Overview of the UK Electricity Market

Structure

Part 1: Some general context

Part 2: The retail market

Part 3: The networks

Part 4: The wholesale market

Part 5: Thinking system wide

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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.

Key characteristics of the energy sector

Energy characteristics influence design and effectiveness of the markets:

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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

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Bills & the breakdown of bills

Bills & the breakdown of bills

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UPSTREAM PRODUCTION

WHOLESALE MARKET

TRANSMISSION NETWORKS

DISTRIBUTION NETWORKS

RETAILMARKET

CONSUMER

GAS

ELECTRICITY

Offshore production, LNG,

pipelines and interconnectors

sell their outputs on the

wholesale market

Electricity generators and interconnectors sell their output

on the wholesale

market

Bilateral and exchange

trading between producers, suppliers,

traders and larger

consumers

Bilateral and exchange

trading between generators, suppliers,

traders and larger

consumers

High-pressure gas network owned and operated by

National Grid Gas (NGG)

High pressure electricity

network owned and operated by

National Grid Electricity

Transmission (NGET)

8 regional gas distribution

networks (GDNs)

14 regional electricity

distribution network

operators (DNOs)

Suppliers purchase energy in the wholesale market for their

consumers.

Suppliers purchase energy in the wholesale market for their

consumers

REGULATED MONOPOLIES

The supply chainElectricity and gas

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

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

How is the retail market changing?

Switch & save

The retail challenges

Part 3: The networks

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

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.

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Sources of supply

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Sources of supplyElectricity

• 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

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The timescales for power trading

• 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

Over-the-Counter (OTC) Exchanges

Party A Party B

Financial flow

Delivery of commodity

Party A Party B

Exchange

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Trading gas and power

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

Price Formation

Coal

Oil

Gas

Nuclear

Wind

Hydro

Generators Interconnectors

Conventional

Low carbon

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Supply curve:Combining the costs on the previous slide gives a supply curve…

Price Formation (2)

Renewables&

Nuclear

Coal Gas

Supply

Renewables&

Nuclear

Inte

rcon

nect

ors O

il

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

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Balancing the system

Gate Closure – trading stops

Settlement period (30 mins)

Balancing MechanismBalancing Mechanism

Parties submit:To National Grid1.Final Physical Notifications (FPNs)2.Bids and OffersTo Elexon3. Contract notifications

tt-1

Forward trading

NG accepts bids/offers to balance the system

t+0.5

Ele

ctric

ity

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Wholesale Challenges

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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!

ScopeScope

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

ProcessProcess 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

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Why?Why? “Reference test” threshold met: reasonable grounds to suspect features of

market restrict/distort competition

MIR now will lead to faster conclusion to market uncertainty

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 placeWhy now?Why now?

Market Investigation Reference (MIR)