20 run marginal cost of gas, so that the price of gas in the flexibility market reflects the true market value of gas.

Transactions in the flexibility market are carried out through an auction because of BGT's monopoly or monopsony position as a seller or buyer of gas. The auction is guided by the Network Code and Ofgas. BGT operates the system on a nonprofit basis and so does not directly benefit from transactions in the flexibility market. Its incentive is thus to restore system balance rather than to speculate in the flexibility market.

_Operation of the flexibility mechanism_ The flexibility mechanism operates as follows:<sup>7</sup>

- Shippers decide to sell gas to or buy it from BGT, depending on their estimates of system supply and demand and the price of gas.<sup>8</sup> If a shipper expects a system imbalance on the next gas day and has some flexibility in adjusting its own portfolio of supply and demand contracts, it posts a flexibility bid on the electronic network. A flexibility bid can be for a "system sell" or a "system buy," depending on the kind of system balance expected. (The transactions in the flexibility market are always considered from the point of view of the system.). A typical flexibility bid specifies the type of bid, the date, the quantity and calorific value of gas, the injection or withdrawal points, the duration of the implementation of the offer, and the price per kilowatt-hour. Shippers can offer alternatives to their bid or withdraw it at any time except when the bid is being evaluated or after it has been accepted. Shippers can also see other bids but not who posted them.

- X The list of bids becomes available to BGT at 6:00 p.m. on the day preceding the gas day. If a system imbalance occurs, BGT accepts the best bid, typically the one with the best price. (Other parameters considered are time, location of injection and entry points, and duration of implementation of the offer relative to the same parameters of the system imbalance.) That means that BGT accepts the lowest-price bid for a system buy and the highest-price bid for a system sell. The price of the last accepted bid becomes the system marginal price. BGT then notifies the successful bidders, who must implement the offers. If shippers fail to comply, they incur scheduling and imbalance penalties. All unaccepted flexibility bids become redundant at 4:00 a.m. on the current day. Transactions in the flexibility market are settled in a subsequent monthly invoice.

The flexibility mechanism was introduced as part of the Network Code in April 1996. The Network Code requires all shippers to keep a daily balance between injected and withdrawn gas within a certain tolerance. If shippers exceed their daily balance, they are

> 7 This discussion of the flexibility's mechanism's operation draws from EIGT 1996. Changes in supply and demand cause changes in the injections and withdrawals of individual shippers, resulting in system imbalance and action by BGT in the flexibility market. If the system runs a positive - - imbalance, BGT must sell the extra gas a "system sell" to restore system balance. If the system runs a - negative imbalance, BGT must purchase the missing gas a "system buy." The price for a system sell is lower than the prevailing spot market price, while the price for a system buy is higher.