Today, the day we recognise the non-achievements of Guy Fawkes, will see the regulator's Electricity Balancing Significant Code Review (EBSCR) changes to electricity imbalance pricing arrangements (or cash-out) come into effect.

The goal is to shake-up the incentives and encourage parties to invest in flexible generation and more accurate forecasting. Ofgem has long held concerns that current rules under the Balancing and Settlement Code (BSC) do not send an efficient signal to parties to trade electricity in wholesale markets in time scales leading to delivery. In response it prompted then endorsed a series of changes to industry codes that involved sharpening of the cash-out price calculation, ascribing an additional cost to demand disconnections and reserve actions, and replacing the dual imbalance pricing structure with a single price in each half hour period.

This blog reprises why the changes are being made and speculates on what they might lead to. Will there be fireworks?

Fall out

We have been using the 500MWh of most expensive (to the system operator) actions to set the main energy imbalance price (of two) in any settlement period. From today this will be shift to using only the 50MWh most expensive offers, sharpening up the incentive to trade by exposing parties in imbalance to potentially higher prices and a single price.

Cornwall Energy has created a distribution (see chart below) to show the number of occurrences of a spread of prices under the current methodology for the past year. It also shows the impact on a "what if" basis, as if prices of the new methodology had applied over the same period. While these could be considered representative, they obviously do not reflect any behavioural response. 

Click here to view table.

Although the distribution for the single price peaked at a similar price to the current System Buy Price (SBP) and System Sell Price (SSP), and most settlement periods remained in the £30/MWh-40/MWh range, a greater number of settlement periods will see prices at both ends of the spectrum (either >£100.0/MWh or <£10.0/MWh) under the new single price. Over this period there would have been 44 more half hourly periods where negative spill prices were encountered and 290 extra periods where top-up prices would have been over £100/MWh.

Banger

As already noted, these reforms are all about sharpening and manipulating the incentives to balance and trade by making the price more marginal. But in our opinion the most significant change is moving to a single imbalance price.

As it stands, we currently have two prices in each half hour; a SSP or spill price for parties who are long against their reported contracts, and a SBP or top-up for parties who are short. These prices are presently set in different ways depending on the conditions (or net length) on the system: if the system is short it is the SBP that is set by National Grid's actions, and if the system is long the company will set the SSP. In both instances the reverse price is presently set by reference to a traded market index.

Going forward, a single price in each half hour would remove this dynamic of a spread and reward those parties who were in imbalance in the opposite direction to the system to the full value realised by grid not having to balance their positions. If the price is sharpened, then smaller parties who are more often long should benefit from the single imbalance price when the system is short, but be worse of than now when the system is long. This is the alteration to market rules of the current raft most likely to drive behaviour change--parties could see greater benefits from imbalance if they can forecast system length accurately and trade in the opposite direction.

Run very fast

Ofgem does not see this being a problem because National Grid is to provide a forecast of the Net Imbalance Volume ahead of delivery. In practice there are a number of objections to this:

  • National Grid itself is not very good at forecasting with precision the net length of the system especially when the system is liable to flip;
  • all but the most dynamic of active participants under the BSC will not have the capability to trade their position or resort to physical adjustment, and even if they had the necessary information their prices to most customers would reflect legacy settlement profiles;
  • for most embedded generators tied into ahead of the event notification arrangements with their offtakers, the impact will be a lottery.

In fact most participants will not be looking forward to bonfire night at all. While they understand the rationale behind the regulatory agenda to improve the value of flexibility, they also continue to have real doubts over why Ofgem seems to have pushed through reforms in short order that will penalise not so much their inflexibility but which bring into focus the rigidities that the current technology baseline and trading rules impose on them.

In this context the trading arrangements not only penalise those who are less good balancers (systematically disadvantaging those who lack scale or technology diversity) but rewards better balancers (systematically rewarding those who enjoy the benefits of scale and who can diversify risk). How this has slipped through in a wider context where governments have sought to promote low carbon generation and independent supply is something of a mystery.

Flaming balls

Anyway back to the technical stuff. In addition to the more marginal, single price, there will be two extra functions added to the cash out calculations on 5 November.

The first will be creating a Value of Lost Load (VoLL), which will be applied whenever National Grid instructs a distributor to disconnect a consumer under the Grid Code. This mechanism is the last weapon in National Grid's arsenal of balancing and is therefore priced at £3,000/MWh from winter 2015, increasing to £6,000/MWh from winter 2018 (to coincide with the introduction of the capacity market). More importantly, the VoLL will also be applied whenever National Grid calls on Supplemental Balancing Reserve (SBR), its contingency reserve service, which places plant outside the energy market only to be called on as a last ditch measure to keep the lights on.

The second new function will be called the Reserve Scarcity Pricing (RSP) function and will relate the cost of using non-Balancing Mechanism (BM) Short Term Operating Reserve (STOR) to the level of scarcity on the system. A Loss of Load Probability (LoLP) curve is now used to calculate the likelihood the system could be unable to meet demand. This factor will then be multiplied by the VoLL to calculate the price for using reserve (or the reserve's utilisation price, whichever is higher). At first this will be calculated by relating the margin to a historic measure of the LoLP, but from 2018 we will move to a dynamic calculation, where system conditions will be run through a stochastic model of supply and demand every half hour.

Between November 2014 and October 2015 (again in the absence of any behavioural response), there were 1,142 periods when non-BM STOR was called; this mechanism could push the price over £150/MWh and up to £3,000/MWh depending on margin and the Net Imbalance Volume. We estimate there would have been over 1,000 half hours where the RSP function pushed the price over £130/MWh under a Price Average Reference (PAR) 50 single price.

Party pooper

It's relatively easy to look back over time and apply the new rules to the system as it was, but this is a modification designed to drive new behaviours. Therefore backward casting cannot give us the full picture of what a P305 world will look like.

With single pricing, sharper values and new functions, the cash-out regime will drive behavioural change. Prices will be higher, more volatile and more complex to forecast, but this change has been anticipated for some time by most parties in the market who will have been preparing for 5 November, and as a result we would not expect to see any real fireworks under a business as usual scenario.

However, if there is a prolonged cold-snap with low wind speeds, or an unexpected failure at significant stations, which then requires the activation of the various reserve services, prices could spike to levels which could have material impacts on a wide array of trading parties in the market. This is especially true of smaller ones that have historically been more exposed to imbalance over peak periods than their larger peers.

If we needed a reminder of some of the "what ifs", a prosaically timed example occurred on 4 November, when in relatively benign system conditions, National Grid called its first security warning (or NISM) in over three years and made its first use of DSBR.