UK power market liquidity growth needs banks – CMA

Henry Evans

16-Mar-2015

An increase in liquidity on the UK wholesale electricity market can not be accomplished without the involvement of more financial institutions in trading, the UK’s Competition and Markets Authority (CMA) has concluded in its latest publication released as part of its full-scale investigation into the UK energy market.

Despite acknowledging the role the energy regulator Ofgem has played in improving liquidity and pricing signals on certain products, the CMA said the creation of two designated market making windows is more likely to dissuade speculative trading. This is because exiting positions at any time regardless of liquidity windows is deemed necessary by speculative parties.

Last year, Ofgem introduced new regulation obliging the UK’s six biggest utilities to post bid and offer spreads on a select number of products on the forward curve during two hour-long windows opening at 10:30 and 15:30 London time (see EDEM 31 March 2014).

Although market participants, the CMA and Ofgem’s preliminary analysis have detected an increase in liquidity centred within those two windows, the CMA’s paper released on Friday highlighted continued concern over product availability during the rest of the day.

The CMA said this is a deterrent to financial institutions entering the market, which in turn is proving the most significant barrier to allowing further liquidity growth.

“Various parties have told us that speculative traders do not find products attractive unless they can get out of positions at short notice at any time,” the paper said.

“Based on parties’ comments, we thought a step change in liquidity may be unlikely without attracting more financial players and a consequent injection of substantial risk capital,” the CMA concludes later in the paper.

Unlikely return

The dearth of large financial institutions in the UK wholesale power market has persisted since the start of 2014, when notable international banks such as Barclays, Deutsch Bank and Bank of America Merrill Lynch closed trading desks (see EDEM 25 February 2014), citing regulatory burdens and increased reserve capital requirements.

With these burdens showing no sign of easing, the return of such participants remains highly unlikely.

Despite specialist commodities trading houses and hedge funds continuing to represent the financial sphere, the return of the larger financial institutions would be required for a noticeable change in speculative liquidity to occur.

Statistical and anecdotal evidence was also referenced in the report to highlight that product availability early in the session had worsened since the introduction of Ofgem’s liquidity reforms entitled Secure & Promote.

The focus also fell on products that the CMA regarded as being crucial for domestic suppliers to access.

The paper drew attention to a lack of availability of Block 6 products tied to the futures markets. The CMA suggested this would be an attractive product to domestic suppliers who are concerned particularly with delivery between 7pm and 11pm.

The secure and promote regulations on liquidity apply to the two front months, the front quarter and the front three seasons on both baseload and peaks markets, as well as the fourth baseload season.

Despite refraining from a conclusive judgement, the paper said availability of other products outside the scope of the regulations had declined as market makers focus on the regulated products.

However, the likelihood of market making obligations being extended to other products is small because of cost prohibitions, according to Ofgem.

An increase in available products such as additional evening peak contracts is also unlikely over concerns this could shift liquidity from existing products which already struggle to generate accurate pricing signals. Henry Evans

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