New generation licence condition to stop ‘excessive’ balancing profits

Ofgem is proceeding with proposals to introduce a new licence condition to 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.

The move comes after parallel investigations by National Grid Electricity System Operator (ESO) and Ofgem following a surge in balancing costs over the winter of 2021/22 found instances of what the regulator described as “immoderate” behaviour by generators.

Over the four month season from November to February, the ESO incurred total balancing costs of £1.5 billion, including record breaking daily costs of more than £60 million on 24 November. This compared to a seasonal average of around £500 million during the winters between 2017 and 2020. The three-fold increase in costs was primarily driven by higher prices rather than greater volumes.

Ofgem said the immoderate behaviour included instances of generators notifying the ESO of their intention to cease generating during a particular period by submitting a zero-megawatt physical notification, sometimes shortly before gate closure, and then significantly inflating the prices of their offers to continue generating during said period.

The regulator said there were also instances of gas generators doing this in the early afternoon, meaning the ESO was forced to pay them inflated prices for a number of hours to ensure they remained available to meet the evening peak in demand.

Once a generator has ceased generating it must remain at zero output for a set duration, known as its minimum zero time, which reflects its technical capabilities. Gas turbines typically have a minimum zero time of six hours.

In a call for input in November, Ofgem proposed a number of potential measures to prevent these behaviours, including a price cap on balancing prices, a new reserve service and restrictions on amendments to physical notifications. It identified a new licence condition preventing generators from gaining excessive profits after submitting a zero-megawatt physical notification as its preferred option.

Following feedback from stakeholders, the regulator has now decided to proceed with this option.

The Inflexible Offers Licence Condition will apply to any settlement period where a generator has submitted a zero-megawatt physical notification and it has a minimum zero time of longer than 60 minutes. In these circumstances, generators’ offer prices must reflect “only their costs plus a reasonable profit that is not excessive”.

Ofgem originally proposed that the licence condition would only apply if the zero-megawatt physical notification was submitted within the operational day but the regulator has removed this criterion after respondents argued the measure should focus on defining excessive profits rather than the timing of the notification.

The criterion that the licence condition should only apply to generators with a minimum zero time of more than 60 minutes was also added by the regulator after a number of stakeholders, particular storage operators, warned the original wording would capture the normal running behaviour of assets that reoptimize within day.

Ofgem said these changes would ensure generators have two options for participating in the Balancing Mechanism: they can either follow the “flexible path,” whereby their units are operated flexibly in response to market and system conditions and can price scarcity into their offers; or the “inflexible path,” whereby their units are operated in a way that limits their responsiveness to market and system conditions.

According to the draft guidance published alongside its latest consultation, excessive profits will be determined based on a number of factors including generators’ variable costs, such as fuel, operating costs, emissions and wear and tear; shutdown costs, including any lost revenues; reasonable profits on these costs; and general market monitoring to compare offers between generators.

The deadline for responses to the consultation is 13 March.