The Transmission Constraint Licence Condition (TCLC), which came into force on Monday , gives Ofgem an important new tool to tackle the exploitation of transmission bottlenecks to charge excessive prices. However, the wording of the condition is unsatisfactory in a number of important respects, and Ofgem’s guidance will be published only as the condition takes effect. Generators will need to exercise caution in their dispatching and pricing decisions.
Ofgem has long been concerned about transmission constraint exploitation and has attempted to tackle it on previous occasions (see box). This latest attempt was prompted by a number of cases in the past couple of years in which high constraint payments to windfarms have made the headlines. Enabled by the Energy Act 2010, the Department of Energy and Climate Change (Decc) and Ofgem have introduced the TCLC to combat this abuse of market power.
The licence condition prohibits two types of conduct:
· where a generator creates or exacerbates a transmission constraint by deciding to generate or not to generate with a particular plant when it has more economic options available to it, and then seeking or charging an excessive price for reducing or increasing generation in the balancing mechanism;
· where a generator exploits a period of export transmission constraint (where there is more generation within an area than can be transmitted out of it) by paying or bidding to pay excessively low amounts to reduce its generation, or by being paid or seeking to be paid excessively high amounts (negatively-priced bids) to reduce generation.
Although the final version of the TCLC makes a number of improvements to the wording of the consultation draft, some of the deficiencies remain.
First, the drafting does not reflect entirely accurately a number of the technical definitions relating to the operation of the balancing mechanism and transmission constraints. Such points will no doubt be argued over in the event of an investigation or an appeal against any decision. Other substantive enforcement points are of greater concern.
For example, the TCLC continues to treat as the creation or exacerbation of a constraint the despatch or withholding of generation when the licensee had more economic options available to it – irrespective of whether those other options would also have created or exacerbated the constraint.
Ofgem’s draft guidance explains how it will enforce the rules. In assessing whether the generator had more economic options available to it, the regulator will take into account a number of factors. It notes that it has its own internal estimates of the profitability of all generating units in the country, but that before reaching a conclusion, it will invite the generator to comment, in case it has overlooked any costs. It will also take into account any plant-specific costs.
If the generator is treated as having created or exacerbated the constraint, then any bid or offer accepted in the balancing mechanism will be treated as giving rise to an excessive price. However, where the generator did not itself create or exacerbate the constraint, Ofgem will then need to establish that the price charged in the balancing mechanism was excessive. It will do this by reference to the avoidable costs of the generating unit.
These costs will include short-run marginal costs, maintenance and ramping down costs. Ofgem will also take into account opportunity costs and reasonable profits (including the price of Renewables Obligation Certificates in the case of renewable generation). The accurate assessment of these costs, however, will be a complex exercise and will not always be realistic in the context of ensuring compliance when submitting balancing mechanism notifications ahead of real time. While opportunity costs will be factored into the calculation of excessive prices, it appears they will not figure in Ofgem’s calculation of profitability at the stage of assessing whether the generator dispatched economically. Argument on this and similar issues can be expected in any enforcement dispute.
In both cases, (creation and exacerbation, and exploitation) the wording of the condition covers situations where a generator submitted excessive prices in the balancing mechanism, irrespective of whether its bid or offer was accepted. There is some suggestion in the guidance that Ofgem may focus on cases of repeated excessive offers and that isolated instances might not attract its attention.
Decc rejected suggestions that National Grid should be required to notify constraints to generators. While transparency as to outages and other constraints is increasing, it is not always evident to generators that there is a constraint, in particular where the constraint requires resolution by means of measures such as voltage support or reactive power. The prospect of inadvertent infringement in such circumstances cannot be dismissed.
Breach of the TCLC could result in penalties of up to 10 per cent of the licensee’s turnover. Appeals will be to the Competition Appeal Tribunal and would involve a rehearing on the merits rather than merely a review of the legality of Ofgem’s decision. This will provide a valuable opportunity to challenge any weaknesses in Ofgem’s methodology.
The TCLC will impose significant obligations on generators in constrained areas – currently mainly in Scotland but potentially also in other areas as more generation is developed in remote areas. Each dispatch decision will need to be carefully weighed against other potentially more economic options, and bids will need to be priced carefully by reference to avoidable costs. The practice of high-priced “sleeper bids” will come under close scrutiny.
One unanswered question is whether the TCLC will have the unintended consequence of deterring generators (in particular, flexible generators) from bidding into the balancing mechanism at all, so as not to risk accusations of breaching the prohibition. This would reduce the options available to the system operator to balance the system.
Peter Willis is a partner at Bird & Bird
The constraints problem
During certain periods, at certain points in Britain’s electricity transmission system, there is insufficient capacity to transmit electricity from where it is generated to where it is consumed. During such periods, National Grid, as system operator, must balance the system by paying generators to increase generation, or accepting a payment from them, or paying them to reduce generation (to be “constrained off”). These “constraint costs”, which are ultimately borne by customers, totalled £324 million in 2011/12.
Ofgem has long suspected that some generators have sought to create or exacerbate transmission constraints by taking uneconomic dispatch or withhold decisions in the expectation of charging higher prices to correct the situation in the balancing mechanism. It estimated that the cost of such conduct could have been as much as £125 million in 2008/09.
Ofgem previously attempted to use its competition powers to address the problem, but found it difficult to establish that the individual generators under investigation (SSE and Scottish Power) were “dominant” during the relevant period and in the relevant locations, which is a prerequisite for establishing an anti-competitive abuse.
This article first appeared in Utility Week’s print edition of 2nd November 2012.
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