Phil Hewitt, director and founder of EnAppSys, warns that with tighter supply margins forecast for winter 2016/17, SBR arrangements are likely to force wholesale electricity prices even higher

 

National Grid has confirmed that next winter will be the first time since the current market arrangements began in 2001 that it has not forecast a surplus margin of spare power plants in the UK market in the run-up to a winter period. Instead, it has forecast negative margins.
As a result, it has already contracted for significant extra capacity to come on stream to ensure the lights stay on. However, it is still a moving picture that will also be subject to increasingly important contributions from renewable generation, so these efforts could drive wholesale electricity prices up to unprecedented levels, with system prices – the charges imposed on generators and suppliers for an undersupplied position – potentially reaching £3,000/MWh.
Recent unit closures at Eggborough, Ferrybridge, Longannet and Rugeley coal-fired power stations have increased the strain on National Grid to maintain healthy available system margin. This in turn has increased the need for backup generating options at times of high demand.
In the circumstances, some coal plants that have decided not to close or convert to biomass have opted to limp on supported by supplemental balancing reserve (SBR) contracts. Under this arrangement, plants that would otherwise have closed and surrendered their transmission entry capacity are entering into SBR contracts to be available in the winter months of November to February. This gives National Grid the ability to bring them into the market at times when the system is under significant stress due to undersupply.

Effect on price
If an SBR action is called by National Grid, it is deemed to be an extreme event. In such events the station gets paid its contracted utilisation price but a default price of £3,000/MWh is used for much of the volume entered into the system pricing calculation, which in turn raises the overall system price, enticing other units to generate through market feedback mechanisms.
In the electricity market, system prices are used as a price of last resort for participants. If their contract position does not meet their metered out-turn, they have to pay the system to buy power to fill a gap or sell power to get rid of a surplus. This system price is set by complex pricing rules, which in summary are the more expensive actions in the balancing mechanism on the side that corresponds to the national imbalance. This means that if the market as a whole is short, the system price will be higher than the market price, and if the market as a whole is long then the system price will be lower than the market price. In extreme situations these prices can be very low (negative) if the system is significantly oversupplied or very high if the system is undersupplied.
The default price when SBR is called essentially sets a new cap on the system price of £3,000/MWh, and because the use of SBR is a last resort, power stations could use the £3,000 as an effective ceiling price for the balancing mechanism because grid is obligated to take them first before SBR. This should lead to increased profits for marginal stations at times of system stress and potentially more extreme system prices. System prices feed back into wholesale prices, so this could lead to a very heated market during system stress events.

System prices feed back into wholesale prices, so this could lead to a very heated market during system stress events.

A negative by-product of this action can be created for generators that are already operating when an SBR action is called. For example, if a power station fails to meet its supply position because of a unit trip or other unforeseen problem during an SBR, it will face a penalty at the much higher system price created by the SBR action. For a 1GW power station, this £3,000/MWh price could result in a penalty charge of £3 million per hour if they encounter problems that prevent them from generating during these periods. The penalty charge would be well in excess of the normal margins earned at such a power station, which may usually be less than £5/MWh.

“A penalty charge well in excess of the normal margins earned … will make generators reluctant to sell power through conventional means, prompting them to hold back generation”

It is therefore entirely conceivable that this risk will make generators reluctant to sell power through conventional means, prompting generators to hold back their generation unless they are able to sell it at a price that will justify the risk of failed delivery. This could drive power prices in the market up to unprecedented levels well in excess of £1,000/MWh.
We saw warning signs during last winter’s periods of tight supply and spare margins. On those occasions National Grid spent millions of pounds a day procuring extra margin by bringing plants online and simultaneously turning down other generators to their minimum export levels as a safety net should any extra power be needed unexpectedly.
This meant that on days when system prices were their highest, there were actually more units being turned down than there were being brought up by National Grid; an indication of the attempt to maximise the amount of reserve power mechanisms available to deliver extra power to the market quickly and reliably.

Winter is coming
As we roll forward toward Winter 2016/17, National Grid will have to balance the system with less generation available because of recent plant closures. At the same time a large portion of the market that played a crucial role in balancing the system last winter is now excluded from the main market and will only be able to participate through SBR.
On days with little solar and wind generation – which now play an increased role in Britain’s power generation mix – the SBR units that were active in the market last winter may well play a key role in facilitating a well-supplied system, in turn bumping up system prices and subsequently taking market prices ever higher.
In some respects this activity is positive for the system. In recent years, generators on the margins of the market have been earning insufficient margins and this has been the primary driver behind recent plant closures. By increasing the rewards for generating on days of tight margins, the system hopes to slow the rate of closures that are affecting the market. However, in the precarious world of power sector economics, for some supply units an unforeseen fault or trip when the penalty price is so high could mean serious cash flow issues and, potentially, plant closures. For some the question will be if this really is a risk worth taking.

“Less diversified generation portfolios could be heavily exposed to the consequences of high and potentially unexpected system prices.”

All this increases the stakes for winter 2016/17 and although many generators could win big, profit greatly and keep their least viable plants open as a result, those with less diversified generation portfolios could be heavily exposed to the consequences of high and potentially unexpected system prices. Smaller suppliers and other participants in the market that operate at a distance through contracts that expose them to system prices could also face unexpectedly high bills.
Time will tell who will win and lose from this activity, but for the sake of the market, let’s hope that generators and suppliers are able to navigate through the winter without getting hit by a knockout blow.

 

This article was first published in the June 2016 issue of New Power.

Further reading: Price spikes, not blackouts, are the biggest risk this winter

Ofgem acts to protect customers in credit if their energy company goes bust

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