Centralised arrangements are best for competitive markets

Thursday, 03 December 2009

With significant changes necessary in the gas and electricity sectors to pave the way for a national smart meter rollout, the development of supporting market arrangements is subject to much debate. The prospect of competition in the water sector only serves to focus this debate further. Should we adopt a centralised approach, where key market functions are facilitated through a central hub? Or should we go for a "direct" path, where market participants define interactions to meet their business requirements? To help decide, it is helpful to assess what we have learnt so far from various different utility markets in the UK and beyond.

Evolving electricity

The retail electricity market in Great Britain evolved in several stages. Initially, there was a small market for large volume users only, administered as a central market. This suffered from severe problems in metering and data communications. Suppliers could not bill customers correctly and had no control over the failed processes. For this reason, when domestic competition was introduced, suppliers were given responsibility for metering and data collection via the "supplier hub" principle.

Systems were developed so that agents working for the competitive supplier hub were responsible for customer and market data. Customer metering point data was, and still is, sent via electronic flows direct to and from the individual supply-side market participants. This direct competitive arrangement has caused data to become inconsistent between different market participants. The problems occur due to subtle differences in how agents and retailers interpret and process metering point data.

The market has established several initiatives addressing data quality, including th e electricity centralised online enquiry system (ECOES), which have been useful in mitigating problems. Many competitive agents have also used single software vendors to minimise their system development costs. The industry has developed a standard distribution connection and use of system agreement (DCUSA) to standardise protocols, reduce costs, and improve efficiency in processes relating to distribution networks.

Power in Ireland

In the Republic of Ireland, full retail competition has been established for both non-domestic and domestic premises. But the retail arrangements run via a central hub, where information is sent and then distributed to the relevant retailers and central market agents. The central hub validates and stores data for use in allocation and central settlement calculations. This ensures that all parties have a consistent view of the metering point data in the retail market. The introduction of competition in other parts of the supply chain does not exist in the Republic, as ESB Networks undertakes all meter operation, meter data processing and registration activities as the monopoly service provider.

GB gas market

The gas market in Great Britain initially used a centralised model, where most wholesale and retail functions were performed by a central system, run by the monopoly network business. As time progressed, to promote competition, retail agent functions became more disparate and communication was direct between market participants. The introduction of competition in gas metering and for new distribution networks resulted in more direct supplier-agent communication protocols.

Communication between the many new market participants operating in the gas sector has led to data quality becoming degraded. As a result, the industry now shows increased interest in the centralisation of data, its communication and interface hubs. The introduction of an independent central market organisation to administer governance and systems is being widely promoted as the best way to ensure a fair and unbiased mechanism for these market arrangements.

Similarly to the electricity market in the Republic of Ireland, retail competition in the gas market is a centralised model run by the monopoly network business (Bord Gais).

Scottish water competition

As for water markets, Scotland has retail competition for all non-household customers. The wholesale market uses a central hub for submission and distribution of all data between the retailers and wholesaler (Scottish Water). The central hub validates and stores data for use in allocation and central settlement calculations. There is a consistent view of the data between the market participants, as well as a readily available audit trail. Physical operations within the market are performed by the monopoly wholesaler and the market is administered via an independent Central Market Agency.
Large water user retail competition in England and Wales exists under direct marketparticipant-controlled communications. However, almost no customer switching has occurred and the Cave Review has recommended a centralised operating system as the most appropriate mechanism to facilitate retail competition for non-domestic customers.

Central to direct and back again

To summarise, the general trend in electricity and gas in Britain has been to move from central to more direct arrangements as competition developed, only to move back again as problems emerged. This experience appears to have influenced the approach to energy competition in the Republic of Ireland and water in Scotland, where central trading hubs are used. This has avoided the problems and associated costs caused by direct trading systems.

Ultimately, central arrangements are a cheaper way to deliver competition to new entrants, because they require less effort to develop and operate. The use of central hub arrangements so far has been with a limited degree of supply chain competition. However, there is no reason why other supply chain functions relating to utility markets could not be made competitive via a central hub interface that supports the benefits of competition without the problems of direct inter-participant communications.

For one thing, secure communications technologies and their ability to handle large volumes of data have dramatically improved since the failures in the early British electricity market. For another, a lesson has been learned from that early failure: the centralised model should not be over-prescriptive or stifle the ability of competing market participants to innovate. Correct governance arrangements have to ensure that incentives are in the right places to drive adequate performance.

Alec Thompson is a principal consultant at Gemserv. Email: This e-mail address is being protected from spambots. You need JavaScript enabled to view it .