UK electricity market making blamed for liquidity pooling

Liquidity on the UK wholesale electricity market has increasingly pooled within the two market-making one-hour windows in recent weeks, causing traders to call for tweaks to energy regulator Ofgem’s secure and promote licence.

Concerns that the UK’s biggest six utilities were exerting undue dominance in the wholesale market persuaded Ofgem to introduce two one-hour long liquidity windows in March 2014 (see EDEM 31 March 2015).

The first year of the reforms, which oblige utilities RWE, EDF, Centrica, E.ON, SSE and ScottishPower to post bids and offers on particular products during the windows, coincided with a boost in general liquidity (see EDEM 10 September 2015). Ofgem confirmed at the time it would extend the licence for two more years.

One sided markets

However, evidence has emerged in recent weeks of a vacuum in the market outside of the two daily windows between 10:30-11:30 and 15:30-16:30 London time.

One-sided markets on the curve’s most liquid products, which are subject to mandatory market making, have commonly appeared outside of the windows. When bids and offers have been present on screen simultaneously, the market has commonly been wider than the market-making obligations dictate during the windows.

Data collected by ICIS also shows that 44.5% of curve transactions on the front month and beyond occurred during the two windows in October and November.

“They’re [the windows] at odds with the underlying drivers, which trade all day,” said one utility trader, referring to fuels markets such as the UK’s NBP gas market that typically drives the UK power curve.

“I have no problem with it,” he added. “It would seem much more sensible to make it 80% over the course of the day rather than two hour windows.”

Other traders agreed that the focus of the regulations on two hour-long liquidity windows meant trade automatically gravitated to those windows.

“Markets do tend to behave in packs. The more numbers appear in the window, the more people wait for the window,” one source from an energy-to-business supplier said.

“Nobody really looks either side of those windows now, which is a by product of the market making,” another source said.

Speculative traders lose out

“If you’re a speculative trader in the market, you’re doing nothing between those hours,” the source, who works for a supplier, said. “From our point of view, it’s not a problem as long as there’s liquidity in those two hours.”

Ofgem said market-making was working for the intended target, namely the small supplier base.

“Small suppliers say they have found it easier to access products since our rules were introduced,” a spokesman for Ofgem said. “This was one of the main aims of the reforms.”

He said Ofgem had noted a decrease in liquidity since April, which is likely due to benign market conditions.

While Ofgem says it will continue to monitor liquidity, tweaks to market-making requirements do not seem imminent.

“We took a proportionate approach by bringing in market making windows,” the spokesman said. “They ensure that parties are able to trade a range of products at set times during the day.” henry.evans@icis.com