Zone Merger – learning from experience and developing an evidential based approach

Target Model Workshop 3, London 11 April 2011

Nigel Sisman Senior Adviser

Zone Merger opportunities and challenges

2

Challenges

Risks of internal congestions- changes in flows may expose new constraints- Which options to manage risk

Establishment of “balancing market operator”- New operational and settlement functions

Enhanced cross-border TSO cooperation - Increased contractual, tariff and operational complexity

Opportunities

Enhanced trading opportunities- Focussed liquidity- Robust price indexes

Simpler transportation arrangements- Less entry/exit zone bookings

Easier system user balancing- Access to functioning balancing

markets

… free lunches do not exist; so how do we assess the tradeoffs?

Presentation structure

• Learning from merger experience • Developing an evidential approach to assess challenges• Understanding liquidity and trading depth• Conclusions

3

Learning from merger experience

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Recent Merger Experience

Gas experience

• France - a single TSO experience• Integration of northern hubs to create PEG Nord

• Germany – a multi-TSO experience• A stepwise integration towards two zones

… and lessons learnt from electricity?

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French experience

PEG North/West/East merger2 Full Entry/Exit PEG zones

For reasonable scenarios 360 M€ investment

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0

1 000

2 000

3 000

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5 000

6 000

7 000

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1 000

6 000

11 000

16 000

21 000

26 000

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Num

ber o

f tra

des

Trad

ed v

olum

es (G

Wh)

Traded volume South zone

Traded volume North zone

Number of trades South zone

Number of trades North zone

Source GRTgaz

PEG Nord has the critical size for liquidity to develop• 6 IP, 1 LNG terminal, 9 storages, 330 Twh of demand

which enabled :The creation of a gas exchange (Nov 2008)The development of market based balancing An increased attractivity for CCGT projects

… zone merger facilitated by investment

German experience• Progressive reductions in number of zones

- By 1.4.2011 3 zones- Legal obligation by 1.8.2013 2 zones

• Balancing Operators introduced• “Statistical firm” capacity model

- Successful model if no sudden major changesof market behaviour occur

Otherwise capacity reduction• Prerequisites

- Intense cooperation and trust between involved TSOs needed- Specific characteristics of the individual grids need to be considered- Involvement of NRA when defining the model

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… increasing complexity necessitates cost benefit analysis for next step

… zone merger facilitated by reflecting congestion risks in system user’scapacity entitlements

Electricity experience

Scandanavia experience • single Swedish price zone but significant internal constraints• “Constraints exported to national borders”• accusation of discrimination domestic/international consumers• Swedish pricing zones to be established

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… the underlying physical realities of transmission are important … internal constraints must be “small” to ensure efficient merger outcomes

Developing an evidential approach to assess challenges

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The Challenge of Zone Merger

Internal bottlenecks are “transferred” to new zone borders

• New risk management approaches needed

Zone mergers have implications

• benefits from enhanced trading environment

• redistributive effects between system users • tariff implications • changes in values of flexibility offered to

market/TSOs.

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Enlarged Zones

Less certainty and changed flows

Increased risk of internal

congestion

Managing internal congestion risks in enlarged zones

• Investment• Flow commitments• Reduced firmness of capacity or reduction of capacities• Point-to-point capacity arrangements• Constrained on/off (local purchase/sale of gas behind/in front of constraint)• or combinations of any of the above

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… the options may have different costs and different benefits in delivering enhanced liquidity

Possible methodology to assess potential for internal congestion costs arising from zone merger

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Simulation model

Internal ConstraintsFreq/Size

Evaluation model

Flow scenarios

Network Model

Investment Options

Capacity availability

options

Flow commitment

options

Balancing - constrained

on/off options

Preferred option or

combination costs

International merger involves greater challenges

• Legal framework• Tax issues• Governance

• Location of virtual trading points• Who manages the system

• Regulatory and Member State sovereignty

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… international zone merger in gas has not yet been delivered

Understanding liquidity and trading depth

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Benefits of larger zones – liquidity and trading depth

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• How deep and liquid does the market need to be?• What criteria define a “Functioning” market?

… what value do we attach to:• traded volumes?• churn rates?• competition measures (HHIs)?

Assessing market efficiency - daily NBP Gas Trades

0

5

10

15

20

25

30

Twh

NBP Trades March 96 to January 07

Total Gas Traded Total Daily PhysicalNational Grid data

Improvements in balancing regime and market experience

Simple commoditised, zero tolerance daily balancing

NBP Trade Sells by shippers - same day in January

Shipper

Ener

gy tr

aded

… over 100 players each side of the market…. HHI around 370 on both side of the market

Recent NBP trading & liquidity

National Grid data

NBP Trade Buys by shipper - single day January 2011

Shipper

Ener

gy tr

aded

11/8/2008

11/29/2008

12/20/2008

1/10/2

009

1/31/2

009

2/21/2

009

3/14/2

009

4/4/2009

4/25/2

009

5/16/2

009

6/6/2009

6/27/2009

7/18/2

009

8/8/2009

8/29/2

009

9/19/2

009

10/10/2009

10/31/2009

11/21/2009

12/12/2009

1/2/2010

1/23/2

010

2/13/2

010

3/6/2010

3/27/2

010

4/17/2010

5/8/2010

5/29/2010

6/19/2

010

7/10/2

010

7/31/2

010

8/21/2

010

9/11/2

010

10/2/2010

10/23/2010

11/13/2010

12/4/2010

12/25/2010

1/15/2

011

2/5/2011

2/26/2011

3/19/2

0110

10

20

30

40

50

60

NBP Daily Trade - Nov 2008 - Mar 2011Tw

h

… but how do we value the consumer benefit of this level of liquidity?

Conclusions

Mergers afford both opportunities and challenges

First steps may be straightforward but challenges escalate rapidly

Trading/liquidity benefits delivered via a range of alternative approaches• but physical constraints can’t be too great

Assessing benefits and costs• How do we assess benefits?• How to assess best option(s) for risk mitigation?

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… no free lunches; evidential approach should support the case for zone merger