Electricity Generators inquiry: Remedies Letter

1. The Commission’s terms of reference require it, in summary, to consider:

1. whether the continuation unchanged of those provisions of the generation licences of AES and British Energy which concern the determination of wholesale electricity prices may be expected to operate against the public interest; and
2. if so, whether the adverse effects could be remedied or prevented by modification of licence conditions.

If the answer to both questions is yes, then the Electricity Act requires the Commission to specify appropriate modifications.

2. In its Issues Letter of July 2000 the Commission invited views on the issues which it had identified as arising in the inquiry. In accordance with its normal practice, the Commission now wishes to consult on possible remedies. This is on the hypothetical basis that the Commission answers question (a) in the terms of reference in the affirmative: in other words, it concludes that there will be adverse effects for the public interest if AES’s and British Energy’s generation licences continue unchanged. The Commission wishes to emphasise that it has not yet reached conclusions on this or any other aspect of the inquiry.
   
3. As noted in the Issues Letter, the Commission has concentrated its attention primarily on the prospective situation under the new electricity trading arrangements (NETA) which are due to come into operation before the end of 2000. There must be some possibility that this will not be achieved, however. Until such time as the introduction of NETA on or before a specified date becomes a certainty, the Commission is obliged to give attention also to the prospects over the remaining life of the Pool.
   

Hypothetical remedies

4. The inquiry has arisen because the Director General of Electricity Supply (DGES) proposed a particular modification, known as the market abuse licence condition (MALC), and AES and British Energy were not willing to have this new condition added to their licences. In these circumstances the Commission has already received many submissions concerning the MALC itself: consequently, subject to paragraph 10 below, the Commission sees no need to invite further submissions on that particular remedy.
   
5. The Commission does, however, wish to invite views on a possible alternative to the MALC which would prohibit specified forms of manipulation of the present wholesale electricity market which are intended to raise, and have the effect of raising, prices. This would separate the concepts of manipulation and market power (the latter being the focus of the MALC). The evidence which the Commission has received suggests that various aspects of the present Pool arrangements are vulnerable to manipulation. Some, but not all, of these have been addressed by rule changes. Given that further changes to Pool rules are unlikely at this stage in its life, it may be that a licence condition prohibiting specified forms of manipulation would be appropriate for inclusion in the licences of AES and British Energy for the remaining life of the Pool.
   
6. One question which arises is whether a definition of manipulation would be necessary and, if so, what it should be. A second, related question is what the test should be for an adverse effect on prices. One possibility might be the creation of anomalous Pool prices, defined as prices significantly higher than would reflect the prevailing supply, demand and cost conditions.
   
7. The Commission also wishes to invite views on what specific forms of manipulation might be covered by a condition on these lines. The following are put forward for consideration:

1. the withholding of capacity in order to cause increases in the Loss of Load Probability (LOLP) component of capacity payments;
2. the use of inflexibility markers for reasons other than technical reasons;
3. the use of complex price bidding structures in ways designed to raise the System Marginal Price (SMP).

These are all forms of behaviour which have been noted in Ofgem’s Pool price investigations since the beginning of 1999 and which do not appear to have been fully addressed by subsequent rule changes. The Commission invites views on whether other specified forms of manipulation should also be addressed.

8. Given the complexity of the issues which could arise in relation to any alleged breaches of such a condition, it would seem necessary to make provision for some kind of independent review mechanism. It is for consideration whether an advisory body on the lines of that which the DGES has set up under the MALC would be suitable or whether, for example, the appointment of expert assessors such as those which review generators’ decisions to close plant permanently might be preferable. (The Commission understands that this provision for independent review of closure decisions is included in the licences of a few of the larger generators.)
   
9. A draft of a possible licence condition on market manipulation is attached as Annex B.

The MALC and NETA

10. As a separate matter the Commission wishes to explore how the MALC would work under NETA. At present the DGES’s guidelines are to a considerable extent drafted with reference to the Pool. Ofgem has embarked on a consultation exercise on how the guidelines should be adapted for NETA, and the responses to that consultation have been provided to the Commission. Whilst, therefore, the Commission would welcome any additional submissions which other interested parties might wish to make on the subject, its prime concern is to explore the matter with Ofgem and with AES and British Energy.

Annex B

Draft of a possible licence condition on market manipulation

1. The Licensee shall not engage in conduct, whether alone or with one or more other undertakings, which amounts to manipulation of the arrangements for the sale and purchase of electricity under the Pooling and Settlement Agreement and which has an adverse effect on wholesale electricity prices.
2. For the purpose of this Condition manipulation is defined as conduct by the Licensee, whether alone or with one or more other undertakings, which:

a. limits generation or capacity availability without good cause; or

b. uses inflexibility markers for reasons other than technical reasons; or

c. uses complex price bidding structures which are designed to cause the System Marginal Price to be set at a higher level than would otherwise be the case; or

d. [any other specified form of conduct].

3. For the purpose of this Condition conduct has an adverse effect on wholesale electricity prices if it creates, and could reasonably have been expected to create, prices significantly higher than would reflect the prevailing supply, demand and cost conditions in the market.

4. Whether any conduct is prohibited by this Condition shall be determined having regard to any guidelines on the application of this Condition issued from time to time by the Director after consultation with the Licensee and any other person who may have a relevant interest in them.

5. This Condition shall cease to have effect on the coming into effect of trading arrangements which supersede the arrangements under the Pooling and Settlement Agreement.

1. The circumstances in which the withholding of generation or capacity would be regarded as being "without good cause", based on the application of the avoidable cost principle over a reasonable period of time, eg six to twelve months.
   
2. Examples of the possible use of inflexibility markers for reasons other than technical reasons.
   
3. Examples of the use of complex price bidding structures to raise SMP.
   
4. How the expression "prices significantly higher than would reflect the prevailing supply, demand and cost conditions in the market" would be interpreted.
   
5. The role of any independent review mechanism, methods of appointment etc.