1. Regulation of electricity markets Jean-Philippe Meloche, 24 Feb 2010 JPMeloche@nus.edu.sg

2. Introduction to the world of competition regulation Introduction to electricity regulation Applied microeconomics Contents

3. History and Structure

4. In 1990, the government decided to deregulate and to privatise the electricity sector to reduce costs through competition Industry was separated into 4: Generation Transmission Distribution Supply Regulator (Ofgem) was created History of the energy deregulation

5. Actual production of electricity Opened to competition Main technologies: Nuclear, Hydro, Combined Cycle Gas Turbines (CCGT), Coal, Renewables, Oil, French and Scottish exports Generation

6. Types of station Base-load Cheap and/or inflexible (Nuclear, CCGT) Peak-load High cost and high flexibility (Oil, Pumped storage) Pumped storage stations Mid-merit plants fall between these two categories. Usually flexible and coal-fired Generation

7. Transmission: high-voltage power lines Natural monopoly operated by the privately-owned National Grid Company (NGC) Distribution: low-voltage power lines to the final consumers Natural monopoly operated by 12 regional utilities Some very large consumers are connected directly to the Grid Supply: Sale of electricity to the final customers Competitive segment Transmission, Distribution, and Supply

8. The Office of the Electricity and Gas Market (Ofgem) acts as a regulator Security of supply Market rules Some competition rules Decisions of the regulator can be appealed to the Competition Commission Regulation

9. Costs and installed capacity

10. How does it work?

11. As uniform as it gets Demand must always be met Demand is very inelastic in the short run Demand varies every minute Supply cannot exceed demand Electricity cannot be stored in meaningful quantity Special nature of electricity

12. Every day, the System Operator publishes a forecast of the electricity demand for the next day in half-hour increments The System Operator asks every company to submit one bid per half-hour bids for every gensetthey operate Electricity Pool

13. Graphical representation of a bid

14. Example of a market supply curve Problem?

15. Market Price is established by equating demand and supply Every supplier scheduled to run receives the same price per MWh, regardless of its bid Consistent with economic theory Insures efficient dispatch Pricing mechanism

16. Are prices too high?

17. Decreasing gas coal prices

18. Increasing plant efficiencies

19. No change in real prices since 1991

20. Price volatity

21. Price volatity

22. Prices are higher than they should be Generators have market power because: Electricity is a unique commodity Single Price under the Pool gives them an incentive to manipulate the pool rules Regulator needs more power to prevent abuse (Market Abuse Licence Condition) Ofgem’s price analysis

23. Market is competitive Price is the result of the interactions of buyers and sellers and should not be mandated by the regulator They have not been convicted of any wrong-doing Generator’s case

24. Given that some generators had refused the market condition, review if the continuation of their activities without that licence condition was contrary to the public interest. Competition Commission mandate

25. The inquiry

26. Politically-appointed members of the inquiry Permanent staff divided in three main groups: Economists Accountants Industrial advisers Lawyers on staff to advise on legal issues Structure of the inquiry

27. Legal review What is ‘Abuse’ MALC vs other laws Utilities Act Competition Act Accounting review Supernormal profits Economic review Public interest, Market power, Market structure, Incentives Technical review Manipulation of the rules Methodology

28. Public interest Prices at competitive levels Market power Ability of a generator to increase prices consistently and profitably above competitive levels Depends largely on concentration of plant ownership, overall production capacity Prices What is the “correct” price? Short-term marginal cost? New entry cost? Should the regulator try to mandate price levels? Economic review -1

29. Market definition Energy vs Electricity? Substitutes? Every half-hour? Every day? Base-load vs Peak? Market structure Dominant firms? Evolution of ownership in time Barriers to entry & exit? Perfect information? Incentives Repeated auctions provide room for collusion (concept in game theory) Single-price auction means that many benefit from a price increase Economic review -2

30. Ways to ‘manipulate’ the market Increase bids Withdraw capacity Manipulate rules (third increment & capacity payments) Change in market rules (NETA) Technical review

31. Example: Capacity withdrawal - 1

32. Capacity withdrawal - II

33. No case for their new market licence condition ‘Abuse’ was ill-defined No documented case of abuse Market rules were changing (Pool vs NETA) Conclusion