of the Electricity Act 1989 (“Orders for securing compliance”) for the enforcement of the MPLC. Subsection (2) allows licence holders who are the subject of an order to appeal to the Competition Appeal Tribunal (“the CAT”) against the order. Under subsection (3), the CAT can decide whether it wishes to decide on all or part of the matter, or whether it wishes to remit all or part of the matter back to Ofgem (or, indeed, do both). Subsection (4) provides for what the CAT may do in the event it re-determines an appealed matter: permitting it to uphold, set aside or substitute its own final or provisional order.
108.Appeals to the CAT will be subject to the Tribunal’s rules, and subsection (6) provides that subsections (2) to (5) will be subject to those rules.
109.Subsection (7) prevents an order for securing compliance from being challenged by any form of legal proceedings other than an appeal to the CAT under this section. Subsection (8) provides that any decision by the CAT will have the same effect, and will be enforced in the same manner, as a decision of Ofgem.
Section 21: Penalties: appeals
110.This section allows generation licence holders to appeal to the CAT regarding a penalty imposed by Ofgem under section 27A of the Electricity Act 1989 in relation to the MPLC. Subsection (2) provides that an appeal can be made against the imposition of a penalty, the size of that penalty and the date on which they have been directed to pay the whole, or part, of that penalty. Subsection (3) enables the CAT to uphold the penalty, set aside the penalty, substitute another amount for the penalty or vary the date by which the penalty, or any part of it, is required to be paid.
111.This section has a number of provisions that are identical to those in section 20. Any decision by the CAT will have the same effect, and will be enforced in the same manner, as a decision by Ofgem (subsection (7)). Furthermore, appeals to the CAT will be subject to the Tribunal’s rules, and subsections (2) to (4) are subject to those rules (subsection (5)). Subsection (6) ensures that it will not be possible to challenge penalties imposed by Ofgem except by an appeal to the CAT under this section.
Section 22: Further appeals
112.This section provides for further appeals from specified decisions of the CAT to appropriate courts (the Court of Appeal or, in Scotland, Court of Session).
Section 23: Expiry of power
113.Subsection (1) ensures that there is a limited time period within which an MPLC can be in force. This period is initially 5 years, but subsection (2) allows the Secretary of State to make an order to extend this period by up to 2 years. Before making any such order, subsection (4) requires the Secretary of State to consult generation licence holders, Ofgem and any other appropriate person.
114.Subsection (5) provides that any licence modifications made under this Part will cease to have effect after the expiry date set by subsections (1) and (2). Under subsection (6), however, any actions (including the imposition of penalties or other enforcement actions) that have previously been taken by Ofgem, or any other party, would not be affected.
115.Subsection (7) allows the Secretary of State to modify a regulatory instrument (which includes a licence) as a consequence of the powers to make licence modifications expiring. Subsection (8) provides that the Secretary of State must consult the holder of any generation licence, Ofgem and any other such persons considered appropriate before making any such modification.
For the purposes of the ongoing balancing actions, the geographic definition of the ‘electricity market’ will be subject to constant change.
The system operator is responsible for the operation of the national electricity transmission system.
The wholesale market is divided into 30 minute periods for trading purposes and ‘normal’ trading occurs until one hour prior to the start of each period – a point known as ‘gate closure’. After gate closure electricity generators and purchasers may not trade any further with each other, but may trade with National Grid. The ‘balancing mechanism’ is one market arrangement by which such trading with National Grid occurs.
Importantly, a ‘bid’ put forward by a company equates to an amount that they will pay National Grid not to generate. The company will, however, still realise a net financial benefit because it will have already received payment from its original contract with a supplier to produce electricity, while saving on avoided fuel and other costs by not running.