UK electricity market braced for impact of balancing cost reforms

Impending reforms to cash-out prices incurred by UK power companies from the system operator when they fail to balance contractual positions could introduce greater volatility into the wholesale electricity market, according to experts.

The UK power sector – including system operator National Grid, energy regulator Ofgem and balancing services provider Elexon – is close to agreeing on a system of charging that could see energy companies penalised more heavily for passing the burden of balancing their positions onto National Grid.

The reforms, which had been scheduled to take effect at the start of November, have been drawn up to ensure that cash-out signals encourage parties to take greater responsibility for meeting contractual supply and generating obligations and reduce hefty balancing costs incurred by the system operator.

As a result, these enhanced signals are expected to incite participants that are out of position to enter the intra-day wholesale market, increasing volatility but also moulding wholesale prices to reflect supply scarcity more effectively.

“Prices intraday will become much more volatile and sharper, and balancing actions will become more expensive,” one source said. “Day ahead prices may rise with it,” he added.

And volatility is likely to extend beyond the prompt market into forward prices, according to Intergen’s head of energy markets Chris Elder, who said the increased risk associated with imbalance exposure is likely to force counterparties into the market more.

Currently, the method for determining the cash-out or imbalance price results in parties that have contributed to the imbalance paying a price calculated off an average of the most expensive 500MWh of bids and offers submitted by generators to balance the system.

But the price average reference (PAR) of 500 is regarded by industry regulator Ofgem as failing to generate a price that conveys the true cost of balancing the system and as a result has proposed a modification that will initially see a PAR of 250MWh introduced this winter.

Intra-day volatility

The ultimate aim is to have a PAR of 1MWh in place by the start of Winter 2018/19 that will mean transgressors are charged on a marginal basis through the cost of the most expensive balancing action.

Elder believes that the establishment of a PAR value of 50MWh, which Ofgem is proposing to enforce from the start of Winter 2015/16, will instigate a “significant” change in the wholesale market when intra-day price volatility will be felt.

In the meantime, the industry has been haggling over the level of PAR that enters force this winter, with balancing and settlement body Elexon proposing that Ofgem raise the level of the initial PAR threshold to 350MWh, instead of 250MWh.

Although there are doubts about how much of a change in balancing habits a PAR of 350MWh or even 250MWh can affect among counterparties, it could be sufficient to entice some of the UK’s most marginal plant to switch on more frequently as they benefit from a larger payment to generate power at short notice.

“It will mean some generators that previously had no reason to come on start turning on,” one source said.

A spokeswoman for Ofgem told ICIS that final proposals for implementing this winter’s value are being examined by the Gas and Electricity Markets Authority (GEMA), the legal decision-making body of Ofgem, with a decision expected soon.

The reforms had initially been expected to enter force on 31 October, although the deadline for Ofgem to give notice of implementation in time for this date has now passed.

When GEMA reports with its decision, the reforms will take ten working days to become active. Henry Evans