Why does FFR look so good?
The power market conditions have changed significantly since last year, and key on everyone’s minds in the battery space is the recent (relative) success of FFR (Firm Frequency Response). All of Modo Energy’s February’s Top 10 batteries earned most of their revenue from this service. So, we have taken a deep dive into what has been going on.
Two main factors at play have resulted in this pricing and subsequent changes to the leader board.
Continuous falling of baseload electricity prices
As we have experienced a mild winter, gas stores on the continent have remained higher than their seasonal average and supplies remained robust. Security of supply fears that caused prices to rise, eased as winter progressed. This has caused gas prices to fall over the last few months, with power prices following.
The decision for FFR pricing is taken on the 1st working day of the previous month; the February FFR pricing decision is made on the first working day of January. This means participants must analyse and forecast the potential wholesale market opportunity (our opportunity cost to deliver FFR) 30 to 60 days ahead of the contract delivery.
We have then seen power prices (and wholesale opportunity) drop from this FFR pricing decision point. FFR bid prices overestimated realisable market value - as did the wider power market at that moment in time.
However, every market participant is looking at the same prices, so this still does not explain fully why some typically high earning assets have been priced out each month. So, it is important to take note of the next factor:
Battery Duration
The average duration of the Modo Top 10 in February was 0.86 hours, and all earned most of their revenue from FFR. In August 2022, the average duration of the Top 10 was 1.2 hours, with FFR making up a much smaller proportion of the revenue stack.
Longer duration assets have capacity to take more advantage of daily wholesale arbitrage opportunities, and so their opportunity costs are higher than short duration assets. This leads them to price into FFR higher than many of the assets that have won contracts. Their increased duration is why they are priced out of this market.
In some senses it is the more limited duration of FFR assets that has led to their windfall. Any asset not winning an FFR contract was subsequently impacted by the effect of wholesale prices dropping (in some months APX MID price out turned 75% lower than baseload had been trading at). This price decrease from the decision point was so large that the benefit of their extra duration could not make up for the FFR prices set from the month previous.
On some days, there has been a reduction in spreads in wholesale markets to the point that there have been no arbitrage opportunities for batteries once efficiency and throughput costs have been included.
This ‘Cliff-Edge’ drop off in value also impacted the other services, as anything procured at the day-ahead stage DC (Dynamic Containment), DM (Dynamic Moderation), DR (Dynamic Regulation) was also reduced to little value. By this point in time, the fleet’s opportunity cost (value of wholesale trading) had also fallen. This exacerbated the value difference between FFR and non-FFR assets.
Benchmarking
This chart shows the leaderboard positions broken down by duration. The shortest duration assets sit at the top, followed by the longest duration assets who can earn the most value from wholesale trading. Assets in between followed by assets, of 1-hour duration who have missed FFR contracts.
This goes against the general trend observed, of longer duration assets leading the way. The graph below shows the August leaderboard by duration.
In short, FFR looks lucrative when prices are falling but the opposite effect occurs when prices are rising. The same could be said for any service procured far ahead of delivery. If power prices continue to fall, this trend may continue, however with prices down 75%+ during some months, it is unclear if this fall will continue. In the last couple of weeks, the May baseload has risen 25%.
Trading strategies should be built for the full lifetime of assets, and part of that is a careful consideration of asset configuration and duration. This defines potential trading value and opportunity cost. While remaining adaptable to market changes as they arrive is important, a few short months of exceptional FFR pricing should not result in a wider shift towards sub-optimal pricing strategies.