Back in December, Andrew Ward, Energy Editor at the Financial Times, reported that Ofgem has responded to suspicious activity in the wholesale electricity market during November. Their letter threatened generators with prosecution, if they are found to be pushing prices higher when margins are tight, then taking advantage of the high prices by increasing output.
Ofgem’s letter brings into question not just whether the retail market is functioning fairly, but also whether the wholesale market is. However, the threat of yet another investigation into the energy markets is unlikely to change behaviour when so many others have failed, and this behaviour is incentivised by the market structure.
What’s in a price?
Market prices are set by sellers and buyers agreeing to a price at which they are willing to trade with each other. Forward prices – for next month, the summer or even further into the future – may be loosely based on assumptions of demand or future spot prices. Prices for tomorrow though are based on greater certainty of supply and demand, and many reports refer to the normal price for electricity as being the day ahead Baseload price.
This ignores the fact that demand, the generation mix, and prices vary for each half hour of a day. The trading activity for each half hour is based on the most accurate forecasts of demand and the nominations of available generation.
Ofgem investigates (again)
Ofgem investigated the behaviour of SSE and SP in the wholesale market in 2007 after plant became unavailable due to maintenance, and then became available when a Notification of Insufficient Supply Margin was issued.
I don’t spend as much time on our trading desk as I did in the months leading up to the crash of 2008, but amongst all the mayhem of that year, I do recall discussing at the time the events that led up to the Ofgem investigation into SSE and Scottish Power behaviour in the wholesale market.
One day in October 2007 stands out in particular, as National Grid called a NISM (Notification of Insufficient Supply Margin). Despite already tight, but manageable margins, the plant became unavailable due to maintenance then after the NISM was called, they became available.
Looking back at the data, it is hard to prove any wrongdoing. Ofgem had concerns with this behaviour, but felt that the likelihood of making an infringement finding under the Competition Act 1998 was low and dropped their investigation.
The future isn’t what it used to be
In any case, wholesale price spikes at that time were not reflective of the stress on the system, and Ofgem’s Electricity Balancing Significant Code Review allowed higher cashout prices at times of system tightness in order to incentivise flexibility.
Elexon has now published its monthly System Price Analysis Report, which covers the period of high prices in November. The report explains that these prices are the expected result of the changes to system codes that increase the scarcity value of flexible plant at times of system stress, and that future changes would result in even higher prices from the same situation.
This might appear to increase the reward for market misbehaviour, but the ability of large thermal generation to take advantage is being eroded by demand response, storage, interconnectors and diesel generators, and the capacity mechanism rewarding plant for staying open and available to the market.
What we saw in November may well be the last hurrah of the old energy industry.