Behind the squabbling and political sabre-rattling over UK retail energy prices is a move scheduled for early next year that promises to throw a bright light into the darker corners of electricity pricing. Four power exchanges and 13 transmission system operators have collaborated to link up electricity markets across northern and central Europe, including Britain.
Power exchange Nord Pool Spot, which owns N2EX, one of the UK’s two electricity exchanges, has a central role in the UK’s involvement. According to Nord Pool Spot chief executive Mikael Lundin, the UK stands to be the chief beneficiary of the imminent coupling of day-ahead power markets of Europe’s biggest economies. “The main implication for market coupling is for the UK because central Europe and the Nordic area are already coupled and largely seamless,” he says.
Market coupling will pull together electricity markets across the European Union to realise the European Commission’s goal of creating a single European energy market by 2014. Coupling across the North West Europe (NWE) region will link Britain, the Central West Europe (CWE) region (Belgium, France, Germany, Luxembourg and The Netherlands) and the Nordic region (Denmark, Sweden, Finland, Norway, Latvia, Lithuania and Estonia). It will pull together more than two-thirds of the EU power market.
According to its designers (see box on page 10), NWE day-ahead price coupling will optimise the use of cross-border transmission links. They also claim that it will provide signals to bring on new investment in power infrastructure across Europe in a more efficient way. “Liquidity will be increased, volatility will decrease, buyers’ and sellers’ surplus will be optimised across all involved markets,” its creators claim.
Power coupling could address problems at the heart of the political turmoil over energy in Britain because it is expected to increase the liquidity in the day-ahead market here. And exchange trading promises to improve the prospect of new entrants to the market by tackling poor transparency. Greater competition may rein in retail prices and better transparency may bolster public confidence that consumers are not being ripped off.
Nord Pool Spot sales and business development manager Richard Sarti is keen to emphasise that exchange trading in itself does not bring down prices. “This is something that people misconstrue – that exchange trading can keep prices low. It really should be reflective of generation availability and supply and demand and that can be anywhere,” he says.
“We view price as a by-product of efficiency in the market. We provide a price that is truly reflective of supply and demand – a true price. From a government standpoint, one of the concerns has been price transparency and the auction has been able to deliver that.”
N2EX has established itself swiftly in Britain with its day-ahead auction already topping 45 per cent of the market from a standing start less than four years ago.
“Auctions enable market coupling to happen because they provide robust, transparent prices, which are used to determine the ‘direction of flow’ on spare interconnector capacity, moving electricity from low price areas to high price areas. The use of day-ahead auctions in EU markets is very different to how the GB market has traditionally traded. But in four years we’ve gone from people refusing to accept an auction and the reference price it produces, to an auction becoming a standard practice, and a day-ahead price that is used a as a benchmark for hedging tools, such as futures contracts,” says Sarti.
Lundin says Nord Pool Spot has about 85 per cent of the Nordic day-ahead market and he expects it to be close to that in the UK in far less time than the 17 years taken in Scandinavia. The impetus, he says, will come from market coupling: “Maybe in eight years, with the cross-bidding arrangement, 70 per cent is realistic. Integration with the EU will expedite that process.”
Sarti anticipates that the need for renewable generation to gain access to day-ahead shape will see a boost in liquidity. He says exchange trading gives new players a way round the complex and lengthy UK process which has traditionally relied on bilateral over-the-counter deals. That requires participants to hold, for all other counterparties, grid trade master agreements (GTMAs) which set out terms for settling each deal and delivering the power.
“When you become a member of the N2EX market you instantly have access to all our counterparties (at the time of writing, 44). Before, it could take years just to sign up to three bilateral agreements as a result of the GTMA structure” Sarti says. “We see a lot of European companies looking to invest in new low carbon generation, such as wind. The auction gives them an easy mechanism to get access to wholesale prices. Otherwise it’s a bit convoluted and costly when you have to sign up to multiple bilateral arrangements.”
With market coupling and growth in exchange trading, Britain’s electricity market is close to making two major changes in culture and operation. And a third shift – greater interconnection with the rest of Europe – is underway. Meanwhile, the UK government is pushing through its own changes. The Electricity Market Review is seeking to bring on investment in low-carbon energy infrastructure and replace redundant plant to avoid a looming gap in generation capacity.
“As a country will help plug the gap. We will be able to tap into the rest of Europe’s flexibility around generation,” says Sarti.
He sees, too, specific operational contributions from greater flexibility. “In times when renewable plant comes offline, thermal generation comes on and you need flexibility to manage the period between thermal ramping up and wind coming off. Market coupling and greater utilisation of spare interconnector capacity will help facilitate that more efficiently.”
Lundin says the possibility of a tight capacity margin in the UK means “the first thing do is make sure the transmission capacity is efficiently managed to make it easier to import and export.” He says efficient transmission management is an implicit element of auctions. “What we can do here is make the trading on the cable as efficient as possible.”
So, is greater interconnection and market coupling the silver bullet against intermittency problems? Lundin is not comfortable with the metaphor: “It is a step in the right direction. If there is to be a silver bullet, it’s combining different power systems: flexibility in the Nordic region’s hydro capacity with the UK. If there is a silver bullet, that is it.”
The prospect of connection to the array of generation technologies in the rest of Europe has called into question the UK’s planned capacity market, which is intended to spur investment in generation to counter renewable intermittency and make sure meet peak demand is met.
European energy commissioner Gunther Oettinger recently questioned the sense of separate EU member states pursuing their own capacity market arrangements. He claimed they were jeopardising the single European market ambition in energy. France and Germany, as well as the UK, are pondering introducing capacity markets.
“The most efficient way of working an auction is an energy-only market with no capacity market,” says Lundin. “A lot depends on the decisions in Germany and France – if they will interact or be contradictory,” he adds. “Long term, I think Europe hasn’t found a solution – or the UK. I have some concerns about this.”
Meanwhile there is some indication that exchange trading in the UK has increased liquidity at least in the near term, according to Ofgem. Long-term liquidity retains a poor rating, but Sarti questions whether that’s true: “Ofgem thinks it’s still an issue but some people say it’s as good as it’s going to get at the moment.”
Lundin says regulatory and policy uncertainty Europe-wide is stymieing growth in longer-term liquidity. “Look at hedge portfolios – they are getting shorter and shorter because of huge uncertainty in market development. Twenty years ago the power industry was hedging three-to-five years ahead.
“Reshuffling of regulation, policies, capacity markets and so on – the willingness to trade long term has dried up, from all participants.” He says the same issues are holding up investment.
Sarti describes a “paradox” in the industry: “Generators are saying we can’t put prices out that far because they don’t know what the curve looks like. And the supplier wants to have surety on price further out, so the two are mismatched.”
Meanwhile, Ofgem is proposing to intervene to address this low-liquidity equilibrium through a licence condition. It will include obligations on the big six to trade in the near term markets and a market maker, buying and selling products and taking a premium for providing liquidity.
Government and regulatory interventions and energy company obfuscation are stealing the headlines in the soap opera that UK energy has become. But within reach, it seems, are market solutions that go a long way to addressing root problems – poor transparency, illiquid trading and the need for flexible plant. Further growth in exchange dealing, marginalised opaque over-the-counter deals and greater market coupling and interconnection are paving the way.
They underpin the European Union target model for the single market in energy by next year. And there is support from industry: chiefs from ten of Europe’s largest power firms (none British) this autumn penned a letter to Brussels warning that EU energy policy was becoming regional not European. Oettinger described it as “entirely justified”.
So, could this be a European union that delivers what British consumers need?
Trevor Loveday is a freelance journalist
Crossing the line
Cross-border traded power flows in the North West Europe (NWE) region were slated for a November 2013 start but that was shifted only this week to 4 February 2014, subject to confirmation.
The overall objective is a day-ahead market coupling in the NWE region based on a program – Euphemia – devised in collaboration by six European exchanges, APX-ENDEX, Belpex, EPEX Spot, GME, Nord Pool Spot and OMIE. It is needed to implement by 2014 the European Day-Ahead Target Model based on implicit auctions. The NWE regions (Central WE, Nordic-Baltic and GB) will use Euphemia for price coupling within NWE.
The 17 partners of this project are power exchanges: APX-Endex/ Belpex, EPEX SPOT and Nord Pool Spot; and transmission system operators: 50Hertz, Amprion, Creos, Elia, Energinet, Fingrid, National Grid, RTE, Statnett, Svenska Kraftnät, Tennet (Netherlands), Tennet (Germany) and TransnetBW.
Virtual hub
Nord Pool Spot has the contract to develop and operate a virtual hub to address issues arising from there being two power exchanges operating it the UK: N2EX and APX-ENDEX. It will pool liquidity between more than one exchange and multiple interconnectors. And it will provide a common reference price for electricity across all participating exchanges while GB is coupled to the NWE region. The virtual hub will go live at the same time as NWE market coupling.