Scarcity pricing in the Balancing Mechanism

The last couple of weeks saw some power stations make some bumper profits as cold weather drove scarcity pricing. The greatest profits were made by some large gas (CCGT) plant in the balancing mechanism on Friday 9th and Wednesday 13th January, earning up £4,000/MWh (around 100 times the normal cost of power), so what was it that enabled these plants to earn large revenues compared to other assets? 

The first thing to bear in mind is that the Balancing Mechanism (BM) is not a single market with a well-defined supply and demand but a marketplace for several system needs. The BM is used to correct supply demand imbalances that naturally occur (eg from demand forecasting errors) but crucially also to manage constraints, voltage, frequency, inertia, reserve (and more) in real time (sometimes augmenting specific tendered markets for these services). 

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If we examine the accepted actions by the System Operator (NGESO) on the afternoon Wednesday 13th after the event we can see this immediately given the large volume of both Bids and Offers accepted. If the only purpose was to correct the overall system imbalance it would be very inefficient to pay one plant £4000/MWh to turn up while turning others down at £0/MWh.

 Bids and Offers accepted 1700-1730 on Wednesday 13th. Source: LCP Enact.

These actions only start to make sense once we consider other requirements which the BM is used for, namely Reserve. Operating Reserve is needed to ensure sufficient backup from sudden impacts (like an interconnector tripping off or wind generation dropping off) and therefore GWs of back-up power is required to be available and able to respond in minutes. Reserve can be created by the System Operator through tenders ahead of time (STOR & Fast Reserve), bilateral contracts (SpinGen) and by creating headroom in the BM.

Headroom refers to difference between current output level and the Maximum Export Level (MEL) on thermal plant, the amount they can ramp up to and hold indefinitely. CCGTs take hours to start from zero ouput, but once operating above a Stable Export Level (SEL) they can change output in minutes and so contribute to Operating Reserve.

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A CCGT brought on to provide Headroom. Source BM Reports.

This is where we see the perverse incentive of being a large, slow moving beast sometimes emerges in the BM. Faster (traditionally smaller) plant like OCGTs, batteries and pumped storage can ramp up in a timescale of minutes (or faster) from a standing start which means they are naturally providing Reserve simply by offering volume into the BM. Whereas CCGTs must be turned on to SEL (and paid for this) to create Reserve.

Put yourself in the shoes of a Control Room engineer as the evening peak approaches: if you are looking at the resource available and think you might come up short clearly the best thing is to start up the slower plants in preparation for this. But if no incident does happen or the demand turns out lower than expected then the faster assets will likely not have been used during this period, whereas the CCGTs will have been renumerated heavily from the start-up instruction. 

This is what happened on Wednesday where each of four CCGTs were ramped up from zero to their Stable Export Limit (SEL), ie the least amount NGESO could procure, to create as much Headroom as possible. However, it turned out the system was long over the peak and with no incidents occurring meant many OCGTs received no instructions, despite offering much cheaper volume into the BM (it should be noted that size also plays a role here, the CCGTs offer much more volume). 

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 Accepted Offers from CCGTs to SEL 1700-1730 13/01/21. Source LCP Enact.

Offers from OCGTs not accepted 1700-1730 13/01/21. Source LCP Enact.

Offers from OCGTs not accepted 1700-1730 13/01/21. Source LCP Enact.

The problem is because in a utilisation payment only market the insurance value provided by fast responding assets isn’t valued if they aren’t called into action. NGESO are taking the right steps to remedy the issue by reintroducing STOR at Day Ahead (which allows providers to value in tight system conditions to their tenders) and investigating new methodologies like the BM Reserve Trial; both of which feature availability payments for those best able to provide Reserve. These are part of a wider package of Reserve reform which is fundamentally about the strategic shift to managing the system with predominantly duration limited resource, like batteries, instead of traditional notions of Headroom (and Footroom).

But this still doesn’t answer why the CCGTs were able to command such high prices. The answer is of course scarcity, cold days with little wind can create tight system conditions and we saw this reflected in the Day Ahead wholesale price at 1700-1800 (£1500/MWh on the N2EX). These CCGTs made the calculation they could earn more by not self-dispatching against the peak hour-long wholesale price and instead Grid would need to bring them online and pay high prices for an entire six hour run. It’s a gamble which doesn’t always pay off but did here, with a single unit at West Burton earning £3.78m from the BM that day compared to £0.53m if it had made the same run against wholesale.

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West Burton Unit 3 profits in the BM compared to wholesale. Source BM Reports.

The wholesale market and Balancing Mechanism are linked of course by the imbalance price and it is the SIP calculation formula which drives these trading decisions between the wholesale market and the BM. The SIP didn’t clear at high levels on Wednesday afternoon because ultimately there wasn’t a shortage of energy so the large costs of balancing on this day, shown below, are put down as Reserve costs and so instead pass through via BSUOS. Interestingly SIP did reach £990 earlier at 1pm that day when similar actions were being taken but the system was short (also on the 8th Jan when it cleared at £400/MWh). Whether this is the SIP calculation working well, or a sign it is broken, however is for another post.

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Balancing costs on week starting 11th Jan. Source NGESO.