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Publications / Consultation responses

Energy UK response to Ofgem’s Call for Input on Power Market Liquidity

Dear Olivia

RE: Ofgem’s Call for Input on Power Market Liquidity

We would like to thank Ofgem for their publication of the Call for Input on Power Market Liquidity, as this is an important issue for all market participants and consumers. The Call for Input questions are directed at trading participants, so we cannot respond to them directly, however, we would like to provide you with a high-level industry view on the issues. Energy UK members agree in principle with Ofgem’s assessment of the current liquidity levels in Great Britain’s (GB) wholesale electricity market and the four potential factors that Ofgem has identified as constraining liquidity – although some members believe that certain factors carry more significance than others.

Energy UK is supportive of Ofgem’s role in monitoring liquidity levels in the wholesale market to support market efficiency and competition. Liquid wholesale electricity markets are crucial not only for efficient electricity trading but also for investment in generation. Given the scale of investment required in the coming decade, we must remove any barriers that could deter new investors from entering the market. However, we are concerned about Ofgem pursuing regulatory interventions for benefits solely in the short to medium term. Any potential intervention needs to be carefully considered by Ofgem and DESNZ within the framework of broader electricity market and retail reforms, to ensure a sustainable and enduring impact, that addresses the structural factors.  

Liquidity in GB power markets is currently sub-optimal

Energy UK members across generation and supply agree that liquidity has decreased in recent years. Our members endorse Ofgem’s findings on the key drivers and would underscore the impact of recent geopolitical events on electricity trading, including Brexit, Covid-19, and Russia’s invasion of Ukraine. This has presented various challenges for different market participants, and there is currently a large number of companies for whom hedging and overall risk management have become more difficult.

Ofgem should consider ‘no regrets’ options for improving liquidity

Given the uncertainty surrounding the full extent of the impact of recent events, and with no guarantee of a return to a more “normal” market, it is prudent for both Ofgem and DESNZ to consider no-regrets options aimed at improving liquidity, which are outlined below.

Improve cross-border trading arrangements in the UK-EU Trade and Cooperation Agreement (TCA)

With increasing levels of interconnection between GB and neighbouring markets, we must consider how to make cross-border trading contribute most effectively to liquidity. Following the UK’s withdrawal from the European Union, electricity trading no longer follows the EU market coupling system, which has resulted in varying arrangements for allocating interconnector capacity.

For instance, the Channel interconnectors now adopt explicit capacity allocation selling their capacity separately from electrical energy. The Single Energy Market-Great Britain (SEM-BG) interconnectors use a type of market coupling based on intraday auctions and the North Sea Link interconnector with Norway employs a distinct day-ahead market coupling alongside the EU regime. These inefficiencies are often felt most acutely by consumers while increasing average wholesale prices and contributing to lower levels of liquidity. Improving cross-border electricity trade will increase liquidity, strengthen market integration and resilience, and reduce price volatility. While the TCA lays the framework for the concept of Multi-Region Loose Volume Coupling (MRLCV), this is viewed by many in the industry as an unsatisfactory solution. The UK Government should therefore work to ensure that effective new trading arrangements are put in place as soon as possible.

Re-couple the GB Power Exchanges

Another consequence of the UK’s withdrawal from the EU and Internal Energy Market (IEM), was the de-coupling of GB’s Power Exchanges (EPEX Spot and Nord Pool), which now operate independent day-ahead markets with separate settlement and clearing prices. This separation has led to additional risks for market participants and consumers, and lower levels of liquidity. This was illustrated in 2021, where lower levels of liquidity led to high volatility and unpredictability, and the price deviations between the Power Exchanges were significant, adding additional risk costs to trading activities[1].

In September 2021, the former Department of Business, Energy and Industrial Strategy (BEIS) now the Department for Energy Security and Net Zero (DESNZ) launched a consultation on the post-Brexit arrangements for trading electricity on the Power Exchanges in the GB wholesale electricity market. The consultation proposed ‘a new mechanism for a single GB clearing price’,[2] which Energy UK welcomed as a necessary ‘no regret’ step in resolving the immediate consequences of the day-ahead price de-coupling issue.[3] We would therefore strongly encourage efforts to re-couple both Power Exchanges and re-merge their order books with a single day-ahead auction. This would reduce risks and costs, and enhance liquidity in the market.

Improve Ofgem’s Price Cap methodology

As identified in Ofgem’s analysis, the current structure of contracts in the domestic retail market is reducing the incentive for suppliers to hedge on the far curve. For some participants, liquidity levels may have been too low to buy the necessary volumes of the contracts indexed against the standard variable tariff price cap. The data in Ofgem’s Call for Input also illustrates how traded volumes on quarterly contracts increased following a change in the indexation of the standard variable tariff price methodology. Energy UK is not suggesting that moving back to the previous indexation is the solution, but it seems clear that the design of the price cap methodology has knock-on implications for market liquidity.

Other opportunities

There may be other options for Ofgem to explore quick wins. For example, whether more could be done to incentivise intraday trading and reduce clustering of trades at gate closure. More broadly, diversity of hedging strategy across suppliers and product types is an important source of market competition. A lack of diversity can also increase overall market risk. Price regulation should be mindful of this, and any future review should include both liquidity and competition impacts as key considerations.

Further, consideration should be given now to the impacts on liquidity of future market developments. For instance, the implementation of market-wide half-hourly settlement is likely to have a significant impact on trading strategies, volumes, and incentives. Any strategy for improving market liquidity should therefore be designed with the transition to these future arrangements firmly in mind.

Long-term solutions should be embedded in broader market reforms

Many of the underlying problems stem from the structural aspects of the market, suggesting that lasting or permanent solutions are likely to arise through comprehensive market reforms. Ofgem, in collaboration with DESNZ, must explore avenues within REMA and other aspects of the market framework to bolster liquidity. This could involve reviewing how the Contracts for Difference (CfD), which falls within the scope of REMA, can be improved. However, it is important to acknowledge that, while REMA holds potential benefits, it also carries the risk of exacerbating low liquidity levels. For instance, a shift to locational marginal pricing (nodal or zonal) could have a significant and adverse impact on liquidity. Providing certainty on the trajectory of REMA itself has the potential to alleviate concerns that could deter market participants from engaging in longer-term contracts, such as PPA’s which discourages investment.  

Short-term regulatory interventions, such as the mandatory Market Making Obligation or similar, have the potential to introduce uncertainties and distortions that disrupt market dynamics[4]. Any short-term intervention may also fail to address the root causes of structural market challenges and instead create inefficiencies. It is therefore important that a cautious and thoughtful approach is adopted to tackle long-term liquidity challenges and to promote stability and sustainable growth.

Yours sincerely

Kisha Couchman

Deputy Director, Policy

[1] “UK-EU Energy and Climate Cooperation: Why heightened engagement is imperative for Net Zero’, (Energy UK, May 2023).

[2] ‘Recoupling GB auctions for cross-border trade with the EU at the day-ahead timeframe’, (BEIS, November 2021)

[3] ‘Recoupling GB auctions for cross-border trade with the EU at the day-ahead timeframe’, (Energy UK, December 2021)

[4] One of our members, Eon suggests that Ofgem should explore the re-introduction of a tendered market maker, as implemented successfully in other jurisdictions, to improve liquidity and cite that the benefits will outweigh any potential drawbacks.