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Regulation of market power in Irish electricity

This entry was added to http://www.reckon.co.uk/headlines-franckblog on 21 August 2005.
Full blog table of contents available at Contents | viewpoint: Franck.

Update, February 2006. The regulators have published proposals for mitigating market power. See Market power in Irish electricity, part 2 | viewpoint: Franck.

The regulatory agencies responsible for the development and implementation of a single electricity market across Ireland released a consultation document on the regulation of market power last week. This is available as a 13-page PDF file from the All Island Project website. (The published document has a prominent "Version 0.8" marking on the front page; I am not sure what this implies about change management processes in the All Island Project.)

The question of market power in electricity markets is well known, and generally considered to be difficult. It is linked with the issues of "gaming" in electricity trading mechanisms which (for example) led to a long and expensive UK Competition Commission inquiry into generators' behaviour and conduct regulation in the England and Wales electricity markets.

It was therefore interesting to me to see how the Irish regulators were going about analysing and addressing this issue.

The consultation paper comprise three substantive sections, considering generation, (retail) supply and networks separately. I adopt the same structure in this note.

Generation

In generation markets, we are told that "the incumbents are initially expected to retain some form of market power in the SEM". It would have been nice to know what form of market power they are thinking of, for example within which relevant markets it was thought be held.

Then we are told that "the Regulatory Authorities maintain that it would be prudent to ensure that no generator on the island has the ability to exercise market power to the ultimate detriment of the consumer", specifically:

"A participant with market power has the ability to discourage competition, to thwart the attainment of the objectives of the SEM and to reduce or remove market benefits. Such behaviour would include:
- raising prices in the spot or contract markets in order to increase electricity prices and profits; and/or,
- deliberately suppressing prices in order to discourage new investments in generation and maintain its market share."

Both examples quoted above have serious problems:

• "raising prices ... in order to increase electricity prices" seems like a statement of the obvious, and "raising prices ... in order to increase ... profits" is a description of normal commercial behaviour as much of any abuse. There may well be scope for exploitative abuse of market power in generation, but such abuse is not defined or characterised by either increasing prices or profit-making behaviour by themselves.

• "deliberately suppressing prices" is a strange wording. Given the context, it is probably something to do with charging low prices. But charging low prices, deliberately or not, in order to displace competitors and maintain market share is also normal competitive behaviour and cannot be, by itself, a characterisation of abuse. Perhaps they are trying to describe abuse of market power through predatory exclusion, but if so they are doing a remarkably bad job of it.

More generally, using "discourage competition" as a description of abuse is riddled with problems since it equally describes a process of effective competition.

I cannot understand why the regulators did not place more reliance on standard characterisations of abuse of market power, such as:

• Abusive maintenance or strengthening of a dominant position within a market, by using capacity or other resources whose use is not constrained by competition (such resources must exist if there is a dominant position) to exclude future competition from other firms. This includes non-price practices (e.g. in bus markets, scheduling spare buses just before a competitor's to force its exit) as well as predatory pricing. I imagine that there are ways in which this type of abuse could happen in wholesale electricity markets, although there is no obvious example that I can think of. Anyhow, the consultation paper sheds no light on this, on or how this might be distinguished from normal competitive behaviour (which is hardly surprising given how little the paper says about the scope of any market power).

• Exclusionary abuse in a related market by offering prices for an input that have the effect of eliminating all competition from one or more competitors, as in Commercial Solvents. This is most obviously an issue in relation to retail supply. It could also describe exclusionary abuses between, say, wholesale electricity markets and ancillary services markets, although analysis of such abuses would require a much more precise definition of the relevant markets in which market power is held than the consultation paper offers.

• Exploitative abuse, or "reap trading benefits which it would not have reaped if there had been normal and sufficiently effective competition" (United Brands). It is not immediately obvious what normal and sufficiently effective competition would be in the context of Irish generation markets, and the consultation paper sheds no light on this. Perhaps undue influence over market rules by the incumbent which has the effect of restricting competition would count? Perhaps the abuse of which the generators were accused in the old England and Wales Pool days was exploitation of the lack of normal and sufficiently effective competition in providing short-term reserve, if such a lack resulted from the working of the Pool rules on LoLP? The whole issue of exploitative abuse of market power in electricity trading systems seems to be a rich and complex area, and is not even touched on in the consultation paper.

Whilst the above summary descriptions of particular types of abuse cannot, on their own, form the basis for any serious analysis, at least they are not completely wrong headed, and they refer to specific past cases which can be studied in more detail to gain a better understanding of what they mean. I am surprised that these standard theories of abuse of market power are not used at all in the consultation paper.

Moving on, we are told that, given the perceived problems of abuse of market power, "regulation of players with market power, is being considered by the Regulatory Authorities as a means of ensuring that the market operates in a competitive fashion". But I thought that we had accepted that there will be market power, and therefore that the market will not be fully effectively competitive. Perhaps we can assume a generous reading of this as being a statement of intent to regulate in order to avoid abuses of market power that affect competition. Even then, it is not explained why abuses that are not anti-competitive, in particular exploitative abuses, are apparently not worthy of consideration.

In terms of tools to regulate conduct and prevent abuse, the paper tells us that:

"The various regulatory tools that might achieve this include regulation of bids, extensive market monitoring, ex-post review of bids and review of contracts among other things."

So what are we talking about? I don't really have a clue, beyond perhaps noticing a slight obsession with "bids", presumably referring to submissions into the proposed gross pool (whereas presumably most electricity trading will take place through contracts for differences). What would a "review" of contracts or bids do to prevent abuse? Or would the review only be used to punish past abuses? If so, what makes the regulators think that a review would be more effective than waiting for complaints from victims of exclusionary conduct? Or is that what extensive market monitoring is? I am left entirely in the dark.

But I am not entirely surprised: it would have been a miracle for the paper to identify useful tools given its failure to identify the problem that it is trying to solve.

An incidental tidbit is the claim that:

"while it may be technically possible to buy-out the remaining long term contracts in Northern Ireland it is unclear to the Regulatory Authorities whether this would bring many benefits given that there have been no analyses conducted on this issue".

It strikes me as more than a bit odd for a regulator to say here is an idea, it could be done, there is an obvious competition benefit, I don't know whether it's a good idea because I have not looked into it, and then not to propose to look into it or to say why he is not proposing to look into it. Maybe this is a coded way of saying that there is a ministerial veto on work in this area (since raising the money for any buy-out would seem likely to require Government action) — but, then, should public consultation papers be written in code?

Retail supply

As regards retail supply markets, we are told that the incumbents are large suppliers and that their procurement of electricity is subject to an economic purchase obligation.

There is no discussion of entry possibilities, which would seem a standard consideration in analysing market power in a market such a retail supply which does not necessarily require significant assets other than working capital.

Then the following implications are claimed:

• "it is important to consider how the [economic purchase obligation] will be implemented in the [single Irish electricity market]"
• "the means by which the [economic purchase obligation] may be met could give rise to concerns as to market power"

I don't really know what these sentences means.

The paper offers no meaningful discussion of market power — again, there is no indication of which markets the regulators think might be relevant — and no discussion at all of what the potential misuse of market power might consist of, other than the rather elusive comments quoted above.

Standard theories would identify margin squeeze (from wholesale markets and/or network access and/or metering services), predatory behaviour or pricing, exploitative excessive pricing, and unfair marketing practices as natural candidates for abuse. The consultation paper has nothing to say on any of those.

Networks

On network infrastructure, the paper mainly states that most of the problems (whatever they might have been thought to be) are expected to be solved by unbundling and ring-fencing of network businesses.

I have little doubt that information ring-fencing can provide effective protection against the misuse of information gained from network operations in generation or retail supply markets.

However, by failing to identify the risks of abuse and the effect of ring-fencing sufficiently precisely, the paper seems to miss some potential adverse effects.

For example, there is a potential risk of exclusionary effects arising in the context of new generation, even with highly effective information and accounting ring-fencing. This may be the case for example if the transmission charging and regulation regime were such that, for some types of generation projects (e.g. in some parts of Ireland), the total additional revenue earned by the transmission business as a result of a new connection was higher than the cost imposed on the network by that connection. In such circumstances, and with common ownership of transmission and generation businesses, the charging regime could have an exclusionary effect on generators not affiliated with the transmission company, as the effective cost to the relevant investors of developing such a generation project is lower for the integrated operator than for an independent generator.

Another potential issue might be abuse of network market power in transmission markets themselves, e.g. predatory behaviour tending to exclude unfairly merchant transmission or interconnector projects. Is that a potential issue in Ireland? I don't know, and the consultation paper does not tell me.

Overall

The consultation document sets itself a clear and sensible aim in section 1:

"to help identify the issues relating to market power that might affect the all island market and in particular the [single Irish electricity market], and to consider appropriate regulatory remedies that might be developed to address those concerns".

Its other great quality as a consultation paper is its length: it is short.

Unfortunately, it largely fails to meet its two stated aims.

First, it fails to identify most of the "issues relating to market power that might affect the all island market". Having established that the issue is the potential misuse of market power (given that the regulators cannot or will not seek major structural changes to remove market power "at source"), I would have expected the paper to describe, at least in general terms, the potential forms of abuse of market power that the regulators had identified as capable of affecting cross-border electricity trade in Ireland. This would in turn have required a somewhat more precise characterisation of the different form of market power that might exist (for example, of the specific markets within which market power may be held).

Second, the paper fails to say anything about regulatory "remedies", other than repeat that, in essence, the regulators do not really know what to do. There is no apparent attempt at any analysis of these remedies — whether in terms of clarifying what they might entail in practice, or which specific purposes they might be trying to meet.

I suppose that the second failure follows straight from the first: it is difficult to design remedies when you don't know what the problem is. Yet, several things could, and should, have been said even on the basis of the most cursory identification of potential problems:

• Article 82 of the EC Treaty prohibits the abuse of a dominant position that might affect cross-border trade. This seems to address exactly the issues raised here. NIAER has, I believe, specific powers to investigate potential infringements of Article 82, as a UK appointed body for the purposes of Council Regulation 1/2003. I do not know what the arrangements are in the Republic, and I would have expected to paper to tell me, and to discuss whether and to what extent the usual ways of enforcing this prohibition address the "issues relating to market power that might affect the all island market".

• A standard way of addressing a margin squeeze issue in retail supply related to market power in generation, assuming that divestment of the retail supply business (or of generation assets or power purchase agreements) is not available as a solution, would be to require companies with market power in wholesale electricity supply (whether they have generated it or acquired it under long-term power purchase agreements) to offer a detailed price list for all products (e.g. seasonal and time-of-day profiles, ancillary services) over which they have market power, available to all retail competitors and priced in such a way that there is no squeeze with their retail tariffs; this would be similar to the methods used in comparable telecommunications markets. There are serious complications with this form of "solution", particularly in a wholesale electricity market where prices may change quickly and any regulatory oversight of prices to avoid a margin squeeze needs to be able to accommodate such changes. But why is this not discussed or even outlined in the paper?

Because the consultation document fails to identify the potential abuse of market power than are thought worth preventing, or to describe or even outline any specific regulatory proposals, it seems that respondents are left to do everything: figure out what the problem is, identify potential solutions, and address whichever detailed issues within these solutions that they can think of and think worthwhile to address. This seems likely to result in responses that are all over the place, each geared to the specific issues that happen to bother particular companies, and leaving the regulators unable to reach any properly informed view about the effectiveness and proportionality of particular solutions since each respondent will have given only a partial commentary on their own elements of solution. This is no way to run a consultation.

Key links

• All Island Project
  The AIP website provides consultation documents and updates on the development of a single electricity market across the island of Ireland, including the consultation document (13 pages, PDF) reviewed above.

• Northern Ireland Authority for Energy Regulation
  NIAER (formerly known as Ofreg) is the electricity and gas regulator in Northern Ireland.

• Commission for Energy Regulation
  CER in the electricity and gas regulator in the Republic of Ireland.

• Viewpoint: Franck
  My regulation and competition economics blog.

Entry added by Franck Latrémolière on 21 August 2005

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Last changed by Franck at 1:02 PM on Saturday 11 February 2006.