An alternative to Ofgem’s proposals for reform of the interruptible gas regime
The reforms set out in March 2001 to create a market in gas pipe capacity. Since that time a number of changes have been made to the proposals, with the present situation being to abandon the idea of an exit capacity market and introduce markets to turn down gas use instead. We believe there remains strong potential for additional cost and complexity, distortions, and added health and safety risk. EIUG does support the reforms and prefers no change to the present proposals. However, EIUG accepts the current regime has a number of inequitable aspects, but recommends that OFGEM should halt the current detailed design of changes and return to what it perceives as the root problems with a view to developing an evolutionary approach to reform.
THE REGULATORY RATIONALE FOR REFORM
The rationale for reform is set out in a March 2001 Ofgem document1, which cites a number of perceived weaknesses in the present regime:
- Incentives for under-investment in pipeline capacity: Transco is a monopoly and therefore might see interruption as a free resource to call upon.
- Limited choice of contract and discrimination amongst different categories of interruptible customers: The current 45-day regime presents consumers with only one choice. Additionally, there are a number of inequitable aspects of the present regime. For example, network sensitive loads (NSLs).
- Preference to interruptible customers compared with terms offered to firm customers.
THE REGULATORY SOLUTION
Capacity is to be separately identified as a product, with customers booking and purchasing firm NTS exit capacity. Customers will then offer capacity back to Transco, by interrupting.
PROBLEMS WITH THE REGULATORY SOLUTION
A series of questions arise about the benefit to consumers and the effect on the functioning of the gas market:
- An economic and efficient network? Powerful consumers will be present at network pinch-points and Transco will sit as the monopoly setter of transportation charges and a monopsony buyer of interruptible services. These distortions are exacerbated by the present proposals being for partial reform only. A market to solve NTS constraints, unchanged LDZ arrangements will encourage the perception that LDZ interruption is cheaper than NTS interruption. Industrial customers will not be able to discern the source of the constraint and partial reform presents considerable opportunity for gaming between NTS and LDZ constraints.
- Complexity and transaction costs: if it were assumed that all current interruptible customers were required in a reformed world, there would be the possibility of 1,700 rounds of bilateral negotiations. The practicability of such a system is questionable, and there would inevitably be associated transaction costs introduced to the supply chain.
- Potential for irrational behaviour: Consumers faced with the need for periodic negotiations might not behave in the rational way that would be assumed in theory. Many may simply avoid a complex market, even if in financial terms it made sense to enter. If this effect were large, the reforms would yield a less efficient network, with Transco pushed towards reinforcement, where cheaper interruption might have been obtained. Moreover, we understand that Transco wishes to maintain reserve powers to preserve network integrity. This lends support to the belief that the proposals will result in considerably reduced demand side participation.
- Health and Safety concerns: A system that excludes desirable players also carries more serious questions about health and safety. The interruption regime is, in effect, a form of insurance policy for a 1 in 20 extreme winter. In leaving such sensitive provision to a market, there would have to be considerable certainty that network reinforcement could seamlessly follow a reduction in interruptible services on offer.
EIUG’S VIEWS ON THE PROPOSED REFORMS
Though the stated aim of reforms as a whole is to encourage an economic and efficient network, and improve consumer equitability and choice, it seems unlikely that on balance the proposals will achieve these ends. Moreover, there is strong potential for additional cost and complexity. A move towards a market also risks creating distortions and (if the wrong dynamics were to emerge) questions about health and safety. For the reasons set-out above, EIUG cannot support the proposed reforms and prefers no change to any of the alternatives put forward to date.
EIUG’S ALTERNATIVE APPROACH
However, EIUG accepts that the current regime suffers from a number of inequitable aspects. It believes that the best approach would be a piecemeal evolution, which could address and rectify these areas without excessive cost, distortions or risks to security of supply. It recommends that OFGEM should call a halt to the current detailed design of changes and return to what it perceives as the root problems as the starting point for evolutionary reform:
- Incentives for under-investment in pipeline capacity: EIUG favours a much stronger element of planning and regulation in network provision. Problems of under-investment would be much better addressed by OFGEM setting, and rigorously enforcing, challenging targets for capital investment by Transco.
- Limited choice of contract and discrimination amongst different categories of interruptible customers: We believe that these aspects are best addressed by a continuation of the philosophy adopted by OFGEM for the current transitionary arrangements. An increased weighting towards the variable element of the interruptible discount would better compensate those who suffer a greater degree of year-on-year interruption.
- Preference to interruptible customers compared with terms offered to firm customers: To date no evidence has been presented to support this view. Transco continues to state that the discount offered is cost-reflective and therefore fair recompense for the service offered. EIUG believes that the reverse is probably true given the non-cost reflective nature of the capacity/commodity split in Transco’s charging regime.