Overview of the UK Electricity Market

Part 1: Some general context Part 2: The retail market Part 3: The networks Part 4: The wholesale market Part 5: Thinking system wide Structure

Who are Ofgem?

• •

About us

Office of Gas and Electricity Markets (Ofgem) Regulator for both gas and electricity markets in Great Britain (separate regulator for Northern Ireland) •

Our statutory Principal Objective and general duties

Protect the interests of energy consumers – – – – Existing and future consumers Environmental objects Security of supply European objectives • •

National Regulatory Authority and National Competition Authority

Regulation of the network monopolies through licences and domestic and EU legislation; price controls; economic and efficient tests.

Suppliers in competitive market. No price controls but some regulation of behaviours through licences. 3

Key characteristics of the energy sector

Energy characteristics influence design and effectiveness of the markets: Essential product: cost and security of supply / carbon = public policy issues Highly regulated sector Monopoly networks with technical complexities Complex / detailed market rules Challenges to differentiate products Consumer engagement weak 4

Bills & the breakdown of bills

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Bills & the breakdown of bills

The supply chain

Electricity and gas

R EGULATED MONOPOLIES

G AS E LECTRICITY Offshore production, LNG, pipelines and interconnectors sell their outputs on the wholesale market U PSTREAM PRODUCTION Electricity generators and interconnectors sell their output on the wholesale market Bilateral and exchange trading between producers, suppliers, traders and larger consumers W HOLESALE MARKET Bilateral and exchange trading between generators, suppliers, traders and larger consumers High-pressure gas network owned and operated by National Grid Gas (NGG) T RANSMISSION NETWORKS High pressure electricity network owned and operated by National Grid Electricity Transmission (NGET) 8 regional gas distribution networks (GDNs) D ISTRIBUTION NETWORKS 14 regional electricity distribution network operators (DNOs) Suppliers purchase energy in the wholesale market for their consumers.

R ETAIL MARKET Suppliers purchase energy in the wholesale market for their consumers C ONSUMER

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Part 2: What is the retail market?

• •

The retail market is: The place were energy companies sell energy to consumers and businesses The only interaction between consumers and the market

• • •

Who are the participants Generally perceived as the Big 6 and independents Price comparison websites and intermediaries Consumers

How is the retail market changing?

The Big 6’s joint market share, which had been relatively stable during 2009-early 2012, has fallen 6% as a consequence of independent suppliers’ steady growth from mid 2012.

In June 2014 their market share was 7%, about four times the market share they had in 2012

Switch & save

The retail challenges

Building trust & confidence Promoting customer engagement Ensuring competition works for all customers Moving to a smarter world Making sure wholesale price rises are passed through

Part 3: The networks

Transmission

• High voltage

networks

• 3 companies

onshore.

Distribution

• Lower voltage

networks.

• 14 regional

areas.

Offshore

• Offshore

Transmission Owner

• Appointed via

tender.

Interconnection

• Owners of

interconnectors.

• Also certified as

TSOs The System Operator

• Operates the

grid.

• Coordinates

planning and development.

Network Costs post privatisation

Network costs are determined via periodic price controls.

Our RIIO framework focusses on what customers value.

Network costs recovered from system users via charges.

Network Challenges

Making sure RIIO delivers Thinking about more competition Getting interconnection built Betting planning/ coordination Continuing to drive down costs but ensure investment

And the role of the SO will need to evolve.

Part 4: The wholesale market Part 1: The industry structure, roles & responsibilities. Part 2: The retail market Part 3: The networks Part 4: The wholesale market

Part 4: The wholesale market The wholesale market is:

• • • • The place where generators sell their energy The place where suppliers buy their energy Supply and demand must be matched, or balanced, at all times (in the case of electricity in real time). The market incentivises suppliers and electricity generators to balance their own supply and demand positions.

Overall responsibility for balancing supply and demand sits with the System Operator.

• • • • • • •

Who are the participants

The Big 6 and independent suppliers Generators, Interconnector/LNG operators Banks and financial institutions, Hedge funds Exchanges Brokers National Grid, as system operator Elexon as the BSC Company

Wholesale market design

- The NETA/BETTA market which replaced the Electricity Pool is based on the

following principles

- The market should incentivise parties to trade as they wish to manage their

risk (with prices set based on the cost of the marginal plant).

- The role of the SO should be minimised – “residual balancing”. - Parties which causes costs should face the costs they cause . - Market rules should be capable of being changed by market players. - There should be a single GB price/ bidding zone.

Sources of supply

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Sources of supply

Electricity

• • • Power generation in recent years dominated by coal, gas and nuclear Coal has been providing majority of seasonal swing, as plant look to save running hours under environmental legislation Gas generation expected to play a key role providing flexibility going forwards 120 100 80 60 40 20 0 2012 Q1 2012 Q2 2012 Q3 2012 Q4 2013 Q1 2013 Q2 2013 Q3 2013 Q4 2014 Q1 Other fuels Oil Pumped Storage Bioenergy Wind and Solar Hydro (natural flow) Gas Coal Nuclear 19

The timescales for power trading

Buy & sell power from many years ahead to day ahead.

In order to hedge risks.

Where a lot of power is traded.

Market coupled with Europe.

Allow the fine tuning of positions near real time.

SO run market to balance demand & supply.

Based on bids and offers in a balancing mechanisms. 20

Trading gas and power

Over-the-Counter (OTC) Exchanges • • • • Bilateral agreements Opaque market Facilitated by brokers and Price Reporting Agencies Counterparties won’t necessarily post collateral • • • Act as an intermediary between parties Transparent market Counterparties have to post collateral Party A Party B Party A Financial flow Delivery of commodity Party B Exchange 21

Conventional Low carbon Generators Gas Coal Oil Nuclear Wind Hydro

Price Formation

Interconnectors • • • • Costs of production mainly determined by: Cost of plant Commodity prices Plant reliability and efficiency Government policies e.g. carbon price floor/Contracts for Difference • • • • Costs of production mainly determined by: Cost of interconnector Prices in other markets Exchange rates Interconnector reliability and efficiency 22

Price Formation (2)

Supply curve:

Combining the costs on the previous slide gives a supply curve… 10 8 6 4 2 0 0 Renewa bles& Nuclear 2 4 Supply Gas 6 8 10

Maximum Export Limit (MW) Demand curve:

• • • • Demand, on the other hand, is determined by: Temperature Light Weekday/weekend Over the long-term: GDP Demand is quite inelastic, i.e. not very responsive to changes in price, and therefore has a steep curve: 10 8 6 4 2 0 0 2 4 Demand 6 10 23

Balancing the system

Forward trading

Parties submit:

To National Grid

1. Final Physical Notifications (FPNs) 2. Bids and Offers

To Elexon

3. Contract notifications Gate Closure – trading stops Settlement period (30 mins)

Balancing Mechanism

t-1 t t+0.5

NG accepts bids/offers to balance the system 24

Ensuring liquidity Greater European integration

Wholesale Challenges

Rewarding flexibility/ encouraging investment Getting the demand side involved Interactions with policy initiatives 25

It’s all about the system!

We can think about individual parts of the electricity sector.

But it’s all part of one very complex system. A tweak in one place can have big consequences in another.

The biggest challenge is ensuring coherence. We at a point where lots is changing.

Ensuring security of supply, keeping costs down & decarbonisation rely on getting things right!

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Market Investigation Reference (MIR)

Why?

 “Reference test” threshold met: reasonable grounds to suspect features of market restrict/distort competition

Why now?

 Still expect RMR reforms to directly address market failings, but investigation will clear the air and allow CMA to ensure right industry structure is in place

Scope

 Supply of gas & electricity to GB households and small businesses  Features of the market that could harm competition  Recognising Ofgem’s RMR remedies and future developments

Process

 Jul/14-Jan/16: CMA market investigation – 18 months, can add 6 months  Jan/16-Jul/16: CMA remedies (if required) – 6 months, can add 4 months

MIR now will lead to faster conclusion to market uncertainty

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