An argument for Pay-as-Bid v. Pay-as-Cleared
At the excellent Energy Storage Networks Annual Conference last week in London, energy minister Michael Shanks spoke very well about the recently issued NESO document: Clean Power 30.
When asked whether the vision he had set out of CP 30 would break the price link for gas with power he didn’t answer that particular question, but did say some gas would still be needed. Indeed, the NESO CEO Fintan Slye claims in his introduction that we will have “home-grown energy that breaks the link between volatile international gas prices”
This is borne out at the top of page 7 of that CP 30 report: ‘A clean power system is one where demand is met by clean sources (mainly renewables), with gas-fired generation used only rarely to ensure security of supply, primarily during sustained periods of low wind’.
Now, imagine we still have the same market structure in 2030 as we do now i.e. pay as clear.
Do we think this gas plant is going to be happy sitting around twiddling its thumbs and waiting for its moment in the sun? Because by 2030 the load factor it’s running at, if it’s just confined to these low renewables moments, will be very low – 10%? 20%? Therefore in the moments when gas plant does get to run, it needs to make hay to justify being kept on-line. Meaning it will extract as much scarcity value as it can, so that when it gets called, it will need to charge very high prices to justify being kept online. And as we know under pay as clear, all generation then gets that price.
So the gas price-power price link will NOT be cut, as the NESO report asserts – without market reform. Let’s look at this.
The day ahead (DA) and on the day power(M7) markets are run by exchanges. A significant amount of power is traded DA, with a lot of the activity in M7 being adjustment trades (as forecasts change), or pure speculative trading by trading houses.
The DA market currently gets its price for each half-hour (HH) via the pay as cleared mechanism. This means all bids and offers (buy orders and sell orders) are submitted until the TSO, in conjunction with the exchange, has matched up enough bids and offers to meet the forecast demand for a particular half-hour. The last MW of power offered in to meet the demand sets the price for all the power offered in to meet the demand. Pay as cleared results in the plant at the margin being the price setter for the whole HH – and this mechanism thereby creates super-profits for plants with a low marginal cost, such as nuclear and renewables. These low marginal cost generators will always offer into the market power at low prices to ensure they get called in the generation stack, knowing they will get a higher price.
This is illustrated below:
The UK within day market, M7 however, is a ‘pay as bid’ (PAB) market’ – which means a generator needing to sell has to be offering at a price that is likely to trade – if it gets too greedy it may be undercut by other plant and fail to sell (and therefore generate). Similarly a buyer needs to put in realistic buy prices in order to trade – or risk paying imbalance costs (with all that attendant uncertainty).
Having a market which is predominantly pay as cleared results, as can be seen in the box above, in a material transfer of value from consumer to generator. When we get to the situation where there are only a very few gas generators left, and they only run intermittently (rather than baseload) they will be sure to extract maximum scarcity value at times of system tightness – which will result in some fairly eye-watering prices if the continent is tight also, and the ageing French nuclear fleet is running below par.
This is of course why an island like the UK needs as many interconnectors to different parts of the continent as possible – the ultimate flexibility.
The risk of these sort of spike highs could be alleviated at a stroke were the DA market changed from pay as clear to pay as bid, and this does mean that both buyers and sellers have to become more precise in their pricing, rather than just lazily offering in and getting best price whatever. Note that the BM is also a pay as bid market which, given the added locational element of BM, uncertain run times, and skip rates makes the pricing precision even more challenging.
In conclusion, pay as bid would involve a substantial change to the way we trade energy in the UK – but logically, it’s the only way to break the power price link to the gas price in our system.
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