Trading Electricity and Ancillary Services in the

Reformed England and Wales Electricity Market

Goran Strbac
UMIST
Manchester
UK

Introduction

The England and Wales Electricity market is changing radically. One of the basic
principles of the New Electricity Trading Arrangements (NETA) is that those wishing to
buy and sell should be able to enter into any freely negotiated contracts to do so. It is
expected that under NETA the bulk electricity will be traded on one or more long and
short term exchanges through a variety of bilateral and multilateral contracts. The major
role of NETA program is to provide a mechanism for near real-time clearing and
settlement of the imbalances between contractual and physical positions of those buying,
selling, producing and consuming electricity [1].

The paper stresses the need for generating companies to apply sophisticated tools to
support and develop bidding strategies and risk-management activities in this new
environment. The paper also discusses the need for generating companies to understand
and quanti~ the value of various energy and ancillary services products in order to
optimally allocate their activities in a number of competing markets.

Electricity trading

Under NETA, generating companies will be able to place the outputs of their plant to
several markets: (1) Forward and Futures Markets (FFM) , that are expected to evolve in
response to the requirement as of participants, (2) short term Power Exchanges (PX), to
give the participants the opportunity to fine tune their contract position and (3) a
Balancing Market (BM) in which the system operator accepts offers and bids from all
participants in order to balance the system in real time. This new structure imposes a
spectrum of requirements on the participants to optimize their positions in order to realize
expected revenues and profits. This clearly indicates the need for generating companies to
apply sophisticated tools to support the risk-management activities and sharpen their
short-term strategies under the new environment [2,3,4]. The main issues driving this
requirement are:

(1) Although each market operates independently, each party must participate in at least
one of them, which opens the question of the basis for selecting the appropriate
market or the combination of the markets.
(2) Balancing market will pay generators their bids, rather than a uniform clearing price.
In the pay-as-bid market all participants must develop their bidding strategy. Even a

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 small player that used to behave as a price taker under Pool, must now optimize its
bidding taking into account uncertainty of demand and its competitors behavior.
(3) Prices in these markets are interrelated. The decisions to contract early are based on
the expectations of prices in BM. From a generating company perspective it is critical
to ensure an optimal balance of the output in all markets with appropriate pricing.
(4) In the new market generators and demand can submit offers and bids for every half
hour (under the Pool, single bid applies for 24 hours). Setting bidding strategies to
respond to varying market conditions is a critical element of the bidding strategy. ~
(5) The new market requires generators to internalize their fixed cost and submit offers
and bids that contain only block unit prices. This requires the risks of and rewards of
such bidding to be properly understood and quantified.
(6) Portfolio generators now need to schedule their own plant against their contract
position taking short-term opportunities in power exchanges and balancing market. It
is however important to emphasize that the demand in the short term markets as well
as the actions of competition are likely to be volatile.
(7) It is also important to bear in mind that the capacity payments, that used to create
significant amount of profits for the generating companies, will seize to exist with the
introduction of NETA. This may make it particularly difficult for peaking plant to
recover its cost and create sufficient profit in already oversupplied energy market.

The presentation will discuss classes of tools and the underlying methodologies that
might be particularly useful in this context.

Ancillary services markets

In the England and Wales electricity market system operator National Grid Company
(NGC) performs two roles (i) energy balancing (matching generation and demand) and
(ii) system balancing, ensuring that the frequency and voltage remain within statutory
limits. A combination of ancillary services contracts, rescheduling of plant by accepting
bids and offers, and NGC own equipment is used to ensure both system and energy
balance. The current debate is focused on to the mechanisms for procurement and
utilization of balancing services as well as the development of appropriate markets to
facilitate these activities. Several alternative market arrangements have been proposed
[5]. The presentation will critically discussed the proposals with a particular emphasis on
their ability to facilitate the competition in the provision of the services, market power
and the relationship with the energy market.

On the other hand, the main issue facing generating companies, that are the main
providers of system balancing services is the question of the value of such services to the
system operator. Although the costs involved in provision of basic ancillary services, such
as frequency and voltage regulation, are not straightforward to quantifi, the question of
value, that matters considerably more in a market driven environment, is equally more
complex. In order to maximize their profits generating companies need to understand and
quantifi the value of their products in variety of competing markets.

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 Reactive power service [6]

Adequate reactive reserve and voltage regulation services are necessary to enable a secure
transport of active power over a high voltage AC transmission network. The present
commercial arrangements are conceptualised around cost based, rather than value based
compensation. The present arrangements lack the main features of a market-based
provision of the service as (i) provision of reactive capability is compulsory rather than
voluntary (all generators are obliged to comply with the Grid Code and provide a
minimum reactive capability), (ii) transmission facilities that provide reactive power do
not compete in the reactive market; although these facilities reduce the need for reactive
power support from generators that compete in the market, the cost of the equipment is
recovered from outside of the market, through Transmission Use of System charges (iii)
the prices in the market are effectively capped by the default mechanism.

In general, there are two approaches to quanti& the value of reactive power services
provided by a particular supplier. One is to determine the cost of providing the service
from alternate sources or to compare it with the value of expected lost load as a result of
lack of the service. Alternatively the value of reactive power support of the individual
supplier can be quantified through measuring the relative competitiveness of the
participating sources. This latter approach to quantifi the relative value of each particular
generator, or a portfolio of generators, by measuring the amount the capability and
utilisation purchased by the system operator as a function of their bid prices, will be
discussed and illustrated on suitable examples.

Frequency regulation service [6]

The balance between demand and generation must be continually and automatically
maintained such that the system frequency is kept within limits defined by the quality of
supply standards. In the England and Wales electricity market, this service is supplied by
various generators and is handled through the notions of primary response, secondary
response and high frequency response services. Generally, NGC enters into bilateral
contracts with generators and large consumers for the provision of these services.

In addition to the technical characteristics of individual plant, the selection of the most
economic portfolio of generators to be contracted for the provision of frequency response
services requires consideration of cost related to the response services and the opportunity
cost (re-dispatch cost) associated with individual generators. Hence, the value of the
service delivered from a particular generating plant, is influenced by the prices in the
energy market.

The interaction between the two markets, tools and techniques required to determine the
value of frequency regulation services will be discussed.

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 Conclusions

The paper stresses the need for generating companies to apply sophisticated tools to
support and develop bidding strategies and risk-management activities in this new
environment. The paper also emphasizes the need for generating companies to understand
and quanti~ the value of various energy and ancillary services products in order to
optimally allocate their activities in a number of competing markets.

References

[1] OFGEM and DTI “An Overview of The New Electricity Trading Arrangements,”
31 May 2000.
[2] Derek Bunn, Editor, “Strategic Price Risk in Wholesale Power Markets,” Risk
Books, London, 1999.
[3] Richard Green, Tanga McDaniel, Expected Revenues in the Balancing Market:
Equivalence between Pay-as-Bid and SMP, Department of Applied Economics,
University of Cambridge, 1999
[4] Richard Green, Tanga McDaniel, Modelling NETA: A model of forward trading
and the balancing mechanism, Department of Applied Economics, University of
Cambridge, 1999
[5] OFGEM, Consultation Document on Ancillary Services, April 2000
[6] NGC, Ancillary Services Business (Www.ngc.co.uk)

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