Ofgem rules are not enough to boost market liquidity, says CMA

Ofgem’s drive to boost trade in the UK power market is not enough to cause a step change in its overall liquidity, according to the Competition and Markets Authority (CMA).

In its latest working paper the authority concluded that the UK power market needs the participation of financial players to improve its constrained level of trading, but that Ofgem’s market reform rules mean that the prospect is not an appealing one for banks.

The CMA opted to investigate the liquidity of the power market, which lags that of the more popular gas market, to decide whether the low levels of activity pose a barrier to smaller companies.

Although its current thinking concludes that the limited amount of trade is still enough for suppliers to hedge their forward positions up to a year, the findings add fuel to criticism that Ofgem’s rules are themselves a major cause of dysfunction in the energy sector.

Under its ‘secure and promote’ reforms Ofgem has managed to boost trading in a specific set of contracts traded through the wholesale market by forcing generators and suppliers to commit to a minimum level of participation in designated trading windows.

Although the CMA acknowledges that the April 2014 rules have improved availability for the contracts which are covered, there is no evidence that this will benefit liquidity overall.

“It was not obvious to us that micro-level interventions had any potential to cause a step change in the overall level of liquidity in the market,” the CMA report said.

In addition the rules could deter involvement from financial participants, who prefer to be able to trade at any time of day, which is needed if liquidity is expected to improve.

“A step change in liquidity may be unlikely without attracting more financial players and a consequent injection of substantial risk capital… it may be that electricity continues to remain a relatively unattractive market for speculative activity,” the CMA said.

In April last year Barclays Capital became the latest financial player to back away from UK energy trade with the announcement it will exit commodities markets, including energy, to refocus on more profitable areas for the group.

The move away from energy commodities follows similar withdrawal from JP Morgan, Deutsche Bank, Bank of America Merrill Lynch and Morgan Stanley, all of which have reduced or closed their European power and gas trading units in the past two years.

The CMA will make its full initial findings public this summer, after the May general election, with full recommendations expected by the end of the year.