Is the Balancing Mechanism (BM) the next big thing in flexible energy? We believe it is – for the foreseeable future.
The most lucrative options shift as the energy landscape changes which means you need to be able to stay ahead of the curve to maximise your revenue. This applies to aggregators like Flexitricity as much as it does to energy users, generators and developers. As Mr Darwin so aptly put it: “It is not the strongest species that survive, nor the most intelligent, but the ones most responsive to change.”
The competition in the reserve and response services is increasing rapidly - take batteries, for example. Full time dynamic Firm Frequency Response (dFFR) is still just about the most lucrative option. However, as more battery storage enters the market and competes for frequency response revenue, the price erosion that many, including us, predicted is now happening. Tender rejections are increasing, people are securing night-only contracts and there is a bit of strategic head-scratching going on to figure out ‘what do we do now?’. Short Term Operating Reserve (STOR) and Capacity Market (CM) present a similar picture.
There are still opportunities in these markets – if you have the right team in your corner – but the key to making a return on these projects is now all about agility and market access. The evidence shows that valuable long-term contracts are fast becoming a thing of the past. So, rather than pigeon holing an asset in a certain market, people are getting their heads around ‘going merchant’ to build a more flexible revenue stack - and trading in the BM is becoming widely recognised as a critical piece in the puzzle.
That is why Flexitricity will be the first to take customer-side flexibility into the BM. Many suppliers and aggregators, including us, are planning to offer BM access to merchant assets like batteries and peaking generators. However, only Flexitricity has the operational capability and experience to unlock BM access for all flexible resources, from developers to commercial and industrial energy users.
What’s the size of the prize?
We know that prices in the BM can reach £2,500/MWh, compared to around £50/MWh in wholesale markets. And while that makes for a good headline, in truth it doesn’t happen very often. We’re not known for being a company that sugar coats things, so here’s a more down to earth stat for you: over the last two years, the price has been above £100/MWh about a third of the time. And this doesn’t include lots of 'flagged' expensive actions which certain assets (including batteries) will also be able to compete for.
Having said that, take a look at the BM with decidedly not rose-tinted glasses on, and you can see that there’s a lot to be excited about. The market is already used around 3,000 times per day at a cost of £350 million per year. And with the continuing growth of the renewable energy sector and the resulting increase in system volatility – it’s only going to grow.
The BM was expected to balance 2% of the market when it was established in 2001. Today, it’s already being used to balance over 5% of electricity on average and we’re seeing days where National Grid has to use the Balancing Mechanism to reposition over 50% of the market. The opportunity is clearly there for the taking and there’s no reason energy customers and small generators shouldn’t get a piece of the pie.
With every reward comes risk
Being the first aggregator to take customer-side flexibility in to the BM gives Flexitricity the first-mover advantage. But obviously with every reward comes risk. Just like with that uniquely brilliant business idea that pops into your head in the middle of the night, there’s a reason - or rather a host of reasons - why no one has attempted it before. National Grid has been very supportive along the way but they’re only just removing the shrink-wrap from their ‘aggregation in the BM’ rulebook; being the first companies to try to use it has understandably presented some hurdles.
Setting up and operating as a gas and electricity supplier is also an incredibly complex, not to mention costly, process – which explains why the BM has so far mostly been a playground of the Big Six.
Energy customers and small generators cannot access the BM directly; they have to go through licensed suppliers. But large suppliers of course own their own generating assets and are thus incentivised to trade their own capacity first. That’s why the door to the BM market has been firmly closed to customer-side flexibility until now. I’m glad to say that we’ve fought our way through most of the challenges now and are ready to make history this October.
But needless to say – the learning never stops. Sites with flexible load and/or behind-the-meter generation, and developers/owners of flexible distribution-connected assets (batteries, gas peakers, hydro, etc.) are keeping the team busy with all the expected questions, and some unexpected ones.
Like with any other trading opportunity, price volatility and the associated risk are an inherent part of the BM proposition. By looking at the price patterns from previous years and analysing a host of other factors (kudos to our team of analysts who spent the long Scottish winter working on this), we can forecast potential BM revenue with a reasonable degree of accuracy – but there are no guarantees.
There’s no ‘one size fits all’ strategy when it comes to BM. It depends on the asset type and whether it has a day job or it’s purely merchant; asset condition and associated warranties; business strategy and risk appetite - a whole host of parameters which set the broad rules of engagement.
Furthermore, market shifts can alter both the long-term strategy and affect the more immediate decisions. For example, National Grid’s System Needs and Product Strategy (SNaPS) is likely to introduce the day-ahead purchase of frequency response. Whilst we know that the insecurity of day-ahead contracts gives investors pause for thought, and that SNaPS is still being refined, it is fair to say that this is a direction of travel which now (forgive the pun) carries too much inertia to be changed. Not that we think it should!
The most lucrative opportunity for 2019
So, it’s more than likely that in 2019 the most lucrative opportunity for batteries will be switching between BM trading and frequency response – possibly on a daily basis. For other types of assets that can’t participate in frequency response, maximising their BM revenue is already the way forward, and we’re excited about this!
This setup - balancing real-time system needs with flexibility from active customers - is what the system needs and that’s where the market is headed. Inevitably, this involves a whole host of moving parts and a degree of risk – the key to success lies in how you manage it and how quickly you can adapt to change to ensure you aren’t left behind.