Market Report Q4 2021
The final chapter to possibly the most volatile year ever!
Introduction
The Q3 report of 2021 ended with ‘We have never seen market conditions this volatile, but it won’t be too surprising if we see even bigger extremes across Q4’…the market didn’t disappoint. There have been similar record breaking high’s throughout Q4, and in between those, we have witnessed even more surprising crashes as the energy markets continues to be on a knife’s edge. Our Q4 Market Report takes a look back at the events of Q4 of 2021, events that ultimately contributed to the UK’s current energy crisis.
The Forward Market
Gas
Throughout September Gas continued it’s bullish trend, carried by the same fundamentals as Q3 – low storage levels and restricted flows coming from Russia. This seemingly unstoppable charge came to an abrupt stop on October 6th when the most volatile day of trading in NBP history occurred. This ‘momentous’ event was a result of Russia announcing that it would be reducing the gas flow to Europe via Belarus and Poland by 70%, and Ukraine by 20% compared to the week before. As a result, Day Ahead gas prices increased by over 100p/therm from the 5th, and this rise continued into the 6th with Front Month prices breaking through the 400p/therm mark. However, later that day, Putin announced he would increase gas flows to Europe which led to an almighty collapse in gas prices, with a mass sell off resulting in a 35% drop in prices by the day’s close. By the end of November, prices dropped even further when the German Economy Ministry announced that the Nord Stream 2 pipeline doesn’t break security of supply regulations, which was a major step forward for the commissioning of the pipeline. This didn’t last too long however, with the EU pausing the project until the headquarters were moved to Germany, add this to the rising tensions on the Russian/Ukrainian border, resulted in a further even more extreme spike in prices and new record high prices. There was one final twist to 2021, over the final two days of trading of 2021 (markets closed between 25th – 29th), the market witnessed Q122 NBP prices collapse by over 50% from 428p/therm to 211p/therm. The drivers behind this massive sell off were a combination of very high winds, unseasonably high temperatures and heavy gas flows coming from Norway and LNG tankers from the USA. Throughout 2021, LNG tankers had been skipping Europe and heading to Asia as prices were even higher than Europe’s. Asia’s storage levels are now adequate, therefore Europe is now the highest bidder and attracting the LNG distributors.
Power
The power market has, essentially, mirrored the gas market. Gas continues to be the dominant energy source in the generation stack, therefore it is the price setter. During the lead up to Christmas, power jolted upwards even sharper than gas following the announcement that an additional four French nuclear plants had their return dates pushed back to April, removing 3GW of power. Offline interconnectors have a huge impact on UK power prices as these usually provide the UK with 2GW of energy. Therefore, the flow of power switched and the UK started exporting to France, resulting in a 4GW swing. As was the case with gas, the power market witnessed the UK Baseload Q122 power prices collapse from £515/MWh to £250/MWh at the end of the year.
The Prompt Market
With exposure to consistent high winds and mild temperatures, the UK experienced a quieter quarter on the prompt market. However, on the rare occasion, we saw wind generation plummet, leading to lively Day Ahead and Intraday markets. On November 2nd, system prices peaked just below £4000/MWh. System prices reached above £3,000/MWh for the 15th settlement period this year. To put this into context, this occurred 0 times between 2016-2020. Day Ahead prices also experienced volatility during events of low wind such as on the 16th – 17th of December. Wind dropped from 10GW to as low as 0.5GW which saw the de-rated margin slump to just above 1GW and as a result, Day Ahead prices spiked to £1,500/MWh and £1,451/MWh on the 16th and 17th evening peak respectively.
Another event worthy of a mention occurred on November 24th, which broke the record for being the most expensive day in the UK Balancing Mechanism (in terms of total net cost of bids and offers). This means that the 10 most expensive days have occurred since September 2021. This has reignited the debate as to whether the Balancing Market configuration is fit for purpose.
Ancillary Services
Dynamic Containment
Dynamic Containment has undergone significant changes over the past quarter. We have seen two crucial changes to the service which has materially affected revenues. Firstly, the procurement has been changed from a daily procured service to an EFA block level. This has reduced overholding for National Grid and led to downward pressure on prices. Secondly, the Dynamic Containment High (DCH) service was released, previously National Grid had just been procuring the Dynamic Containment Low (DCL) service, even though National Grid had a greater system need for DCH. Assets can deliver both services simultaneously, however, they must withhold some volume if delivering both.
The chart, left, shows DCL prices by EFA block over the quarter. They paint an interesting picture. Post 1st November, we see significant increased volatility in DC prices. This is driven by the move to EFA block procurement, incredibly volatile wholesale prices and triads also. This has made the optimisation challenge a lot more interesting. Where wholesale prices have spiked, we have generally seen DC prices also spike, as DC is competing with wholesale in terms of MWs.
Firm Frequency Response (FFR)
The weekly FFR service was retired in November. The trial, run by National Grid, was very successful giving National Grid significant value for frequency services, whilst providing optimisers more optionality.
The monthly FFR market saw prices rise significantly over the quarter. See chart. The price ‘rebound’ was driven by two factors. Firstly, the Triad season begins in November and always experiences an uptick in prices as assets have to cover the opportunity cost of missing Triad revenue. Secondly, with extreme volatility in the Wholesale Market, asset owners will be giving up optionality by delivering an FFR contract. Therefore, assets are likely to be hamstrung in terms of competing in the wholesale market.
This rebound in prices saw some participants switch from DC to FFR. This resurgence in price is interesting given National Grid’s plan to begin retiring FFR from Q2-22. Dynamic Moderation and Dynamic Regulation (in addition to DC) will be replacing FFR, National Grid have not yet communicated a timeline but are likely to migrate once DR and DM are up and running. Limejump is discussing the matter with National Grid and will communicate the dates when they are firmed up.
Regulation Update
The continuing energy crisis
The Energy Crisis has continued to dominate the news and the Government focus has been well documented. We have now seen 28 Suppliers go bust with 3.8 million customers moved to a ‘Supplier of Last Resort’. In addition, we saw Bulb fall into Special Administration with it’s 1.7m customer base too large to migrate to a single supplier. It is not surprising that against this back- drop there has been much discussion around market design and what is needed to support the transition to Net Zero Carbon Emissions by 2050.
The retail market will continue to be a key focus in 2022, especially following the recent price-cap announcement – the next phase is focusing on the financial resilience of suppliers and how best to monitor them. In the slightly longer- term we expect to see the Government focus on market design in a post pandemic, post energy crisis world and to support more renewable generation.
National Grid Balancing Mechanism Review
Across September to November 2021 balancing costs (actions taken by National Grid to balance supply and demand across the country), were double the levels seen for the period in the previous year (£1bn in 2021). As mentioned earlier, the 24th of November was the highest ever day with costs totalling £60m. In December, NG launched a review of it’s balancing tool, the Balancing Mechanism, for Q421 and expects to present it’s findings in April 2022. The scope of the review includes a current bidding behaviour across 3 high priced days and a review of market rules and design. We are participating in discussions with National Grid to provide insights and to ensure the market design supports the transition to a low carbon system.
National Grid Product Development
We submitted our response to the National Grid’s consultation on their outstanding Dynamic Frequency Products, Moderation and Regulation. These products are to address ‘pre-fault’ frequency variations. Once fully operational, National Grid will retire the monthly Firm Frequency Response product. We envisage that Dynamic Moderation, which has a similar response time to Dynamic Containment of 1 second, will be a valuable product for batteries. Dynamic Regulation has a response time of 10 seconds, requires a constant hold, or 60-minute duration for batteries. It will be the next product to launch in early April.
National Grid is yet to provide revised dates for it’s new Reserve Products, which are used in the event of a large supply issue or demand change. The first new Reserve Product will be ‘Negative Slow Reserve’ which will require participants to turn-down if called upon within 15 minutes and to hold for up to 120 minutes. This product may be of interest for renewable generation which can respond within 15 minutes. We will review this product in more detail when National Grid consults on it later this year.
BSUoS & Network Charges
In anticipation of possible high balancing costs in Q1 2022, an urgent modification (CMP381) was approved on the 14th January which was effective from the 17th January. The modification capped BSUoS costs at £20/MWh until 31st March or until £200m has been deferred. Any deferred costs will be recovered over the year April 2022 until March 2023.
The Government published their latest network charges update on 24th January with all changes in line with market expectations. Specifically, assets connecting at the Distribution level will no longer be charged for the full reinforcement of the shared network. They have also proposed firmer access rights for distribution connected assets including the introduction of explicit end-dates for non-firm arrangements. Both of these changes support deployment of distributed connected assets and are planned to come into force from April 2023.
Capacity Market
The Capacity Market prequalification results were published on the 24th of November. The volume qualifying for the year beginning in October 2022 was 5.3GW. The auction target volume was recently increased from 4.6GW to 5.3GW which means the auction is now expected to clear in the first round which is the highest round with an auction price of between £70k-£75k/de-rated MW. The increase in volume reflects the Government’s concerns around security of supply for Winter 2022/23.
Assets prequalifying for the so-called T-4 auction (which starts 4 years in the future in October 2025) were 53.4GW and the volume being procured in the auction has remained at 42.1GW. Whilst this auction is oversubscribed, it still requires new build assets to win a contract in order to meet the required volume target.
The capacity market is open to all technologies, including wind and solar and we recommend it for unsubsidised wind and solar over 30MW. If you did not enter last year but would like to register your interest for this year, then please get in touch.
Conclusion
It has been a challenging winter, a period of record breaking highs and lows across the market. We have witnessed established energy suppliers struggle and in some cases cease to trade, we have seen the commodity markets hit record highs and lows. The question on most people’s lips is ‘how long will the energy crisis last?’, truth is, limejump does not have an answer, and it would be risky for any commentators to attempt to give a timeline due to the drivers behind the price spikes. There is however a glimmer of hope, we are approaching the spring months, where we will start to see a rise in temperatures, enabling us to start to ensure our gas stockpiles are sufficient for next winter. The energy price cap in early Q1 2022 should stabilise the remaining energy suppliers, but sadly at the cost of the end user. Limejump will continue on their mission to optimise a 100% renewable energy future to ensure that in the long term, the grid is green, resilient and affordable. If you have any questions or comments about our report, please get in touch.