This series is part of our broader New Energy Insights series from our New Energy team. Stay tuned for regular updates and commentary on topical issues across the sector.
In this two-part series, Hamilton Locke sat down with Quintas Energy and Fluence Digital to consider one of the biggest changes to the National Electricity Market in years – the switch to 5-minute settlements (5MS).
In Part I, we explored how 5MS will change the energy market and the risks that will arise in this new landscape should renewable generators fail to act. In this Part II, we will focus on some of the strategies generators should consider implementing to get ahead in the 5MS world.
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.
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 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?
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.
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.
The Hamilton Locke team advises across the energy project life cycle – from project development, grid connection, financing, and construction, including the buying and selling of development and operating projects. For more information, please contact Matt Baumgurtel.