9 minute read 12 Sep 2019
Overhead view family assembling jigsaw puzzle at table

Putting together the pieces of Ireland’s Wholesale Energy Market

By David Cashman

EY Ireland Business Consulting Director

A result-driven professional with strong analytical skills.

9 minute read 12 Sep 2019

The Wholesale Electricity Market on the island of Ireland is undergoing significant change to integrate with European markets and to decarbonise the electricity sector.

For utility companies and large energy consuming businesses, new market forces bring new challenges and opportunities. In this article, I will break down the components of the new market and the opportunities across the island.

The Integrated Single Electricity Market (I-SEM) was introduced on October 1st 2018 after an extended trial period to allow the market operator and participants to prepare for the overhaul. I-SEM has already dramatically changed the way energy is traded as the market here aligns with European rules. Coupled with this is the launch of the new System Services market under EirGrid’s Delivering a Secure Sustainable Electricity System (DS3) programme. This market is designed to facilitate more renewable generation by incentivising services that help keep the grid stable at critical times.

Overview of the DS3 Market

The combination of the new market rules in I-SEM with new revenue opportunities through DS3 System Services offers significant commercial, strategic and operational opportunities for existing players. It also provides exciting possibilities for new entrants through upcoming auctions.

Market reform overview

As noted in our previous article on I-SEM, updates to the market rules will lead to significant changes in how market participants will operate going forward. Increased trading activities and a responsibility to balance energy generation with the traded position requires more sophistication in trading operations. Auctions for capacity completed earlier this year, indicate that competition for contracts will lead to a squeeze on revenues with far reaching implications for market participants. This includes winners and losers in the auctions and the overall market allocation for capacity revenues decreasing from €530m to €330m. Utilities will need to find new sources of revenue and DS3 System Services provides a real opportunity for generators to supplement revenues in the new energy markets and capacity auctions.

DS3 System Services Market Overview

Ireland and Northern Ireland have ambitious targets to achieve 40% renewable generation by 2020. This means there will be times when renewables are a much higher portion of the energy mix. The system operators have set out a target to allow for up to 75% of generation from renewable sources, such as wind and solar, at any given time. The purpose of DS3 System Services is to encourage the provision of grid stabilising services that are necessary at times when renewable generation is high.

For market participants across all generation and technology types there are significant opportunities to obtain additional revenues through this new market framework.

Opportunity for New Value Added Services

There are 14 value added services that participants can tender for through the new framework. These services include traditional reserve products, such as Primary and Secondary Operating Reserves, and new fast acting services to help support grid stability. Most market participants will have the capability to provide a subset of the 14 services and can assess them based on capabilities of their generation asset.

*Source: SEM Committee Tariffs and Scalars Decision Paper

Revenue Streams and contracts

An annual spend of up to €235 million for the DS3 System Services market has been allocated from 2020. This is a significant increase on the previous Ancillary Services market which had an annual spend of €75 million and offers a significant opportunity. In the initial years of the market there are contract terms of up to 6 years on offer to successful applicants. These contracts also define a specified tariff rate which will be paid for each service*. Participants can determine the cumulative rate they are likely to receive based on the combination of services that their asset can provide. This helps them estimate their revenue potential.

*Source: SEM Committee Tariffs and Scalars Decision Paper

How it will work

A prominent feature of the DS3 System Services framework is the inclusion of scalars. Scalars are multipliers that act on the base tariff rates and are aimed at incentivising best in class performance when required most.

‘Scarcity’ scalars increase the rates paid at times when renewable generation is very high, typically when the grid has a scarcity of stabilising services. The scalars increase the rates paid for services by 6 times the base rate when renewable generation on the grid is high. Therefore, service providers that are available at those times stand to benefit most.

‘Product’ Scalars ensure the best in class delivery for a specific service product. This includes faster response times of service provision.  Service providers can obtain significant increases in the tariff rates obtained by meeting these best in class standards.

Source: DS3 System Services Scalar Design

A key element of the framework is the ‘Performance’ Scalar. Service providers are incentivised to provide services that meet the standards set by system operators on a consistent basis. Ensuring consistent delivery of services will be essential to ensure maximum returns.

Service providers can ensure maximum returns by providing best in class delivery, consistently, when renewable generation is high.

Openings for New Technologies:

New technologies will play a significant role in the transition to a power system with high penetrations of renewable generation. The system operators will issue auctions for up to 300 MW of capacity for new technologies with the first auction taking place in February for 100 MW of capacity. This auction will offer a 6 year contract for the provision of 5 services. Under the framework, successful parties will receive a steady income stream in return for offering certainty of service provision.

The auction is expected to generate interest from developers of new technologies such as battery storage and similar devices. Experience from the UK and Australia, provides a promising outlook for battery storage in providing services similar to those outlined in DS3. The auctions are expected to be highly competitive so developers will need to carefully consider the commercial arrangements when making offers.

Other revenue streams may offset some of the upfront investment allowing for a more competitive submission to the auction. Arrangements have been developed for the treatment of storage devices and demand response in future capacity auctions. The opening up of capacity and DS3 System Services auctions provides significant opportunities for utilities to make investments in new technologies. There are also now attractive signals for large energy users to harness the flexibility within their own consumption to provide services and generate revenues to offset energy costs.

1Source: DS3 System Services Volume Capped Competitive Procurement
Source: DS3 System Services Fixed Contracts Procurement Arrangements

Putting the pieces together DS3 and I-SEM

The introduction of the DS3 System Services framework at a time when wider market reforms are being driven by ISEM is a significant change for participants. We consider 6 opportunities for success under the new market arrangements.

1. Understanding Opportunity Cost:

Creating trading strategies that optimise returns across the different markets will be essential. One such area that participants will need to consider is making trade-offs in trading in the Ex-Ante or balancing markets versus being available for providing services. Effectively assessing the opportunity cost in these situations will form part of the overall trading strategy.

2. Optimising Performance:

A key element of the DS3 System Services framework is to incentivise best in class delivery and reliability in performance. To ensure maximum revenues, generators will need to ensure that their asset can deliver the highest level of service possible, on a consistent basis. Monitoring performance and ensuring reliable delivery will be critical to success.  

3. Striking when the iron is hot:

Scalars incentivise providing services when the system operators need them most. This makes the provision of services at these times significantly more lucrative than in more benign conditions. Being able to offer services at these times will be an essential cornerstone in maximising revenues. Accurate forecasting of when wind generation will be high will be a key differentiator in enabling effective trading.

4. Preparing for the changing landscape:

New technologies could threaten revenues from traditional assets. An effective strategy to seize the new opportunity whilst also managing threats to existing operating models will be key. The auctions for new technologies will attract interest in the short term but it will be important to consider all revenue streams from DS3, Capacity and the energy markets when making investment decisions and market entry strategies over the medium to longer term. 

5. Understanding the risks:

The DS3 Scalars offer significant upside potential but there is also some downside risk. Different assets are suited to providing different services so understanding your asset and what services it can provide will be important in determining the revenues that can be achieved. Scalars incentivise provision at times of high renewable generation, therefore the revenues achieved from year to year will vary depending on the amount of renewables available over the year. Similar to revenue forecasts for wind farm projects, new DS3 revenues will need to be assessed on different scenarios and expectations.

6. Harnessing Flexibility:

The new arrangements under ISEM and DS3 create opportunities for large energy users on the island. DS3 offers a route for customers to harness flexible consumption to provide services and generate revenues to offset energy costs. Engaging with your supplier and with a demand aggregator can provide a route for large energy users to best use their assets and reduce overall costs.

ISEM is leading to a transformation in the wholesale energy markets on the island of Ireland. DS3 System Services will form another piece of the puzzle that utilities must consider when re-defining their approach. Those that fit the pieces together to form a coherent strategy will stand to benefit most. Utilities will need to put system services provision at the centre of their trading strategy and not consider it as just an ancillary activity.

Summary

ISEM is leading to a transformation in the wholesale energy markets on the island of Ireland. DS3 System Services will form another piece of the puzzle that utilities must consider when re-defining their approach.

About this article

By David Cashman

EY Ireland Business Consulting Director

A result-driven professional with strong analytical skills.