1

Evolution and Challenges for the

Post –Liberalised British

Electricity Market

Derek Bunn

“Surprises are foolish things; they are frequently inconvenient

and the pleasure is not enhanced” Jane Austen, Emma

Long-term Plans &

Uncomfortable Surprises

A Big Ask?

For many years, policy has sought to manage prices and competition

Now, policy is seeking to manage investment and competition

The evidence on policy interventions has been one of unintended

consequences, surprises and successive reforms……

………here is a flavour >>>

2

A Decade of Surprises

1988, The Secretary of State for Energy introduces the Government’s White Paper on Privatisation

“It will create a customer-led industry…..a new industry will evolve and be

shaped by the needs of the customers”

1998, The Secretary of State for Trade and Industry presents the Conclusions of the Pool Review:

“The Pool was a club in which customers could not participate…”

(And even more surprising after a decade of duopoly market power……)

“The uniform Pool price….gives a positive advantage to smaller players…the rate

of new entry exceeds what would be expected from the underlying economics….it

is not in the interest of larger generators..”

Another Decade of Surprises

1998, The Director General of Electricity Supply states

“Capacity Payments …provide a poor signal with regard to the longer term

need for capacity”

2012, The Secretary of State for Energy and Climate Change states

“a Capacity Market .. will be designed to provide investors with the

certainty they need to put adequate reliable capacity in place, and protect

consumers against the risk of supply shortages”

1998, The Secretary of State for Trade and Industry states

“A related distortion has been the use of long-term Contracts-for-

Differences…this gives a positive incentive to bid zero to run”

2012, Energy Bill introducing the EMR

“CfDs improve long-term revenue certainty, lowering the cost of capital for

low-carbon generators”

3

A UK Electricity Market has not Existed

Gen.

TSO

Dist.

Great Britain (England & Wales and Scotland) Northern

Ireland

Interconnectors

14 Regional Distribution Cos. (6 owners)

NIE

Scottish Power / SSENational Grid Electricity Transmission

IPPsEON

RWE

EDFCentrica SSE

Iberdrola

Supply EON RWE EDF Centrica SSE Iberdrola

6 principal supply companies

(vertically integrated with generators)

Market Power in Generation is not

a Major ConcernCentrica

5%E.ON

12%

EDF

21%

RWE

14%Scottish Power

7%

SSE

14%

Interconnectors

3%

Independent

and Joint Ventures

24%

4

Wholesale Power Prices

Carbon Price

Floor has an

effect.

20

30

40

50

60

70

80

90

2010 2011 2012 2013 2014 2015

(€/MWh)

German Power 1-Y Fwd (€/MWh) French Power 1-Y Fwd (€/MWh)

Italy Power 1-Y Fwd (€/MWh) Spain Power 1-Y Fwd (€/MWh)

Nordic Power 1-Y Fwd (€/MWh) UK Power 1-Y Fwd (€/MWh)

Moody’s Investors Service

Forward Trading is Moderate

5

And Actually Decreasing

Technological Change is Disruptive

6

Transmission is an

Emerging Issue

Generators do not

face nodal prices,

but annual

connection charges

(£/kW) vary by

zones.

More interconnection

12

Moyle +/- 500MW

E-W +/- 500MW

BritNed +/- 1000MW

NEMO +/- 1000MW

Norway +/- 1000MW

Now: +/-3500MW

2020: +/-7000MW

7

And More

Offshore

Connections

The Regulator would like to

see more competition in

transmission ownership

NG >>> Demerge TO & SO

The DNOs may then follow.

40

50

60

70

80

90

100

110

120

Ind

ex (

19

89

/90

= 1

00

)

Year

Real Movement in Electricity Network Prices since Privatisation

NGC Av E&W EDNO Sweb Yorkshire

DNOs

TSO

Network

Regulation has

been Effective

8

Comparative Retail Prices do not look Extraordinary

But Ofgem is Concerned with Retail

Profits of the “Big Six” have Increased

9

Domestic Electricity Market Shares

have remained rather stable

With Low Monthly Switching by

Consumers

10

Retail Price Co-ordination

Retail Prices and Wholesale Costs

Average for Big Six: Ofgem note that total costs underestimate by £150

11

Asymmetric Monthly Changes

The cost data displays monthly wholesale cost for electricity and gas from Ofgem’s SMI Database for

the period January 2004 and December 2013.

Effective Regulation should be enough….

Why is there now so much policy intervention?

• 2008 Climate Change Act of Parliament >>>defined plan and

budget to 2050

• Incentives needed for renewables – green certificates did not

seem to be as good as FiTs

• Asset impairments for incumbent generators and emission

directives, plus intermittent technologies posed a question of

resource adequacy >>capacity payments.

• The EUAs were not doing enough work >>>carbon price

floor

12

Reserve Margin is a Concern

Moody’s Investors Service

Capacity Margin Forecasts0%

10%

20%

30%

40%

50%

60%

70%

2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

UK Germany Spain Nordics Italy France

Ofgem Reliability Standard

LOLE £3hrs /yr

Target

And European Utilities face difficulties

Earnings Per Share Decline

13

They Have Seen Significant

Ratings Migration» Moody’s rates 87 groups > €450 billion of debt

» Over the last fifteen years the ten largest European utilities have seen a

deterioration in credit ratings from the Aa/high single A rating level to mid

single A to Baa.

EMEA Electric & Gas Utilities: Ratings Migration

Source: Moody‘s Investors Service

Equity Providers want more than Lenders

14

The Value Chain is Changing

• Generation– Asset Performance risk ; more joint ownerships; policy risk

• Transmission– New Infrastructure . SO responsibilities for delivering policy.

Emerging conflicts of interest. Potential Split.

• Distribution– Distribution system operators (“DSOs”) may have to emerge

• Retail– chronic public scrutiny with increased expectations for consumer

engagement, energy efficiency and new services.

Main Reforms

• Capacity Payments for resource adequacy through

competitive auctions

• CfDs for carbon-free technologies through

competitive auctions

Plus:

• A carbon price floor to support EUAs

• Performance standards on new generation

• Energy efficiency standards (including smart

meters)

15

GB Capacity Mechanism

Annual capacity adequacy study by Ofgem indicates Capacity Requirement Criterion is Loss of Load Expectation (LOLE) < 3 hrs per yr.

Annual Auction for new and existing plant. New plant will be given 15 year contract; existing plant 1 year. Plant getting CfDs/ROCs cannot enter. Demand-side can.

Plant with contracts can be called at 4 hour notice.

GB Capacity Mechanism

Penalties if unavailable when called set at VLL – SBP,

capped at 200% of monthly income & 100% of annual income

(VLL = £17,000/MWh; SBP capped perhaps at £6,000/MWh)

Auction is a mult-round decreasing auction with a pre-defined demand curve:

CONE = annuitised cost of an OCGT = £47,000/MW/yr

Net Cone = CONE – estimated annual revenue of an OCGT = £29,000/MW/yr

Cap = £75/MWh

16

Capacity Auction Outcome

Low clearing price of £19.4

for 49.3 GW for 2018

Only 2.6 new build

and 0.2 DSR

But 12.9 refurbished (eg IED)

And 33.6 existing

Some of the large facilities did

not succeed. Some plants are

closing.

Interconnectors in the Next

Auction. De-Rating Factors?

Is it £1Bn well-spent?

The quantity purchased in capacity auctions is

a concern to the market

The GB capacity assessment for LOLE:

�Half-hourly independent simulations of demand,

supply and duration of outages.

�Loss of Load defined at the point Grid has to take

actions, not disconnections

�The operational reserve (largest infeed loss) is

never used

�Demand-side activity is cautiously estimated

�Very cautious view on contribution from Imports

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CfD Auctions

How can a government

� Provide Early Technology Support selectively

� Have a technology neutral policy

� Use competition for price discovery

Contracts for Differences (CfDs)

Curtailment Risk and Output RiskBasis Risk. Reference price is daily for wind and quarterly for nuclear

Counterparty is the Government but cashed–out on a monthly basis, >>extra risks for suppliersMax payment to generators is the strike price, but generators can offer negative to run

CfD strike prices are administered caps Quantity constraint (Levy Control) on amount of CfDs issued per year >>>> Auctions

CfD

Removes

Price Risk

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CfD Administered Strike Prices

Hinkley Nuclear Strike price …..£92.5, …………expected to be £121 in 2023

2015 CfD Auctions

Composite auction for 4 years;

Separate yearly clearing prices

Flexibility alternatives for Projects

Interyear budget carryovers

27 Projects Successful,

Mostly below ASTs

Onshore £79 - £82.50

Solar PV £50 - £79

Offshore wind £114- £119

EfW £80

Winner’s Curse for £50 PV

(13 month Penalty for Walkaway)

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Policy

Initial policy reviews have been cautiously favourable, but:

Complex annual auctions do not favour smaller new entrants

Capacity markets may not be helping the low carbon transition

Interconnector participation in capacity auctions needs more

detailed multiregional resource adequacy analysis

The carbon price floor is more of a tax than a remedy for EUAs

CfDs may not be the least cost subsidy mechanism

End

dbunn@london.edu

Related publication:

“The progressive inefficiency of replacing renewable

obligation certificates with contracts-for-differences in

the UK electricity market” Energy Policy 2015