Part 3: Regulation of Gas and Electricity Markets Exploitation of electricity trading and transmission arrangements Summary & Background
94.On 30 March 2009 Ofgem launched a consultation on Addressing Market Power Concerns in the Electricity Wholesale Sector – Initial Policy Proposals(10). This initiative reflected the regulator’s observation that the current market structure, coupled with limitations in physical transmission capacity in some areas, allows companies to exploit unduly the market in a way that results in higher bills for the consumer. During a recent investigation Ofgem also found that their existing competition law powers were unlikely to be effective due to difficulties in identifying the market in which a company could be perceived as dominant(11) and the possibility of companies having substantial market power without being dominant as understood in competition law. Their consultation considered a number of ways in which this regulatory loophole could be addressed, including the introduction of a Market Power Licence Condition (MPLC).
95.Under the electricity market arrangements in Great Britain (the British Electricity Transmission and Trading Arrangements) generation companies are entitled to operate power stations without taking into account network limitations. This would not be an issue if the existing transmission network had sufficient capacity to send the required electricity to and from all parts of Great Britain but, in some areas, the existing capacity of the wires does not always allow this. Such scenarios are called transmission-related ‘constraints’ and require action to be taken by the system operator(12), National Grid, to ensure that supply and demand is balanced on both sides of this constraint.
96.Currently, the most significant constraint boundary is that between Scotland and England (known as the “Cheviot Boundary”) and the most common scenario is one known as an ‘export constraint’, where there is too much generation ‘behind’ a constraint (in the smaller region – Scotland) and it cannot be transmitted to the larger region (England). The reverse scenario, where there is too much generation in the larger region, is known as an ‘import constraint’.
97.To balance supply and demand, National Grid can accept, as part of the ‘balancing mechanism’(13), both ‘offers’ to increase generation and ‘bids’(14) to reduce generation at specific plants. They may also have long term bilateral contracts in place with companies, including a category called inter-trip contracts. These involve National Grid paying the company an ‘arming fee’ that, via an automated trip-switch, means a particular plant could be taken off the system if the network becomes overloaded. This ‘tripping’ happens very rarely, nationally less than once a year, but the existence of inter-trip contracts allows National Grid to increase safely the electricity flow on the system and, therefore, is an effective way of expanding the available capacity of the network.
98.Ways in which companies could unduly exploit the above arrangements are by:
	manipulation of where electricity is generated in order to achieve excess profit from either ‘offers’ or ‘bids’ in the balancing mechanism. This hinges on whether, because of the limited number of generation plants in particular locations, the company can predict when National Grid would have no choice but to accept an offer or bid from them to be able to balance electricity supply and demand. In this case the consumer may meet costs over and above those expected if power stations operate in economic merit order;
	making exploitative ‘bids’ to take advantage of both being behind an ‘export constraint’ and being the only company with which National Grid can arrange balancing actions. For example, they may be the only generator available to reduce output in a particular location and so can name their ‘bid’ price and/or they might use such a locational advantage to extract unduly high ‘arming fees’ for inter-trip contracts with National Grid.
99.These sections will allow the Secretary of State to introduce a licence modification that will enable Ofgem to use its existing licensing powers to monitor and act on any examples of the actions described in paragraph 90 above. The objective is to provide a targeted and proportionate provision that will address the exploitation of market power whilst avoiding unnecessary uncertainty in the electricity wholesale market in Great Britain which could undermine investment in generation and, hence, security of energy supply.
100.The sections will not provide the long-term solution to the problem of ‘constraints’ – this will be resolved by the increased transmission capacity that will be delivered between now and approximately 2015 with additional capacity expected to be delivered by 2018. Reinforcement work on the Cheviot Boundary is already underway. The Energy Network Strategy Group (chaired by DECC and Ofgem) set out a vision for the network for 2020 needed to support a low carbon energy system(15). The sections will, however, give protection to the consumer during a time when the required upgrading of the transmission system may create more potential for exploitation to occur. Using primary legislation to introduce the MPLC will also allow the introduction of a tailored appeals process, which provides the generation companies the right to appeal directly to the Competition Appeal Tribunal (CAT) against enforcement orders or penalties imposed by Ofgem.