Energy UK has outlined a series of “no regrets” options which it claims will improve liquidity in the power market.
The trade association said that post-Brexit trading conditions, the lasting affects of Covid-19 and Russia’s invasion of Ukraine have resulted in a “sub-optimal” power market with generators and suppliers seeing liquidity decrease in recent years.
In its submission to Ofgem’s consultation on power market liquidity, Energy UK calls for the regulator and the government to implement “sustainable and enduring” reforms, expressing concerns “about Ofgem pursuing regulatory interventions for benefits solely in the short to medium term”.
In particular, the trade association calls for three “no regrets” options including:
- Improving cross-border trading arrangements in the UK-EU Trade and Cooperation Agreement (TCA)
- Re-coupling the GB Power Exchanges
- Improving Ofgem’s Price Cap methodology
The first two options are both hangovers from Brexit, which Energy UK claims need addressing given “increasing levels of interconnection between GB and neighbouring markets”.
On improving the Price Cap methodology, Energy UK says that the current structure of contracts in the domestic retail market is reducing the incentive for suppliers to hedge on the far curve.
It adds: “For some participants, liquidity levels may have been too low to buy the necessary volumes of the contracts indexed against the standard variable tariff price cap.
“The data in Ofgem’s Call for Input also illustrates how traded volumes on quarterly contracts increased following a change in the indexation of the standard variable tariff price methodology.
“Energy UK is not suggesting that moving back to the previous indexation is the solution, but it seems clear that the design of the price cap methodology has knock-on implications for market liquidity.”
Energy UK adds that there are other “quick wins” to be explored, including reforming the contracts for difference (CfD) mechanism to be more effective and looking at whether more could be done to incentivise intraday trading and reduce clustering of trades at gate closure.
It adds: “More broadly, diversity of hedging strategy across suppliers and product types is an important source of market competition. A lack of diversity can also increase overall market risk. Price regulation should be mindful of this, and any future review should include both liquidity and competition impacts as key considerations.”
The trade association adds that consideration should also be given now to the impacts on liquidity of future market developments, such as market-wide half-hourly settlement, which it says “is likely to have a significant impact on trading strategies, volumes, and incentives”.
Its submission adds that the outcome of the review on energy markets (REMA) will also have a bearing on liquidity.
It says: “It is important to acknowledge that, while REMA holds potential benefits, it also carries the risk of exacerbating low liquidity levels.
“For instance, a shift to locational marginal pricing (nodal or zonal) could have a significant and adverse impact on liquidity.”
It added that providing certainty on the trajectory of REMA has the potential to alleviate concerns that could deter market participants from engaging in longer-term contracts, such as power purchase agreements (PPAs).
As revealed by Utility Week last week, the government has taken nodal pricing “off the table”, however zonal pricing is still in the running to be included within the REMA recommendations.