Significant changes to imbalance pricing may bring new risks and rewards to market participants, driving behavioural change by incentivising accurate forecasting and investment in flexible generation and demand side response technologies.
In Great Britain, if a participant to the balancing mechanism supplies or generates electricity in differing quantities to that which it has agreed to sell or buy, it will be required to pay an imbalance price in respect of the difference.
Following Ofgem’s Electricity Balancing Significant Code Review (“EBSCR”) launched in August 2012, Ofgem has approved the required modifications to the industry codes (known as modification P305) to bring into effect some significant changes to the imbalance price mechanism, effective from 5 November 2015.
The EBSCR was launched with the aims of:
- reducing imbalance costs (management consultants, Baringa, estimate an indirect saving to consumers of in the region of £200 million by 2030);
- increasing the incentive for participants to avoid imbalances; and
- driving investment in flexible capacity and demand side response technologies by sharpening the imbalance price at times of system stress.
The old arrangements
The old system used two imbalance prices:
- System Sell Price (“SSP”), payable by parties who were long against their contracts; and
- System Buy Price (“SBP”), payable by parties who were short.
SSP and SBP were calculated in different ways depending on whether the system as a whole was long or short. SBP (when the system is short) and SSP (when the system is long) are calculated by reference to the cost to National Grid of its actions to balance the system.
The reverse price in each case (SSP where the system is short and SBP where the system is long) will be set by reference to the wholesale value of energy traded on that day.
The EBSCR identified several flaws in the above approach, including:
- imbalance prices were calculated by reference to the average cost of actions taken by National Grid (in its role as system operator) to balance the system as a whole, rather than the cost of balancing the system at the margins (which will be significantly higher);
- the old system did not reward participants for ‘helpful’ imbalances. For example, if the system as a whole was short, participants who had generated more than their contractual position were, in effect, helping to balance the system despite their contractual position differing to the actual amount generated or supplied (as mentioned above, in such circumstances, the imbalance price paid or received would be calculated by reference to the wholesale market price); and
- imbalance prices did not include the costs to consumers of disconnections due to imbalance issues or voltage reductions.
The new order
The implementation of modification P305 has resulted in the following changes.
- The introduction of a single cash out price. This means that imbalances which help the system as a whole are rewarded to the full value of the saving to National Grid in not having to balance their positions.
- The new cash out price will be calculated by reference to the most expensive 50MWh of actions undertaken by National Grid to balance the system (500MWh previously), dropping to the most expensive 1MWh from 1 November 2018. This could lead to a significantly higher imbalance price at times of system stress.
- Inclusion of a cost for disconnection and voltage reduction into the imbalance price calculation.
- Pricing National Grid’s Short Term Operating Reserve actions into the imbalance price.
What it means
Ofgem believes that the changes will strengthen the incentives on parties to make efficient balancing decisions and, by incentivising investment in flexible capacity and demand side response, should reduce the total cost to National Grid (and ultimately consumers) in balancing the system.
Although participants have been aware of these changes for some time, it may take a while to get a proper view of what the new pricing system will mean for them. However, energy consultants, Cornwall Energy, believe that projected higher imbalance prices at times of system stress could have a detrimental impact on smaller participants who may be more exposed to imbalance over peak periods. The corollary of this is that parties who are able to accurately forecast system length and trade power in the opposite direction could reap significant benefits.
The changes may also indirectly impact on power purchase agreements (“PPAs”), which commonly refer to SSP and SBP in their pricing mechanisms. It is possible that such PPAs will require amendment to reflect the new arrangements, possibly invoking change in law provisions, if drafted widely enough to include changes to industry codes. Where a change in law is deemed to have occurred, PPAs commonly provide for the parties to renegotiate terms to ensure the same overall balance of risk and reward for each party.
If you have any questions on the changes, or how the changes could impact on your PPAs or other agreements, please do not hesitate to contact us.