Memorandum from British Energy
SUMMARY
— The UK requires a stable energy policy
and regulatory framework that balances security, diversity and
care of the environment with competitive markets and price stability.
This in turn will encourage the much needed industry investment
required to underpin security of supply. In light of this we do
not consider there to be a need to significantly amend the regulator's
remit through changes to its statutory duties.
— Since the introduction of NETA the
wholesale electricity market has seen relatively lower liquidity
with trading largely focussed on the fine tuning of short-term
positions. This has contributed to a more volatile wholesale market
where relatively low levels of trading activity can result in
significant swings in market prices.
— Liquidity issues are widely recognised
by the industry and there are a number of initiatives currently
underway which are looking to address them. BE welcomes these
initiatives and continues to actively participate in the development
of proposals that have the potential to introduce more liquidity
into the market.
— One of the key themes the UK's energy
policy is attempting to address is to improve the environmental
performance of the overall energy system. Whilst we fully support
this theme there is a need for an increased emphasis on reducing
the regulatory compliance costs in respect of environmental measures.
We consider there is scope for simplifying the regulatory provisions
without undermining the effectiveness of dealing with the environmental
issues. There also needs to be better focus on ensuring that measure
introduced are consistent and both cost-effective and affordable.
— We actively support the opening of
the European market and believe the development of genuine competitive
European gas and electricity markets will help to sustain the
competitiveness and security of the UK industry. However, real
progress is slow and potentially hindering the development of
more competitive wholesale markets across the EU.
— In the context of fostering a competitive
single European energy market, it would be neither appropriate
nor efficient for there to be significantly different, more complex
or more burdensome arrangements in the UK. Regulatory decisions
need to be closely co-ordinated with neighbouring jurisdictions.
Consequently, when proposals are presented to modify the existing
UK market arrangements it is important that consideration is given
to the effect such changes will have on the integration of the
UK market with other European markets.
INTRODUCTION
1. A FTSE 100 company, British Energy Group
plc is the UK's largest producer of electricity and the lowest
carbon emitter of all the major UK electricity generators. We
produce around one sixth of the UK's electricity requirements
and employ about 6,000 staff. British Energy owns and operates
eight nuclear power stations and one coal-fired power station
in the UK. Of British Energy's nuclear power stations, seven are
AGR power stations and one is a PWR power station with a combined
capacity of about 9600MW. Eggborough Power Station, our coal-fired
power station in Yorkshire, has a capacity of about 2,000MW. During
the year ended 31st March 2007, British Energy's power stations
produced total output of 58.4TWh.
2. Our electricity production is sold via
a number of routes to market, including through structured trades,
through the electricity wholesale market, and through the company's
direct supply business, British Energy Direct Limited (BEDL).
BEDL only supplies industrial and commercial electricity customers
in Great Britain, and it is one of the largest suppliers of electricity
in that sector, supplying around 29TWh to over 1650 customers
across 9,365 sites in 2006-07. The Group also has a trading division
that is responsible for arranging the wholesale sale of the Group's
electricity output as well as providing trading risk management
and balancing services to the Group.
3. British Energy plays a major role in
helping the UK meet its emissions targets. In 2006-07 our nuclear
stations avoided the emission of 33.7 million tonnes of CO2 (MtCO2)
that would otherwise have been emitted had the same output been
generated by fossil fuel stations. This is equivalent to removing
around half of the cars from the UK's roads.
OVERVIEW
4. The electricity industry is a capital intensive
industry characterised by long-term investment and planning horizons.
There is currently a requirement for a significant and sustained
investment programme in the UK infrastructure including new generating
capacity to ensure on-going security of supply. With this in mind
there is clear need for a stable political and regulatory framework
in order to encourage the investment required to deliver this.
5. Ofgem has recently announced a parallel investigation
into the electricity and gas markets following expressions of
consumer and public concern over the competitiveness of the markets.
We welcome this announcement and will be actively participating
in its investigations. There is clearly some considerable overlap
between the issues that fall within Ofgem's investigation and
this inquiry. Consequently, we recommend that the BERR Committee
should review the findings of Ofgem's investigations before finalising
its own conclusions and recommendations. To do otherwise would
be potentially inefficient and counter-productive.
6. As our primary operations are within
the GB electricity market the views expressed below predominantly
relate to this market.
Whether the current market structure encourages
effective competition in the retail markets for gas and electricity
7. BE does not operate directly within the
retail markets for domestic customers in either gas or electricity
and is not therefore well placed to comment on this issue.
8. The Group is however licensed to supply
electricity to any non-domestic customers within Great Britain
through its subsidiary BEDL. The top end of the industrial and
commercial sector of the electricity supply market where we predominantly
focus our direct supply activities is a highly competitive, low
margin market sector. It is characterised by generally well informed
customers who are highly price sensitive and overall has high
levels of customer switching. This degree of competition has brought
real benefits to consumers in terms of vigorous competition on
price, quality of service and responsiveness and innovation on
contract forms and terms.
9. It is acknowledged that the UK has one
of the most developed liberalised energy markets in Europe with
energy prices relatively competitive with many EU markets. The
European Commission ("EC") as part of its recent energy
sector inquiry and the development of the 3rd Energy Package has
been investigating national market structure issues and their
potential to restrict competition. However, in the main the EC
did not identify any significant concerns with the existing UK
energy market structure. In particular, the EC has greatly focused
on the issue of network ownership unbundling with a view to promoting
effective competition in generation and supply markets. However,
unlike in most European countries, this is not a significant issue
in Great Britain since National Grid, its transmission system
operator, is fully unbundled from generation, distribution and
supply activities. Although some electricity distribution companies
are part of vertically integrated groups consisting of both generation
and supply activities these businesses have been ring-fenced and
are subject to regulatory conditions designed to promote effective
competition. These regulatory provisions appear to be working
effectively as we are not aware of any evidence of discriminatory
behaviour having been identified.
10. Notwithstanding the above, we do have
concerns with the development of competition in the provision
of metering services across the whole electricity supply market.
It is clear that competition in this section of the market has
not developed as Ofgem anticipated when deciding to open up this
sector of the market. Indeed, many incumbent metering service
providers are now starting to withdraw from offering their services
to BE and other independent suppliers. This may have an adverse
effect on supply competition. This situation could be exacerbated
by some of the current proposals on Smart Metering. In particular
we do not support the ERA's proposals to create regional franchises
to implement the roll-out. Instead, we have been advocating a
solution for the mass introduction of smart metering which works
within the current competitive market framework and which, amongst
other benefits, would remove these competition concerns.
Whether there is effective competition in the
wholesale markets for gas and electricity
11. Since the introduction of the new electricity
trading arrangements ("NETA") in England & Wales
in 2001 (extended to Great Britain in 2005—"BETTA")
the wholesale electricity market has seen relatively low liquidity.
This was confirmed in the EC's interim sector report from 2006.
The wholesale generation market is increasingly confined to the
role of a secondary balancing mechanism where trading is largely
focused on the fine tuning of short-term (within day/day ahead)
positions as opposed to the trading of longer term positions.
This has contributed to a more volatile wholesale market where
relatively low levels of trading activity on the longer-term forward
curve, (both in terms of the number of and volume covered by trades
executed), can result in significant swings in market prices.
These factors, combined with the continued absence of any meaningful
traded derivatives market, make it more difficult for independent
power producers or suppliers to trade their output or requirements
and manage market risk effectively.
12. Vertical integration has been a natural
reaction of the major market participants to the inherent risks
they face following the introduction of NETA. Under the trading
arrangements prior to the introduction of NETA (the Pool) market
participants and even pure financial traders were better able
to mitigate wholesale electricity price risk by signing contracts-for-differences
that used a single wholesale price as a reference price. Under
these arrangements, generators generally sold their output at
the reference price and retailers bought their requirements at
a separate selling price in which the reference price was the
main element. Both parties could hedge their risks by signing
contracts to hedge themselves against variation in the reference
price.
13. Such contracts are no longer available
to manage risk. Under NETA market participants no longer have
a single reference price but instead sell their forecast output
through bilateral contracts. Their physical exposure is limited
to the risk associated with the (dual) prices assigned to "imbalances",
ie to the differences between contracted sales (or purchases)
and actual output (or consumption). This complex (and deliberately
punitive) dual cash out pricing regime makes it difficult for
participants to be sure of their price exposure and hard to devise
effective hedging against a variation in two separate imbalance
prices.
14. The level of market liquidity is also
affected by the significant demands for credit. Under the Pool,
credit risk was effectively spread across the whole market. Under
NETA, the uncertain risks faced by market participants through
contract default tend to drive contract counterparties to require
high levels of security from sellers in the form of collateral/bank
guarantees etc. The combination of the lack of financial hedging
products and credit arrangements provides strong drivers for market
participants to become vertically integrated in order to better
manage these risks.
15. The issues highlighted above are widely
recognised in the industry and there are a number of initiatives
currently underway which are looking to address them. For example,
the Power Trading Forum of the Futures and Options Association
is looking to establish a reliable day-ahead index which may encourage
more liquidity and the development of a range of financial products
for hedging and trading purposes. Also Ofgem is currently undertaking
a review of the balancing market cash-out regime with a view to
potentially amending the rules used to set prices on imbalances.
We welcome both these developments and will continue to participate
actively in the development of proposals that have the potential
to introduce more liquidity into the market.
The implications of growing consolidation in the
energy market
16. As highlighted above, vertical integration
is largely a response to the market structure and the risks faced
by market participants under NETA/BETTA. Similarly, horizontal
consolidation can lead to "netting out" of imbalances,
and thus also potentially improve the ability to manage the risks
faced under NETA/BETTA. Of course, high market concentration can
have adverse effects on competition, which need to be balanced
against efficiencies. The UK merger control regime relies on the
OFT and the Competition Commission to perform this balancing exercise.
The relationship between wholesale and retail
markets for electricity and gas
17. As highlighted above, we currently are
not directly involved in the retail supply to domestic customers
and therefore have little experience to base any views on the
relationship between the wholesale and retail markets. With respect
to the industrial and commercial sector of the supply market in
which we operate there is traditionally a strong and increasingly
direct relationship between end user and wholesale market prices.
Customer prices in this market sector are well correlated to wholesale
prices—indeed many more customers are actively choosing
to enter in to contracts where prices are indexed to market prices
thereby directly exposing them to wholesale price fluctuations.
The interaction between the UK and European energy
markets
18. It is recognised that the UK has one
of the most developed liberalised energy markets in Europe. However,
European energy markets together with EU regulatory and competition
policy is having an increasingly important impact on the UK's
energy markets and consumers. There is therefore a clear need
for the UK to participate in the development of European policy
in energy markets in order to influence the way in which this
develops.
19. We continue to support actively the
opening of the European market and believe the development of
genuinely competitive European gas and electricity markets will
help to sustain the competitiveness and security of the UK industry.
In particular, we are playing an active role in discussions on
regulation, cross-border trading and environmental policy issues.
Further, we fully support Ofgem in its role in Europe in particular
through its participation in CEER/ERGEG[12]
where it is clearly engaged in promoting and developing competitive
energy markets and effective network regulation across the EU.
20. Although some developments have occurred
in Europe (eg increased transparency in gas market information
in some European markets), real progress is slow. This is hindering
the development of more competitive wholesale markets across the
EU. For example, as part of the ultimate move to a competitive
single European energy market, proposals to develop well functioning
regional markets are being discussed. However, real progress on
a number of significant issues in respect of the UK, France and
the Republic of Ireland (FUI) regional market has been difficult.
If an effective FUI regional market is to be developed and UK
competitiveness is to be maintained, a number of barriers to trade
need to be addressed such as the compatibility or consistency
of trading/balancing arrangements, differences in transmission
charging, transparency of market information and the removal of
the potential for discrimination from all market sectors.
21. In the context of fostering a competitive
single European energy market, it would be neither appropriate
nor efficient for there to be significantly different, more complex
or more burdensome arrangements in the UK. The EC in a report
in early 2007 on the internal market commented that "Britain
can no longer be regarded as an isolated, self sufficient market
for electricity and gas. Regulatory decisions need to be strongly
co-ordinated with neighbouring jurisdictions. If not there is
a continuing risk that inconsistent regulatory frameworks will
create perverse incentives for energy companies". Consequently,
when proposals are presented to modify the existing UK market
arrangements it is important that consideration is given to the
effect such changes will have on the integration of the UK market
with other European markets.
The effectiveness of regulatory oversight of the
energy market
22. Experience with electricity markets
is still evolving and conditions in the British electricity market
are changing all the time. Some regulatory oversight may be desirable
to ensure that changing market conditions do not harm consumers'
interests. However, competition might also be hampered by inappropriate
regulation. For example, although lower prices can be in the interests
of consumers and could potentially increase the competitiveness
of UK businesses in the short-term, simply lowering prices should
not become an aim in itself. Significant interventions in the
market should therefore only be contemplated when the regulatory
authorities have demonstrated a clear benefit to consumers. Given
the specific features of the electricity market, the demonstration
of clear benefits requires objective empirical analysis and cannot
be justified merely by reference to abstract theories of the market
and of competition. Such ideologically motivated interventions
would lead to uncertainty about future regulation, undermine investor
confidence in the market and hence hinder the delivery of the
required investment in new generating capacity needed to underpin
security of supply.
23. Government quite rightly takes no role
in the day-to-day operations of Ofgem. However, whilst we fully
support this independence it is vital that the decisions of Ofgem
do not fundamentally conflict with overriding Government policy—particularly
given the important role Ofgem plays in helping to deliver the
Government's energy, social and environmental objectives. There
is therefore a question of how best to ensure there is a coherent
policy and regulatory framework against which market participants
can make business decisions, whilst maintaining Ofgem's independence
from Government. At the very least, effective scrutiny of how
and to what extent Ofgem's policies are consistent with and complement
the framework of energy policy set by Government is required.
24. One of the key themes the UK's energy
policy is attempting to address is to improve the environmental
performance of the energy system. Whilst we fully support this
theme there is a need for an increased emphasis on reducing the
regulatory compliance costs in respect of environmental measures.
We consider there is scope for simplifying the regulatory provisions
without undermining the effectiveness of dealing with the environmental
issues. For example, the prevailing Emission Trading Scheme (ETS)
addresses environmental damage from CO2 emissions by way of a
cap-and-trade system. Such a system allows the authorities to
set the optimal level of emissions whilst also creating market-based
incentives to minimise the cost of achieving that level. By contrast,
some other arrangements are very complex and, in BE's view, unnecessarily
complicated and costly. For example, the Renewable Obligation
(RO) aims to reduce CO2 emissions from electricity generation,
even though they are already capped by the EU ETS. Moreover, it
mandates a method for emissions reductions (renewable energy)
which carries a significantly higher cost per tonne of CO2 abated
than current and forecast prices in the ETS.
25. Similarly, many energy efficiency policies,
such as the EEC/CERT and CRC, amount to "double regulation"
of emissions and impose a regulatory rather than market-based
choice of methods for emissions reductions. Finally, interactions
between policies can create unintended consequences contrary to
cost-effective reduction of CO2 emissions. For example, the separate
targets for renewables and energy efficiency risk creating uncertainty
about future prices for CO2 emissions and energy production. We
consider that the compliance costs of the EU ETS and similar market-based
systems are likely, in the long run at least, to be lower than
for more complex regulatory solutions.
26. Notwithstanding the above, we do not
consider there to be a need to significantly amend the regulator's
remit through changes to its statutory duties. Britain requires
both an energy policy and a regulatory framework that balances
security, diversity and care of the environment with competitive
markets and price stability. The continuing challenge for Ofgem
is to develop an energy regulatory framework that satisfies the
public interest test by striking the right balance between these
priorities whilst operating in accordance with best regulatory
practice. As part of this, it is important that the regulatory
authorities explain in full how they intend to balance their (potentially
conflicting) priorities when making regulatory decisions, in order
to create a stable and more predictable environment for new investment.
Progress in reducing fuel poverty and the appropriate
policy instruments for doing so
27. As we have already indicated we are
not directly involved in the supply of electricity or gas to domestic
consumers and do not therefore have any direct relationship with
customers that are affected by fuel poverty. Our primary activity
is the generation and trading of electricity where we contribute
to and actively promote a fully competitive electricity wholesale
market. Competition is the best form of constraint on electricity
prices. Consequently, we make a positive, albeit indirect, contribution
to addressing fuel poverty through competition.
28. Notwithstanding the above, we do acknowledge
that fuel poverty is a major issue that requires careful consideration.
However, we believe fuel poverty is a public policy/government
social policy issue rather than a market/regulatory one. As such
this issue should be addressed via appropriate and properly targeted
social policy instruments such as the benefits/taxation regime
as opposed to interventions in the electricity and gas markets.
Any attempts to do the latter will potentially distort the energy
markets and thus have an adverse effect on investor confidence
at a time when there is a need for a large scale investment programme
in infrastructure including new generating capacity to address
a looming capacity gap. This in turn could lead to customers and
tax payers paying more in the long run.
29. If the Government wishes to use energy
policy or the liberalised energy markets to deliver its social
policy objectives then this is a different model than the one
that is currently in place and understood by market participants
and investors. Consequently, any significant change such as this
should be made explicit so that the additional implications faced
by market participants can be fully assessed.
April 2008
12 CEER-Council of European Energy Regulators; ERGEG-European
Regulators' Group for Electricity & Gas. Back
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