Supplementary Memorandum by the Lattice
THE RELATIONSHIP BETWEEN MARKETS AND PUBLIC
POLICY IN A LIBERALISED MARKET
Lattice Group gave oral evidence to the Trade
and Industry Select Committee on 4 December.
It appears that one of the questions that raised
particular interest was how markets can operate within a public
policy framework with clearly defined security standards. Our
thinking on this issue is set out below.
1. THE LIMITATIONS
Market mechanisms alone cannot be relied upon
to both set the level of and deliver security of supply, for the
Liberalised markets and the significant
competitive pressures they entail cannot be relied upon exclusively
to ensure adequate supply provision for all customers. This particularly
applies to domestic and small industrial/commercial customers
who are not well placed to provide back-up energy supplies, and
where the safety implications of supply interruption are material.
Energy networks are a public good
and highly interdependent. Hence they cannot generally deliver
different security levels to different customer groups or different
locations. Accordingly, a small number of market players could
potentially put at risk the safety of the network and the reliability
of major parts of the gas supply chain.
Liberalisation can easily lead to
efficiency becoming the only criterion for network design, thereby
allowing for an insufficient degree of network flexibility and
resilience. A certain amount of spare capacity in networks is
necessary not only to mitigate the effects of potential supply
interruptions from one source but also to allow for flexible gas
flows and trading.
Markets should therefore be set within a framework
of public policy with clearly defined security standards. It should
be left to markets to meet these standards flexibly and efficiently.
Security of supply requires (a) adequate provision
of gas supplies to cover customers' needs under both average and
extreme conditions, and (b) the ability to deliver that gas, ie
adequate provision of infrastructure.
To hedge against the risk of under-provision
of both gas supplies and transportation infrastructure we propose
the following measures:
(a) The establishment of mandatory storage
obligations on suppliers
These could take the form of a requirement on
suppliers to hold a certain level of inventory in storage, proportionate
to the size and nature of their customer base. Such requirements
could vary between different customer groups, with customers which
traditionally are uninterruptible, weather sensitive and cannot
easily switch to other fuels requiring particular protection (typically
domestic and small industrial/commercial). Big industrial customers,
which can easily resort to alternative backup fuels or interruption
in case of a supply shock, can be left to choosing their own level
of security without putting the system or other customers at risk.
(b) The consistent application, across the
EU, of minimum output standards for network resilience.
The UK's future security of gas supplies will
directly depend on the resilience of the pan-European gas network
as a whole.
This applies in both average and extreme circumstances.
Under average conditions, it is vital that there is adequate capacity
in the European transmission system to allow for efficient trading
and for supplies to be transported to the UK. This could well
be provided on the basis of commercial incentives.
However, under severe circumstances, eg a severe
winter or a supply shock, the European gas network will in addition
need to have a sufficient degree of resilience to accommodate
additional sourcing of gas from any point of input into the European
system. For example, if there was a prolonged interruption of
supplies from Russia, UK customers will directly depend on the
ability of the European transmission network to accommodate a
prolonged sourcing of gas from an alternative source, eg Norway
or Continental storage. Avoiding a position where gas is available,
but cannot be delivered in peak conditions, may require regulatory
standards to underpin the necessary infrastructure investment.
In our view, this therefore warrants the establishment
of pan-European security standards for network resilience and
One example of such output standards would be
the ability of the network to withstand a supply interruption
from any source of input into the system for a given period of
time, in addition to more traditional security criteria such as
the one in 20 peak day and one in 50 severe winter requirement.
2. THE ROLE
The above listed regulatory obligations should
be designed in a way that allows markets to deliver them in the
most flexible and efficient way.
For example, storage obligations should be designed
in a way which enables market participants to consider a range
of substitutes to physical storage, including demand management
such as the provision of "virtual" storage in the form
of coal stocks at reserve power stations standing ready to displace
gas fired power stations if needed.
Security standards should therefore be output-driven,
ie define levels of security to be achieved rather than prescribing
how they are to be achieved. Market disciplines offer the prospect
of more efficient and innovative delivery of such standards, and
should provide investment signals to competing storage operators
and other providers of flexibility.