RegTrail Insights: CNMC Fines Spanish Generator €6 million for Market Manipulation

[1] Case Facts & Background: Bidding above market conditions

CNMC provides an overview of how revenue is generated through the technical restrictions process noting that revenues from Naturgy’s participation in the technical restrictions process is determined by the bid submitted by the Sabón 3 thermal power plant itself, also known as ‘a pay as bid market’.

Over the period in question, the prices of Naturgy’s technical restriction bids showed a high variability in 2019 with values between €54/MWh and €122/MWh, remaining around €100/MWh for continuous periods.

In 2020, the prices of its constrained bids remained around €85/MWh for most of the year. These values differed from the daily market bids from the same Sabón 3 thermal power plant in the same period, both in absolute value, since the daily bids were between €40 and €60/MWh, and in the relationship between them, since while on some days the difference between daily market bids and restrictions was barely €4, on other days it reaches €70.

Given that there was a disparity in the prices offered in the constraint market with respect to the daily market, and given the level of excessive revenues obtained by the Sabón 3 thermal power plant, the CNMC deemed it necessary to gather information on the possible justifications for the prices offered by Sabón 3 thermal power plant in the constraint market.

[2] CNMC’s initial request for information.

28 July 2021. In a letter from the Director of Energy dated 28 July 2021, CNMC issued a request for information from Naturgy on the following:

1. Value of each of the components used to prepare the price reflected in the bids for the technical restrictions process, with a daily breakdown for the period 2019-2020 with the following components: day; reflected price of natural gas (justification of the price used); price of CO2 emission rights; variable operation and maintenance costs; yield used to prepare the bid; Other (economic breakdown of the components and justification of the inclusion of each of them).
2. Detailed justification of any variations that have occurred in the price of the tenders to technical constraints that are not due to variations in the above components. In particular, indicate justification for variations that have occurred under the heading "Other".

[3] Naturgy’s initial response.

15 September 2021. Naturgy provided a response on 15 September 2021 including the value of each of the components used to draw up the price reflected in the bids for the technical restrictions process, with a daily breakdown, according to the table model provided by the CNMC.

Naturgy argued that: "...its use can lead to erroneous conclusions by mixing information that corresponds to different time horizons and expectations for the operation of a facility.

The concept "Others" includes variables that have a direct impact on the value of the installation and therefore need to be reflected in the bids made on a daily basis".

The data provided by Naturgy, however, did not break down "Other" into the sub-components mentioned above. Naturgy did not justify in detail the variations that occurred in the price of the bids to technical constraints.

[4] CNMC initiates disciplinary proceedings.

07 February 2022. CNMC decided to initiate disciplinary proceedings noting the following justifications:

“The facts that motivate the initiation of the present procedure lie in the alleged manipulation of the price of the adjustment services carried out by Naturgy Generación SLU having assigned excessive price values to the bids for technical restrictions at the Sabón 3 power plant and with these prices being different from the prices offered in other segments of the production market by the power plant itself.

The purpose of these bids could be to increase Sabón's dispatch price in the technical constraints segment and thus obtain higher revenues, as this is a pay as bid market. This behaviour took place during most of the period monitored in the background report. These bids would have led to an increase in the price of technical restrictions obtained by the plant, despite the context of daily market prices and generation costs being significantly lower than the average revenue obtained by Sabón in the technical restrictions segment.

In particular, the conduct imputed to Naturgy Generación SLU is the assignment of a price for the bids for technical restrictions of the Sabón 3 power plant that is excessive and different from the price offered on the daily market, without it being justified by the lower efficiency that could result from the dispatch due to technical restrictions, conduct that would have been maintained during the period 23 March 2019 - 31 December 2020. This conduct would have been carried out intentionally by the aforementioned company, taking advantage of the market circumstances specific to the geographical area of Galicia in which it is located, during the aforementioned period, in which a thermal group is usually necessary for the security of the electricity system, in a context of a reduced level of competition. Thus, it was able to obtain higher revenues from technical restrictions than it would have obtained by submitting bids at values in line with those submitted in more competitive markets.”

[5] Naturgy denies allegations.

11 March 2022. Naturgy filed a letter to CNMC denying the allegation of the infringement as it 'appears to be based exclusively on the information injunction and its reply'.

Naturgy alleges "defencelessness" arguing that "it is unaware of the specific scope of the conduct which, in the CNMC's opinion, may make it deserving of a sanction classified as serious and the elements which lead the CNMC to conclude that there are accredited indications that Naturgy has engaged in the conduct described in art. 65.33 LSE, and which justify the decision to open this sanctioning proceeding".

It argued that, similar to bids in day-ahead markets, the debate lay in the costs that can be taken into account to construct a bid in the constrained market, in this case a 'pay-as-bid' market.

Naturgy also stated that 'it is not acceptable to conclude without further reasoning that the only criterion that differentiates the bid in constraints from the daily bid is that it is justified by the lower efficiency that could result from dispatch due to technical constraints, even only in situations of technical minimums'.

It further argues that the concept of wholesale electricity market manipulation has to comply with Regulation (EU) 1227/2011 i.e. REMIT.

It also states that 'the actions carried out by Naturgy in the present case are far from being manipulative', that 'it has submitted its price offers for the technical restrictions mechanism, taking into account, inter alia, its total costs', and that 'In any event, there is no applicable regulation, nor specific guidance on how to construct such an offer or indicating which elements the bidder has to take into account in order to make it'.

Finally, Naturgy argues that the concept of excessive pricing is an indeterminate legal concept. It also argues that it is not sufficient that the profits exceed the costs of production incurred, but that in order to know whether the price is excessive, it must be compared with the economic value of the good or service. Reference to the margin is not in itself sufficient to establish that the price is excessive, nor is the mere fact that the revenues may exceed the costs actually incurred.

[6] CNMC additional analysis of Naturgy’s market manipulation.

CNMC noted that the Sabón 3 power plant is located in the Galicia electricity area, which frequently faces technical restrictions, requiring scheduled power plant usage for resolution.

Based on factual findings, CNMC claims that Naturgy knowingly anticipated the high likelihood of being called for scheduling due to technical restrictions. Additionally, increased costs of coal-fired generation and reduced competition led to a favourable environment for the Sabón 3 plant to profit from dispatch opportunities.

The CNMC analysis reveals that bids submitted by Naturgy for technical restrictions were significantly higher (averaging 95%) than daily market bids when in less competitive situations, and 34% higher than the daily market bids when in more competitive environments.

CNMC noted that Naturgy failed to justify the price disparities adequately, and it thus concluded that the intention was to exploit weak competition in the Galician area to solve technical constraints and make a profit. CNMC estimated the profit gained by Naturgy from this strategy amounts to at least €EUR 43.2 million.

[7] CNMC proposes sanctioning procedures and resolution.

20 February 2023. CNMC formulated a proposal for a decision in the sanctioning procedure declaring that:

“FIRST. Naturgy Generación SLU is responsible for a serious infringement, in accordance with the provisions of article 65.33 of Law 24/2013, of 26 December, on the Electricity Sector, as a consequence of the bids made to the technical restrictions market for the production of the Sabón 3 thermal power plant in the period between 23 March 2019 and 31 December 2020.

SECOND, impose a sanction on the aforementioned company consisting of the payment of a fine of €EUR 6,000,000 for the commission of the aforementioned serious infringement.

THIRD. To require the aforementioned company to contribute €EUR 43.2 million to the System Operator, distributed in equal monthly instalments over the next twelve months, for the damage caused to demand, in accordance with the provisions of article 69.1.b) of Law 24/2013, for its subsequent incorporation in its system operation settlements”

[8] Naturgy submits further response to CNMC’s proposed sanction.

23 March 2023. Naturgy submitted a letter of allegations in which it argues that the offers made for Sabón 3 are the result of the methodology used by Naturgy for the process of calculating bids for technical restrictions, which allows, in particular, the recovery of fixed costs.

Naturgy defends that "the plant has consistently (and not only in the period analysed) formulated its bids in constraints seeking to reasonably recover - but not achieving - its total costs based on the best and imperfect estimate of the competitive conditions at any given time.”

Naturgy in its response addresses the following issues:

- Naturgy claims that the revenues obtained with Sabón 3 in the technical restrictions segment are within the normal range obtained by combined cycle plants.

- As regards to the value of its constraint bids, it indicates that this value is the result of applying a methodology in which the plant's fixed costs are taken into account in particular.

- With regard to the circumstances in the area of Galicia, it states that, at all times during the period analysed, there has been a plant available, as an alternative to Sabón 3, to meet the needs of technical restrictions, needs whose modelling would be impossible for Naturgy to anticipate.

- In relation to the three concurrent situations in that area identified by the CNMC in its proposal, Naturgy indicates that the consideration of situation 3 (in which the system requires the programming of both PGR5 and Sabón 3 to solve the restrictions) is erroneous, since, as PGR5 has two independent gas turbines, its programming alone would solve the needs of the system.

- Regarding the profits derived from the infringing conduct, Naturgy points out that, over the last ten years, the plant has obtained a generally negative EBITDA.

- With regard to the procedure, it considers that the evidence supporting the conclusions reached in the motion for a resolution has not been deduced.

- In relation to the offending rate, Naturgy makes several rebuttals:

1. The proposal ignores that manipulation is a separate element of the [technical] rate;
2. The CNMC itself has adopted decisions indicating that fixed costs can be recovered through the restrictions segment;
3. The concept of excessive price cannot be determined on the basis of margins on variable costs;
4. The Sabón 3 plant has been far from obtaining revenues in excess of those necessary to obtain a reasonable return;
5. The disparity between bids to the daily market and bids for technical restrictions is due to the marginalist nature of the daily market as opposed to the pay as bid rule for technical restrictions; and
6. The justification for the disparity of bids (between day-ahead market and technical constraints) requires consideration of the market and technical constraints) requires considering of a longer time horizon than the one examined by the CNMC.
   
   

[9] CNMC provides additional case facts to support decision.

We summarise further additional case facts outlining market definitions, market conditions and related manipulation based on CNMC's analysis. We recommend reviewing the sanction in its entirety given there are multiple graphical visuals depicting events related to the alleged market manipulation in question.

• The price of Sabón 3's bids to restrictions during the period 23 March 2019 - 31 December 2020 were different from the price of its bids to the daily market, and its evolution was not justified by a variation in the plant's costs.

The electricity market is made up of several markets that differ fundamentally in terms of the time at which they are traded and the objective they pursue. Thus, the daily market is the market where generators sell their production and traders buy most of the demand for electricity consumers for the following day.

In the event that, following the matching resulting from the day-ahead market, the system operator identifies that there is a security problem in a specific area of the electricity system, it schedules by technical restrictions (RRTT) to one or more of the non-dispatched power plants in the area to solve the problem, paying it back at the price of its offer.

In the period analysed, the bids to the RRTT market of Sabón are different from those presented in the scheduling periods for this same plant in the daily electricity market. Specifically, in the period 23 March 2019 - 31 December 2020, although there are days when the price of the bids to the restrictions process is around the market price, there are other days when it is up to 167% higher than the price of the bids made for this same plant on the daily market. Thus, in view of the graph provided (see original Order), it can be seen that the evolution of the price of bids from the plant to technical restrictions and to the daily market follow a very different evolution.

• The evolution of the price of the plant's offers to restrictions is not justified by variations in the price of natural gas or by the costs derived from the operation of the plant in the restrictions market.

- The price of natural gas, the main input for electricity generation in a combined cycle power plant, showed a decreasing trend on international markets during the period analysed until June 2020, recovering from that moment onwards.

The offers to restrictions of the Sabón 3 plant in the same period, however, did not follow a clear trend and did not reflect these variations per the graph provided (see original Order) which shows both the offers to RRTT of the plant and the evolution of the gas price according to the gas reference prices provided by the company itself.

Therefore, the different evolution between the prices of bids to the day-ahead market and the prices of bids to technical constraints is not justified either by the operating regime of the power plant or by the costs associated with it.

• The price presented by Sabon 3's bid at restrictions with respect to its daily market bid when it is in an environment of less competition and, therefore, with a lower risk of losing the dispatch opportunity, rises, in average terms (average of situation 2 and 3) by 95% with respect to its bid in the daily market, while when it is in an environment of greater competition, where it may lose that opportunity, its bids are 34% above the daily market.
• The actions of Sabón 3, consisting of submitting bids to the technical restrictions process at prices much higher than those in more competitive environments had a direct impact on the cost of system adjustment services, and gave Naturgy a profit of €EUR 43.2 million.