The ‘market making’ obligation (MMO) that requires major electricity market participants to respond to offers to trade, to create a liquid market, is set to disappear.

The MMO was initially placed on six vertically integrated suppliers, but restructuring could shortly reduce that to one. E.On’s obligation was removed when it spun off conventional generation into Uniper. Scottish Power’s obligation ended after it sold its generation assets to Drax. Centrica’s obligation was removed when it divested its large generation portfolio, and when RWE complete the sale of its interest in Innogy to E.On it too will no longer have an obligation. Ofgem says, “On balance, we do not think it is feasible for the MMO to continue with only two parties” and what is more, SSE is expected to lose its obligation when a planned sale of its domestic supply business to Ovo is completed. As a result EDF Energy would be the sole remaining market maker and Ofgem says the cost would be disproportionate.

In market-making the MMOs, who had a 98%  share of the market in 2013, when the measure was introduced, were required to post ‘buy’ and ‘sell’ offers for specific products during morning and afternoon trading windows.

Ofgem had consulted at the end of last year on removing the obligation if the market-makers were reduced to two. At the time a merger between Npower and SSE’s supply businesses was expected and Ofgem decided not to suspend the MMO when that merger fell apart. Now it says companies should be ready for the MMO to disappear as soon as it confirms RWE’s removal – a decision that will require market participants’ hedging strategies, credit and risk controls to be revisited, with one party saying six months’ notice would be required.

Opinion is divided on the success of the MMO. Canvassing opinion among smaller players previously, New Power was told that its effect had been to concentrate, not increase, liquidity. Although it had improved during the MMO ‘windows’, at other times liquidity had fallen, and very few traders were active.

Some large companies also questioned its value. In response to consultations over closing the measure last year, Centrica said, the MMO “is constraining rather than helping liquidity to develop,” and said there was “clear and unambiguous evidence that the MMO has distorted the market” due to concentration in the trading windows and it had created a “perverse incentive” to “rely on obligated parties’ trading activity and prices to settle their bilateral deals, rather than participate actively in the market”. Centrica also complained that the windows did not align with the constantly-traded gas market, limiting the opportunities to react to market changes.

Other companies expressed concern, however. Calon Energy, VPI Immingham, EP UK and Triton Power, jointly operating a dozen power plants, argued last year against any suspension, saying it “would be detrimental to liquidity and functioning of the market”. Similarly, mid-tier suppliers Co-Operative Energy, First Utility, Octopus and Ovo expressed alarm about a suspension, saying it would have a “significant and material negative impact on fair wholesale market access”. They noted that bid-offer spreads had halved since the measure was introduced.

Smaller players have consistently told New Power that securing lines of credit and trading partners were a bigger bar to joining the market than a lack of liquidity. Equally important was that the measure was restricted to a few products, while small suppliers needed to make smaller trades (smaller ‘clip’ sizes) to match up demand and supply.

Removal of the MMO may also have implications for the Contracts for Difference regime , which requires a reliable market price to be set as a reference against the CfD price.

Last yearmany of the complaints arose because Ofgem proposed lifting of the obligation while it carried out a review, rather than afterwards. With no analysis of the effect on the market it was “poor administrative governance,” said Orsted. Cornwall Insight also argued that no action should be taken until a broader review had been undertaken.

Although part of the Secure and Promote package included reporting requirements for the obligated companies, Ofgem said this month that, “Given the influence of the MMO on the market, there is a lack of recent data on the natural state of liquidity in the market which means we cannot know with any certainty what the impact of suspension will be.” It said that if suspension is confirmed, “we will continue to closely monitor market liquidity and will take the impact of the suspension into account in developing any new policy proposals.” It said it would continue work on an options assessment begun in May this year to support a decision on future liquidity policy.

That review is not complete but it seems that Ofgem has been overtaken by events.  When it proposed suspending market-making last year it was told that the timing “could not have been worse” given other market structural changes. Some, such as the shift to Par 1, have now taken effect but others, such as  Brexit and the retail price cap, remain uncertain.It remains to be seen how well companies have been able to use the last year to prepare for the MMO’s removal.

 

Supplier market access

Other initiatives in the Secure and Promote measure included ‘supplier market access’ rules that required the eight largest electricity generators (adding Engie and Drax to the big six MMOs)  to follow a set of rules when trading with small independent suppliers.

But the number of companies taking advantage of the option has fallen. At its peak, in March 2017, the measure took in 20 companies, but in July this year that number had fallen to 14, including now-defunct Solarplicity.

 

Further reading

Is the Secure and Promote liquidity fix fit for purpose?

Ofgem asks: Does mandatory market making work?