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Demand Side Response – How to generate revenue from flexibility when the capacity market closes at £0.77/KW.

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What is the Capacity Market?

If you are not familiar with the capacity market – the UK government set up the scheme in 2014 to ensure security of supply for the electricity market, particularly in the winter months where demand is at its highest. Every year those with the ability to generate power (or turn down usage) at peak times enter into an auction to determine the price they will be paid for every KW made available to the grid if required. There are hefty fines that are levied on participants within the Capacity Market if they don’t respond to respond, however it is worth noting that to date there hasn’t been a full “event” where participants are asked to deliver against their contracted capacity. In order to enter every participant must pass a qualification process which involves At least 2 tests in order to prove and demonstrate the amount of power that can be reduced or generated when it is required by National Grid.

This scheme comes on the back of the larger shift towards a “smart grid” in the UK. This change is essential as more and more power is generated by renewable energy - which can be hugely intermittent, more and more smaller scale generators of power are coming on grid and the electrification of our transport and heating networks. These factors are forcing National Grid and the Local Distribution networks to completely rethink how to effectively balance the requirements of end users and generators with the constraints of the grid. This has brought about schemes such as the Capacity Market and a whole host of others besides and the term Demand Side Response or DSR is now considered a key part of this transition.

How have we got here?

Rewinding the clock slightly to 2017 Capacity Market at the time was separated into the T-1 and TA auctions. This served to separate the traditional “turn down” capacity – those customers that can reduce power when called upon (TA) and those that generate power when called upon (T-1). For this year we saw a price of £45/KW achieved for customers in the TA auction. CUB managed to secure 5MW of capacity in this auction, achieving income of £141k for 8 customers in 12 months.

Ahead of the 2018 auction, the decision was taken to combine the TA and T-1 auctions. This was inevitably going to reduce the final clearing price however the market was quite surprised that the price for the T-1 Auction (capacity to be delivered for the coming October for 12 months) out turned at a record low price of £6/KW. There was many coal and gas units that were very aggressive with their bids and this drove the price to this level.

The market “crashed” this year from last year’s price of £6/KW to just £0.77/KW. This means that all but those participants who would have generated power anyway have had to pull out, leaving the majority of those receiving payments through this scheme as the larger gas and CHP plants as well as a few storage installations.

This most recent result comes against a backdrop of uncertainty around the capacity market. The clearing price above will only be delivered if the Capacity Market is reinstated and state aid approval is granted. This is following a legal challenge by Tempus Energy who contended that the scheme was unlawful because it rewarded the largest market participants more handsomely than those at the smaller end with more “traditional” DSR capacity such as the ability to simply turn down power usage at peak times. This legal challenge was upheld by the European Court of Justice and has left UK government bodies scratching their heads somewhat in an attempt to bring an appropriate working model back to the market as soon as possible to ensure security of supply over the winter period.

The Tempus Energy challenge may bring about some positive changes for the Capacity Market if the principles of the challenge are carried into the new structure. We may see a return to a split auction to allow the traditional DSR participants an opportunity to participate in their own stand alone auction, which will hopefully result in a higher price for those customers who are unable to compete with large power stations who would arguably produce power at those peak times anyway.

At CUB we had a very low expectation of the clearing price for this year due to the level of oversubscription to the market, despite a lower level of participation that last year there was still 9420 MW that entered the auction whilst only 3626 MW were awarded an agreement. There was also an expectation that because of the aggressive nature of those participants entering the auction with a “agreement at any price” attitude that we would see the price lower than even the lowest forecasts. This turned out to be exactly the case. Nevertheless, CUB entered 3 customers totalling capacity of 1.8MW into the auction but the price expectations of these customers were unsurprisingly not matched by the clearing price.

So, what do I do now with my flexible capacity?

The capacity market is just one of many mechanisms available to customers that have flexibility within their usage pattern or those that can export power at peak times. National Grid have a whole raft of other income generation products available and more recently Local Distributors have started to make similar schemes available to customers who fall within their regional distribution networks. The fact that the Capacity Market has crashed certainly should put customers off DSR schemes.

In my opinion the most exciting opportunity available to customers with flexibility is Energy Market Optimisation. This involves selling power back to the wholesale market at peak times when prices are at their highest.

As we have seen the bottom fall out of the Capacity Market, we are likely to see increased volatility and higher peak prices over the winter period in the wholesale price. The electricity market is traded in HH blocks and during the height of winter, when demand is highest some of these HH periods can trade upwards of £150-£200/MWh. If you consider the current price of Winter 19 is £55.70/MWH, this means that any customer with the ability to reduce their electricity load at peak times can benefit from the difference between the price purchased and the price of the market on that day.

During the last 12 months there have been a staggering 1266 HH periods where the market has traded over £80/MWH, with the spot price reaching as much as £410/MWH on one occasion! This creates a huge value opportunity to those with flexibility.

So how does this work in practice?

One of the key advantages of this product is that the customer is in complete control and can be highly flexible with their availability. The process involves posting availability of “assets” on an online system whereby you determine the amount of power that is available to sell to the market, the times that this power is available and agree a “strike price” which is a minimum value that you would want to achieve for the power sold back to the market.

The “strike price” is customer specific and will depend on a number of factors such as loss of production, man hours etc which determine the “cost” of turning down for that particular period. For many customers there may not actually be a specific strike price as they may plan their turn down events in line with things such as maintenance periods.

A herb grower based in Lincolnshire is currently taking advantage of this product. Their main electricity demand is from lighting and ground source heat pumps. They have a very high level of flexibility within their usage profile therefore given that crop only needs a certain number of lighting hours and heat level maintained. They can therefore set a very low strike price in order to capture as much value from the market as possible, if this is needed to trigger a trade as there is no base “cost” for turning power down, it is simply changing the time that this happens.

Once the strike price, amount of power available and times of availability are posted the trading team of the chosen supplier will analyse this against the wholesale market, looking at within day and day ahead markets. Where possible they will carry out a “trade” selling back the power purchased for that particular day to the market, against the prevailing price for the HH period sold against. For example – customer buys 3 MW of power at £59.00/MWH for that month. They agree to make 1 MW of that power available for 1 hour between 6 and 7pm on that day. The market trades at £200/MWH for that period. The trade would generate a profit of £141 (1 MW traded for 1 hour at a price of £200/MWH, sold back against a purchase price of £59/MWH  - profit of £141) which would be then split between the supplier and customer, deducting any trading fees as agreed when the product was put in place. 

The customer will then receive a monthly statement showing any trades carried out that month and the amount owed to the customer for the trades carried out.

The revenue stack of the future

The opportunities created by accessing wholesale markets as a route to monetise flexibility add another option for customers to see their power consumption as an asset, not a liability. The concept behind this is not a new one, however these products tend to simplify what has historically been a risky process, only available to the largest end users in the market.

With the “smart grid” transition already in action we are likely to see more volatility on the wholesale spot market. This is due to the level of renewable power being supplied to the grid at any given point in time and the intermittent nature of this form of generation. It is also interesting to see the local distributors offering their own DSR schemes and I do believe that this will continue with new and innovative ways for system owners, operators, suppliers, generators and end users themselves collaborating and coming up with new and innovative solutions to facilitate the smart grid transition which will result in cost saving and income generation for those willing and able to be flexible.

I am personally quite excited about the future of the energy industry and I believe the energy revolution that we are witnessing currently will bring about a huge and very positive step for the UK. I recommend strongly to any customer that has some form of flexibility within their process to look into how they can start to monetise their existing assets or invest to create on site flexibility with on site generation or a battery in order to participate in the future of the energy industry or face being left behind!

Do you have any stories of participation in DSR markets that you would like to share? I am always interested in hearing people’s views and opinions on this subject so please get in touch with me, like share and comment in order to open up a wider conversation.

Louis Fairfax's picture

Thank Louis for the Post!

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Richard Brooks's picture
Richard Brooks on Jul 29, 2019 2:15 pm GMT

Wholesale Capacity Markets in the US are also showing signs of wear. Clearing prices are dropping and new capacity is coming onto the system at a rapid rate, resulting in large excesses in capacity. Capacity exchanges are begining to come online and there has been some discussion of the need for a standard platform for capacity exchanges. I wrote an article on the electricity supply chain changes underway in the US that you may find interesting:

Louis Fairfax's picture
Louis Fairfax on Aug 7, 2019 10:00 am GMT

Thanks for your comments Richard, and great article by the way!

Bob Meinetz's picture
Bob Meinetz on Jul 29, 2019 4:56 pm GMT

Q: So, what do I do now with my flexible capacity?
A: Um...plow it under?

Louis, there is a fundamental disconnect here, a contradiction which can't be resolved by revenue stacks, hefty fines, DSR, split/standalone/T1/TA auctions, innovation, flexibility, usage profiles, value opportunities, or Energy Market Optimisation™:

  1. The purpose of a capacity market is to promote construction of energy sources capable of reliably meeting demand in the future.
  2. Renewable energy sources are, and forever will be, incapable of reliably meeting demand in the future.

All there is to it - renewables are useless in that role. But evangelists, like a psychotic girlfriend I once had, don't know how to take "no" for an answer (I think my girlfriend once mentioned something about Energy Market Optimisation).

"This legal challenge was upheld by the European Court of Justice and has left UK government bodies scratching their heads somewhat in an attempt to bring an appropriate working model back to the market..."

Honestly, it leaves anyone with a brain left scratching their head. So how does this work in practice? It doesn't work in practice. Next...

Louis Fairfax's picture
Louis Fairfax on Aug 6, 2019 12:08 pm GMT

Hi Bob,

Thank you for your comments and I take on board your points, paticularly on security of supply. In my opinion the issue is that the Capacity Market is/was trying to solve too many problems and therefore is flawed in its set up which is why we have to go back to the drawing board. 

As I am sure you will agree there is no getting escaping that energy grids across the world are rapidly changing and therefore the commercial structures that aim to support, improve and maintain these systems must adapt to accomodate this change. 

My article was aimed at end users who may be sitting on some very valuable flexibility and have been left with a sour taste from the diminishing returns seen from traditional DSR markets. 

Many end users (paticularly in the UK) are unaware that they can utilise this flexibility against the ever increasingly volatile wholesale markets in order to monetise their assets. 

Lincolnshire Herbs is a customer I have been working with since 2005 and they have recently recognised the value that can be achieved through Energy Market Optimisation. 

Matt Chester's picture
Matt Chester on Jul 29, 2019 5:36 pm GMT

A herb grower based in Lincolnshire is currently taking advantage of this product. Their main electricity demand is from lighting and ground source heat pumps. They have a very high level of flexibility within their usage profile therefore given that crop only needs a certain number of lighting hours and heat level maintained. They can therefore set a very low strike price in order to capture as much value from the market as possible, if this is needed to trigger a trade as there is no base “cost” for turning power down, it is simply changing the time that this happens

I particularly like this tangible example, thanks for sharing Louis. Your article focuses on the UK market-- I wonder what you'd take away as the most important lessons learned thus far in that market of which those looking to institute a similar program elsewhere should take heed?

Louis Fairfax's picture
Louis Fairfax on Aug 7, 2019 10:05 am GMT

Hi Matt,

Thanks for your comments. My article certainly focuses on the UK market, in terms of a takeaway for any markets it is simply to not allow oneself to become so focussed on traditional DSR markets and to look further afield. This is especially the case if prices in those markets have fallen. Any good energy consultant should be able to offer alternative and innovative income streams to monetise flexibility in other markets. 

I also beleive that once a customer has engaged with some DSR activity, to cease completely would be taking a step back and valuable lessons that may prove very worthwhile will be missed while these markets are in there infancy, relatively speaking!

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