Supplementary evidence submitted by E.ON
UK plc
WHOLESALE MARKET
LIQUIDITY
1. At the Select Committee hearing on 24
June 2008, it was indicated that Ofgem had suggested that the
value of the total Over the Counter (OTC) market in 2007 was £31
million. A question was raised about the limited size of this
market, with the underlying concern being that the companies before
the Committee (in the particular session, E.ON UK, EdF and RWE)
were not trading in the market but instead were only trading internally,
hedging between their generation and supply businesses, without
this volume ever reaching the market.
2. Initially, it is worth correcting the
picture given above. In fact, the value of the UK wholesale market
that is screen traded through brokers (ie part of the OTC market),
was nearly £31 billion in 2006-07 (April to March) and more
than £41 billion in 2007-08. The volume in 2006-07 was 767TWh
and in 2007-08 was 928TWh, where physical output volume in each
of those years was around 332TWh. Trades through brokers are available
to anyone who uses that broker (brokers are, for example, GFI,
ICAP, Spectron, Tullett Prebon), subject to credit risk. In addition
to the brokers, a small amount of trades (perhaps 1-2%) go through
exchanges and there are also some bilateral contracts on OTC or
bespoke terms.
3. It is certainly not the case that the
players in the market who are vertically integrated do not trade
in the market. They all do so, to greater or lesser extents. This
may be for a variety of reasons—including because they run
their supply and generation trading businesses entirely independently
of each other; because they need to add "shape" to their
trading profile to meet their retail demand which their own generation
portfolio cannot provide; because they may be "short"
or long" in generation and therefore need either to make
up volume or to sell it on; or because they wish to optimise their
trading position—the "make/buy" decision.
4. For E.ON's part, it trades more than
100% of its generation volume through the wholesale market. Indeed,
in 2007-08, this was more than 200% of its generation volume,
as shown in the table below. All of this volume was through brokers.[272]
| ESI Year | Generation Volume (MWh)
| Wholesale Market Sales Volume (MWh)
| Sales as a % of Generation |
| April 2006 to March 2007 | 37,049,369
| 49,560,875 | 134% |
| April 2007 to March 2008 | 41,480,605
| 92,239,488 | 222% |
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5. In fact, as was set out in our written evidence, liquidity
in the electricity wholesale market is not falling[273]—it
is increasing. We provided graphs in our response that demonstrated
that, as do the figures in paragraph 2 above This has also been
independently confirmed by the Financial Services Authority (FSA)—the
FSA analysis of activity in energy markets 2007 states that UK
traded power volumes increased 52% in 2006-07 over 2005-06.[274]
The electricity wholesale power market is actually quite disaggregated,
with low levels of concentration. Based on the number of counterparties
we trade with, we believe there are about 50 active participants.
6. However, we do believe that the trading market structure
can be improved. As the market is currently set up, liquidity
is dispersed across the various different product pools and there
is no robust reference price that can be used as a basis for a
simple, cash-settled futures contract. This contrasts with many
European markets that have a centrally organised spot market with
a single, published, reference price that encourages the use of
financial swap and futures contracts, reducing credit risk and
the need to take power to physical delivery.
7. This was recognised by a number of players in the
industry and therefore the "Market Design Project" was
initiated by the Power Trading Forum (registered to the Futures
and Options Association (FOA)) in March 2006 to review the current
market structure and provide alternatives, with the goal of stimulating
forward power liquidity. A Market Design Project Steering Group
was set up on which E.ON sits, together with representatives of
other major players in the wholesale market, including Drax and
International Power, as well as representatives from the FOA and
others.
8. The following rationale was developed for the project:
— In order to attract additional forward liquidity,
the correct products, easy access and financial and physical contracts
must be developed;
— To trade financially settled contracts, robust
reference prices are required;
— Reference prices are best established day
ahead from the underlying physical market, and it is proposed
to do this through both continuous trading and an auction process—this
suggests a platform which hosts continuous and auction based trading;
— For reference prices to be robust, all (or
a significant majority) of trades must be captured. A central
clearing platform (energy exchange) is the most efficient way
of achieving this goal (this in addition provides a revenue stream
to the platform provider);
— This platform should then form the starting
point for the future development of financial trading, once the
reference prices have been accepted.
9. The Market Design Project proposal, therefore, is
for a platform which hosts continuous and auction based trading,
capturing all, or a significant majority of trades, through a
central clearing platform (energy exchange).
10. A request for proposals from potential service providers
was issued in June 2007 to try to find solution providers who
could host the auction and intraday platforms and provide clearing
services. The process was delayed due to the time required for
providers to submit detailed responses and for the Market Design
Project to evaluate those proposals thoroughly. Commercial negotiations
began with the leading provider but subsequently broke down due
to issues with commercial arrangements between the two parties
that had put forward that solution. The RFP process has now begun
again with the short-listed parties and it is hoped that a recommendation
for a way forward will be made in August 2008, with implementation
as soon as possible after that, but realistically likely to be
in Quarter 2, 2009.
11. The aim of the Market Design Project is to encourage
players operating on the fringe of the wholesale market, or operating
indirectly, to participate. Many industrial players and brokers
take part in other European markets such as Nordpool and EEX because
of the ease of entry and the fact that credit risk is reduced
via the use of cleared instruments, as described above. So, for
example, Bizz Energy and other independent suppliers will be able
to participate more fully and the new arrangements should also
attract new risk capital that will further enhance liquidity.
Other large players on the demand side such as Corus, SCA, Linde
Group, and Ineos Chlor are also interested in these developments
and E.ON has worked to keep them informed of development.
12. The Market Design Project is an example of the market
seeking its own solutions—the market is not perfect and
is looking to evolve and improve through its own initiatives and
actions. The proposed structure will allow a better range of hedging
instruments, thereby encouraging companies without their own generation
assets, or large industrial companies to enter the market and
enabling more active hedging and trading by market participants.
June 2008
272
E.ON also trades a small amount through the APX, a power exchange. Back
273
It did fall between 2004 and 2006. Back
274
This gave a market size of 984.8TWh in the period August 2006
to July 2007, with a value of £31 billion, see: www.fsa.gov.uk/pubs/others/analysis_energy_2007.pdf Back
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