"Non-physical trading" - this expression comes up a lot when talking about optimizing flexible assets (like battery energy storage). But what does it actually mean? And why is it important?
Let’s start by explaining physical trading. Physical trading is when an optimizer places a trade to sell an asset’s power ahead of delivery, and the asset then generates the required power as per the traded position that’s been sold. This asset has been physically traded.
In non-physical trading, the first part is the same: an optimizer places a trade to sell power ahead of delivery. However, before the delivery period, the optimizer buys back the previously sold power in a second trade. Therefore, at the time of delivery, the asset is no longer committed to generating power. This asset has been non-physically traded.
In this explainer, we go through three scenarios to explain:
- What non-physical trading is.
- Why you might want an asset to back up non-physical trading.
- How the Balancing Mechanism can offer an additional opportunity to trade power.
Jargon buster
We refer to several markets for trading power through this explainer.
In the day-ahead market (which runs at 10am the day before physical delivery), optimizers can trade power in every hour of the following day (or, more accurately, 11pm that day until 11pm the next day).
There is another chance to trade power on the intraday market. This is a rolling market, where power starts to be bought and sold (typically) two to three hours ahead of delivery. Most trades are in the final hour before delivery.
After gate closure, one hour before the delivery window, assets can submit bids (to buy energy from the grid) or offers (to sell energy to the grid) to the Balancing Mechanism, which may get accepted by the system operator (National Grid ESO).
More info on how these different markets can be stacked together, along with the various ancillary services for battery energy storage (and time scales for doing so), can be found here.
Scenario 1
Let's consider a storage asset - looking to sell power from a 100% charged position.
- In the day ahead market, the optimizer submits positions that result in a £200/MWh discharge planned for 7pm the following day.
- In the intraday market, the price for 7pm has fallen. This could be because more wind has been forecasted, as compared to the previous day. The optimizer is now able to purchase the discharging energy at £120/MWh.
Scenario 1 is illustrated in figure 1 below.
In this case, the optimizer has made £80/MWh by buying low (in the second, intraday trade at £120/MWh) and selling high (in the first, day ahead trade at £200/MWh).
There are clear advantages to this strategy:
- If no further action is taken, the asset doesn't have to charge and discharge. This saves on degradation, warranty conditions, and risk - while still generating returns. This is one of the benefits of non-physical trading.
- If a new trading opportunity arises closer to the delivery period (e.g. in the Balancing Mechanism), the asset can be traded again for additional revenue. We’ll look at this later on, in Scenario 3.
In this scenario, the optimizer has made £80/MWh without having to run the asset. So, why do you need an asset at all? Well, the market doesn’t always go the way you’d want it to. We explore this in Scenario 2.
Scenario 2
We start off in the same way as Scenario 1, with a fully charged asset.
- In the day ahead market, the optimizer submits similar positions that result in a £200/MWh discharge planned for 7pm the following day.
- In the intraday market, the price for 7pm has now risen to £300/MWh. This could be due to less wind than anticipated in an updated forecast driving up prices.
This is illustrated in figure 2, below.
Let’s return to our previous question: why do you need an asset for trading power?
- With an asset, the optimizer can physically deliver on the discharge (sell) trade arranged via the day-ahead market. It does not matter that prices have changed as we approach delivery time because no further trades need to be placed. The asset physically delivers upon its agreed original position, shown in figure 3, below.
- Without an asset, the sell trade needs to be reversed to get an overall 0 MWh position. Taking the latest market prices (ie an increase in £100/MWh), the optimizer would be down £10,000 on a 100 MWh trade, shown in figure 4.
- Without this reversal, the trader will be forced to buy the volumes through the imbalance price which can be more volatile and present an unacceptable risk.
Scenario 3
Let’s consider one more case of non-physical trading, revisiting Scenario 1.
- In the day ahead market, the optimizer submits positions that result in a £200/MWh discharge (or sell trade) planned for 7 pm the following day.
- In the intraday market, the price falls to £120/MWh, and we buy back our previous position in a second trade.
- As time moves on past gate closure, we enter into the time window of the Balancing Mechanism. A shortage of power occurs close to delivery, and prices then rise to £250/MWh, as in figure 5, below.
- Not only do we benefit from the £80/MWh earned via steps 1 and 2, but we may also be able to discharge the asset via offers in the Balancing Mechanism and capture the higher price of £250/MWh. This is shown in figure 5, above.
- Assuming all 100 MWh is sold into the Balancing Mechanism, the optimizer earns a total of £330/MWh in this delivery period, delivering higher revenues.
So, should you physically deliver or non-physically trade?
In all cases, the optimizer is trying to make the most money it can for the asset. Back in Scenario 1, the optimizer could either deliver on the first sale at £200/MWh or follow a non-physical strategy of buying back the sold energy. Both are profitable strategies, but which is better?
Well, it comes down to how power prices are behaving in the market. For example, if the highest price possible for the sale is in the day-ahead market and prices steadily decline until delivery, the optimal strategy for the asset might be to sell in the day-ahead market with no further optimization (or trades placed).
Ultimately the ability to pick the right period to trade in and maximize profitability (potentially through non-physical trading) is part of the expertise that asset optimizers bring to energy storage.
Key takeaways
- Non-physical trading involves buying and selling power in different markets, at different times in the run-up to the delivery window.
- An example of this is selling power in the day-ahead market, buying it back in the intra-day market, and re-selling again in the Balancing Mechanism.
- Non-physical trading generates money for the asset and helps to balance energy markets in each trading period.
- It can also save on physically cycling the asset - which helps to conserve the valuable asset warranty. For owners and operators of lithium-ion battery storage, it also reduces degradation.
- Asset-backed trading reduces the risks involved with non-physical trading. If the market moves in the ‘wrong’ direction - i.e. that money would be lost, instead of gained when a trade is reversed - then the asset can simply deliver the initial position. There is no need to ‘buy back’ any of the previously sold energy. Risks are lower as there is less exposure to market movements.
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