Supplementary memorandum by the Renewable
RPA SUBMISSION TO GOVERNMENT RESPONSE TO
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
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 arrangementsreview
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.
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.
1.1 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 consultationaddressing
the adverse effects of NETA on small generators is of vital importance
if the government's targets for growth in renewables are to be
1.3 NETA has had a major adverse impact
on renewables. Ofgem's review of the first two months of NETA
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
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
1.6 This response comments on the options
suggested in the consultation paper and also suggests some additional
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
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
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.
|System Buy Price||36.1
|System Sell Price||10.3
2.3 The various options for mitigating (but not removing)
the adverse impact of the dual imbalance pricesnotably
active risk management and consolidationare complex and
expensive to arrange, disproportionately so for small generation
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
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.
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.
Balancing supply and demand: contractual positions versus physical
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
3.8 Balancing contractual positions against expected
metered output right up to gate closure is expensiverequiring
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
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
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
a substantial increase in part-loaded plant as
compared to operations in the Pool, one consequence of which is
the market has typically been long rather than
balanced, potentially creating a new set of problems for the System
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 pricesboth in design and in practiceare
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
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
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
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
4.8 RPA believes that ex-post trading has advantages
over consolidation. The advantages are:
ex-post trading is potentially more complete than
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 timemarket
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"
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 arrangementan element of
the surplus involves the recovery of costs that have not actually
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.
THE RELATIVE MERITS OF A SINGLE CASH-OUT PRICE VERSUS
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
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
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.
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" sensethe 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 NETAthe 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
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
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.
Source: Elexon monthly report for October Back
While taking into account network constraints and the need to
schedule frequency response, reserve etc. Back
Source: Milborrow, D J, 2002 (to be published). Accommodating
Wind. IEE Review, Vol 48, No 1 (January). Back