29 April 2002
Just over one year on from the implementation of the New Electricity Trading Arrangements (NETA) in the England and Wales wholesale electricity market, discussions are now focusing on the success of the arrangements and their impact on market participants.
NETA was intended to encourage greater competition in the electricity market, drive down prices, promote market liquidity and reduce system balancing costs. It is a system far more aligned to the trading of other commodities and operates on the basis of market participants entering into over-the-counter or exchange-traded bilateral contracts for the sale and purchase of electricity.
The regulator has claimed a victory, with wholesale electricity prices stated to have fallen by 20-25 per cent. The regulator also claims that system balancing costs have halved and that there is now significantly increased market liquidity.
So is it worth the reported £100m cost of implementing NETA? It is clear that NETA has at least contributed to lower wholesale electricity prices, with commercial and industrial customers enjoying the knock-on effect of this (although the benefits of a more competitive market environment appear to be taking some time to filter down to the domestic market).
For generators, however, falling prices are causing problems. An aim of NETA was to reduce the market power of the dominant generators, but it is arguable that NETA has instead hit the entire sector hard. As summer prices fall below the marginal cost of generation, some companies are finding it preferable to withdraw generation capacity from the market rather than attempting to operate in what is an increasingly loss-making environment. Of particular concern in the light of more stringent national emissions targets and environmental requirements, is the mothballing of new clean and efficient plants.
But with around 30 per cent overcapacity in the generation market, should we be concerned? This raises the question of whether the low prices are the result of NETA or overcapacity. If the latter, arguably market forces should correct the situation before capacity becomes an issue. If NETA, there is potential for a capacity squeeze as plants are voluntarily mothballed and existing nuclear stations reach the end of their working lives; but market prices are such that there are few incentives for further investment in the generation sector. A key indicator for future trends may be the success or failure of new plants, the trading and operating arrangements for which have been designed specifically for NETA. While the market appears to be viable in its present state, if prices fall much below predicted summer levels, questions such as these will come to the fore.
The renewables and combined heat and power (CHP) sectors, promoted by the Government in response to the challenge of reducing emissions, have been hit hardest by NETA because the output of renewable and CHP generators is often relatively small and difficult to predict. The regulator believes that consolidation of output provides the best solution to assist CHP and renewable generators to function in the NETA market, but given the relatively weak negotiating position of small generators with respect to consolidation service providers, as well as the impact of the imbalance risk and the continuing slip in electricity prices, it seems that this is unlikely to be enough to ensure that the Government's target of expanding this type of generation is met. And although the newly-introduced Renewables Obligation, which obliges suppliers to source some of their electricity from "renewable" sources, may provide a counterweight to concerns relating to the damage done by NETA to the renewables sector, it does not apply to most CHP schemes.
A more disturbing product of NETA is the reported increase in carbon emissions over the last year, as renewables and CHP generators have dropped out and we have seen an increased use of more reliable coal-fired generation. The Performance and Information Unit Energy Review, published in February, contained a number of recommendations in relation to the renewables sector, but was not intended to provide solutions about how best to promote the sector. Clearly, the Government and the regulator have their work cut out in deciding how to implement the Energy Review's recommendations. A clear legislative brief from the Government, which sorts out the mismatch at the heart of the energy policy between environmental and economic objectives, would be a helpful first step.
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