The UK energy regulator is mulling a rule change to stop energy companies from reaping “excessive” benefits from the UK’s power balancing market at billpayers’ expense.
A new 'inflexible offers licence condition' could be introduced by Ofgem in several ways, including through a new price cap on balancing offers, to an entire overhaul of the market’s structure.
Essentially, Ofgem, the UK’s energy market regulator, will attempt to stem price rises on the balancing market, which ensures supply and demand match.
Ofgem suggested renewed regulation could push generators to invest in more “flexible” production capacity or energy storage, making them more responsive to changing market conditions.
Drax Group (LSE:DRX) previously agreed to pay a £6.1mln fine to Ofgem in January after it was found to be submitting higher bids to the balancing market to turn down generation from its Cruachan hydro-energy plant.
As a result, National Grid ESO was forced to make “excessive” payments to the generator between early 2019 and July 2022 for it to reduce production at times of transmission constraint – essentially traffic jams on power lines that mean energy cannot be moved.
So how does it work?
National Grid's system operating wing (ESO) uses the balancing mechanism to make sure the supply of power will meet UK demand in real-time.
Simply put, it tells generators how much power is needed in the next 60 to 90 minutes and then picks bids from firms offering to produce or consume energy at the cheapest rates.
‘Bids’ are submitted to decrease output, while ‘offers’ are made to increase it.
“Generally, we go with the most competitively priced bids and offers, but sometimes we consider other operational and locational factors in our selection,” National Grid ESO said.
These bids and offers then determine a new output for generators to supply, changing the amounts they originally put forward on the wholesale market, where suppliers buy power to sell to customers.
Balancing mechanism costs are subsequently passed on to consumers, making up around 2% of energy bills, according to experts at Resolve Energy.
Although this seems small, £1.5bn was spent on balancing the grid between November 2021 and February 2022, ESO data shows, almost tripling from the £500mln spent in the same periods between 2017 and 2020.
For the full year, the ESO faced a £3.1bn bill from the balancing market, Ofgem added, prompting it to suggest action was needed to reform the market and protect consumers who faced higher prices in the past year anyway.
Around 1,800 daily balancing instructions were sent out in 2020, regularly exceeding 50% of the UK’s energy demand, the ESO said, up from an average of just 5% in 2012.
As balancing becomes a more prominent feature of the UK's energy market, the need to ensure excessive profits are not made on the back of higher bids becomes ever more important therefore, it added.
It's not in "consumers' interests," Ofgem suggests, for generators to make excessive profits if users are the ones having to fork out.