Explaining Balancing Costs: Drivers and How to Optimise Contract Negotiation

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How Imbalances Are Formed

Wholesale electricity markets are typically divided into three main stages:

• the Day-Ahead Market, where participants submit bids based on forecasted generation for the following day,
• the Intraday Market, which includes several sessions throughout the delivery day, and
• the Continuous Intraday Market, the final opportunity to trade before actual delivery.

During these stages, the parties responsible for representing a power plant in the organised markets can adjust their expected production by buying or selling electricity based on updated forecasts. The goal is to minimise any deviation between forecasted and actual generation at the time of delivery.

An imbalance occurs when the actual generation at the time of delivery, after accounting for all corrections made in the previous markets, does not match the forecasted volume. In such cases, producers must settle the shortfall or surplus through the imbalance market.

What Are Imbalance Costs?

Imbalance prices represent the cost of restoring system stability caused by deviations between scheduled and actual energy delivery, on both the consumption and generation sides. These prices reflect the cost incurred by the system operator to deploy balancing services in real time.

Depending on the country, imbalance pricing mechanisms vary. In some cases, the price includes both upward and downward regulation costs, either by applying a premium or discount to the Day-Ahead Market price or by defining separate prices for upward and downward imbalances. The imbalance cost for a generator or consumer is essentially the difference between the imbalance price and the Day-Ahead Market price.

Main Drivers of Imbalance Costs

The imbalance costs borne by generators are influenced by both market dynamics and the characteristics of the selected market aggregator or Balancing Responsible Party (BRP). Below, we explore key market-driven and BRP-related factors that affect the final cost:

Market Drivers

• Reduction in Dispatchable Generation Sources: Dispatchable power plants, such as thermal and nuclear facilities, provide stable and controllable output. As these sources are phased out or reduced, system flexibility decreases.
• Higher Share of Renewable Generation: The variable nature of wind and solar generation leads to greater variability. During periods of high renewable output, forecast errors tend to rise, increasing the need for balancing services and putting upward pressure on system-wide costs.
• Competitiveness of Ancillary Services Markets: The availability and competitiveness of ancillary services are key cost drivers. A well-developed and competitive balancing market provides cost-effective alternatives during periods of high system stress, helping to lower imbalance prices.
• Demand-Side Variability: Fluctuations in electricity demand, due to weather, industrial activity, or consumer behavior, can result in unexpected imbalances, widening the supply-demand gap, increasing the cost of balancing.
• Transmission Constraints: Limitations in the transmission grid can prevent electricity from flowing efficiently from surplus to deficit areas. These bottlenecks lead to localised imbalances and higher costs for system operators to restore balance.
• Market Design and Regulation: Regulatory structures and market design significantly influence imbalance costs. Factors such as imbalance settlement periods, penalty schemes, pricing mechanisms, and rules around responsibility allocation all shape how imbalances are managed and monetised.

BRP Drivers

• Forecasting Capabilities: Transmission System Operators (TSOs) often tolerate high balancing costs in imbalance settlements to incentivise accuracy. BRPs with strong forecasting capabilities can reduce deviation exposure, incur lower imbalance charges, and offer more competitive fees to generators.
• Portfolio Diversification: BRPs with large and geographically or technologically diverse portfolios can offset underproduction in one area with overproduction in another. This internal balancing reduces overall exposure and typically leads to lower imbalance-related fees.
• Participation in Ancillary Services: Allowing a generating plant to participate in ancillary services gives the BRP more flexibility to manage deviations. This added flexibility can lower imbalance costs and result in more favourable representation terms for generators.

Choosing the Right Market Agent

Renewable energy generators typically participate in organised electricity markets through third-party market aggregators, also known as Balancing Responsible Parties (BRPs). Depending on the BRP, their responsibilities may include forecasting, bidding, and trading in wholesale markets, and in some cases, providing balancing services if acting as both BRP and Balancing Services Provider (BSP).

The commercial terms for plant representation vary by geography and provider. Charges may consist of fixed and/or variable fees, such as:

• discounts on the Day-Ahead Market price
• partial coverage of imbalance costs
• indexation to monthly fluctuations in imbalance costs.

The level of exposure to market volatility often depends on the generator's risk appetite. Generators seeking full protection against imbalances, when available, typically pay higher premiums. Fee structures and contract terms also depend on the BRP's trading strategy, portfolio composition, and market access.

To minimise balancing costs, generators should evaluate multiple BRP offers and consider participation in ancillary services. Doing so may lower representation fees while creating additional revenue opportunities.

As imbalance costs rise, assessing revenue structures, contract duration, and market accessibility becomes critical. For generators entering Power Purchase Agreements (PPAs), the negotiation process is growing more complex, as both parties must ensure that PPA and BRP contracts are compliant with each other.

Conclusion

Imbalance costs are becoming a more critical factor for power generators.  As the share of renewable energy in the energy mix continues to increase along with reduction of dispatchable energy sources, the system will tend to become more fragile and susceptible to sudden changes in generation, increasing system management costs and ultimately also the costs of managing imbalances.

Generators must carefully evaluate the structure and conditions of their BRP agreements, including exposure to imbalance costs, access to alternative markets and the forecast capabilities and portfolio of BRPs. If PPAs are in place for a specific asset, assessing BRP contracts capable of including cost mitigation strategies can add another layer of complexity.

Would you like to explore how Synertics can help you in tailoring a better BRP deal while ensuring compliance with your PPA? Get in touch with us.