CMA publishes final report on the Energy Market Investigation

United Kingdom

On 24 June 2016, the Competition and Markets Authority (CMA) published its final report on the Energy Market Investigation. The report is available here. The report follows on from the CMA’s Energy Market Investigation provisional findings report published on 7 July 2015 and a provisional set of remedies published on 17 March 2016.

This law-now considers the CMA’s findings and remedies concerning the wholesale electricity market.

The CMA found that the wholesale electricity market was generally “working well”. However, it identified the following two aspects of the regulatory regime that had led to adverse effects on competition:

a)    the absence of locational charging for transmission losses; and

b)    the mechanisms for allocation Contracts for Difference (CfDs).

Accordingly, the decision has set out proposals to address these elements of the regulatory framework. The CMA notes that, broadly, its proposed remedies aim to “help ensure that competitive pressures are brought fully to bear on the wholesale cost of electricity, helping to reduce the prices paid by electricity customers.”

Locational charging for transmission losses

In its report, the CMA criticised the lack of locational signals for losses incurred in transporting electricity on the transmission network. Under the current framework, these costs of transmission are allocated to generators and suppliers in a way that takes no account of geographical location.

The CMA considers that this distorts competition between generators, raises bills to customers and causes certain short and long-term effects:

  • Short term: costs are higher due to the absence of locational pricing because cross-subsidisation will lead to some plants generating when it would be less costly for them not to generate, and other plants, which it would be more efficient to use, not generating.  Similarly, cross-subsidisation will result in consumption failing to reflect fully the costs of providing the electricity.
  • Long term: the absence of locational pricing may lead to inefficient investment in generation, including inefficient decisions over the extension or closure of plant.  The price effect could also lead to inefficiency in the location of demand, particularly high-consumption industrial demand. 

The design of the remedy will be identical in technical aspects to the P229 BSC modification previously assessed in 2011.  The remedy will be implemented with effect from 1 April 2018 through an order imposed on National Grid, as System Operator.

Additionally, the CMA has issued recommendations to Ofgem to facilitate the implementation of the order on National Grid and to assess alternative solutions to the remedy as implemented.

Comment:
  • The introduction of locational pricing will affect generators differently depending on their location, with generators located furthest from demand (for example offshore wind) adversely affected.  Change-in-law provisions in agreements could be triggered as a result.
  • The CMA has not followed its provisional decision to move transmission losses entirely onto generation, away from suppliers.  This means that “avoided transmission losses” will continue to be available as an embedded benefit for distribution-connected generators, at least pending the wider reviews of embedded benefits that are taking place. 

Contracts for Difference

The CMA criticised the allocation process for CfDs on two grounds:

a)    DECC’s ability to allocate CfDs outside the auction process in certain cases, which the CMA considers may have resulted in overcompensation of certain generators with no requirement on DECC to explain its use of its power, making it more difficult for parties to seek recourse to challenge decisions made by DECC.

b)      Insufficient disclosure of the analysis around the division of technologies and budgets into pots. In particular, the CMA is concerned that technologies may be allocated to more expensive technology pots than need be.

Accordingly, the CMA has recommended that, prior to each CfD auction:

a)    DECC undertakes and consults on a clear and thorough impact assessment before awarding any CfD outside the CfD auction mechanism; and

b)    DECC undertakes and consults on a clear and thorough assessment before allocating technologies between plots and the CfD budget to the different plots.  

Comment:
  • While the comments and proposals in relation to CfDs are limited, they will lead to more scrutiny of, and potentially more challenges to, DECC’s decision-making. Additionally, the CMA’s decision will need to be considered by DECC in the context of its latest consultation to extend CfD allocation rounds to 31 March 2026.
  • In its provisional decision on remedies, the CMA had recommended that DECC finalise proposals for Contracts for Difference budgets and the allocation of technologies to pots at least one year ahead of an auction. This recommendation has been dropped from the final report.  

Next Steps

The CMA will impose an order on National Grid, as System Operator, ensuring that imbalance charges are calculated in line with the new approach as of 1 April 2018. As regards the recommendations to Ofgem and DECC, it will ultimately be for Ofgem and DECC to decide whether to act on them. However, in line with its guidelines, the CMA has consulted with both bodies prior to making these recommendations and the government has made a commitment to give a public response to any recommendation made to it within 90 days of the publication of a CMA report.