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Consolidating power

The UK power and gas sector is blazing a trail in terms of deregulation and increased market competition. No feed-in tariffs here – it’s a market-driven arena with prices going up and down throughout every trading day. It’s a unique model within the EU, and offers opportunity for a new breed of power market player – the consolidator.

Steve Armitage, SmartestEnergy, UK

The overall landscape of the power sector in the UK is quite different from that of many of its European neighbours. Back in 1990, the British government broke up the centralized system symbolised by the 12 local electricity supply and distribution companies and the national generation and transmission company (the Central Electricity Generating Board). It introduced the twin concepts of deregulation and increased competition to the wholesale electricity market.

As part of this ongoing policy of liberalization, the New Electricity Trading Arrangements (NETA) came into effect in March 2001. NETA is the main instrument through which increased competition and transparency was delivered.

NETA replaced the electricity Pool Purchase Price system under which market prices were determined centrally and replaced it with a system where prices in the wholesale electricity market were set through bilateral contracts, supported by a central system to adjust and balance the positions of the industry players.

Under NETA, generators could enter into a bilateral contract for their exported power with any counter-party, at any time, for a specific duration of their own choosing at a price agreed between the two parties and fixed delivery at any point. This is in marked contrast to the typical pre-NETA situation where all generators sold their power to the central trading body, with the exception of the embedded generators, in particular the renewable generators who would sell power to suppliers at the centrally set price.

Figure 1. This graph shows the clear relationship between power and gas prices in the UK. Price fluctuations have been more marked since the introduction of NETA
Click here to enlarge image

But with this new-found freedom came new-found responsibilities. Generators were now exposed to fluctuations in market prices and, in addition, faced having to purchase costly spot price electricity for under-delivery of power versus contract terms or, alternatively, receive just the spill price for any over-delivery of power versus contract terms – both downsides from which they had previously been protected.

While the larger, better-resourced generators could adapt to the ‘Brave New World’ of a market-driven power sector in the UK, smaller electricity producers, for whom power generation was not necessarily their core activity could not easily do so. Knowing with whom to trade, when to trade and at what price, had become a greater challenge and one which brought with it real financial risks.

Risk management

It was the government’s and Ofgem’s (the UK’s gas and electricity market regulator) thinking that a new breed of player, namely consolidators, would establish themselves in the marketplace to represent these smaller and renewable generators, provide them with a range of off-take and risk management services and help them maximize the value of their power and the associated benefits.

SmartestEnergy is one of these consolidators which was set up to meet the needs of this new segment of the market and is today the UK’s leading independent provider of consolidation services with close to 1 GW of power within its consolidation portfolio.

At the heart of SmartestEnergy is its Energy Management Centre (EMC), which operates on a round-the-clock basis. Through sophisticated IT and telemetry systems, it receives half-hourly meter readings from each customer site and monitors these outputs in real time to ensure that SmartestEnergy’s agglomerated customer portfolio remains in balance at all times. The EMC works hand in hand with SmartestEnergy’s own electricity and gas trading desks which buy and sell power and gas contracts, on both a spot and forward basis as required, to meet its customers’ trading obligations.

A typical SmartestEnergy customer is a renewable generator with a number of different sites. Not only will SmartestEnergy contract to take all the power and any embedded benefits (i.e. those resulting from being ’embedded’ in the local distribution network and thus receiving a benefit for reduced transmission losses), but will also contract to take the LECs (climate change Levy Exemption Certificates) and the ROCs (Renewables Obligation Certificates), the latter two being mechanisms to help ensure the UK meets its CO2 and other greenhouse gas emissions targets and stimulate the growth of renewable power generation.

The principles behind each SmartestEnergy contract are the same, namely ensuring each individual customer’s precise requirements are met through the provision of particular contract terms. For example, some of the larger generators require closer access to the markets, buying and selling throughout the trading day to take advantage of the marked price fluctuations which have been a constant feature of the power and gas sector since NETA came in.

Other generators, often companies for whom power generation is not their core activity are keen to lock out all risk and secure a power selling price which is fixed, with any input fuel purchased forward simultaneously on a back-to-back contract with the power deal.

One interesting development on its standard off-take and consolidation offer is SmartestEnergy’s innovative risk management contract with Good Energy, one of the leading green electricity supply companies in the UK.

Under the terms of the contract, known as a Supply-Side Electricity Trading Service Agreement (Supply-Side ETSA), SmartestEnergy will manage Good Energy’s imbalance exposure. Alongside the Supply-Side ETSA, Good Energy and SmartestEnergy have also executed a ‘ROC Repo’ agreement. This adopts the principles of Global Master Repurchase Agreements, commonly used in the City for securities lending and allows Good Energy to use its inventory of ROCs more efficiently.

Good Energy purchases wind, small hydro and solar power from a number of renewable producers which it supplies to retail and business customers throughout the UK. It also has a sister company which owns wind assets, but it is not a generator in its own right. As a purchaser of power, it has less control over generation output projections and with the added uncertainties due to its power deriving from wind: 75 per cent, small hydro: 25 per cent, and solar under one per cent, Good Energy needed to ensure that any risks it might be exposed to under NETA were fully hedged and that any spikes in customer demand for power could be met instantaneously.

In this way, Good Energy can ensure that it can deliver green power to its customers on a round-the-clock basis, whatever the demand profile, while simultaneously ensuring that any potential risk exposure is professionally managed as cost-effectively as possible.

Different strokes

In contrast to the route adopted by the UK to achieve deregulation and increased competition in the UK power market, many of its European neighbours have adopted different procedures to create more liberalized power markets, while some are still near monopolies, virtually dominated by a single, vertically-integrated supply company.

For example, in France, although power contracts are negotiated bilaterally, there is a national balancing mechanism managed by RTE (Réseau de Transport d’Electricité), the transmission system operator. In addition, although there are 50 power companies operating in France, EDF (Electricité de France) still supplies around 90 per cent of the country’s power.

Figure 2. Monkton Generation owns Delabole Wind Farm near Camelford in Cornwall, UK, and supplies the power to sister company, Good Energy. The power is consolidated by SmartestEnergy
Click here to enlarge image

Unlike France, Spain has a much more deregulated power market, with a non-mandatory pool and optional physical bilateral contracts, while capacity payments to generators are regulated. The Spanish power sector comprises the following categories of players:

  • Producers produce electricity as well as build, operate and maintain production stations.
  • Special regime producers benefit from particular incentives because they improve energy efficiency and reduce environmental impact thanks to the use of renewable energy sources, residues and co-production.
  • Carriers take the power from the generation sites to the distribution grid and build, maintain and manage grid installations.
  • Distributors and resellers are companies which have access to the transportation or distribution grids and whose responsibility is to sell electricity to qualified consumers or other members of the system.

All of the above are overseen by the National Government Office which is responsible for electricity planning, regulation and operation of the production market. It defines the basic governing rules of production, transportation, distribution and sale of electricity and specifies the minimum quality and safety levels for supplying electricity.

In addition, there is a National Energy Commission which ensures competitiveness, objectivity and transparency in the electricity sector, a system operator which is responsible for guaranteeing continuity of supply and a market operator, responsible for financial management, and final settlement of the energy buy and sell offering system used by the various players in the power market.

Scandinavian exchange

Denmark’s power market needs to be considered simultaneously with that of Norway, Sweden and Finland, as it is part of Nord Pool, the Scandinavian power exchange which was established in 1993 and is the world’s only multi-national exchange for trading power.

With Nord Pool, Danish market participants trade residual volumes on a day ahead spot market basis (bid and offer stacks creating the marginal price) with counter-parties in Norway, Sweden and Finland, with prices varying if there are constraints on the interconnectors between those countries. Imbalances in Nord Pool are settled with the National Grid Operator, which has its his own balancing mechanism.

Generally speaking the market is bi-lateral with over the counter (OTC) trades, but there are some national anomalies in Denmark such as specific environmental taxes which do not apply in other Scandinavian markets.

In 1988, Germany opened up its power market to competition without passing through any transition phase and allowed network operators to develop the access rules, the pricing rules and data exchange standards with the network users. The outcome was an OTC, exchange-based market place with regulated third party access to transmission and balancing/reserve handled via an auction process.

It is clear from these examples that power trading in the EU is far from being a single market. However, the common theme of deregulation becoming more of a key driver, supported by the EU’s competition agenda, it is likely that over time, the various national power trading regimes will begin to converge.

This process is likely to accelerate as the dominant generation and supply companies continue to expand their business activities internationally and make significant acquisitions in other European territories.

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