BSC Insight: What is Credit Cover and how does the Credit Assessment Price affect it?
The Credit Assessment Price has changed nine times in 2021 and we recently consulted on increasing the Credit Assessment Price again to a record high of £184/MWh. The Credit Assessment Price is used as a proxy for future Energy Imbalance Prices in the calculation of Credit Cover requirements. Emma Tribe, our Senior Product Analyst from the Analysis and Insights team, explains how the Credit Assessment Price is related to a Parties Credit Cover requirements.
Why does the BSC have credit arrangements?
When a Supplier fails, the companies who remain operational in the market are required to cover the failed Suppliers unpaid costs and ultimately these costs are passed on to end consumers.
Elexon’s job, as the manager of the Balancing and Settlement Code (BSC), is to do everything we can to minimise the parts of these costs that arise under the BSC. In particular, the BSC Trading Charges.
Understanding BSC Trading Charges
Each BSC Trading Party is liable to pay or receive Trading Charges for each Settlement Day. These charges are calculated in relation to Imbalance Settlement and Balancing Mechanism activity.
The first invoice for Trading Charges due to a Party, or due by a Party, is 29 days after the Settlement Day that the Trading Charges were incurred. For example the Trading Charges incurred on 1 September 2021 are due to be paid on 29 September 2021.
There are instances where a Supplier cannot pay the Trading Charges that they have incurred. This is often because their circumstances have changed in the 29 days since the Trading Charge was incurred. To protect the market against unforeseen changes, the BSC requires each BSC Party to lodge Credit Cover.
The unpaid outstanding charges will be taken from the lodged Credit Cover. For example if a BSC Party has £20,000 in Credit Cover and didn’t pay a Trading Charges invoice of £450, then the outstanding £450 would be taken from the Credit Cover. This would leave the Party with £19,550 of Credit Cover. The outstanding charges will be taken from the Credit Cover until no more Credit Cover remains. After the Credit Cover has been exhausted the outstanding charges are invoiced to the remaining BSC Parties.
Understanding Credit Cover
The BSC credit arrangements require Suppliers to lodge enough Credit Cover to cover the 29 days of unpaid Trading Charges should a Supplier have a change in circumstance and be unable to pay. This is called a Parties Indebtedness and is in place to protect the market.
If Suppliers can accurately forecast how much energy their customers will use and buy sufficient energy to cover that consumption, Trading Charges and Credit Requirements can be kept to a minimum.
The BSC has stringent credit and payment arrangements in place. Not complying with these arrangements can have serious consequences. These can trigger a default as soon as 24 hours after an issue occurs, with automatic restrictions on trading wholesale electricity as well notifying the market of the Credit Default.
How is the Credit Assessment Price related to the Credit Cover arrangements?
The Credit Assessment Price is a parameter used in the Credit Cover arrangements. We use this parameter to convert financial amounts in pounds into an energy volume equivalent in megawatt hours (MWh). It will also work the other way to convert an energy volume into an equivalent financial amount.
This conversion is needed because indebtedness is calculated as a volume in megawatt hours, while Credit Cover is lodged and Trading Charges are calculated in pounds sterling.
For example, if a Party had lodged £5,000 as their Credit Cover and their indebtedness was 20MWh then we need to convert one of the figures to compare the two. Using a Credit Assessment Price of £137/MWh, the Credit Cover can be converted into megawatt hours by dividing it by the Credit Assessment Price. So the Credit Cover is equivalent to 36.5MWh. By multiplying the indebtedness by the same Credit Assessment Price we can convert this into a financial amount. So 20MWh is equivalent to £2,740.
Using this example, we compare the indebtedness to the Credit Cover by calculating a Credit Cover percentage that indicates how much indebtedness is covered by the Credit Cover, in this instance the Credit Cover percentage is 55%.
Estimating the 29 days of Total Indebtedness
The total indebtedness calculated by Elexon for each BSC Party is estimating what the most recent 29 days of Settlement Final (SF) Trading Charges will be for that Party.
There are four different estimation methods used in calculating the indebtedness depending on what the best available data is. We calculate a different indebtedness amount for each day included in the 29 day period and add these together to calculate the total indebtedness.
Actual Estimated Indebtedness (AEI)
Where available, the credit calculation adds together the Trading Charges calculated at the Interim Information (II) Settlement Run and converts these into a megawatt hour figure using the Credit Assessment Price. This data gives the best estimate of what the Trading Charges will be at the point of 29 day SF invoice. However, data from the II Settlement Run is only available five working days after the Settlement Day, so cannot be used for the entire indebtedness period.
Metered Estimated Indebtedness (MEI)
Some electricity market participants have electricity meters that can provide data to the Central Data Collection Agent (CDCA). Metered generation or demand for these participants are available for use in the indebtedness calculation after two working days. The difference between metered energy generation or demand and aggregated energy contract volumes is the MEI volume, which is in megawatt hours.
If metered data is not available then the Credit Assessment Energy Indebtedness (CEI) calculation is used until the data for the AEI calculation is available.
Credit Assessment Energy Indebtedness (CEI)
There are two different estimation methods for the CEI part of the indebtedness calculation.
If an electricity market participant has Credit Qualifying Balancing Mechanism Units then the Physical Notifications that they send to National Grid ESO, notifying how much electricity will generated or consumed, can be used in the indebtedness calculation. The difference between Physical Notification electricity volumes and aggregated energy contract volumes gives the CEI volume for Credit Qualifying units. Most generation units are Credit Qualifying.
For market participants that don’t have Credit Qualifying units the CEI calculation uses an estimate of average generation or demand in a season to compare to aggregated energy contract volumes. The estimates of average generation and demand require market participants to submit estimates of their expected maximum generation and demand. Most suppliers do not have Credit Qualifying units.
Indebtedness under different Credit Assessment Prices
The graph below show what the total Indebtedness was in megawatt hours for all parties in every day of 2021 up to 26 September 2021. This is compared to a modelled Indebtedness to show the effect of changing the Credit Assessment Price.
The Credit Assessment Price is also shown for context. Since April 2021 the Credit Assessment Price has increased five times to reflect increasing forward market prices. It is also due to increase on 5 October 2021 to £137/MWh.
You can set the Credit Assessment Price using the scroll bar in the top right corner of the graph to see how different values of Credit Assessment Price would have changed historical values of total Indebtedness.
This graph has a filter for BSC Parties that are registered as either Generator, Supplier or other. The ‘other’ includes BSC Parties that have registered as both Generator and Supplier, Non-Physical Traders and Interconnector users.
In general increasing the Credit Assessment Price increases the total indebtedness and decreasing the Credit Assessment Price decreases the total indebtedness.
Indebtedness compared to calculated Trading Charges
The graph below has been created to allow you to compare every day, for every BSC Party, what the total indebtedness was at the end of the day against what the Trading Charges for those 29 days were at the II and SF Settlement Runs. This demonstrates the effectiveness of the indebtedness calculation for estimating 29 days of SF Trading Charges.
As we are comparing the Indebtedness to Trading Charges, the Indebtedness has been converted to a financial amount using the Credit Assessment Price.
The Net Trading Charges are negative because overall more is paid out to Parties through Trading Charges than is paid by Parties. However, if filtered for Suppliers then the Net Trading Charges are positive, as suppliers tend to pay more in Trading Charges than is paid to them.
Improvements to the CAP calculation
There have been several Modifications and Issue Groups to investigate and implement improvements to the estimation of indebtedness since the New Electricity Trading Arrangements (NETA) were introduced in 2001. The most recent changes implemented in February 2019 were introduced to improve estimates submitted by market participants for use in the CEI calculation.
The CEI part of the calculation contains the most estimation, and is the least reflective of the SF Trading Charges. While the modification introduced in 2019 did improve the submitted estimates, this is still an issue for the indebtedness calculation.
The Credit Assessment Price is part of the estimations to calculate a fair indebtedness that will ensure that Parties lodge sufficient credit cover.
Indebtedness per BSC Party
While the analysis above is looking at the total indebtedness and Trading Charges, the reality is that indebtedness and credit cover percentages can be very different for different BSC Parties. Indebtedness changes based on trading strategy, Imbalance Prices and the accuracy of the estimated generation and demand.
Changes to the Credit Assessment Price can impact a Parties indebtedness. In the majority of cases, this does not affect the Credit Cover a BSC Party is required to lodge. We have estimated that increasing the Credit Assessment Price from £113/MWh to £137/MWh will mean that five BSC Parties may need to lodge additional Credit Cover.
BSC Parties should monitor their Credit Cover Percentage positions to ensure they always have sufficient Credit Cover to avoid a Credit Default. The consequences of which could be a notice on the Balancing Mechanism Reporting Service (BMRS), restrictions on the Trading of Energy or if left unresolved a Section H Default and referral to the BSC Panel. This is particularly important when there are extreme System Prices and changes to the Credit Assessment Price.