BSC Insight: Increasing costs for balancing the GB System
The Electricity System Operator (ESO) plays an essential role in balancing supply and demand using the Balancing Mechanism (BM). Matching supply and demand requires payments to be made between the ESO and participating consumers and generators. Consumers and generators submit prices for volumes of energy they can provide within a half-hour period (Settlement Period) to balance the system. In this Insight article, analyst Angus Fairbairn looks at balancing costs of ESO since 2015.
System Operator role is becoming more challenging
The ESO role in Great Britain, performed by National Grid ESO, is becoming more challenging and costly. All electricity consumers pay for these costs as part of their bills. In 2020, some contributing factors were the move to a more decentralised system and increases in intermittent generation with a push to a net zero future. The ESO also faced forecasting challenges with changing demand profiles due to COVID-19.
See our previous insights for some examples of the challenges faced in 2020
ESO role may be carried out by a different body in the future
The rising costs for balancing the system are under review by Ofgem. In August 2020, the regulator announced the review, noting that between March and July 2020 balancing costs totalled £718m – ‘39% higher than expected costs for this period’. National Grid ESO has incentives (set by Ofgem) to balance the system in the most economical way. The ESO also has a 5-point plan for reducing the cost of constraints (incidences where the ESO has to curtail output from generators in exchange for payments).
The ESO role may be carried out by a different organisation in the future. In the current arrangements, National Grid ESO (a legally separate entity that is still part of the National Grid Group) performs the role. However, in January 2021, Ofgem recommended to the Government that the ESO role is delivered by a body that is fully independent of National Grid.
Elexon’s views on reforming the System Operator roles and the energy codes
Following the publication of the Energy White Paper in December, it is expected that the Government will consult further on future system operation and energy code arrangements, later this year. Elexon believes the system operator roles for gas and electricity, and the energy code arrangements should be reformed together.
Generation sources used to keep the system in balance
The graph below shows how payments for balancing energy produced from different fuel types has contributed to net balancing costs since 2015. This graph only includes payments for utilised balancing energy in the BM and outside the BM in Balancing Services Adjustment Actions. Additional payments, such as availability fees or start-up costs have not been included.
Net balancing costs were £506m in 2015. The system pressures mentioned above have pushed the net cost in 2020 to £1.3Bn, 67% higher than 2019 (£794m).
Rising balancing costs between 2019 and 2020
Increases in balancing costs were seen across all fuel types (except coal) from 2019 to 2020. The cost of balancing energy from wind rose from £142m to £277m (a 95% increase) and biomass doubled from £11m to £22m. Increases in balancing costs for wind are expected as installed onshore and offshore wind capacity has risen by 71% since 2015.
Battery storage Balancing Mechanism Units (BMUs) first started providing balancing energy in 2019 where the total cost for the year was £0.7M. In 2020, £1.1m of balancing costs were for storage BMUs. The current approximate capacity of Storage in the UK is 1GW with the pipeline of planned projects reaching a capacity of approximately 14GW.
Balancing costs for coal have fallen as plants head towards closure
Some balancing costs have reduced since 2016. Coal was responsible for 25% of balancing costs in 2016, dropping to 2% in 2020. In 2015, the UK Government announced the remaining 14 coal-fired power stations would be closed by 2025 as the Large Combustion Plant Directive put limits on the emissions from remaining plants. Coal generation capacity has decreased by 65% since 2016. There have also been increases in costs of coal generation due to economic initiatives such as the carbon tax. The ESO will choose the most economical balancing actions available, so increases in the price of coal compared to other fuels will result in less coal balancing cashflow.
The increase in cashflow with renewables, combined with the decrease in expenditure on coal balancing energy signifies the transition of the GB electricity system to a low-carbon future. However, gas still accounted for the majority (58%) of balancing costs in 2020.
How Bid and Offer Cashflows have changed
Balancing service providers submit prices to the ESO to increase or decrease their electricity output or consumption during a Settlement Period. When the ESO requires a change in energy levels on the system the services these providers offer are called balancing actions.
Balancing actions can be categorised as Bids or Offers. Bids are accepted by National Grid ESO to reduce generation or increase demand whilst Offers are accepted to increase generation or reduce demand.
Net Bid and Offer cashflow
The graph below shows changes in net Bid and Offer cash flow between 2015 and 2020. Bids have a negative volume as they are a reduction in energy on the system. The Bid price represents the amount paid to the ESO by the balancing services provider and therefore the lower the Bid price, the more expensive it is to the ESO and a negative price will represent a payment to a BM Participant.
Bid cashflow is the price (£/MWh) of a Bid multiplied by the volume of the Bid (MWh). A net positive Bid cashflow across a year means more money was paid to Balancing Service providers for negatively priced Bids by the ESO than the ESO received from positively priced Bids.
Prior to 2020, the yearly net cost attributed to Bids was negative. This means more money was received by National Grid ESO for reducing energy on the system than was paid to Balancing Service providers to reduce energy on the system. Balancing Service providers will pay to reduce their generation as they may save costs of operation and/or fuel. They may also pay to consume more electricity.
The negative net Bid Cashflow from Bids reduced the overall cost of balancing the system by an average of £125m per year from 2015 to 2019. This trend significantly switched in 2020 with a positive net Bid cashflow, of £257m being paid from the ESO to Balancing Service providers to reduce energy on the system. This represented an additional 19% of cost on top of Offer costs.
Net positive Bid cashflow means more money is being paid to BM Participants from the ESO than Balancing Service providers are paying to the ESO to reduce energy on the system. Bids which result in payment from the ESO to the Balancing Service provider will have a negative price in £/MWh.
Bids with negative prices usually come from wind generators as they have no fuel costs and will lose payments from their Renewable Obligations Certificates (ROCs). ROCs are paid to certain renewable generators for each MWh of electricity generation delivered to the grid.
The Offer price represents the amount paid from the ESO to the Balancing Services provider. The higher the Offer price, the more expensive it is to the ESO. Offers have a positive volume as they are an increase in energy on the system. Offer cashflow is the price (£/MWh) of an Offer multiplied by the volume of the Offer (MWh).
Yearly net Offer cashflow has always been positive as it is very unlikely for Participants to pay to increase electricity on the system; to consume less or generate more.
Since 2016, net Offer cashflow has been rising. From 2019 to 2020, net Offer costs rose by 23%. As the cost increased for both Bids and Offers, this meant that balancing costs rose by 50% from 2019 to 2020.
Energy versus System Balancing Actions
Balancing actions are accepted to help manage supply and demand. However they can also be accepted for system management reasons (e.g. locational constraints). If an action is accepted for system management reasons, National Grid ESO marks this action with a System Operator (SO) Flag.
SO-Flagged Offers had a net cashflow of £330m to Offer providers in 2020, the highest amount in the past six years and over three times the amount paid in 2013 (£106m). Net SO-Flagged Offer cost was equivalent to 31% of the total cost of Offers accepted in 2020.
Net SO-Flagged Bid costs have increased consistently year-on-year since 2015. In 2015, the net cashflow was -£2.5m and was the only year in this time period where SO-Flagged Bids saved some balancing costs. In 2020, the costs reached £262m, the highest levels in the past six years and a 241% increase on the 2019 cost of SO-Flagged Bids (£77m).
Notably, the net SO-Flagged cost from wind was £258m. The concentration of wind generators in Scotland, where capacity to export surplus electricity is not always available, means that the ESO has to constrain generation output.
With the increasing influence of wind on the system, SO-Flagged costs to wind units are beginning to heavily outweigh those paid to the ESO through Bids from other fuel types such as Gas (-£44m net cashflow in 2020).
Average Bid and Offer Prices
Balancing costs are understandably affected by the price of each Bid and Offer accepted.
Cheaper Offer prices would usually result in less ESO expenditure on Offer volume. However, despite net Offer costs increasing by 23% in 2020 compared to 2019, the average Offer price decreased by £8.89/MWh to £55.27/MWh. 2020 saw the lowest, and therefore the cheapest, average Offer price over the past six years. The increase in expenditure comes from significant increases in Offer volume in 2020; an increase of 6.3TWh (48%) from 2019 to 19.3TWh.
The lowest monthly average Offer Price from 2015 to 2020 (£42.34/MWh) occurred April 2020. Low monthly average Offer prices lasted until September 2020 where the average Offer price was greater than the lowest monthly average Offer price seen in 2019. This suggests low Offer prices are directly linked to the first national lockdown (from 22 March). The result of this was a reduction in demand of 24% compared to April 2019.
Lowest monthly average Offer price in April 2020
The lowest monthly average Offer Price from 2015 to 2020 (£42.34/MWh) occurred April 2020. Low monthly average Offer prices lasted until September 2020 where the average Offer price was greater than the lowest monthly average Offer price seen in 2019.
This suggests low Offer prices are directly linked to the first national lockdown (from 22 March). The result of this was a reduction in demand of 24% compared to April 2019.
One of our previous insights on negative System Prices resulting from the impact of COVID-19 shows the effect on System Prices during the first national lockdown. The same effects on Offer prices were not seen in November and December 2020; the monthly average Offer prices exceeded those for the same months in 2019.
Average bid price in 2020 the most expensive for six years
Bid prices represent the amount paid to the ESO from Participants to reduce the amount of energy on the system. Therefore, a lower price represents more expenditure for the ESO. The average Bid price decreased from 2019 to 2020, dropping by £16.92/MWh to -£13.78/MWh.
Bid volume was therefore more expensive than 2019. There was no spike in monthly average Bid prices when the first lockdown was implemented like that seen in Offer prices. Lower Bid prices can be linked with the influence of wind generation in the BM. The lowest average monthly Bid prices in 2020 occurred in February (-£25.05/MWh) and November (-£27.18/MWh). These two months also had the highest monthly volume of Bid volume from wind generation for the whole year.
The average Bid price in 2020 was the most expensive average price in the past six years. This was the first year where the average Bid price has been negative. Bid volumes also increased from 2019 to 2020, increasing by 4.8TWh (35%) to 18.7TWh. This explains the significant swing in net Bid cashflow to a cost for the ESO in 2020.
Expenditure on balancing energy for the ESO has risen significantly in 2020. There has been more expenditure on all Bid and Offer volume with the greatest changes seen in money spent on reducing the energy on the system through Bids. Reducing energy on the system in 2020 came with significant financial expenditure rather than benefit to the ESO. More Bid volume was required, and at a higher price.
Low demand due to the impact of COVID-19, combined with the difficulty in forecasting new demand profiles in 2020 is likely to have increased the need for balancing energy. This looks set to be a short term influence on the system. As lockdown restrictions ease and working behaviours return to normal, balancing the system may become more predictable and less costly.
Significant increases in balancing costs from low carbon sources, such as biomass and wind were seen in 2020. This has been a long-term trend, with the cost of biomass balancing energy rising from 2017 and wind from 2016.
Economic incentives for renewable generation with low fuel and operational costs result in the costs for turning down generation from these sources being more expensive. This was seen with wind Bids where no fuel costs and financial benefits of generating (ROCs) contributed to the lowest (most expensive) Bid prices in February and November 2020.
Increased costs for managing renewable generation looks set to continue with the push to a net zero future. National Grid ESO is addressing these costs with projects like the ‘4D Heat project’ with Scottish and Southern Electricity Networks (SSEN) mentioned in their 5-Point Plan. Also, new technologies such as battery storage) may also provide new tools that help to integrate wind and other intermittent generation into the system.