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2 December 2016 2 December 2016 Cornwall’s team of independent specialists have experience of liberalised energy markets and their regulation since their inception in Great Britain and elsewhere in the late 1980s. We provide consultancy, intelligence and training, and are a trusted and reliable partner whether you are a new entrant or a large, established player. Specific areas of our expertise include: Wholesale and retail energy market competition and change Regulation and public policy within both electricity and gas markets Electricity and gas market design, governance and business processes; and market entry Disclaimer While Cornwall considers the information and opinions given in this report and all other documentation are sound, all parties must rely upon their own skill and judgement when making use of it. Cornwall will not assume any liability to anyone for any loss or damage arising out of the provision of this report howsoever caused. The report makes use of information gathered from a variety of sources in the public domain and from confidential research that has not been subject to independent verification. No representation or warranty is given by Cornwall as to the accuracy or completeness of the information contained in this report. Cornwall makes no warranties, whether express, implied, or statutory regarding or relating to the contents of this report and specifically disclaims all implied warranties, including, but not limited to, the implied warranties of merchantable quality and fitness for a particular purpose. Numbers may not add up due to rounding. 2 Contents 1 Purpose 5 2 The Markets for Electricity & Gas – The Basics 5 2.1 Importance of the Energy Sector 5 2.2 “Unbundling” 5 2.2.1 Energy Markets 5 2.2.2 Monopolies 6 2.3 Market Transformation 6 2.4 International Moves 8 2.5 Climate Change Act 2008 8 2.6 EU Emissions Trading Scheme 9 2.7 Electricity Market Reform 10 2.8 Policy Mechanisms to Support Renewable Generation 11 2.8.1 The Levy Control Framework 11 2.8.2 The Renewables Obligation 12 2.8.3 Small Scale Feed-in Tariffs 12 2.9 Policy Mechanisms to Support Energy Efficiency 13 2.9.1 Climate Change Levy and Climate Change Agreements 13 2.9.2 Carbon Reduction Commitment Energy Efficiency Scheme 13 2.9.3 Energy Company Obligation 13 2.9.4 Renewable Heat Incentive 14 2.9.5 Green Deal 15 2.9.6 Warm Homes Discount 15 2.10 Retail Market Review 16 2.11 Competition and Markets Authority Referral 16 2.12 Principles Based Regulation 17 3 Smart and Advanced Metering 18 4 European Internal Market 19 5 The Electricity Industry 19 5.1 Overview of Industry Structure 19 5.2 Generation 22 5.3 Networks 24 5.4 Trading 24 5.5 BETTA and the Balancing and Settlement Code 24 5.6 The Balancing Mechanism 25 5.7 Elexon 25 5.8 Supply 25 5.9 Significant Recent Developments 26 5.9.1 Ofgem’s Switching Significant Code Review 26 3 6 The Gas Industry 27 6.1 Overview of Gas Industry 29 6.2 Exploration and Production 29 6.3 Networks 30 6.4 Storage 31 6.5 Joint Office 32 6.6 The UNC 32 6.7 Xoserve 33 6.8 Supply 33 6.9 Trading and Balancing 33 6.10 The National Balancing Point 34 6.11 Imbalance (Cash-out) 34 7 Recent Significant Developments 35 7.1 Project Nexus 35 8 Legal Framework 35 8.1 Legislation 35 8.1.1 Electricity 35 8.1.2 Gas 35 8.2 Regulation 36 9 Price Trends 36 9.1 Domestic Prices 36 9.2 Industrial Prices 37 9.3 Electricity and Gas Prices in Europe 38 10 Bibliography 39 10.1 General industry statistics 39 10.2 Electricity generation companies 40 10.3 Gas and electricity suppliers 40 10.4 Transmission and Distribution Companies 41 10.5 Regulation 42 10.6 Industry Statistics 42 10.7 Consumer Prices 43 10.8 The GB Electricity Market 43 10.9 NETA / BETTA 43 10.10 The Pool 44 10.11 The GB Gas Market 44 4 This is a primer for new beginners entering the industry. We assume you do not know much about how the market provides electricity and gas to customers in Great Britain and your company’s role in it, but would like to learn a lot more. It explains the importance of the sector to the economy and the basics of how the market works, before outlining how policy has reshaped the sector as the government seeks to implement ambitious targets for addressing climate change while addressing the cost to do so. We then pick out the main points of how the electricity and gas markets operate. Also highlighted is key information on sector legislation, regulation and prices. If you would like further information or to discuss the contents of this primer, please contact: James Brabben via [email protected] 2.1 Importance of the Energy Sector Gas and power supply is crucial to the economy and society. The sectors directly employ and indirectly purchase goods and services that provide livelihoods for many. The direct contribution to the UK economy in terms of Gross Value Added (GVA) was estimated to be £23bn1 in 2014. If all the indirect effects are included, the sector’s GVA rises to £83bn. 2.2 “Unbundling” The introduction of competition brought about a disaggregated cost chain for gas and electricity. Competitive wholesale markets allow trading between gas producers, electricity generators, suppliers and financial houses for the eventual delivery to the consumer retail market. Since the late 1990s all customers have been able to choose their gas and electricity supplier. 2.2.1 Energy Markets Wholesale markets have developed for both gas and electricity to allow participants to buy or sell energy as required. In many respects the wholesale markets are similar to other commodity markets insofar as contracts are traded (either standard or bespoke) for the delivery of an agreed amount of energy at some point in the future. Market participants face several risks that can include forecasting customer demand for energy, the risk associated with fluid wholesale and retail prices, posting credit, and the risk that there are insufficient counter-parties to trade with. Some of these risks arise because of a physical requirement to buy or sell energy; others arise because traders seek to speculate on future price movement. Whatever the motivations for wholesale trading, the respective markets provide opportunities to buy and sell electricity and gas in different quantities and over different time periods. For example, a contract for the coming day or as far forward as quarters, seasons (six months for summer starting on 1 April and six months for winter starting on 1 October) and annuals could be traded. 1 Powering the UK, Ernst & Young, November 2014 Since the end of the 1990s all customers have been able to choose their electricity and gas supplier. Retail competition began with larger businesses in the early 1990s and by the end of the decade choice of energy supplier had been introduced for all households too. 2.2.2 Monopolies While competition has been introduced to the wholesale and retail markets, the costs associated with transporting via networks from the point of its production to its consumption remain regulated as these services are seen as natural monopolies. Ofgem (Office of the Gas and Electricity Markets), the energy market regulator, sets the amount of revenue that the network companies can recover from customers via its “price control” process. The regulator also signs off the charging methodologies that are used to derive charges for different classes of customer. Network activity is split between two functions: transmission and distribution. The former is for the large-scale movement of electricity and gas around the country—basically allowing for the entry into the networks of the energy (from power stations for electricity and gas fields or imported sources for gas) to be moved in bulk from its point of origin around the country and into the distribution networks. The distribution networks then transport energy to the customer meter for its consumption. A small number of customers are connected directly to the transmission networks (e.g. large industrial customers requiring significant volumes of gas and/ or electricity). Likewise, there are a number of producers (small scale power generation or “green gas” injection) connected to the distribution networks. The network operating companies fix the charges themselves subject to the overall price control restraint and all users are charged for their use of these networks using pricing structures that are designed to reflect the cost of providing the network assets related to their production or consumption. 2.3 Market Transformation Opening the energy markets to competition occurred as part of a programme of restructuring and privatising previous monopoly gas and electricity providers that commenced in the 1980s. This restructuring culminated in a wave of consolidation of electricity and gas suppliers and power generators into the “Big Six” companies. These are British Gas, EDF Energy, E.ON UK, RWE Npower, Scottish Power, and SSE. Numerous other companies also have a presence in supply, power generation and gas production. The consolidation of energy suppliers in Great Britain from 14 regional electricity companies (present at the time of electricity privatisation in 1990) to the Big Six is shown in Figure 1. Figure 1: Consolidation of GB Energy Suppliers Source: Ofgem 6 British Gas remains the largest supplier and currently holds a market share of around 23% in the domestic electricity market. The other major suppliers have developed their respective shares of the market mainly through mergers and acquisitions.
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