Memorandum submitted by Welsh Power
INQUIRY INTO UK ENERGY MARKET
INTRODUCTION
Welsh Power Group Limited is a dynamic independent
power company, which aims to build an integrated multi-asset European
energy business using a buy and build strategy.
Welsh Power Group is the owner and operator
of Uskmouth Power, a 363MW coal fired power plant in South Wales.
Uskmouth is one of the most efficient and flexible coal plants
operating in the UK and being fitted with FGD is also one of the
cleanest plants. Welsh Power has a subsidiary Severn Power Limited
who is developing an 850MW gas-fired power station on the brown-field
site next to Uskmouth Power.
In January 2007 Welsh Power launched Haven Power,
an electricity supply company providing predictable electricity
prices and straightforward contracts tailored to the individual
needs of business customers. In June 2007 the Company commenced
the development of a 49.9MW biomass plant at Newport Docks through
its wholly owned subsidiary Nevis Power Limited. This development
is being managed by Carron Engineering & Construction our
specialist power engineering business. Carron Energy Limited is
the commercial and trading arm of the Group managing its trading
and energy management functions, coal, CO2 and gas trading.
As one of the few new market entrants in the
last few years, Welsh Power Group has experienced first hand the
barriers to entry to the GB power market. We believe that the
market is fundamentally broken and in need of a more radical solution
than recent Ofgem initiatives, such as the cash-out review, have
examined. Outlined below are our key concerns and some proposed
solutions.
MARKET DESIGN
CONFERS A
SIGNIFICANT ADVANTAGE
ON INTEGRATED
PLAYERS
The integrated players, owning both generation
and supply businesses, do not have to effectively participate
in the wholesale market. Their position allows them to pass generation
costs straight to their supply arms, via internal power sales,
and on to customers. This has three impacts:
The European Commission's 2006 report into the
EU electricity sector pointed out that the UK was the only power
market with falling liquidity (see graph 1 below). Since their
report in 2006, data from the power exchanges show that liquidity
in the wholesale market has continued to fall with monthly volumes
almost halving in the past two years. Graph 2, illustrates the
falling liquidity for the year 2007 based on data from the London
Electricity Broker's Association (LEBA). This lack of trading
means that the market is not working efficiently with the less
economic plant, in terms of cost and environmental performance,
being dispatched as the market does not trade into an efficient
outcome. A very large proportion of all the electricity sold is
not traded in the wholesale market. This thinness of the market,
making prices increasingly volatile, makes it very difficult for
suppliers (other than the large integrated suppliers) to offer
competitive prices to their customers.
Graph 1
Source: European Commission,
Preliminary Report into the Electricity Sector, February 2006
Graph 2
Customers switching between integrated players
face increased costs as their suppliers are not adopting an economic
purchasing strategy. Incumbent suppliers face very limited competitive
pressure from the threat of new entrants as the lack of a liquid
wholesale market means new market entrants cannot purchase necessary
power at economic rates.
The integrated players see their supply portfolios
alter, but their general supply levels remain large enough to
support their own generation portfolios. Switching numbers for
customers are coloured by some customers being regular switchers,
but the general level of change in the smaller end of the market
is, we believe, overstated. These "sticky" customers
pick-up the cost of expensive generation through inflated tariffs.
SOLUTION
There are several ways to mitigate the market
power that the integrated players have:
The generation licences could be altered to
require generators to sell all of their output via the wholesale
market, rather than to their supply arms. This could be monitored
by Ofgem. The new EU electricity Directive proposes reporting
on power trades, and the UK could develop reporting requirements
to allow Ofgem to monitor the position of the integrated players.
For example all OTC trades and exchange trades would have to be
notified to Ofgem and a market reporting service to stop generators
from concealing trades and this may lead to a requirement to licence
all BSC signatories.
Alternatively, if this was felt to be difficult
to police, a divestment of generation, or full financial separation
of generators from all other larger energy businesses (along the
lines applied to monopoly networks) could be used. Under this
scenario back to back trades between related companies should
be banned and financial penalties, under competition law, should
be applied to any parties found to be in breach of the law.
BARRIERS TO
ENTRY
As well as the lack of liquidity, there are
a number of other barriers to entry to both the electricity retail
and wholesale markets:
The market itself is very complex, with physical
players having to sign a number of multi-party contracts, with
a variety of different governance regimes. The market rules are
subject to regulatory risk with Ofgem signing off all changes
to the market rules and also able to raise its own policy initiative
driven changes that can lead to fundamental changes to the market
structure.
The balancing mechanism at the heart of the
market arrangements imposes further uncontrollable costs on smaller
players. The larger a portfolio the lower the demand forecasting
risk and the more likely you are to have embedded generation,
all of which reduces your exposure to imbalance prices and this
lowers your costs. A number of modifications to the BSC[403]
have been raised that aim to reduce the level of imbalance cash-out
prices. However, changes to cash-out in themselves will not resolve
the structural issues.
Since the advent of NETA/BETTA the credit and
financial requirements for market participation have grown enormously.
Whilst some of this can be traced to supplier failures the level
of credit and security required to buy and sell electricity is
now so great that it represents the most difficult (and potentially
expensive) step for any new entrant. In addition the larger integrate
players tend to have investment grade credit ratings which means
that they are not subject to the same credit constraints and their
overall purchase costs are significantly lower as a result.
For generators, there is currently a significant
queue to get transmission capacity to connect new plant. Welsh
Power has recently requested a connection in the South West only
to be told that the earliest connection data would be 2020. We
are extremely concerned that the Transmission Access Review (TAR)
is looking at ways to allocate scarce capacity, including the
removal of the firm access rights on which generators made investment
decisions. The Government and the regulator need to focus on ways
to get National Grid as the transmission owner to build the capacity
that generators are willing to pay for. We are in danger of missing
out on the benefits of a competitive wholesale market as new generators
will not be able to come to the market and existing generators
will have their transmission rights removed and given to more
expensive, intermittent renewable generation.
SOLUTIONS
Ofgem is currently carrying out a review of
the industry Codes. We are hoping that this may streamline the
number of codes and the way that they are governed. The gas market
arrangements would create a good template for improving the power
market, with only one key code and a more flexible and streamlined
governance process. The regulatory risks would also be reduced
if Ofgem withheld from undertaking fundamental reviews of market
structure unless prompted to do so by change proposals raised
by market participants. Such reviews take up resource and only
the largest players are resourced to participate.
A levy on larger suppliers could be used to
meet the credit requirements of those new entrants that had demonstrated
some competency in their operation. This could work in a similar
way to the current High Distribution Cost Area levy which is used
to subsidize distribution costs in the North of Scotland.
On transmission access, National Grid must be
allowed to progress significant investment in new capacity under
its price control. Ofgem's concern over costs to customers must
be weighed against the costs that the customers will face if effective
competition in generation is eroded still further. New entrants
should expect to be offered firm connection rights within a reasonable
(say 4 years) timeframe if the generator is willing to underwrite
the costs. To encourage new entrants the calculation of the amount
to be underwritten (shallow verses deep connection costs) could
reduce the costs to generators. However, delivery of firm physical
rights is vital. A copy of a confidential letter sent to Ofgem,
in Annex 1 (not printed here), explains how transmission access
is impacting investments today. Alternatively some mechanism could
be found to introduce more competition into the provision of transmission
services; this could involve a break up of National Grid.
WHY PRICES
WILL CONTINUE
TO RISE
Welsh Power believes that the Government, and
the country as a whole, needs to face up to the fact that energy
prices are likely to go on rising. A more competitive energy market
would be better able to absorb some of these costs, but generally
costs faced by generators are increasing:
Renewable energy targets (under the EU Renewables
Directive and the Government's own targets) are expected to add
in the region of £200 to each household bill. We expect that
it will be higher than this as the technologies are expensive,
and thus subsidized, but also the amount of wind results in intermittent
generation that requires additional reserve generation is held
by the system operator.
Global fuel prices are rising sharply. Gas and
oil have risen 135% and 90% respectively in the past year. Biomass
fuels are also going up in price. For those needing landfill to
dispose of waste those costs are also increasing, along with freight
and shipping charges. For those looking to undertake new build
generation, equipment prices are increasing significantly with
global demand and availability is very limited. All of these factors
combine to increase the price of delivered power.
EU ETS is a real cost for generators, all of
whom are theoretically short under phase II, and under phase III
of the scheme the Government has said that is will auction all
permits for the generation sector. The cost of buying carbon contributes
to generators costs and ultimately prices.
Environmental policy, such as LCPD and NECD,[404]
are pushing up costs to generators. They either require installation
of new equipment, further monitoring and reporting, more expensive
(lower emissions) fuel, reduced running hours or closure. The
Commission is already moving forward on environmental legislation
that will continue to add costs to the generation sector. It is
also easy to aim policy at generation, so where policy aims to
reduce one type of pollution and the government is missing its
targets, it is easy to require generators to act rather than other
sectors, such as transport. The use of the generation sector as
the main tool for all clean air policies, despite the most economic
improvements already being made, simply adds to the costs of generation.
SOLUTION
While the Government controls some of these
policies, if its policy framework is fixed it must find an economically
efficient way to help the fuel poor and educate the rest of the
population so that the price rises that are coming are not a surprise
and all customers can prepare and/or budget for them. Attempts
to use the energy suppliers as a vehicle to implement social policy
have not been inefficient as suppliers cannot identify target
groups easily. For example customers on pre-payment meters are
often students and not pensioners.
This Committee can kick start this process by
reporting that the price rises currently look inevitable and that
the promotion of energy efficiency, along with tackling vertical
integration, will help all customers to adapt to the change as
well as reducing emissions.
1 April 2008
403 Balancing & Settlement Code. Back
404
Large Combustion Plan Directive, National Emissions Ceiling Directive. Back
| 
