Select Committee on Trade and Industry Appendices to the Minutes of Evidence


APPENDIX 12

Supplementary memorandum by the Renewable Power Association

RPA SUBMISSION TO GOVERNMENT RESPONSE TO OFGEM'S REPORTS

  Renewable electricity generation is in a particularly perilous situation at present, following the news that the introduction of the Renewables Obligation is likely to be further delayed by some months. Generators whose plants are exposed to the damaging effects of NETA had initially been expecting the obligation to start in October this year. These generators are already suffering due to the current delay and the news that this is to be extended is devastating.

  For new generation projects, the damage this further delay will cause is self-evident.

  This situation only adds weight to the need to do something about NETA for renewable generators.

  RPA submission to Government response to Ofgem's reports "The new electricity trading arrangements—review of the first three months" and "Report to the DTI on the review of the initial impact of NETA on smaller generators" of 31 August 2001.

1.  INTRODUCTION

  The Renewable Power Association (RPA) is a newly established trade association representing producers of renewable energy. Its membership includes renewable electricity generators, fuel suppliers and providers of heat, along with their equipment and service providers.

  The RPA has member companies involved in wind energy, solar, biogas, energy-from-waste, landfill gas, biomass, wave, tidal, marine current and sewage gas industries, together with respected names from the legal, accounting, energy trading and academic communities.

  The RPA works on the large number of generic issues that affect renewable energy producers, irrespective of the technology involved. These include the New Electricity Trading Arrangements, the Renewables Obligation, renewables integration issues, embedded generation, NFFO/SRO contract issues, emissions savings, planning, the Climate Change Levy, etc.

1.  SUMMARY

  1.1  This paper represents the Renewable Power Association's response to the DTI consultation on the impact of NETA on small generators.

  1.2  The RPA welcomes the DTI consultation—addressing the adverse effects of NETA on small generators is of vital importance if the government's targets for growth in renewables are to be met.

  1.3  NETA has had a major adverse impact on renewables. Ofgem's review of the first two months of NETA reported:

    —  a substantial drop in average price received (and without taking into account the impact of the Climate Change Levy Exemption, without which the price reduction would have been significantly greater); and

    —  a 14 per cent drop in output of renewable generation.

  The consequences for the government's target of 10 per cent of electricity from renewables by 2010 are self-evident.

  1.4  Much of the potential growth in renewables over the remainder of the decade is from intermittent technologies, particularly wind, which is more severely affected by NETA.

  1.5  The fundamental cause of the problems created by NETA for small generators is the dual imbalance price arrangement. The imbalance prices to date have been extreme and non-cost-reflective. The cost of mitigating these adverse effects if disproportionately high for small generators. Consolidation, a potential means of partial mitigation, has not materialised in practice.

  1.6  This response comments on the options suggested in the consultation paper and also suggests some additional options.

  1.7  Of the options in the consultation paper, the RPA believes that the best way to address the adverse impact of NETA on small generators is to revert to a single imbalance price, consistent with the underlying economics of electricity markets.

  1.8  The single imbalance price could either be for small generators only, or for the whole market. There is widespread support for a single imbalance price, including from such impartial but expert observers as Stephen Littlechild. There is a discussion on the merits of both approaches in Annex 1.

  1.9  In summary, RPA's views on the various options put forward by the DTI are as follows:

    —  full support for the concept of cost-reflective prices and the corollary, a single imbalance price;

    —  improving consolidation options is addressing a symptom rather than the underlying problem caused by NETA, and is only worth pursuing if the underlying problem is not addressed. RPA is sceptical as to whether consolidation will ever be cost-effective for small generators;

    —  ex-post trading is similarly addressing a symptom rather than the underlying problem, but is probably a more practical option than consolidation;

    —  "de minimis" or deadband provisions might be a practical way of delivering a neutral imbalance price for the majority of renewable generator imbalances, but the deadband would need to be sufficiently large to be of value to larger renewable projects such as offshore wind;

    —  providing greater access to imbalance surplus for small generators would, as for consolidation and ex-post trading, be addressing a symptom rather than the underlying problem, but would be worth pursuing if the underlying problem is not addressed.

2.  THE PROBLEMS CAUSED BY NETA

  2.1  This section of the submission briefly summarises why NETA has caused such undue difficulty for renewable generators as compared to their underlying economic value.

  2.2  The root of the problem is the intentionally unattractive dual imbalance prices. Renewable generators, and intermittent generators such as wind and solar in particular, are disproportionately exposed to imbalances. The imbalance prices, and the spread between them, are not cost-reflective (as discussed in paragraphs 3.11 & 3.12), significantly damaging the commercial value of renewable generation as compared to the underlying economics. Recent NETA imbalance prices are shown in the table below.
Mean prices AugustSeptember October
System Buy Price36.1 29.724.7
System Sell Price10.3 8.38.3
Price spread25.821.3 16.4
Source[31]


  2.3  The various options for mitigating (but not removing) the adverse impact of the dual imbalance prices—notably active risk management and consolidation—are complex and expensive to arrange, disproportionately so for small generation projects.

  2.4  The imbalance regime has undermined the negotiating position of small generators in the contract market. In a market of ever-increasing supplier market power, small generators no longer have a satisfactory market-of-last-resort (as the Pool used to be)—a neutral market into which they can sell power if unable to negotiate satisfactory contractual arrangements.

3.  THE ECONOMICS OF NETA

Bilateral commercial arrangements versus physical pooling

  3.1  NETA is based on a model of bilateral forward contracting. Strong commercial incentives to contract forward are provided by intentionally unattractive energy imbalance prices. Parties are penalised for imbalances on the basis of their individual contracting position relative to their metered output or demand.

  3.2  However, as the DTI notes, this basis for market design is at odds with the physical reality of an interconnected network, with a high degree of diversity amongst both producers (generators) and consumers (via their suppliers). The System Operator (NGC) balances total demand against total supply[32]. In undertaking system balancing, the System Operator will take account of this diversity.

  3.3  The unpredictability of, for example, one wind turbine has no direct relevance to the cost of balancing supply and demand. The following chart illustrates the extent to which the variability of output of a group of geographically distributed wind turbines reduces as compared to a single wind turbine. The variability of output reduces still further as other intermittent sources of generation are added.


Source[33]

Balancing supply and demand: contractual positions versus physical information

  3.5  The System Operator does not know about the contractual positions of individual market participants, and so cannot use this information in the course of system balancing.

  3.6  The cost of system balancing depends more on the quality of the information accessible to the System Operator than on the contract positions of market participants. At present, the System Operator does not request information from generators of less than 50MW, and would almost certainly not be able to make use of such information anyway (because of information overload). Instead, the forecasts demand net of embedded generation and utilises the information provided by large generating units in planning for system operation.

  3.7  NETA is based around the idea that market participants should balance their contractual positions before gate closure and then provide information on their expected physical output or demand to the System Operator, when in fact only the latter action is of direct value in reducing the overall cost of meeting demand.

  3.8  Balancing contractual positions against expected metered output right up to gate closure is expensive—requiring access to an active trading operation which involves considerable cost in the initial set up, in staffing, in credit arrangements, in transactions and so on.

  3.9  The NETA rules contain provision to incentivise the provision of accurate information to the System Operator, via a Grid Code requirement and, if necessary, the introduction of a non-zero information imbalance charge.

  3.10  If an information imbalance charge were deemed to be necessary (in the light of experience of consistently inaccurate provision of information by market participants), then it would probably not need to be very large. The charge would only need to be high enough to outweigh the costs of obtaining and providing up-to-date information on expected output or demand.

The underlying economics: single or dual imbalance prices?

  3.11  Settlement of the wholesale electricity market is based on half-hourly trading periods. Over a half-hour as a whole, the market can only be long or short. It is not physically possible to be both. There can only be one representative price for energy for the half-hour as a whole. If the System Operator takes actions in both directions within a half-hour, these will be for system balancing reasons, including for example within-half-hour energy balancing.

  3.12  Any attempt to create two prices requires some form of artifice, and cannot (by definition) be cost-reflective.

The imbalance prices to date have clearly not been cost-reflective

  3.13  The spread between System Buy Price (SBP) and System Sell Price (SSP) has reduced since the inception of NETA. However, the spreads still remain very large, and far greater than could be rationalised based on the underlying economics of supply and demand.

  3.14  This point is illustrated most starkly for the System Buy Price (SBP) in a market that has invariably been long. An average for SBP of around £30/MWh simply makes no sense at all. Nor do the imbalance price spreads, in a market where there has typically been a large quantity of thermal plant operating at part load.

  3.15  It is worth remembering that in the design phase of NETA, Ofgem initially considered setting dual imbalance prices on the basis of a forward price plus or minus a specified percentage (an indicator of the difficulty in finding a cost-reflective basis for setting prices). The numbers discussed at the time were plus or minus 5 per cent or 10 per cent, compared to the 50 per cent and above that we have seen to date. And we have not yet experienced the behaviour of imbalance prices through the winter months, when they could be significantly more extreme.

  3.16  The extreme imbalance price spreads, and the sometimes extreme levels of System Buy Price have created other perverse effects, including:

    —  a substantial increase in part-loaded plant as compared to operations in the Pool, one consequence of which is higher emissions;

    —  the market has typically been long rather than balanced, potentially creating a new set of problems for the System Operator;

    —  incentives to over-maintain existing plant (generation and demand) and to over-design new plant;

    —  expenditure on trading and consolidation capabilities that do not deliver any economic value (but rather help to mitigate the new risks unnecessarily created by the NETA design); and

    —  uninformed decision-making in short-term time frames because of the unpredictability of the imbalance prices (and the delay in publishing accurate imbalance price data).

A single imbalance price would still incentivise forward contracting

  3.17  Ofgem has expressed concern that reverting to a single imbalance price would remove incentives on market participants to contract forward. Ofgem places value in such forward contracting because it should reduce the extent of system balancing required by the System Operator (although of itself this would not necessarily reduce the cost of meeting demand over time).

  3.18  Experience from the Pool is that a single but volatile price was sufficient to incentivise very high levels of forward contracting. NETA imbalance prices, because they are set much closer to real time than were Pool prices, are inherently more volatile than Pool prices, and so are more likely to incentivise high levels of forward contracting.

  3.19  Developing cost-reflective prices is complex and cannot be achieved simply through dual imbalance prices.

  3.20  Ofgem has argued that the use of dual imbalance prices enables an appropriate targeting of costs on those who impose them. We do not accept this view; for the reasons given above, the dual imbalance prices—both in design and in practice—are clearly not cost-reflective.

  3.21  Designing genuinely cost-reflective pricing arrangements is extremely complex. For example:

    —  defining the boundary between "system balancing" and "energy balancing" is difficult and somewhat arbitrary;

    —  assessing the drivers of the cost of system support is complex. For example, the level of frequency response carried on the system is typically set by reference to the largest single generation or transmission unit on the system, but associated the cost is not recovered on this basis;

    —  NGC is just starting to model the impact of intermittent generation on the cost of system operation. Initial analysis (as part of NGC's evidence to the PIU Energy Review) suggests that there would need to be a significant increase in the volume of wind generation before additional reserve would be needed on the system;

    —  in low demand periods (such as summer nights), the inflexibility of nuclear plant can impose costs on the system.

  3.22  Any attempt to move towards cost-reflective pricing will require some form of simplification. However, the simplification adopted in NETA is clearly not cost-reflective and has the consequence of unreasonably disadvantaging renewable generation, to the detriment of wider government policy objectives.

4.  THE DTI PROPOSALS

  4.1  RPA believes that the fundamental cause of the problems for small generators in NETA is the dual imbalance prices.

Ensuring energy imbalance prices are consistent with cost-reflective principles

  4.2  RPA strongly supports the principle of cost-reflectivity in pricing, which leads inexorably to the conclusion that there can be only one cash-out price. Further moves towards cost-reflectivity could be addressed by other means, which might include some form of information imbalance charge and consideration of the way in which some elements of system support costs are currently allocated.

  4.3  RPA would expect the nature of cost-reflective charges to evolve over time; for example, as and when renewable generation becomes a much more significant proportion of total generation, it might be appropriate to reflect any new costs imposed on system operation through changes to the methodology of charging for system support costs.

Consolidation

  4.4  RPA believes that improving the workability of consolidation is very much a second-best option that tackles a symptom rather than the cause of the underlying problem. The need for consolidation only arises because of the artifice of the dual imbalance prices.

  4.5  As discussed above, the physical reality of an interconnected network is that consolidation of all generation and of all demand happens automatically. The System Operator balances consolidated supply against consolidated demand.

  4.6  Requiring generators and suppliers to incur real costs in order to arrive at commercial arrangements that go only very partially towards reflecting the true physical position seems of questionable value, both for individual market participants and for electricity consumers.

  4.7  RPA would support further the expenditure of further effort in this direction only if first-best solutions to the problem are not pursued.

Other options in the consultation paper

Ex-post trading

  4.8  RPA believes that ex-post trading has advantages over consolidation. The advantages are:

    —  ex-post trading is potentially more complete than consolidation; and

    —  ex-post trading can be done after gate-closure and after real time, and so would substantially reduce the cost of NETA for all market participants.

  4.9  We do not believe that allowing ex-post trading would undermine the incentives to contract ahead of time—market participants will invariably prefer certainty over uncertainty, and will contract accordingly.

  4.10  The relationship between ex-post trading and access to embedded benefits for small generators would need to be addressed if this option were to be pursued.

Single cash-out price

  4.12  The RPA has addressed this argument above, and believes that application of the principle of cost-reflectivity would result in a single cash-out price.

"de minimis" or Deadband provisions

  4.13  We understand that this arrangement would involve use of a "neutral" imbalance price for "de minimis" imbalances.

  4.14  This would be one means of achieving a single imbalance price for most renewable generation. Its merits as compared with a neutral imbalance for all are discussed in Annex 1.

  4.15  However, the "de minimis" level would need to be sufficiently large to be of use to larger renewable projects, such as offshore wind.

Greater access to imbalance revenue surplus

  4.16  As with consolidation and ex-post trading, RPA believes that this would be addressing the symptom rather than the cause. The existence of the imbalance surplus is testimony to the non-cost-reflectivity of the dual imbalance pricing arrangement—an element of the surplus involves the recovery of costs that have not actually been incurred.

  4.17  Intermittent generators, such as wind, will be disproportionate contributors to the accumulation of the surplus, and would only benefit to a very limited extent in getting access to some element of the surplus distribution.

  4.18  However, if DTI does not address the underlying problems in NETA, then changing the basis of allocation of the imbalance surplus would be worth pursuing.

Annex 1

THE RELATIVE MERITS OF A SINGLE CASH-OUT PRICE VERSUS A DEADBAND

The following paragraphs address the merits of benefiting renewables or changing NETA rules for all market participants

  From a commercial point of view, any competitive advantage to renewables would be helpful in promoting further growth towards the government's targets.

  Our understanding is that any arrangement that gives special treatment to renewables within NETA may be difficult to implement from a legal viewpoint, quite apart from Ofgem's likely objections on grounds of "principle".

  The legal problems arise via the objectives contained in the NGC Licence (promoting competition etc) and because of the principle of non-discrimination (notwithstanding that the current arrangements are unduly discriminatory against renewables and CHP).

Singe imbalance price versus a deadband

  A single imbalance price could apply to all imbalance volumes for all parties. As we understand it, a deadband would apply to a limited volume of imbalance. The deadband could be available to all parties, or to specific groups only, such as renewables (subject to legal constraints).

  A deadband applying to all parties within NETA should be proportionately of greater value to smaller players. For example, 100 projects of 1MW each might all avoid any imbalance outside the deadband, whereas one project of 100MW might not. A deadband might be of only limited value to larger renewable projects, such as offshore wind.

  The mechanics of a deadband would require some thought. The issue for renewables is that they typically trade with suppliers outside the central settlement system. The suppliers then trade on a net basis within central settlement.

  To be of benefit to renewables, the deadband would need to be applied to their contractual arrangements with suppliers. This would involve additional complexity in systems, in particular within Supplier Volume Allocation (SVA) (formerly known as Stage 2).

  One advantage of the single imbalance price for all market participants is that renewables would benefit without need for major changes to SVA, although some changes within central settlements would be required.

Annex 2

Making renewables "invisible" within NETA or "exempting" them from NETA

  Making renewables "invisible" is sometimes suggested as an option that RPA should be advocating. We discuss below what this might mean in practice and how it might be delivered.

  The settlement system accounts for all kWh produced, consumed and lost, and forms the basis for financial settlement.

  At present, renewable generators sell their power to suppliers, generally outside the central NETA systems (but not necessarily). The suppliers register the renewable generators' meters in SVA.

  The suppliers are treated in central settlement on a net basis ie on the basis of volume taken from the transmission network to meet demand net of embedded generation within each GSP Group.

  Renewables probably could not be made "invisible" in a "physical" sense—the overall settlement would not add up. However, renewables could be made "invisible" in a financial sense ie they could be protected from the main adverse financial effect of NETA—the dual imbalance prices.

  RPA member ILEX has previously a note prepared for the Cabinet Office's Policy and Innovation Unit, on a way of enabling renewable (and CHP) generators to access a neutral imbalance price. There are a number of issues in any such arrangement that would need to be worked through, including funding. As noted above, any within-NETA funding would raise legal issues.

  Alternatively, and more radically, renewable generators could simply sell their output to a central purchasing agency (along the lines of NFPA), under a standard contractual form, and effectively ignore the complexities of NETA. The price could be based, for example, on a forward market price, or on an administered price set by government. The central agency would then be responsible for the relevant meters within settlement, and for selling the output in the various NETA markets (eg via auctions, as NFPA is currently doing for the NFFO projects). Introducing such an arrangement would involve transitional issues, notably the treatment of existing contracts between generators and suppliers.

Treating Renewable output as if it had been traded in the Balancing Mechanism

  A member of the RPA has put forward the suggestion that small generators should be paid the average price at which NGC despatches power from large generators, ie Balancing mechanism system buy price.

  This method could be seen as positive discrimination in favour of the generators it applied to (be they renewables, renewables plus CHP or all licence-exempt generators). If applied to renewables it would provide an additional stimulus to deployment, which would be welcome in light of the scale of the Government's targets and delayed onset of the Renewable Obligation.

  It is suggested that payment at this level would act as a proxy for other benefits which renewable plant is unable to access under NETA, due to its small size, such as frequency response and the ability to trade in the balancing mechanism. Although ancillary payments are under review by the Embedded Generation Co-ordinating Committee it is likely to take a long time before they are implemented.


31   Source: Elexon monthly report for October Back

32   While taking into account network constraints and the need to schedule frequency response, reserve etc. Back

33   Source: Milborrow, D J, 2002 (to be published). Accommodating Wind. IEE Review, Vol 48, No 1 (January). Back


 
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