Ofgem has clashed with generators over its criteria for determining whether they have obtained excessive profits by taking advantage of constraints on the transmission network.
The regulator has resisted calls to further narrow down the criteria and sought to maintain leeway to judge generators’ actions on a case-by-case basis.
In December, Ofgem launched a consultation on a set of proposed revisions to the guidance on the application of the transmission constraint licence condition (TCLC). It said the revisions would provide generators with a greater level of detail over how the licence condition would be applied, including the definitions of transmission constraints and excessive benefits.
The move came after multiple generators were found to have breached the licence condition in recent years, including pumped hydro storage facilities operated by Drax and SSE, EDF’s Dorenell wind farm and the South Humber Bank gas plant owned by the Czech firm EPH.
The generators were collectively fined almost £80 million. The largest fine of more than £33 million was levied on the Beatrice offshore wind farm – a joint venture in which SSE has the biggest stake.
Ofgem has now published its decision on the updated guidance, including a summary of responses to the consultation.
The regulator said a number of respondents raised concerns over their lack of forward visibility over when constraint periods will occur. There were also complaints that the information they need to determine this can be inaccurate, lacks specificity and may only become available retrospectively; and that this uncertainty could therefore force them to price according to the TCLC in all periods, reducing their incentive to invest in flexibility.
Ofgem said this lack of “perfect foresight” was explicitly recognised when the TCLC was introduced in 2017 and its position remains that generators do not need advance notice of when a constraint will occur. Although limitations exist, the regulator said there is enough information available to generators to enable them to make sound predictions.
Nevertheless, Ofgem said it has clarified in the guidance that it will take account of whether a generator could reasonably be expected to foresee a transmission constraint when deciding whether to open an investigation into their conduct.
The regulator said it has included some examples of the type of information generators should consider but has not provided a fuller description as this “would inevitably not capture every circumstance that a generator may find itself in; would be at risk of becoming outdated…; and could be overly restrictive in terms of determining how generators should approach this task.”
It has also asked the Electricity System Operator (ESO) to consider what further information could be provided to market participants.
In the updated guidance, Ofgem noted that system flags could be a relevant indicator of transmission constraints.
Although the flagging process is designed to identify actions that should be excluded from the calculation of imbalance charges, the regulator said there is a “close overlap” between flagged bids and those that are likely to be subject to the requirements of the TCLC: “We would expect scenarios where a bid was not flagged but did relate to a transmission constraint period to be uncommon.”
Some respondents highlighted that system flags are only known retrospectively, limiting their usefulness, but Ofgem said they can still provide a signal as to the likelihood of transmission constraints in subsequent periods.
Another source of contention was Ofgem’s updates on how it would gauge excessive benefits, in particular its indication that the value of accepted bids in pounds, not just pounds per megawatt-hour, would be a relevant consideration.
Respondents raised concerns over the practicality of limiting profits in pounds, given that this would depend on the volumes accepted by the ESO; the lack of clarity about how Ofgem would expect bid prices to be adjusted over time in response to previous acceptances; and the implication that this could require generators to submit bids at lower prices than their rivals to avoid exceeding a backwards-looking cumulative profit limit.
However, Ofgem said it still believes this is a relevant consideration, explaining: “Our concern is the risk that if (a) the same profit margin in £/MWh were priced into bids by a constrained generator as an identical generator that was not typically bidding in transmission constraint periods and (b) the transmission constraint resulted in the constrained generator having a particularly large volume of bids accepted, then the constrained generator would end up earning a much more significant profit/contribution to indirect costs in £.”
It said failing to take profits in pounds into consideration could “risk putting the constrained generator at a considerable advantage to its rivals as a direct result of the market power it enjoyed due to its position behind a constraint.”
Ofgem said it will take into account uncertainty over acceptance volumes when making its assessments and has added a clarification in the guidance that it would not expect generators price bids at a loss to compensate for a temporary over-recovery.
“However, we do expect licensees to base any forward-looking assumptions they make around bid acceptance volumes on an appropriate and well-evidenced methodology; and to keep bid acceptances and the profits obtained in transmission constraint periods under close review,” it added.
“In the event that a generator observes unexpectedly large bid volumes or high profits as a result of a transmission constraint, and this indicates inadequacies in the licensee’s previous forecasts, then it should update its bid prices without delay to reflect this”.
Responding to queries over what time periods it would assess pricing behaviour, Ofgem said although it would not rule out looking at a single settlement period, it would generally expect to examine longer timeframes. By way of illustration, the regulator noted that its recent investigations covered periods of roughly one to three years.
Ofgem has additionally clarified in the guidance that a generator submitting bids that are less expensive than other accepted bids will not preclude them from being considered excessive.
“A generator which sought to maximise profit by setting its bid prices at the very top of the expected acceptance range in every settlement period would frequently not have a bid accepted at all,” it explained.
“In contrast, a generator behind a transmission constraint does not face the same trade-off. This is because the existence of the transmission constraint has the effect that even where the licensee submits relatively expensive bid prices, the ESO will have few economic alternatives available to it other than accepting the bid of that generator – irrespective of the prices of its competitors or the overall balancing requirement of the ESO.”
It said some acceptance may also be driven by particular balancing requirements for which the ESO is prepared to pay a premium.
At the same time, the updated guidance does state that the prices of rival generators can still provide a useful benchmark when determining whether an excessive benefit has been obtained.