The new system, scheduled to be introduced in the autumn of 2000, will replace the Electricity Pool of England and Wales with market-based trading arrangements similar to those used in commodity markets. The total cost of setting up the new framework is estimated at pounds 700m.
The pool system has been widely criticised for its price-setting arrangements, which fail to reflect the 50 per cent reduction in generation costs that has occurred since 1990. Dr Eileen Marshall, Ofgem's deputy director general, said: "This stranglehold on price-setting has defied market entry and investment."
Dr Marshall said the new system would shave pounds 1.5bn a year off domestic bills, saving the average consumer with a pounds 275 electricity bill pounds 35.75 a year.
Under the pool system, generators place offers each day specifying the amount at which they are prepared to sell their electricity. National Grid, on behalf of the pool, ranks these offers in ascending order and determines a single wholesale price based on the highest accepted offer.
The new framework will decentralise the bidding process by focusing on contracts agreed between willing buyers and sellers. Electricity will be traded on the forwards and futures market and using short-term power exchanges. A balancing mechanism will be set up to ensure supply security and a settlement process will be introduced to charge bidders who fail to provide the generation they promise.
Analysts say the measures will favour large suppliers who have the ability to balance their portfolios. A spokesman for National Power said: "In general we are very supportive of these proposals. The whole market will benefit from the continued downward pressure that the new system will create."
PowerGen has also said it supports the reforms. But a spokesman added it was too early to say whether they would result in the promised cuts. He said: `What is certain is that we will see more volatility, not less.'
The proposals will be implemented through new legislation which Ofgem hopes will be passed in the next parliamentary session. If the recommendations are not approved, Ofgem will go to the Competition Commission. A consultation document on Scotland's future involvement is in draft form.
National Power's shares yesterday closed down 12.75p at 419.25p, while PowerGen was up 9.5p at 606.5p.