Ofgem cracks down on excess balancing profits

Ofgem has given the final go-ahead to a new licence condition to prevent generators from obtaining excessive profits by signaling their intention to stop producing power during periods of scarcity and then charging extortionate prices to continue generating.

The regulator originally proposed the licence condition in November last year after balancing costs “rose alarmingly” to £1.5 billion over the winter of 2021, compared to an average of £500 million per year between 2017 and 2020.

A subsequent review commissioned by the Electricity System Operator (ESO) found instances of coal and gas generators submitting zero-megawatt physical notifications for the afternoon on days when electricity supplies were tight and then charging high prices in the Balancing Mechanism to continue generating. The ESO said the inflexible nature of the generators in question, which take a long time to ramp down and then back up, meant it was forced to pay these high prices for multiple hours to prevent them from desynchronising in the afternoon and keep them online for the evening peak in demand.

In an open letter to the industry published in July last year, Ofgem set out a series of broad options for preventing this “immoderate” behaviour by generators, including restrictions on Balancing Mechanism prices. In a call for input in November, the regulator narrowed this down to six specific options and identified the new licence condition as its preferred solution.

The licence condition states that generators with a “minimum zero time” of longer than 60 minutes “must not obtain an excessive benefit” with respect to settlement periods for which they have revised their physical notification “from a positive MW value to zero MW within the operational day”.

The stipulation that the licence condition should only apply to zero-megawatt physical notifications submitted “within the operational day” was removed from the draft text in Ofgem’s initial consultation launched in February.

However, the regulator added this back in its statutory consultation launched at the end of June after stakeholders raised concerns that the licence condition could otherwise have several unintended consequences, including discouraging generators from quickly returning from outages. Ofgem reaffirmed its position that high prices during periods of “genuine scarcity” are necessary to balance supply and demand and incentivise investment in additional capacity.

The Inflexible Offer Licence Condition will come into effect on 26 October. Ofgem said any generators found to be in breach of the new rules could face “stiff penalties” including provisional and final orders and “fines of up to 10% of their regulated turnover.”

Eleanor Warburton, director for energy systems management and security at Ofgem, said: “This new licence conditions shows Ofgem will not tolerate electricity generators attempting to take advantage of the Balancing Mechanism system to make excessive profits through inflexible generation.

“We believe the new licence condition strikes the right balance between protecting consumers and ensuring they pay a fair price for their energy while also enabling a competitive electricity market that provides fair returns for generators.

“We’ll be monitoring the effectiveness of it to ensure it’s doing what it was designed to do.”