Part I
On 1 October 2021, the National Electricity Market (NEM) will be shifting from 30-minute settlements (30MS) with the dispatch price averaged over six separate 5-minute intervals, to 5 minute-settlements (5MS) with the dispatch price calculated on each 5-minute interval.
The single settlement period promises to spur investment in large scale battery storage by removing market conditions that allow large incumbents to game the system and by cultivating market conditions that favour fast-response technologies like battery storage. However, the new conditions created by 5MS will also bring about their own risks for renewable generators.
What are the benefits of 5MS?
The new market dynamics of the switch to 5MS should – in theory at least – more accurately reflect underlying demand and supply conditions and therefore result in a much truer price signalling. Under 30MS, peaking generators could observe a price spike that they had not foreseen, and then belatedly rebid to ‘pile in’ for the remainder of the settlement period. Such market gaming prevents there actually being a true reflection of underlying supply and demand.
5MS will go a long way to removing this market distortion and in the process incentivise investment in capacity and demand response technologies to balance supply and demand. To the extent this is more accurately matched, consumers should ultimately be rewarded in terms of lower energy prices.
Batteries are well placed to benefit from 5MS in comparison to some other types of dispatchable generation such as gas peaking plants. Due to their fast response time, batteries are better suited to capturing immediate price spikes and are therefore arguably better suited to the new 5MS market dynamic.
Whereas today, the primary revenue streams for batteries come from their participation in the frequency control ancillary services (FCAS) markets, 5MS will ensure that the business case for batteries is truly enhanced by sharpening the incentives to participate in the energy market and undertake price arbitrage, responding to (more accurate) energy price signals.
Currently, under 30MS, large generators can strategically use short-term supply fluctuations to push prices temporarily higher, while also undermining the participation of fast-response technologies like battery storage and demand response. 5MS will make it much harder for traditional incumbent generators to “game the system” to their own advantage.
How does 5MS alter the current landscape of the NEM?
Bidding and pricing dynamics
In the short term, 5MS is likely to introduce additional uncertainty into the NEM resulting in some incremental volatility in the energy market, both in terms of pricing and risk. Whether this translates into a long-term change in pricing trends remains to be seen. The more dynamic nature of 5MS bidding could also mean that the old days of reliable price spikes happening at particular times of the day may no longer be the case. Market pricing will be significantly more fluid with the corollary of this being that generators are going to need a much more dynamic bidding approach.
In practice, this will mean that active forecasting and price monitoring will have to be implemented in combination with dynamic rebidding capabilities. Any participants that are using machine learning models to forecast prices will need to retrain their models following the introduction of 5MS as novel pricing dynamics emerge.
The static bidding strategy implemented by many generators in the 30MS world will no longer be financially viable. In the short term, renewable generators are likely to adopt and implement a risk-averse trading strategy. However, slowly but surely as the market settles and participants gain experience and comfort with the new market dynamics and bidding strategies, predictable pricing dynamics will emerge.
Impacts on existing commercial agreements
For projects that are already in operation, whether 5MS actually changes the scope of work to be carried out by contractors (O&M Provider, asset manager, etc) becomes particularly important.
Projects which commenced prior to the proposal for the 5MS rule change will likely field questions from contractors as to whether a change in law is triggered under the relevant agreement (PPA, O&M Agreement, Asset Management Agreement, etc).
Where contractors take the view that their scope of work has been sufficiently changed due to 5MS, they may consider submitting variation of scope claims pursuant to these agreements which may potentially result in extensions of time and additional costs.
For example, for an asset manager whose scope will usually include data management, not only will market operator data have to be recalibrated to align with 5MS, but so too will the huge databases of the relevant site’s equipment data (ie trackers, inverters and meteorological data more broadly).
Emerging technologies
In terms of market players, big batteries and ‘virtual power plants’ are likely to win out in this new system over old coal generators. 5MS should act as an enabler for future battery projects due to fast response energy sources being better able to respond to negative price periods as they can stop and start supply more readily than the large incumbents. This raises the distinct possibility that incumbent generators might see batteries as part of the solution to the risks associated with 5MS.
What are the market risks to renewable generators following the introduction of 5MS?
Effect on bidding strategies
One of the biggest implications is that static ‘set and forget’ bidding will no longer be a feasible strategy and there will be a much greater need for accurate and dynamic price forecasting. Simply put, renewable generators that do not have dynamic bidding strategies in place, risk being left behind once 5MS comes into effect.
Under 30MS, both traditional incumbents and renewable generators could compensate for incorrect price forecasting by rebidding in the back half of the trading interval. However, this advantage is lost under 5MS – generators must stick with their forecast price for that interval.
As such, generators will need to ensure that their price forecasting is on the money (no pun intended) and can no longer take a hands-off approach to the bidding process.
The main risk being that under a passive bidding strategy, not being in the market at all will hurt the revenue line but equally, simply leaving a static bid at the market floor could ultimately lead to exposure to negative pricing and potential losses. This is especially so taking into account the ramp rates and generator performance standards that need to be adhered to.
Effect on existing contractor scope of works
As outlined above, another material risk for owners is whether the introduction of 5MS is a change in law relating to a change in their contractor’s scope of work. Relevant questions include whether contractors are entitled to a variation to the scope of works and whether there is additional work required especially in the case of monitoring market data in 5MS. EPC Contractors will also undoubtedly be considering their budgets for testing and commissioning plans in light of 5MS.
Effect on PPAs
An interesting divergence in incentives arises in the effect that 5MS may have on PPAs. PPAs are fundamental to the bidding strategy that the owner will implement as they affect the break-even price and what makes a competitive strategy for both parties (which may differ) yet they do not go into the minutiae of the bidding strategy that 5MS may require.
Thus, there is a split incentive for owners in a post 5MS world: PPAs will usually only specify minimum generation requirements and this may come into tension with the need to reduce Contingency Raise FCAS costs.
The situation can arise where the energy price is high, but the asset is bid out of the market because of the need to balance this against FCAS costs. In a project finance context, financiers and lenders will be particularly concerned that assets are not on when prices are high.
According to Chris King, Director of Business Development at Fluence Digital, “an issue that will remain for renewable generators post-5MS is the inherent split incentive around FCAS costs and generation requirements”.
“Sometimes, the asset owner’s desire to reduce FCAS costs can conflict with minimum generation requirements set out in PPAs, however, the level of curtailment to avoid FCAS costs is usually not high enough to jeopardize any minimum generation requirements”.
What are the market risks that will remain post 5MS?
Existing market risks must also not be overlooked. Failure to forecast FCAS prices and to account for expected Contingency Raise FCAS recovery costs in a bid price may result in an asset being dispatched to generate at a loss.
5MS will result in renewable generators rebidding more frequently leading to an increase in compliance risks. Generators will need to continually ensure that their rebidding process complies with regulatory requirements to avoid disciplinary action from the Australian Energy Regulator.
What will happen to renewable generators who don’t change their bidding strategy to incorporate 5MS?
Renewable generators typically face a trade-off between bidding at the price floor to minimise opportunity costs from being constrained off, versus bidding at the break-even price to minimise financial losses from generating below break-even. Currently, a generator might bid at the market floor and use the remainder of the trading interval to compensate for any unforeseen events. This ‘safety net’ will disappear under 5MS. Some renewable generators will choose to manage the new risk of 5MS via bidding at break-even to avoid negative pricing, risking incurring opportunity costs due to constraints in the process.
For renewable generators that continue to bid at the price floor to minimize constrained-off energy, there are two key risks:
- generating during negative prices due to a “missed prediction”: the failure to predict negative prices when setting dispatch targets means that the generator will be required to generate through a negative price interval;
- getting constrained off (i.e curtailed) due to “false positive prediction”: generators may predict a negative price that did not eventuate. Under 5MS this will be a more common occurrence as negative prices will correlate with high wind and high congestion. Constrained assets must be very confident with their predictions of negative prices if they want to step off the break-even price to the price floor.
For renewable generators that elect to bid at their financial break-even price to protect against the possibility of negative settlement prices, there are risks that also come with this approach. Some of these include:
- getting constrained off (incurring opportunity costs);
- being cycled on & off frequently, as the Regional Reference Price (RRP) bounces around the break-even price; and
- being constrained on during negative prices. This is rare but renewable generators will need to detect the positive local price adjustment and move bids up accordingly to avoid losses.
Notwithstanding the above, there are various strategies and mitigation measures available to owners and renewable generators to address some of these key risks under 5MS. In Part II, we will explore some of these to enable owners and generators to get ahead and avoid the potential pitfalls which await those who sit on their hands and fail to act.
Part II
What are some options renewable generators can use to help mitigate the risks associated with 5MS?
Set and forget a thing of the past
Different assets will need different trading strategies. However, post 5MS, static bidding is no longer viable. Renewable generators will need to use a more dynamic bidding strategy, instead of simply ‘set and forget’, which is no longer fit for purpose as a strategy in a 5MS world.
A renewable generator’s main concern will usually be avoiding negative prices and constraints. Accurate price forecasting will mitigate the risk of an asset being constrained or exposed to negative prices. Diverse (and huge) sets of data, constantly changing over 5-minute intervals, will need to be tracked and factored into reaching an optimal bid price.
Price referencing
As a general recommendation, renewable generators should carefully review current bidding strategies in the context of the location and physical characteristics of their assets and the commercial arrangements applying to each. More specifically, renewable generators are best advised to monitor three distinct prices every 5 minutes before settling on a bid price:
- the Regional Reference Price (RRP);
- the local dispatch price or the connection point dispatch price which governs whether an asset is dispatched or constrained off; and
- the contingency raise FCAS price (CR FCAS).
Where these prices land will ultimately inform the most economic bidding strategy, whether that’s at the price floor, the break-even price, or even lower.
For example, if the RRP looks good (ie is above the break-even price), and there is no local price adjustment being applied (ie the asset is not being constrained down) but CR FCAS prices are high, then re-bidding may be required (depending on PPA structure) to avoid generating at a loss due to FCAS costs. Generators must constantly monitor and factor in all three prices to reach an optimal bid price every 5 minutes. Automated bidding systems can add value in this regard, as they are able to accurately monitor these multiple prices and can also model future price movements.
A renewable generator’s new optimal bidding strategy in a post 5MS world for each specific asset may also be based on: PPA structures, the break-even price on that particular asset, historic regional price dynamics that we can expect to continue, historic exposure to constraints, and tolerance for being ramped frequently on/off.
A cautious approach that appropriately weighs all the relevant factors is important in the anticipated initial volatility of a post-5MS market.
Owners should also be reviewing their PPAs if they have not done so already. Most of the time PPAs will be light on the details as to how the project bids in and may only set high level requirements, for example, specifying minimum generation. That in itself could expose the renewable generator to accusations of acting in breach of the PPA. In circumstances where the PPA is underwater for the offtaker, this could allow the offtaker to ultimately reset the PPA. Equally, if the PPA is one that gives the generator discretion as to when they generate, this could lead to significant losses for offtakers where they need to settle at prices below the PPA price.
Software solutions
Software is essential for any viable bidding strategy in a post-5MS world. Juggling the three dynamic prices referenced above and calculating an optimal bid price in every 5MS interval is too much for a human to do with the precision and consistency required for each 5-minute interval. In contrast, software is ideally suited to solving this optimisation problem; notwithstanding that any existing software and models that renewable generators use will need to be fine-tuned post-5MS to respond optimally to the new market dynamic.
An auto-bidder that reacts to automatically re-bid with the correct AEMO requirements will not only increase the overall revenues of the renewable generator but will also decrease the possibility of non-compliance in respect of re-bidding errors if undertaken by a human.
“To assist with mitigating the significant uncertainty and to plan for the future of 5MS, we have taken a very collaborative approach with our clients over the last number of weeks to help them with their bidding strategy post-5MS settlements”, says Chris King, Director of Business Development at Fluence Digital.
Following go-live of 5MS, a cautious approach is advised, with a tailored bid strategy for each asset that balances market risk with returns.
The key takeaway is that a dynamic and forward-looking methodology that leverages software is required, to calculate the optimal bidding price for the current interval. While it might be thought that a more ‘hands off’ approach can be taken without the need for averaging out prices over 30-minute settlements (30MS), a post 5MS world means that software is more important than ever because of greater uncertainty and risk in market dynamics.
What should sponsors be speaking to their asset managers and bidding and dispatch suppliers about?
Retrofitting batteries
The need to manage curtailment and MLF becomes especially relevant post-5MS. There is a growing opinion that renewables, especially solar, are almost not viable without being coupled with batteries. The ability to couple batteries with renewables is a factor that is shaping and will shape future project designs and discussions with offtakers. However, before battery integration becomes the status quo some regulatory hurdles will have to be crossed.
Take for instance the important market registration issue. While the solution is potentially not far away now in the form of the creation of a new market participant category (the Integrated Resource Provider), there is not currently a clear way to register a battery and a co-located power source as a hybrid generator, and to manage dispatch targets in the aggregate. Even though the two may be physically located next to each other and share a connection to the grid under the current regime, they are still bid in separately.
“The regulatory change addressing this issue will need to take effect before we can properly recognise these types of projects as a true hybrid so we can start to see the real benefits of coupling batteries with renewable projects”, says Joanna Leigh, Quintas Energy’s Country Manager in Australia.
Batteries also undoubtedly have many different applications, however, some of these are not currently priced by the market (eg grid services). To increase the profitability of batteries, these new markets will need to be recognised before the true value of battery storage technologies can be realised.
Fundamentally, 5MS and the introduction of the various regulatory rule changes should incentivise the use of batteries coupled with renewable projects. This is because their speed to react will play a huge role in mitigating the risks associated with fluctuations in price over the much shorter 5MS period. Renewable generators which fail to predict a price spike can still capture it through the use of batteries whereas a peaking generator will take 5 to 10 minutes to react which will not be fast enough to meet the price spike.
“All roads ultimately lead to energy storage”, says Matt Baumgurtel, new energy sector lead partner at law firm Hamilton Locke. “The effect of the various NER rule change proposals coming down the track will be to promote the use of battery technology with renewable projects and these rule changes will become all the more important in a post-5MS world“, he says.
Bidding strategies
It is possible that offtakers will take a greater interest in generator bidding strategies particularly given the uncertainty of future revenues in the more dynamic world of bidding post-5MS. Offtakers might require renewable generators to undertake a more sophisticated bidding and dispatch strategy, with the offtaker reserving the right to compel the generator to revise the strategy as the need arises. Offtakers essentially have significant financial exposure to a commodity that will change prices every 5 minutes. They will likely be seeking greater control and involvement in a post-5MS world.
As such, renewable generators will need to consider novel bidding strategies using fit for purpose software solutions that take into account the many variables that are at play in submitting the most economic bid.
Discuss scope of work requirements
Owners should be speaking with their O&M Providers and Asset Managers to consider whether changes to the scope of work under those agreements are required and plan accordingly. The risk is that the services and/or work required to plan and implement effective bidding strategies and mitigation measures may not have been envisaged pre-5MS in commercial arrangements with those counterparties. Therefore, the obligation to carry out the required services will either be at the additional cost of Owners or even worse, could fall between the cracks and not be actioned.
Ultimately, sitting back and doing nothing is the most likely way to expose renewable generators to high price volatility and economic losses.
Making the transition to 5MS
The move to 5MS will undoubtedly change the landscape of the NEM as we know it by promoting the use of renewable technologies and solutions over large incumbent coal generators which are already nearing their end of life. While there is still uncertainty as to what the initial stages of 5MS will bring, what is clear is that by partnering with experienced advisors and service providers like Hamilton Locke, Quintas Energy and Fluence Digital, owners and renewable generators can get ahead and navigate the transition to this brave new world.
Matt Baumgurtel leads the New Energy sector team at Hamilton Locke which specialises in renewable energy, energy storage and hydrogen projects and transactions as part of the firms Energy, Infrastructure and Resources practice. David O’Carroll is an associate and Chanum Torres is a paralegal in Hamilton Locke’s New Energy sector team.
