At a recent energy and climate change select committee hearing, the ante was upped on the whether there are risks of generators withholding capacity to manipulate the market price. This followed reports of high Balancing Mechanism (BM) offers being accepted by National Grid in the recent Notice of Insufficient Margin (NISM) earlier in the month.

In this blog we explore the legitimacy and rationality of market responses to these types of system events, by examining the reaction to the NISM of Severn Power. We argue that a simplistic political focus on headline prices runs the risk of concentrating political fire on two pillars of the market architecture that we all need to operate effectively in an energy system punctuated by intermittency and variability: the proper valuation of flexibility, and the reasonable costing of scarcity.

Rewinding to the incidents that have prompted this political interest--on 4 November 2015 National Grid issued a NISM for 16:30 to 18:30 (periods 33 to 38), following outages at a number of coal plant and a crucial pumped storage station, coinciding with low volumes from wind power. This was the system operator's (SO) first NISM since February 2012, its first ever call-up of Demand Side Balancing Reserve (DSBR) and procurement of 200MW of power from the East West Interconnector (EWIC) with Ireland in an SO to SO transaction.

During these periods the market reaction included some high offers being put into the balancing market. These included an offer price from Severn Power of £1,000/MWh for 107MW in period 34, a further offer price from Severn Power of £2,500/MWh for 6.8MW in period 36, and a peak APX price of £259/MWh on the half hourly spot market in period 35. This increase in the wholesale market price was a rise of £201/MWh (447%) on the £58/MWh recorded for the same period on the same day last week.

Since then, there has been quite a bit of political concern about the actions of Severn Power during the NISM. In particular, it has been suggested that there might have been something inappropriate about Severn asking for BM prices significantly above market rates, with the plant having previously ramped down production ahead of the NISM period and thus potentially deepening the systemic issue. However, we would argue the power station's action were both legitimate and rational.

First of all, as far as we can judge from the information to hand, no rules were broken. There is no limit on an offer a generator can place into the BM unless there is a transmission constraint. Under the British Electricity Trading and Transmission Arrangements, generators are responsible for the scheduling of their own plant. For large licensed generators there is a requirement to inform Grid of their plans at gate closure (1 hour ahead of delivery) and signal their flexibility in the BM. The only limit, under normal circumstances, on a BOA in the BM is the hard limit of how many numbers you can enter into the system (99,999) and what BOAs your competitors had placed.

However, the generation licence contains something called the Transmission Constraint Licence Condition (TCLC). This means a generator will be in breach of their licence if they create, or exacerbate a Transmission Constraint through changing their operation and gain or seek to gain an excessive benefit by entering into an arrangement with the system operator.

A transmission constraint means any limit on the ability of the transmission system to transmit the power supplied to the location where the demand for that power is situated as a result of the need not to exceed thermal ratings, the need to maintain voltage, the need to maintain stability of equipment and systems and any limit caused by the SO having to act within the National Electricity Transmission System Security and Qualify of Supply Standards (NETS SQSS), or other laws.

We don't have the full picture, which will only currently be available to the SO and Ofgem, but the offers taken from Severn Power were not tagged as System actions by the SO, so as far as we can tell they were taken for purely energy reasons. There is no current indication that the system was "constrained" at that time, or that the ramping down of Severn Power ahead of the evening period caused the system to become constrained. Therefore, at the moment, with the limited amount of information available to us, we would conclude that there is no evidence that TCLC was beached.

Secondly, generators which choose not to trade in the energy market and trade solely with the SO through the BM aren't guaranteed a windfall, even in circumstances of a short system. Such plant face significant cash flow risks as there is only one counterparty for volumes under the BM, and many competitors competing for a share of the limited and unpredictable procurement envelope.

When Severn Power took the decision to ramp down ahead of the NISM period it took a calculated risk. In the run up to the NISM, offer prices being accepted by Grid had been over £100/MWh, most likely higher than the price that could be achieved in the energy market. In fact for period 35, a weighted average price of £259/MWh was recorded. This would have acted as a signal to generators of the enhanced value available for providing a balancing service through the BM. But a lot of generators equally would have also been looking at the wholesale electricity price for these periods and scheduling their plant to run there, given they would have been above current normal market rates of roughly £40/MWh. Generators would have also weighed up the risk of gambling too higher share of their volumes away in the BM and getting nothing. In the BM, there can be no certainty of Grid needing your capacity, and no certainty you would be cheap enough to be called upon.

Therefore, by Severn choosing BM participation, it was forgoing higher-than-usual energy market prices on the assumption that other plant would not offer significant volumes into the BM more competitively than it did. With hindsight, it was a smart call from Severn. Most of the market was contracted out in the energy market, allowing Severn to set one of their BOAs at £2,500/MWh and still be accepted. But with imperfect information and the risk of getting no value, it was not without its risks. These risks were reflected in the high price that Severn received for its power and for the provision of a valuable service to the SO at its time of need.

Thirdly, Severn was not alone in undertaking these actions. Grid forecast that the week beginning 26 October was likely to be one of the tightest experienced over the winter; this increased the value of power over peak periods and the majority of CCGT increased the prices of their offers into the BM. The average offer price in the week leading up to 25 October was £97/MWh; in the seven days following 25 October the average offer price posted by CCGT was £257/MWh. Plant placing offers over £400/MWh on the 4 November included Baglan Bay, Damhead Creek, Langage, Rye House, Spalding and Sutton Bridge.

Fourthly, Severn Power can justify the level of the bid as it is below the current accepted regulatory Value of Lost Load (VoLL): a benchmark price that applied to the pricing of actions to address imbalance during the NISM period. Under the Ofgem-approved BSC modification, P305, a VoLL of £3,000/MWh has been adopted from November 2015, increasing to £6,000/MWh from November 2018. These are values that are adopted in the calculation of cash-out prices in proportion to volumes that Grid call upon in its "last resort" measures in order to avoid customer disconnection. If anything, this is not representative of the true VoLL that peer studies have prices at £17,500/MWh.

One of the conditions of the TCLC is that the generator must be able to objectively justify the price it sought. Based on VoLL as described above it is entirely possible to justify a price of £2,500/MWh. Indeed, during the NISM, Grid resorted to activating its Demand Side Balancing Reserve, prompting an application of VoLL at £3,000/MWh in the cash-out price for those volumes. By contrast, Severn Power gave the SO a cost-effective option at £2,500/MWh to avoid disconnecting consumers.

In conclusion then, in our view there are plenty of compelling justifications that the actions that Severn took are justifiable, legitimate and consistent with the intentions of the current system design. Moreover, if the recent furore signals a new focus of politicians to try to proactively tinker in the part of the market that values flexibility and costs scarcity, in order to try to cap prices, then we believe it risks undermining confidence in an area that will be needed to deliver greater flexibility in the future. It would also be counter to substantive efforts to reform settlement incentives through the recent Electricity Balancing System Code Review (EBSCR) to work in the opposite direction.

Running a CCGT plant flexibly to meet increased instances of system events or variability in the output of renewables, as will be required in the future, decreases the certainty of baseload running patterns and predictable income streams, and simultaneously increases the wear and tear and maintenance costs, and in extremis limits the lifespan of plant. Extrinsic value flowing from things like BM participation alone is not enough to address the economic gulf in investment cases to prompt new investment in flexible plant, simply due to the inability to model its frequency and derived prices with any certainty. But we can be absolutely certain that adopting any efforts to limit properly costed extrinsic value will be deeply damaging, and is the last thing politicians should be looking to do in light of the predicted future system dynamics.