The electricity market in Great Britain: the pool, NETA and EMR Linnfall Consulting November 2013

Structure of this presentation Introduction The pool NETA EMR

Possible relevance of UK experience 3 market designs in 25 years: 1990 to 2001: The pool: a gross energy and capacity market in England and Wales 2001 to 2014: NETA: an net energy-only market extended to Scotland in 2005 2014 on: EMR: adding new contracts and a capacity auction to existing design Capacity Gross/net Locational Governance Capacity payment in the pool Energy-only market in NETA Capacity auction under EMR Gross market in the pool Net market in NETA EMR: Net design retained Change back to a gross pool? Single price zone firm access to transmission Stresses of this approach and how to manage them EMR is creating Major shift in role of Govt and regulators Major shift in role of markets versus regulated prices

England and Wales Pool – market design Compulsory Gross pool: all power sold at pool purchase price and bought at pool selling price; bilateral contracts derivatives against pool price Day ahead, last price auction Day ahead bids: for half hourly price periods; close to vertical demand curve; single system market price set by the last bid accepted Firm access rights Firm rights to transmission capacity; congestion costs passed through; following reforms, TSO incentives to manage costs TSO dispatches on basis of day-ahead schedule and unexpected changes in demand, failures by generating plant and transmission constraints. Central dispatch

Capacity and energy market Value of lost load (VOLL) * Loss of load probability (LOLP) = probability weighted outage cost Variable cost of marginal generator SMP + (VOLL – SMP) * LOLP Low/no demand side pressure on price Two dominant price setters Concerns about gaming Double incentive? = Pool purchase price Plus Uplift (reserve, cost constraints, some ancillary services) = Pool selling price

New Electricity Trading Arrangements (NETA) followed on a 1998 review of performance of the Pool   Quality of supply Cost reflective prices   Supply side price pressure Security of supply   New entry Demand side role   Supply competition enabled Transparency and liquidity Ofgem, New Electricity Trading Arrangements, July 1999, available at www.uea.ac.uk/~e680/energy/energy_links/electricity/neta1.pdf‎

NETA established a net pool design Initially 4 hours before real time now 1 Real time balancing by SO, with voluntary balancing market Gate closure One to two year ahead trading, OTC and PX Day ahead market OTC and PX Long term bilateral contracts Intra-day market Imbalance charges for deviation from final positions Final physical positions notified to SO. Balanced positions- injections equal withdrawals TIME

NETA’s distinctive features include the firm transmission access and the imbalance charges Imbalance (cash-out) charges Businesses compensated if constraints prevent use of Transmission Entry Capacity Original proposal - single imbalance charge Connection deferred until necessary upgrades – 12 GW queue in Scotland, long delays Final approach dual charge – buyers of imbalance pay higher price than sellers receive Shifted to ‘Connect and Manage’ – maximum timescales for connection Average 27% buy/sell differential 2010, 50% or more for 11% of settlement periods Major increase in congestion costs – being reduced by new transmission build Ofgem reviews 2004, 2007 and currently. Large number of industry proposed mods. A difference from many other markets – a difficult but not the most contentious issue Liquidity concerns– impact on market power and renewables. Possible licence changes.

EMR has four main components and ambitious timelines for implementation Feed-in tariff Two options considered – close to a fixed price through CfD, or a fixed Premium Payment above market revenues Draft prices published, new nuclear deal negotiated Capacity mechanism Two options considered: strategic reserve held out of the market or capacity payment for all generation (or only new generation) First auction expected 2014 Carbon price floor Floor on the EU ETS price, achieved through a tax on input fuels. £24.62 by 2017/18 versus current EU price around £4 Applies from April 2013 Emissions standard Maximum emissions for new Gen of 0.45 or 0.6 Tons of CO2 per MWh. Prevents new coal fired generation (unless with CCS). Standard of 0.45T/MWh in the Energy Bill

A major driver for the current electricity market reform (EMR) was the Government’s desire to enable investment in new nuclear Wholesale nominal gas price, p/therm Baseload electricity price, nominal £/MWh SMP provides a natural hedge for gas-fired generation Nuclear is a price taker – increasing risk and cost of capital Source IPA Energy and Water Economics, 2013

Generator pays when benchmark above strike The CfDs are intended to provide price certainty while maintaining incentives to maximise value Generator pays when benchmark above strike Step 1: establish a liquid and relevant benchmark CFD strike price Step 2: set a strike price through competition or ‘administratively’ Generator receives payment when strike above benchmark Benchmark price Step 3: make offsetting payments to ensure generator receives strike less benchmark Contracting body government owned company – after some argument. Costs passed through in supplier levy – some major consumers may be exempt.

The CfDs have successfully (so far) been used to support new nuclear investment – but at a high price £92.5/MWh strike price £89.5/MWh if second deal Real 2012 price indexed 35 years from 2023 or start of operations if earlier Fixed price deal but some scope for adjusting up or down Subject to FiD by equity investors, EU State Aid approval EDF: 45-50% AREVA: 10% CGN and CNNC: 30-40%

The approach to rationing CFDs is not yet clear £/MWh in 2015 (2012 prices) by technology and deployment by 2020 c. £40 Bn of support to 2020, obviously not rationed by price A competitive price discovery process ‘as soon as practicable’ 8-16GW 1.8-3.2GW Meanwhile prices set ‘administratively’ – reasonable return based on efficient costs 10-12GW 50% ‘First come first served’ Plus Govt. negotiations Nuclear Onshore wind Solar PV Offshore wind Followed by a framework for allocation when the budget is constrained Source: delivery plan consultation, August 2013

EMR introduces a forward looking capacity auction very similar to US capacity auctions – but with some differences Firm capacity will be procured through auctions 4 years and 1 year ahead, from 2014 Government will decide each year the need for an auction and the key parameters Requirement Term Peak demand plus reserve One year for existing generation and DSR One price zone – no constraints expected at peak New generation will get longer terms depending on capex. 3, 10, 25 years? Sloping demand curve – based on US experience Price Payment and penalties New generation and DSR can be price makers Regular payments for capacity Existing generation price takers – unless high cost, CfD plants not eligible Penalty payment if not available Funded by supplier obligation based on demand at peak Price cap of £29/kW/year proposed – but will go up

EMR is changing the role of government and the role of the market Investment decisions Up to 40 GW of generation based on CFDs with government. Well over £40 billion of which around half directly allocated by Government Market structure Shift to a capacity auction – with key parameters controlled by Government. Similar shifts in much of Europe – creating risks for market integration Institutional roles Ofgem playing a minor role in EMR – a major contrast with NETA. Government in the driving seat. The transmission system operator playing a major role

And if you want more details on EMR…. The proposals for implementing EMR, updated on 24 October, are at https://www.gov.uk/government/consultations/proposals-for-implementation-of-electricity-market-reform The Electricity Market Reform: consultation on proposals for implementation The Contracts for Difference (Allocation) regulations 2014 The Contracts for Difference (Supplier Obligation) Regulations The Electricity Capacity (Payment) Regulations 2014 The Electricity Capacity Regulations 2014 Capacity market rules: consultation draft Modifications to National Grid Licence: special condition N of NGET transmission licence Annex B: background on supporting and transitional policy arrangements Impact assessment: measures to address potential conflicts of interest arising in relation to the choice of National Grid as the delivery body Impact assessment: contracts for difference Annex D: eligibility crtiteria Impact assessment: supplier obligation, contracts for difference Impact assessment: capacity market Impact of EMR on interconnection Capacity market gaming and consistency assessment