Imbalance Pricing Soars as Seldom Used Part of the Pricing Methodology Invoked
5 Mar 2020

Yesterday, the 4th March 2020, saw cashout pricing reach highs not seen since 2015 with System Pricing in settlement periods 37 and 38 reaching £2,242/MWh and £1,708/MWh. This was almost £2,000/MWh above where the Day-Ahead (DA) and Within-Day (WD) power markets valued the settlement periods. So, what drove these price spikes?

Many in the market are saying that fundamentally demand on the grid outstripped supply. Whilst this is true given Net Imbalance Volume showed a system up to 470 MWh short, this isn’t an extreme value. Generation capacity was similar to recent days with no significant changes to plant availability, whilst demand wasn’t overtly high, sitting at the highs of last week and below this year’s Triad demand figures. We think blaming this on a short system alone ignores the extreme nature of the pricing and the intricacies of the UK imbalance pricing methodology. What triggered the high imbalance pricing was the Reserve Scarcity Pricing (RSP) mechanism, which aims to correctly price in the value of demand disconnection from the grid.

The RSP = Value of Lost Load (VoLL) x Loss of Load Probability (LoLP). The VoLL is set at £6,000/MWh whilst the LoLP is calculated using the graph below:

De-rated Margin on the x-axis is how much generation headroom there is above the true demand and where this headroom isn’t ‘enough’, LoLP becomes >0%. LoLP was calculated at just above 37% in SP 37, bringing cashout pricing up to £2,250/MWh. With almost all the available units running, there was little in terms of headroom for grid to manage system tightness, which meant that STOR units were called on and system pricing was set relative to the RSP. With LoLP being forecast and published, it should act as a signal – however markets did not price in the RSP event. Within day, market prices rose to a maximum of just £350/MWh, still significantly below the VoLL and imbalance pricing.

The next important question for those in the market is – will this happen again and what will reactions be next time? Well, the extreme pricing was driven by the interaction of increasingly marginal and volatile components being built into the imbalance pricing methodology and a high penetration of intermittent generation. RSP was only introduced in 2015, in 2018 the VoLL was increased from £3,000/MWh to £6,000/MWh and the system moved from Price Average Reference (PAR) volume of 50 MWh to 1 MWh threshold, making imbalance pricing extremely sensitive to bid/offer acceptance. This means that as we see more plants coming off the grid, increasing inflexible renewable penetration, and pricing methodologies capturing more volatility, RSP events could become more likely. However, these are not necessarily investment-case opportunities due their infrequent nature despite their high potential profitability. Furthermore, when the next RSP event looks likely we would expect to see market players react differently and pay far more attention to LoLP, which may erode the extremity of pricing by creating more headroom.

For more information, please feel free to get in touch with Jim Nichol on our short term power and gas trading desk at tradingdesk@brookgreensupply.com

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