UK market restructuring ends rampant manipulation

Jul 17, 2002 02:00 AM

In the mid-1990s, the United Kingdom wanted to liberalize its wholesale power markets and launch open competition among electricity generators and marketers. Unfortunately, early attempts to do so resulted in widespread manipulation of markets, as evidenced by falling fuel prices, increased efficiency, yet constant or rising pool prices.
Subsequent investigation of bidding strategies uncovered various forms of market manipulation, including the practice by electricity generators of manipulating capacity payments by falsely declaring generation unavailable, driving up the capacity payment value, and then re-declaring generation unavailable on the day of dispatch in order to receive the inflated capacity payment.

When the British government decided to reform the system in 1998, Caminus, a provider of software and consulting services to the global energy industry, was retained as the lead advisor to redesign and implement a new system. The result is the New Electricity Trading Arrangements (NETA) and a now well-functioning power market in the UK.
As the primary architect of NETA, New York-based Caminus, which has its European headquarters in London, led the private-sector transition team and produced the first and most widely accepted NETA-compliant transaction management software. While the specifics of the market problems in the US may be somewhat different from those in the UK in the 1990s, the concerns of the public and the investment community are the same. Something needs to be done.

On July 10, Richard C. Green, Jr., chairman of Kansas City-based Aquila, became the first major energy company executive to endorse a bill proposed by Senator Diane Feinstein (D-CA) calling for more aggressive Commodity Futures Trading Commission oversight of energy derivatives trading.
Speaking before a Senate committee, Green said the bill “provides the necessary safety nets to restore public trust while not impeding the dynamics of this marketplace.” He added, “Derivatives are an integral part of the financial fabric of our economy. They have been shown to be a critical factor in investment and growth of the economy. By utilizing futures, options, and swaps, Aquila and companies like it are able to take price risk from someone who doesn’t want it and distribute it to someone who will accept it. The use and value of derivatives in the energy industry is no different than in the more mature industries like agriculture and banking.”

Two major concerns plaguing today’s energy markets are lack of adequate market transparency and a deficit of credible internal and external reporting, says Gary Vasey, president and CEO of Houston-based VasMark Group, an international consultancy that specializes in technology issues. Market participants face challenges in calculating their earnings and cash-flow risk as well as their credit exposure, he says.
Fully integrated front-to-back-office trade transaction and risk management systems that operate in real time can help solve these problems, says Cameron Rookley, director of Risk Analytics and WeatherDelta for Caminus.
“Traditional risk management products developed for the financial services industry are often inadequate in dealing with the physical aspects of energy trading,” says Rookley. “Mark-to-market accounting and standard financial tools don’t take into account the brutally complex energy marketplace where generation modelling and portfolio optimisation are necessary components to any risk system.”

Source: RiskCenter
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