T he European electricity market has survived a few hiccups since the EU directive on electricity competition was implemented last February. Issues relating to tariffs, transmission access and authorisations have all been addressed, as has the development of trading platforms to reap the full benefits of market competition. Last year, several initiatives were proposed for the UK, German, Austrian and Polish markets.

Now, as the EU directive moves into its second year, the scope and functionality of these platforms are being made transparent.

By the end of this year, the number of European trading platforms will grow to eight, with four in the UK alone, two in Germany and the existing platforms in Amsterdam and Scandinavia. Other platforms will almost certainly follow as the European market moves into an exchange frenzy. But, as in other markets, there is no correlation between quantity and quality. Or, to put it another way, the forces of market consolidation that are apparent in the utility sector will also impact on trading platforms.

The seeds of consolidation have already been sewn before most of the platforms have been launched. Amsterdam Power Exchange is developing a Multi Hub platform, and has targeted Germany as its first non-Dutch hub. And, not surprisingly, the soon to be launched Frankfurt-based European Energy Exchange (EEX) has said that it will look closely at the Dutch market.

While the European electricity market is essentially a series of regional markets determined by the geographic scope of its individual transmission grids, it is also a continental electricity market. This is one of the objectives of the EU directive, which has as its aim the creation of a robust and openly competitive European marketplace. Conventional wisdom therefore suggests that trading platforms must have a Europe-wide scope, thus enabling traders to use one platform to provide all their trading requirements in the European market.

So what is the vision of European electricity trading? Conventional wisdom suggests that a trading platform will only succeed if it has the depth of market to service. With market consolidation expected to reduce the number of European utilities by up to 60 per cent by 2003/4, it is highly unlikely that a plethora of trading platforms will survive as viable entities. Inexorable market dynamics will dictate which companies will be the winners and losers for both utilities and trading platforms.

One approach to developing a pan-European traded electricity market would be to develop a hubs and spokes approach through a series of electronic alliances. Certainly with all the new trading platforms being developed electronically this approach is feasible. It is also assisted by the natural geographic regions within Europe which can broadly be defined as UK, Scandinavia, Benelux/France, Germany/Austria/ Switzerland, and the Iberian market. Each of these five regions has either an existing trading platform or has announced the development of a platform. This scenario assumes that each region will have one prominent platform, which will be linked to the others electronically.

With Nord Pool well established in Scandinavia and Amsterdam Power Exchange in the Benelux region the ‘unknowns’ are Germany and the UK. The choice in Germany will be between Frankfurt’s EEX — which is launching a spot market this summer with futures to follow later in the year — and the Leipzig Power Exchange (LPX) which also plans to launch this year. Although LPX is supported by Nord Pool, the Deutsche Borse/Eurex backed EEX is expected to be the platform of choice, being supported by most of the German market and the government.

The UK scenario is more competitive in terms of platforms. Four platforms are competing for this market — OM Group’s UK Power Exchange (UKPX), International Petroleum Exchange (IPE), California’s Automated Power Exchange and I-Ventures PowerEx. While all plan to launch ahead of the UK’s new electricity trading arrangements scheduled for October 31, only UKPX has announced its contract specifications. The heavyweights of the four are UKPX and IPE, but the success of Automated Power Exchange in its domestic market suggest that it could secure a viable platform in the UK. Most accept though that the size of the UK market will only support one platform.

And with that in mind the critical issue will be contract specification.

UKPX has announced a cascading contract structure with season contracts cascading into quarters, months, weeks, financial days and finally half hour periods. It is expected that the IPE will adopt a similar structure but the two platforms may differ on monthly contracts. UKPX will adopt the EFA (electricity forward agreement) monthly convention, which uses a 4-4-5 week calendar. This will assist the transfer of current EFA trading to its futures platform. But the IPE is believed to favour a calendar month convention, which would increase the correlation of gas and electricity markets as UK gas is traded on a calendar month basis. The benefit for the IPE is that it already has a successful gas futures contract.

But there is no certainty as to the future shape of European electricity trading platforms or indeed the underlying market structure. And it is not just electricity trading that is focussing attention. Last month the European Commission published a green paper on meeting its commitment to emission reduction in line with the Kyoto Protocol. The paper presented an endorsement of reducing emissions through the trading of permits.

Emission trading has been very successful in the USA, and the announcement by the Commission is a positive step forward. The issue to be addressed though is how will it be implemented, and in particular which allocation process will it adopt. With emissions strongly correlated to electricity generation, and therefore considered as part of a convergent energy market, there is every opportunity for the emerging electricity platforms to incorporate emissions as well. Amsterdam Power Exchange has already discussed ‘green electricity’ contracts, the IPE has worked on trading designs and is part of the UK Emission Trading Group, and Germany is also considering the development of an emission trading platform.

As the energy market consolidates and converges it will require trading platforms to facilitate this development process. The successful platforms will be those that adequately reflect the needs of the market. By the end of this year a clearer picture of European energy trading will likely emerge.