Utility Week

Utility Week 11th October 2013

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Comment Utility Week expert view Trevor Loveday "Irrespective of the market or non-market design, at the heart of it all are companies with a history of gaming and exploiting. And it's not ancient history" W hen Ed Miliband pledged that a Labour government would freeze the retail price of energy, he was cast as a throwback to when his party aspired to socialism. But he is in fact swimming with the tide. Miliband's threat is the latest spat in a 20-year off-andon row between the administration and the energy sector as it angers consumers (voters) or fails to invest or undermines competition and the government is driven to intervene. The trend began with Labour's £5 billion windfall tax on the utilities on taking government in 1997. A subsequent episode was Ofgem's launch of a market "probe" in 2008 – days after a dressing down by the then chancellor, Alistair Darling, despite having assured the world that the market was working. Growing nervous about electorate anger over energy prices, the chancellor made a lunge to cap prepayment meter prices. More recently, the coalition gave us Energy Market Reform and David Cameron pledged to force the energy companies to offer their lowest price to everyone. It goes on. Escalating government control in energy wholesale and retail markets arises from a realisation that market signals are not going to provide security of supply and that low carbon is not compatible with cheap energy. Soaring bills and blackouts rarely win elections. Miliband's freeze, however, wasn't the most significant of the energy market gambits that emerged from the Labour conference. That honour goes to a proposal to return to a "pool" system for trading wholesale power. A proposal in fact made by previous shadow energy secretary Meg Hillier two years ago. And a return to something akin to the Pooling and Settlement system of the 1990s might be no bad thing. When the Pool was in play, generators, suppliers and industrial users hedged themselves through contracts for difference with a strike price based on the Pool price. That was 90-odd per cent of the market. A quick recap of the rest of it: the Pool was a compulsory day-ahead spot market in which generators bid and everyone received the highest bid. National Grid would dispatch plant – cheapest first – on to the system. Each generator would also get a capacity payment, money for services such as frequency control and payments if it was constrained. This was a transparent market. But the over-the-counter deals that made up the vast bulk of the trading were, by their nature, not. The market was utterly illiquid, dominated by the three players formed at privatisation. And the market power of those firms grew through their subsequent vertical integration as they snapped up debt-light distribution and supply companies to offset the inherent riskiness of generation. What's more, the day-ahead capacity market could be manipulated by declaring plant unavailable, only to redeclare it available on the day to collect the payment that had been boosted by the declaration of unavailability. Constraint payments proved similarly manipulable. So Labour scrapped the Pool, whose problems were in fact ones of governance and lack of liquidity. But its demise was the product of behaviour by the industry. Substantial capacity payments gave generators with a high (30 per cent) market share a powerful incentive to withhold plant. So they did. And it's that kind of brassnecked behaviour that is the real reason the energy sector keeps getting into trouble with government. The late 1990s were characterised by tacit collusion between the big players. The £700 million New Electricity Trading Arrangements (Neta) emerged from the Labour government's desire to do something. Under Neta, generators were paid as bid, capacity payments were scrapped so that price signals would bring on capacity and a punitive balancing and settlement mechanism was introduced. But Neta was hastily constructed. It failed to address poor liquidity, a static demand-side market and the need for investment. So now we re-enter a world of capacity auctions and administratively set prices. Some of the current proposals may well do the trick. A capacity model akin to that proposed in the UK has worked well in the US. CfDs – if they can be settled – promise stability. Moves toward greater transparency and liquidity could improve things further. Throw in a shift from opaque over-the-counter trades that dominate in the UK to exchange trading with robust indexation and matters might improve. A glance over to Nordpool's success in its markets in northern Europe tell the tale. Encouragingly, market coupling with northwest Europe is imminent. Liquidity in that region is thrice the UK's. But irrespective of market design and measures to stem market abuse, at the heart of it all are companies with a history of gaming and exploiting. And it's not ancient history. We have suppliers who have knowingly left vulnerable customers on the highest tariff because they don't switch, and have mis-sold to others. So Miliband and Cameron are clearly asking themselves: can an industry that has ducked and dived for 20 years be trusted to deliver what is best for its customers, the economy and the environment? The looming election must make it tempting to intervene. UTILITY WEEK | 11th - 17th October 2013 | 7

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