Overview of the UK Electricity Market

Structure Part 1: Some general context Part 2: The retail market Part 3: The networks Part 4: The wholesale market Part 5: Thinking system wide

Who are Ofgem? About us Office of Gas and Electricity Markets (Ofgem) Regulator for both gas and electricity markets in Great Britain (separate regulator for Northern Ireland) Our statutory Principal Objective and general duties Protect the interests of energy consumers Existing and future consumers Environmental objects Security of supply European objectives National Regulatory Authority and National Competition Authority Regulation of the network monopolies through licences and domestic and EU legislation; price controls; economic and efficient tests. Suppliers in competitive market. No price controls but some regulation of behaviours through licences.

Highly regulated sector Key characteristics of the energy sector Energy characteristics influence design and effectiveness of the markets: Essential product: cost and security of supply / carbon = public policy issues Highly regulated sector Complex / detailed market rules Monopoly networks with technical complexities Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc. Challenges to differentiate products Consumer engagement weak

Bills & the breakdown of bills

Bills & the breakdown of bills Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc.

The supply chain Electricity and gas Gas Consumer Electricity Regulated monopolies Offshore production, LNG, pipelines and interconnectors sell their outputs on the wholesale market Bilateral and exchange trading between producers, suppliers, traders and larger consumers Suppliers purchase energy in the wholesale market for their consumers. High-pressure gas network owned and operated by National Grid Gas (NGG) 8 regional gas distribution networks (GDNs) Gas Upstream production Wholesale market Transmission networks Distribution networks Retail market Consumer Electricity generators and interconnectors sell their output on the wholesale market Bilateral and exchange trading between generators, suppliers, traders and larger consumers High pressure electricity network owned and operated by National Grid Electricity Transmission (NGET) 14 regional electricity distribution network operators (DNOs) Suppliers purchase energy in the wholesale market for their consumers Electricity

Part 2: What is the retail market? The retail market is: The place were energy companies sell energy to consumers and businesses The only interaction between consumers and the market Who are the participants Generally perceived as the Big 6 and independents Price comparison websites and intermediaries Consumers

How is the retail market changing? The Big 6’s joint market share, which had been relatively stable during 2009-early 2012, has fallen 6% as a consequence of independent suppliers’ steady growth from mid 2012. In June 2014 their market share was 7%, about four times the market share they had in 2012

Switch & save Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc.

The retail challenges Promoting customer engagement Building trust & confidence Promoting customer engagement Ensuring competition works for all customers Moving to a smarter world Making sure wholesale price rises are passed through Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc.

Part 3: The networks Transmission High voltage networks 3 companies onshore. Distribution Lower voltage networks. 14 regional areas. Offshore Offshore Transmission Owner Appointed via tender. Interconnection Owners of interconnectors. Also certified as TSOs The System Operator Operates the grid. Coordinates planning and development. Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc.

Network Costs post privatisation Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc. Network costs are determined via periodic price controls. Our RIIO framework focusses on what customers value. Network costs recovered from system users via charges.

And the role of the SO will need to evolve. Network Challenges Making sure RIIO delivers Thinking about more competition Getting interconnection built Betting planning/ coordination Continuing to drive down costs but ensure investment Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc. And the role of the SO will need to evolve.

Part 4: The wholesale market Part 1: The industry structure, roles & responsibilities. Part 2: The retail market Part 3: The networks Part 4: The wholesale market Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc.

Part 4: The wholesale market The wholesale market is: The place where generators sell their energy The place where suppliers buy their energy Supply and demand must be matched, or balanced, at all times (in the case of electricity in real time). The market incentivises suppliers and electricity generators to balance their own supply and demand positions. Overall responsibility for balancing supply and demand sits with the System Operator. Who are the participants The Big 6 and independent suppliers Generators, Interconnector/LNG operators Banks and financial institutions, Hedge funds Exchanges Brokers National Grid, as system operator Elexon as the BSC Company

Wholesale market design The NETA/BETTA market which replaced the Electricity Pool is based on the following principles The market should incentivise parties to trade as they wish to manage their risk (with prices set based on the cost of the marginal plant). The role of the SO should be minimised – “residual balancing”. Parties which causes costs should face the costs they cause . Market rules should be capable of being changed by market players. There should be a single GB price/ bidding zone.

Sources of supply

Sources of supply Electricity Power generation in recent years dominated by coal, gas and nuclear Coal has been providing majority of seasonal swing, as plant look to save running hours under environmental legislation Gas generation expected to play a key role providing flexibility going forwards

Buy & sell power from many years ahead to day ahead. The timescales for power trading Forward Markets Buy & sell power from many years ahead to day ahead. In order to hedge risks. Day Ahead/ Spot markets Where a lot of power is traded. Market coupled with Europe. Intraday Markets Allow the fine tuning of positions near real time. Balancing Markets SO run market to balance demand & supply. Based on bids and offers in a balancing mechanisms.

Over-the-Counter (OTC) Trading gas and power Over-the-Counter (OTC) Exchanges Bilateral agreements Opaque market Facilitated by brokers and Price Reporting Agencies Counterparties won’t necessarily post collateral Act as an intermediary between parties Transparent market Counterparties have to post collateral Party A Party B Financial flow Party A Party B Exchange Delivery of commodity

Price Formation Generators Interconnectors Costs of production mainly determined by: Cost of plant Commodity prices Plant reliability and efficiency Government policies e.g. carbon price floor/Contracts for Difference Costs of production mainly determined by: Cost of interconnector Prices in other markets Exchange rates Interconnector reliability and efficiency Gas Conventional Coal Oil Keen to have an interactive presentation. Aware have done some training, Assume they have knowledge of the market but important to go through some key background points. Key messages: Wholesale is technical, complex, artificial, highly regulated market We will play a full role assisting the CMA investigation Focus of today is how we monitor the wholesale market. In addition to this we will provide background slides. Things we won’t cover today: Future drivers of change: EMR, Smart, elec and gas SCRs, Vertical integration and different business models Profitability Detail of Ofgem’s proposals, eg liquidity Barriers to entry for small suppliers / further detail on theories of harm Networks / regulated monopolies, interconnection  But we will make a list of things that we may wish to have further teach-ins, discussions, calls, etc. Nuclear Low carbon Wind Hydro

Price Formation (2) Supply curve: Demand curve: Combining the costs on the previous slide gives a supply curve… Demand curve: Demand, on the other hand, is determined by: Temperature Light Weekday/weekend Over the long-term: GDP Demand is quite inelastic, i.e. not very responsive to changes in price, and therefore has a steep curve: Supply Gas Oil Coal Interconnectors Renewables& Nuclear Renewables& Nuclear 23

Balancing the system Electricity t-1 t t+0.5 Gate Closure – trading stops Settlement period (30 mins) Forward trading Balancing Mechanism Electricity Parties submit: To National Grid Final Physical Notifications (FPNs) Bids and Offers To Elexon 3. Contract notifications t-1 t t+0.5 NG accepts bids/offers to balance the system

Wholesale Challenges Rewarding flexibility/ encouraging investment Ensuring liquidity Rewarding flexibility/ encouraging investment Greater European integration Getting the demand side involved Interactions with policy initiatives

It’s all about the system! We can think about individual parts of the electricity sector. But it’s all part of one very complex system. A tweak in one place can have big consequences in another. The biggest challenge is ensuring coherence. We at a point where lots is changing. Ensuring security of supply, keeping costs down & decarbonisation rely on getting things right!

MIR now will lead to faster conclusion to market uncertainty Market Investigation Reference (MIR) Why? “Reference test” threshold met: reasonable grounds to suspect features of market restrict/distort competition Why now? Still expect RMR reforms to directly address market failings, but investigation will clear the air and allow CMA to ensure right industry structure is in place Scope Supply of gas & electricity to GB households and small businesses Features of the market that could harm competition Recognising Ofgem’s RMR remedies and future developments Process Jul/14-Jan/16: CMA market investigation – 18 months, can add 6 months Jan/16-Jul/16: CMA remedies (if required) – 6 months, can add 4 months MIR now will lead to faster conclusion to market uncertainty