Trading changes ahead for those bringing power to the people

The Commission for Energy Regulation is preparing for 2005 when themarket for electricity will be 100 per cent open, writes Denis Cagney

The electricity industry is facing important issues. New generation capacity is urgently required for 2005 when, coincidentally, the market will be 100 per cent open.

Separately, the Commission for Energy Regulation has brought forward a review of the interim trading arrangements 2001-05 introduced on initial market liberalisation. Both issues arise against a background of misgivings on the extent to which liberalisation is delivering, at least as measured by the scale of new entrants, independent power producers (IPPs) to the Irish market.

For 2005 the commission estimates that an additional 200-300 megawatts (MW) capacity is required to meet expected demand. This is notwithstanding the 750MW capacity recently commissioned at the Synergen and Huntstown plants in Dublin. A conventional greenfield power plant takes some 24-36 months to construct and commission, assuming no unforeseen planning obstacles. The commission is considering "possible special arrangements" to encourage new generation and has illustrated options in a recent consultation paper.

The need for regulated trading arrangements reflects electricity's characteristics as a traded good:

it cannot be economically stored;

demand fluctuates significantly at very short notice requiring instantaneous balancing with supply;

n electrons follow the laws of physics rather than of economics or contracts;

n a unit sold is the same regardless of who or how it is generated

Present trading arrangements rely essentially on a regime of bilateral contracts involving licensed generators and suppliers selling to "eligible" customers. These contracts are backed up by a settlement market for imbalances operated by EirGrid. ESB Power Generation acts as market maker through a system of "top-up and spill" prices. ESB's public electricity supply business, or PES, supplies the non-eligible or franchise customer market at regulated tariffs.

Of course, there is more to ensuring new market entry than redesigning trading arrangements. Potential IPPs have understandable concerns about entering a market that is small, isolated, constrained in the short term by shortcomings in the transmission and gas networks and, of course, still dominated by ESB. The deterioration in the post-Enron international investment climate has not helped matters.

On the positive side, network constraints are being redressed urgently by the €2.4 billion investment programme under way. Additionally, entrants are not facing a legacy of long-term power purchasing agreements, which has hindered market opening elsewhere.

Nevertheless, there is a feeling that current trading arrangements have shortcomings. The commission has begun a major public consultation process. A wide range of alternative trading models is available from international practice. These models differ remarkably, at least in detail. This probably reflects differences in physical and historical characteristics of systems as much as policy choices. Examples of issues likely to arise in the review include:

should bilateral contracts be supplemented or even replaced by some sort of centralised pooling arrangement?

should there be some form of financial compensation for capacity as opposed to energy delivered?

n how should renewables be catered for, bearing in mind the duty on the commission - unlike its UK counterpart - to promote renewables?

The commission has approved average increases in PES tariffs of 8.6 per cent for 2002 and 9.85 per cent for 2003. Were we not better off under the old monopoly regime, you might ask. No. That regime was not sustainable, even ignoring EU requirements. From 1987 to October 2001 electricity prices were frozen - except for a 3.5 per cent rise in 1997 - while the consumer price index rose by 51 per cent.

Blanket price freezes did, to be fair, increase consumer welfare and help induce ESB to reduce its cost base. But they can also store up problems. The California debacle is an extreme case. In Ireland's case investment in new plant and networks suffered. Market opening in 2000 coincided with major grid congestion problems, particularly in the east coast where the gas supply network is developed. The commission has effectively allocated grid access rights to new generators and guaranteed them financial compensation if physical constraints prevent their being dispatched.

Longer term an interconnector between the Republic and the UK would, in principle, ease security of supply concerns and allow consumers capture more of the benefits of market integration. Technological developments have brought down costs. But these costs would still have to be balanced against the impact on IPPs intending to move to the Republic as well as on the economics of the second gas interconnector.

Another factor is that new investors will not enter a market unless there is a prospect of a competitive but sustainable price regime that will allow cost recovery and reasonable profits. This is particularly true of an industry as capital intensive as power generation.

A final notion to mull over: think of energy policy as a triangle pointing to the three objectives of security of supply, competition and protection of the environment. The strains between these objectives differ between jurisdictions. A good policy will strive towards the centre of the triangle but be willing to shift off centre a little from time to time. A perfect policy knows where it should be and is determined to stay there no matter what. But then, as we all know, the perfect can often be the enemy of the good!

Denis Cagney is head of networks with the Commission for Energy Regulation. The views expressed are personal. The consultation papers referred to are available at www.cer.ie