Ofgem criticised for handling of SSE investigation

Ofgem has confirmed its decision to impose a £9.78 million penalty on SSE Generation, despite an energy consultant raising concerns over the regulator’s approach.

The penalty is being imposed following an investigation by Ofgem into SSE Generation’s Foyers pumped storage power station, located on the banks of Loch Ness in Northern Scotland. In particular, Ofgem has ruled that SSE secured excessive payments from National Grid Electricity System Operator (ESO) during periods of transmission constraint.

Transmission constraint is managed by the ESO which typically only has a limited number of alternatives available to it. This, Ofgem said, creates a risk that generators could exploit their position by charging the ESO excessive prices to reduce their output which is prohibited by the Transmission Constraint Licence Condition (TCLC).

The regulator’s investigation found that in May 2020 SSE took the decision to make the bid prices it charged the ESO to reduce Foyers’ output “significantly more expensive”. This included during periods of transmission constraint.

Ofgem said the change was introduced by SSE to bring Foyers in line with what it believed was the market practice of other pumped storage operators, as well as to increase profit.

Its revised prices however were expensive relative to several relevant comparators, and were not compliant with the TCLC.

Ofgem stressed that it had not seen any evidence which suggests that the breach was deliberate. However, it added, it considers that it should have been clear to SSE and its senior management that the company’s revised approach carried a “significant risk of breaching the TCLC”.

Following the regulator’s proposal last month to issue the penalty, concerns have been raised by Lisa Waters of Waters Wye Associates with the approach Ofgem had taken to assessing the excessiveness of SSE’s bids.

Among these concerns include that given the design of the Balancing Mechanism, as well as the lack of foreseeability of application of the TCLC, it seemed both entirely reasonable and rational for a generator to price its bids with reference to competitor bids which it expects will be accepted by the ESO, rather than the costs and benefits of its own asset being bid down as per Ofgem’s assessment.

She said: “I have no idea whether the benchmarks used by SSE were appropriate. However, an economist would expect any bid which has been accepted from another plant to logically be a reasonable comparator for a generator to set its own bid prices regardless of the presence of a transmission constraint as the accepted bid reveals an expected price that NGESO should be willing to pay to reduce output.

“Were Ofgem to require the TOs to notify constraints to the market in real time, as requested since TCLC came in, then it would be reasonable to expect gencos to alter their behaviour in response. In the absence of constraint information the genco can only act based on what information they do have, i.e. what prices are being accepted.”

Waters further pointed to the fact that this competitor benchmarking is explicitly included within the TCLC guidance.

“However, the inference from Ofgem’s penalty notice is that a generator can only ensure compliance with the TCLC if it prices its bids purely by reference to its own costs and benefits of being bid down, rather than with reference to its competitors. This would make the TCLC a blanket restriction on bid pricing in the BM rather than a control on market power in specific circumstances. As such it would interfere with the efficient operation of the market,” she added.

Ofgem said it had carefully considered these concerns but remained of the view that its approach is correct, and that a breach of the TCLC has occurred.

It stressed that far from undermining competition in the Balancing Mechanism, or interfering with the efficient operation of the market, the TCLC both supports competition and ensures that the mechanism works in the best interests of consumers.

“Were generators subject to a transmission constraint free to take an approach to bid pricing along the lines set out in the response, it would result in those generators being able to take advantage of their market power – directly undermining the purpose of the TCLC, pushing up costs to consumers, and giving those generators a significant advantage relative to their rivals,” it said.

The regulator said it agreed with Waters that generators do have an incentive to submit prices close to the expected “marginal” level, but said this does not mean a licensee submitting bids at this level cannot be in breach of the TCLC.

Ofgem explained that in the case of Foyers, SSE’s bids “were priced relative to selected alternatives which might have been available to the ESO” and therefore they could be argued to reflect the “marginal” price of managing the constraint(s), and the price at which the generator was incentivised to submit bids in order to maximise profit given the design of the Balancing Mechanism.

It added: “However the ESO’s willingness to accept bids at this level was a direct consequence of the existence of the transmission constraint, and particularly the lack of economic alternatives available to it to resolve that constraint.

“The TCLC is specifically intended to protect against generators taking advantage of the market power arising in such situations. By submitting bid prices at this level, SSE’s pricing policy by its nature carried a significant risk of giving rise to an excessive benefit, in breach of the TCLC.”

SSE Generation now faces a £1 fine and will pay the £9.78 million into the consumer redress fund by 5 September.

Commenting on the investigation after the regulator announced its initial proposal to impose the financial penalty, a spokesperson for SSE said: “We aim to comply with regulations at all times and believed we were doing so in this case. We co-operated fully with the investigation.

“Following the investigation, we are updating our relevant procedures accordingly.”