Detaching Contract Notifications from Gate Closure – New Trading Options?

Published on 7th February, 2017

In November 2015 the system for setting the prices at which electricity buyers and sellers are “cashed out” due to imbalances between forecast and actual trading volumes was changed via a modification to the Balancing & Settlement Code (BSC) known as P305.

This change had the effect of increasing the volatility of cash out (aka system prices) – while at the same time combining buy and sell system prices into one single system price. We can leave open for the purpose of this blog the question of whether this increased volatility was actually a reflection of the stated objective of the change – namely to sharpen price signals in the balancing market and bring prices more into line with the true marginal economic costs of balancing actions. Suffice it to say that this increased volatility has set a new challenge for buyers and sellers alike in trying to decide what an effective risk management strategy should look like. This challenge will further ramp up in scale when the marginal volume on which calculation of system price is based is reduced from 50MWh to 1MWh in November next year.

To address some of these concerns a new modification (P342) was put forward in May last year which would have the effect of allowing parties to trade for longer than at present in order to manage their position more effectively. At the moment, for each half-hour settlement period the various trading parties are required to submit their Final Physical Notifications (FPNs) and their Energy Contract Volume Notifications (ECVNs) no later than one hour before the relevant settlement period commences (this is the so-called Gate Closure).

Note: It is the ECVNs that fix the contract position of each party against which actual physical out-turn volumes are compared in order to determine imbalance cash out.

P342 introduced the idea of Final ECVNs which could be submitted at any time up to 60 minutes after the start of each settlement period, i.e. an additional 120 minutes of trading beyond the current Gate Closure before contract positions are finalised – this cut off being just before settlement prices are published by the System Operator. The deadline for submission of FPNs would remain unchanged at the current Gate Closure point. The thinking behind this change is that increased volatility of system prices may be causing market liquidity to shrink, increasing uncertainty and increasing the spread between market bids and offers. If a longer trading period is allowed and remains open closer to publication of system prices, parties will have more information about how prices are likely to develop and will be encouraged to manage their exposure actively by entering into trades.

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The economic and financial logic of the proposed change is widely accepted. In particular, the extension of trading beyond Gate Closure is seen by Ofgem as contributing to its wider objective of promoting effective competition in the generation and supply of electricity. The view of whether P342 is consistent with another BSC objective – namely, the need for the efficient, economic and co-ordinated operation of the transmission system – is more clouded.

Some concern was expressed that P342 might have a detrimental impact on the ability of the System Operator to manage the system due to an increased ability for parties to change positions post Gate Closure. Consequently, in discussions about P342 an Alternative Modification was put forward to address this point by allowing trading to only continue up to the start of each settlement period, i.e. an extension of only 60 minutes from the current position rather than the originally proposed 120 minutes.

As we write this blog, a statement has just been issued by Ofgem that they have approved the P342 Alternative Modification and that this will come into operation in November this year. So now this change to trading options is confirmed, both generators and suppliers will need to think about how this will affect their trading strategies.

To the extent that parties are inclined and able to lock in to their preferred position as early as possible, this change will probably have little or no impact – but if parties prefer
a more flexible strategy and/or are forced by their particular circumstances to finalise their contract positions much closer to settlement, then P342 may open a new range of interesting trading options.

For PPA providers such as EnDCo who specialise in trading very close to real time on behalf of our embedded generation customers this latest industry change is particularly exciting.

For further information, please email me at: les.abbie@endco.co.uk

Les Abbie, CEO, EnDCo