During Christmas 2014, headlines focused on the threat that British lights would go out, and on the inaugural Capacity Market Auction designed to safeguard supply. Now Spring 2015 sees the next stage of ensuring safety of supply: the Cash Out Reform.
On 2nd April 2015 Ofgem announced its decision to introduce a single marginal cash-out price, a competing modification from RWE npower that seeks a more incremental approach to cash-out reform and implementation.
This reform goes further than just stabilising supply – it’s a chance for a better deal for consumers, more culpability for energy suppliers and a greener energy mix. It’s also an opportunity for the UK to take the lead on forward-thinking energy policy in Europe.
So what is Cash Out Reform?
Cash-out arrangements are operated in both the gas and electricity markets. These arrangements are designed to address the cost of energy balancing incurred by National Grid to the parties who created those costs. These charges are known as cash-out prices. Under the current electricity market arrangements in Great Britain if a market participant generates or consumes more or less electricity than they have contracted for they are exposed to the ‘imbalance price’, or ‘cash-out’ price, for the difference.
Participants are encouraged to take sufficient actions prior to the end of each Settlement Period to mitigate any risks and ensure that contracted positions are as accurate as possible.
Cash-out prices are designed to provide strong commercial incentives to balance contractual and physical positions and therefore avoid exposure to cash-out prices. Measures taken in response will, in turn, help secure supply. This may include contracting for supply ahead of time, or by maintaining the reliability of a production plant, for example.
There are a number of benefits to Cash Out Reform, some of which are as follows:
1) Security of supply
As the National Grid looks for new ways to guarantee our energy security in winter 2015, the reform gives the price signal necessary to provoke investment in technology and generation to keep the lights on – providing the stick to the Capacity Market’s carrot.
2) A better deal for consumers and culpability for suppliers
At a time when trust and goodwill is fragile, it is essential for consumers to know that their suppliers are appropriately culpable for failing to provide the power they’ve promised.
More importantly, it also represents a better deal for consumers. Although current cash out costs are low, the overall cost of failing to provide power is much higher, and likely to be borne by the end user. By incentivising against failure, the consumer benefits from more stable pricing and fewer shocks down the line.
3) A smarter, greener grid
The Capacity Market was criticised for providing an income to aging fossil fuel assets, such as coal generation. However, it’s important to remember that the Capacity Market and the Cash Out Reform policies are needed, at least in part, because of the rise of intermittent, renewable generation.
As more intermittent generation comes online, we need flexible back-up options to provide a safety net for when they don’t provide what’s required. With a global drive to lower emissions and EU reduction targets, a greener mix will be necessary sooner or later. Reforms such as these represent the cost effective option without future shocks for the consumer.
By strengthening the market for such back-up, as these reforms do, we create a smarter future grid that is ready for the onboarding of even further renewable generation assets. It may seem paradoxical, but these policies ensuring fossil-fuel failover are the foundations needed for a greener grid.
What effect will Cash Out Reform have?
As the share of intermittent generation and baseload nuclear generation grows, flexibility in responding to changes in demand will become increasingly important. This will include encouraging investment in flexible power generation and reduction options.
Cash-out prices provide incentives for generators and suppliers to invest in secure supplies to ‘balance’ positions and meet demand when the system is tight. They are therefore central to the delivery of a secure and competitive electricity market.
The biggest risk will possibly be incumbents within the energy sector (mainly suppliers) being resistant to the change. Higher penalties mean that the onus is on suppliers to deliver their services on time and within budget to avoid penalties. The upside of this is that companies that operate efficiently and effectively will be rewarded for being performing well.
Whilst Cash Out Reform on its own will not fix the market, it is important that companies providing flexible generation are appropriately rewarded for keeping the lights on. This is a welcome step in that direction.