across locations. Nevertheless, once the Enron meltdown occurred, even these arbitrage strategies were used as evidence to convict Enron in the court of public opinion. A more independent regulatory process may have been able to distinguish between legal and illegal activities by the Enron traders. The actions by the state and federal criminal authorities in response to these memos have created significant regulatory risk for merchant energy suppliers. This has partially caused many of them to shut down or significantly downsize their energy trading affiliates. If one takes the position that many of the actions energy traders were arrested for in 2001 and 2002 routinely occurred in 1998 and 1999, then this sequence of events provides a valuable lesson about the importance of a regulatory process that is independent of the political process. If the regulatory process had been perceived as more independent, the Enron bankruptcy and prosecution of traders for illegal behavior could have occurred without the almost complete decimation of the energy trading sector.

# **3.5.2. UK Experience**

The transition from the Pool to NETA in the UK was largely a political decision. Virtually all of the academics studying the UK Pool argued against this change. Their argument was that the divestitures of generation capacity and new entry that had taken place throughout the 1990s had largely solved the market power problem that existed during the early and mid-1990s. There was very little rigorous empirical analysis of the likely benefits of the reform. The high cost of obtaining the bids and market outcomes data made it difficult, if not impossible, for researchers to undertake such an analysis. Moreover, because Ofgem was a major advocate of NETA, it had little incentive to undertake such an analysis. The significant wholesale electricity price decline that occurred following the implementation of NETA has fueled a debate over whether it or the significant generation divestitures and new generation entry during the 1990’s caused the price decline. Greater independence between the regulatory process and the political process could have allowed a more impartial and detailed analysis of the need to incur the significant cost associated with implementing NETA.

The UK Uplift Management Incentive Scheme (UMIS) implemented by Offer during the Pool regime provides an instructive example of the type of problems that might arise if the market monitoring function was part of the market or system operation. Under the Pool rules, National Grid Company (NGC) was responsible for managing the costs of all deviations from day-ahead energy schedules and procurement of the ancillary services necessary to run the system in real-time. These costs were recovered through a per MWh uplift payment. Over time these uplift costs rose substantially, until Offer implemented a regulatory mechanism that capped the maximum amount of uplift charges that NGC could pass on to consumers through the UMIS. As a result of the UMIS, the amount of uplift charges paid by consumers declined substantially. The experience of Offer with the UMIS underscores the significant market efficiency gains possible from effective monitoring of the performance of the system and market operator, as well as market participants.

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