ESO balancing reserve proposals rejected by Ofgem

Ofgem has rejected proposals by National Grid Electricity System Operator (ESO) to create a new balancing reserve that could potentially save more than £1.5 billion by 2025.

Although it recognised the possible benefits, the regulator said it was concerned the service would be unduly discriminatory to smaller balancing providers due the proposed 50MW minimum size limit.

Under the current arrangements, the ESO waits until gate closure to determine whether there is enough headroom and footroom available on the market from units that are running to provide a reserve for system balancing. If this is not the case, the body accepts bids or offers to create this headroom or footroom. When bids are required to create headroom, this energy needs be replaced by accepting offers from alternative units.

In response to rising balancing costs, the ESO has proposed to create a new balancing reserve to procure balancing capacity though a day-ahead pay-as-clear auction. The body said this would avoid the risk of incurring high costs to procure balancing capacity at short notice through the Balancing Mechanism, whilst offering participating units equivalent or higher rates of returns as the wholesale market.

A cost-benefit analysis conducted by LCP Delta concluded that a balancing reserve could cut costs for consumers by hundreds of millions of pounds over the next three years.

In its base case, representing the average of 10 simulations, the net savings totalled £873 million between 2023 and 2025, and in the the most favourable simulation, the savings amounted to £1,518 million.

In the least favourable simulation, the savings were much smaller but still significant at £139 million, although there was a net cost to consumers of £283 million in 2025.

Following a consultation last year, the ESO submitted proposals to Ofgem in January to update balancing-related terms and conditions to enable it to create the new service. The regulator has now rejected the proposals.

Ofgem said it recognises the motivation for, and potential operational and cost benefits of, a new balancing reserve. The regulator itself proposed such a service in a call for input in November as one of six potential options for reducing balancing costs following the record-high prices seen during the previous winter.

The options were put forward after investigations by both the ESO and Ofgem found instances of what the regulator described as “immoderate” behaviour by generators.

However, Ofgem dismissed the option of a balancing reserve last month in favour of a new licence condition that would prevent generators in the Balancing Mechanism from obtaining “excessive” profits by first signalling their intention to cease generating and then raising their prices to remain on.

Explaining its decision to reject the ESO’s own proposals for a balancing reserve, Ofgem said it has concerns over the minimum threshold for participation of 50MW, which respondents to the ESO’s consultation described as unduly discriminatory.

The regulator said the proposals may not be compliant with EU balancing regulations and the ESO’s own licence, which state that balancing markets should be non-discriminatory.

Under the principle of proportionality, Ofgem said limited discrimination may be permissible in some cases, for example, if there are technical constraints.

But the regulator said it is not convinced by the ESO’s argument that the 50MW threshold for minimum bids is justified by the need to dispatch units at short notice. Furthermore, Ofgem said this limit would have significant downsides, including reduced liquidity and elevated prices in the balancing reserve.

The regulator did accept that the ESO faces a technical limit on the number of units it can dispatch to provide reserve until this issue is alleviated through IT upgrades for its control room.

“However,” it added, “we are firm in our view that this should not mean a direct discrimination of units based on their size, especially where this limits the ESO’s access to potentially cheaper providers without breaching the maximum number of units that the ESO can dispatch efficiently.

“We believe design of a balancing reserve-type product that does not directly restrict access to the market for certain units based on their size could be feasible, and may offer consumer value through a reduction in balancing costs.”

Ofgem said it also had concerns that the deterrent for non-delivery is insufficient. The ESO proposed to cap reimbursements at whatever is larger of £250,000 or the value of availability payments for the contract in question.

The regulator said the ESO had failed to properly justify this figure, which it worried is not high enough: “Without a sufficiently high deterrent, providers may be able to take advantage of a change in market conditions between the day-ahead auction for balancing reserve capacity and real time which would negate the benefit of the service without providing commercial detriment to providers.

“While we recognise that the cap can be higher than £250,000 for large contracts, we expect that availability payments for most balancing reserve contracts will be far below £250,000, and hence this alternative figure for the cap would have little effect.

“Therefore, we believe that this cap could invalidate the ESO’s main reason for introducing a balancing reserve, which is to reduce high costs seen during periods of generation scarcity.”

Ofgem said although it has rejected the proposals, the ESO is welcome to put forward an updated design, provided it addresses these concerns and there is further consultation with industry.