The way ahead in energy

Richard Murphy analyses the European and all-island policy proposals that will affect the future of local energy markets.

Energy regulators in Northern Ireland and the Republic of Ireland have published their plans for the future of the island’s Single Electricity Market (SEM) for consultation.

The electricity market in the Island of Ireland has undergone substantial change over the last decade as a consequence of the move towards a Single Electricity Market. Since the SEM was implemented in November 2007, the island has had over 2,000MW of investment in new conventional generation, including two new CCGTs at Aghada and Whitegate and OCGT units at Kilroot and Edenderry.

A further 450MW plant is being developed at Great Island by SSE. There has also been significant investment in refurbishment of existing capacity, in generating and distribution technologies, and Interconnector routes to the Great Britain market. Investment has begun to diversify the energy mix across Ireland, with both gas and coal falling as a proportion of installed capacity from

48 per cent and 13 per cent in 2007 to 43 per cent and 11 per cent in 2013. Installed wind capacity has been the primary replacement with installed wind capacity increasing from 12 per cent in 2007 to 19 per cent in 2013.

These are all encouraging developments but despite the level of investment and relative success of the SEM, there is still more to be done to both ensure the long-term security of energy supply and to capture investors’ share of wallet in what is an increasingly competitive global market for energy investors.

From an energy security perspective, recent events in Ukraine and rising EU tensions with Russia have highlighted the relative fragility of European energy supply, and the island of Ireland which sits at the periphery is not immune to supply concerns.

Meeting demand

Indeed, although in January 2014 EirGrid indicated that there is an overall surplus of generation on the island. With some capacity expected to be mothballed in the near future and an expected deficit in Northern Ireland from 2016 there is still work to be done to secure long-term demand projections are met. As such, the new integrated SEM will be required to take account of the changing generation mix as a result of the increased level of renewable generation as well as the impact of increased demand side participation. It will be important to ensure that the right investment signals are in place to ensure that future energy needs are met.

With this in mind, the SEM Committee which is the decision-making authority on all matters concerning the SEM, has published a draft decision paper based on feedback from an earlier consultation exercise. The paper sets out the features of proposed new energy trading arrangements (ETAs) within the new integrated SEM (I-SEM); as well as the need for and proposed design of a new capacity remuneration mechanism (CRM). The proposed changes are designed to meet the requirements of the EU target model, developed as part of the EU’s Third Energy Package to harmonise cross-border trading rules and co-ordinate national and regional market designs. The SEM Committee intends to publish its final decision on the proposals set out in the paper in early September 2014 and expects the new arrangements to apply from 2016, according to the decision paper. The SEM Committee was seeking feedback on the decision paper from consumers of electricity, market participants and other interested parties until 25 July 2014.

Since the SEM began in 2007, wholesale electricity in Ireland and Northern Ireland has been traded on an all-island basis. All electricity generated on or imported onto the island of Ireland is now fed into a gross mandatory pool market, from which all wholesale electricity for consumption on or export from the island must be purchased.

Once the European requirements come into force, all energy market arrangements will be required to implement a set of prices that would change for a particular trading period the closer the market moved to real time. This is different from the current SEM where there is a single price for a particular trading period. The SEM Committee has proposed concentrating trading in the day-ahead and intra-day markets so that the all-island market would be tightly integrated with the wider European market. However, it has dropped a previous proposal that participation in these markets would be mandatory.

Rights

To allow energy market participants to hedge the risks of cross-border trading, the SEM Committee proposes the use of Financial Transmission Rights (FTRs) as opposed to Physical Transmission Rights (PTRs). FTRs are financial contracts entitling the holder to a stream of revenue based on the day-ahead hourly energy price difference across an energy path but they do not provide the right to physically dispatch generation. The SEM Committee said the use of this mechanism would allow “efficient trading across the interconnector without ‘locking out’ 20 per cent of the market from the DAM that might arise from the use of PTRs”.

In its decision paper, the SEM Committee also recognised the need for an “explicit” CRM on the island of Ireland, to take account of the “potential shortcomings” of a European Internal Energy Market for “a small island system with high penetration of variable renewable generation”. It has proposed the adoption of a quantity-based capacity market, under which market participants would compete to offer an administratively-set level of energy capacity at the lowest price.

The SEM Committee has proposed that the CRM would be implemented through centralised reliability options (CROs) issued by a central party. According to the paper, a reliability option is essentially a financial one-way contract for difference (CfD) issued to all successful bidders for capacity in a competitive auction. The CRO holder would receive a set option fee even if the market reference price drops below a pre-set strike price. If the reference price goes above the strike price, the holder of the CRO would pay the difference back to the centralised counterparty.

The SEM Committee approach appears to be taking sensible steps to create a sustainable and compliant market. The electricity market in Ireland has grown steadily with additional investment in power generation and increased interconnection with Great Britain since the introduction of the SEM in 2007, and it is important that the market design of I-SEM allows that investment climate to continue.

While much of the detail of the proposals is yet to be released, the draft proposals have put the more efficient use of interconnectors and security of supply at the heart of the design agenda to ensure robust compliance with the target model. The draft proposals around the need for and the type of capacity mechanism will also be of particular interest to stakeholders.

The proposals will be judged on whether they increase investment and retail competition, and ultimately on the consumer price for electricity after their 2016 implementation. Ireland’s

2.5 million consumers pay relatively high energy prices and are likely to be disappointed if they expect these proposals to lead to a decrease in their bills. However, the success of the changes may lie in the more unseen areas of mitigating future price rises and navigating the island’s electricity market through stormy global waters while keeping the lights on.

Richard Murphy heads the Pinsent Masons Irish Energy Finance Team. He has a track record in the renewable energy sector, securing a range of high profile mandates across the UK and Ireland, as well as providing expertise on all-island energy issues. Richard is recognised as an energy policy expert, ranked as a leading lawyer in both Chambers UK and the Legal 500.

For more information, contact Richard Murphy as follows.

Tel: +44 (0)28 9089 4844

Email: richard.murphy@pinsentmasons.com