24 Jan 2022
Alex Done

The TCLC: Part Two - why is the TCLC important for BESS?

In Part One, we explained what the Transmission Constraint Licence Condition (TCLC) is, why we need it and how it’s enforced. In this article, we’ll reframe the discussion in the context of battery energy storage systems (BESS) and take a look at:

  • The increasing importance of the Balancing Mechanism (BM) for BESS.
  • How the TCLC applies to BESS.
  • How BESS might navigate the TCLC in the future.

To hear Alex and Neil discuss this report, and the TCLC in general, check out the video below:

Alex and Neil discuss the TCLC.

The rise of the BM

For most of 2021, BM activity has been very low for BESS, with frequency response services making up ~90% of the 2021 BESS revenue stack. However, towards the end of the year, we saw a shift in BESS monetisation strategy towards merchant strategies. Figure 1 (below) illustrates this and shows the average, monthly revenues for the GB BESS across 2021.

Figure 1 - BESS revenues across 2021, highlighting the dominance of frequency response and the shift to merchant strategies in November 2021.

The move into merchant markets has been driven by two key factors:

  • Saturation of GB frequency response markets (see figure 2 below); and
  • Record-high wholesale power prices caused by the ongoing, European-wide energy crisis.

Figure 2 (below) shows the installed capacity of BESS against the current demand for frequency response services, specifically highlighting the period of undersaturation between October 2020 to October 2021. Supply and demand imbalance flips in November 2021, caused by collapsing demand following the ESO reduction in DC requirements.

Figure 2 - Saturation of the GB frequency response market, including total ESO demand for response and installed capacity of GB BESS.

In the face of saturated frequency response markets, BESS has had to look for alternative revenue streams, which has conveniently coincided with increasing merchant opportunities. By extension, this has increased the importance of the BM for BESS in order to manage and adjust arbitrage positions taken in wholesale markets.

With the continued build-out of BESS (3.7 GW by 2025 according to our GB BESS build-out report) and the retirement of legacy frequency response services, ancillary market saturation looks likely to increase in the long run. This means that merchant strategies won’t just be a lucrative alternative revenue stream, but a necessity for monetising battery energy storage. Paired with increasing renewable penetration and the retirement of thermal generation, the merchant strategy (including the BM) looks like the direction we’ll be headed in.

How does the TCLC apply to BESS?

With rising BESS value being realised in the BM, the TCLC has renewed importance for storage. As with all licenced generators, the pricing behaviour of batteries will be under the same careful observation by Ofgem and subject to the same rules and investigative procedures outlined in the TCLC (see Part One for more information on the TCLC). But how exactly does the TCLC translate for BESS?

Battery bidding behaviour

To understand how the TCLC will affect batteries in the BM, let’s first consider their bidding behaviour in the BM. BESS BM bids can be roughly split into two groups (see Figure 3 below):

  1. Turn down - A bid that adjusts an existing position to deliver energy, as indicated by a strictly positive (>0 MW) final physical notification (FPN).
  2. Import - A bid that does not amend an existing position (as indicated by a 0 MW FPN), which results in the net import of energy.
Figure 3 - Example BM bids for BESS, illustrating the distinction between ‘turn-down’ and ‘import’.

While the instruction issued by the ESO is the same in both instances (the acceptance of a bid), Ofgem views these differently for the purpose of administering the TCLC. To understand how, we need to refer to a letter from Ofgem which seeks to clarify how the TCLC applies to energy storage. In this letter, Ofgem states that “where a generator was not due to export any power to the transmission system ... then a bid in the BM to import power would not constitute a reduction in a generation ... [and] therefore the TCLC would not apply”.

To rephrase this in the context of Figure 3, turn-down of generation is covered under the TCLC. However, importing power via the BM is not. The crucial distinction is based on whether a site has posted an FPN > 0 MW. In effect, this means that when pursuing a standard arbitrage strategy (buying low and selling high) that exclusively utilises the BM, pricing levels are not governed by the TCLC.

Locationally specific BM opportunity

One thing that is often discussed when talking about the value of the BM for BESS surrounds locational benefits. Specifically, can storage access more lucrative BM prices that arise from locationally specific constraints? For example, in Scotland, wind generation is frequently curtailed via the BM to alleviate thermal constraints on the transmission network and is often paid to do so. The argument for BESS in said example is simple, batteries can price at a level that competes with wind and ultimately by paid to charge up, providing they are in a similar location.

While an evaluation of the locational opportunity available in the BM is out of scope for this article (although we’ll be covering this soon), it is worth mentioning how this sort of strategy would interact with the TCLC. Specifically, accessing locationally dependent BM value is possible for storage, providing it is done via bids made against a 0 MW FPN - that is as a strict import of energy as opposed to the turn-down of generation.

Navigating the TCLC

As discussed above, the TCLC only governs the adjustment of pre-planned generation that occurs during periods of transmission system constraints - as such the remainder of this article refers exclusively to BM turn-down. Figure 4 (below, and featured in our previous article) outlines the enforcement policy of the TCLC. Let’s take a look at this in more detail in the context of BESS operation.

Figure 4 - Flowchart summarising how Ofgem administers the TCLC.

Excessively expensive

For traditional power generation, the idea of excessive benefit is grounded in the short-run marginal cost of operation. For example, the total cost of gas, carbon, thermal efficiencies, etc. required for a CCGT (combined-cycle gas turbine) to produce 1 MWh might be £50. As such, a CCGT should be willing to pay around £50/MWh to turn down output, representing the cost-saving from not having to generate. Paying any less could be deemed ‘excessive benefit’.

Since batteries don’t require fuel, the idea of short-run marginal cost (and by extension excessive benefit) becomes harder to define. But this isn’t a problem exclusive to batteries. We can see this if we take a look at Ofgem’s investigation (launched October 2021) into SSE’s operation of Foyers pumped-storage hydro plant. Foyers’ alleged breach of the TCLC was detected by observing “significantly more expensive [bid prices] than those it had typically submitted previously. That is, the potential breach of TCLC was detected via a comparison to historical bidding practices.

While this points to one way that excessive benefit for storage can be detected, it presents a further problem in the context of battery energy storage: BESS BM activity has historically been very low, making any benchmarks for ‘historic pricing’ inherently sensitive to outliers.

Of course, as BM volume for batteries increases, assessing historical pricing patterns will become more feasible. However, for the time being, even defining excessive benefit for BESS appears to be relatively difficult. And while this doesn’t mean that BESS is exempt from the TCLC, it does highlight one of the many challenges that arise as a consequence of higher levels of BM participation from batteries.

Consumer impact

While Ofgem keeps a close eye on the pricing behaviour of all generation licence holders, there are some mitigating circumstances that mean an investigation is less likely, namely when the impact on the consumer is low. Presently, there are a number of reasons why a TCLC investigation is less likely for BESS:

  • BESS volumes in the BM (both individually and on aggregate) are an incredibly small portion of balancing actions taken to secure the grid (< 1%).
  • Balancing actions of individual BESS sites are short-duration in nature and often do not span a full settlement period.

As we’ve mentioned before however, this changes when BESS deployment increases and their balancing activities begin to make up more BM volume (and consequently the cost to the end consumer). At this point, we can expect more scrutiny from Ofgem.

Objective justification

Following the launch of an investigation, licence holders will be requested to provide justification for their pricing strategy. To understand this more, it’s worth referring to Ofgem’s guidance on how the TCLC is enforced, which includes examples of what may be required for “objective justification”. Let’s take a look at two specific examples from Ofgem that are particularly interesting for BESS: opportunity costs and operational risks.

Opportunity costs

In its guidance, Ofgem details its methodology for assessing generator pricing behaviour. This is done by comparing “[the prices of] bids accepted to ... estimates of avoidable costs ... defined as short-run marginal cost plus additional maintenance and ramping down costs [in addition to] opportunity costs” (see section 2.15).

With a multitude of ancillary services available for BESS (DCL, DCH, FFR, EFR, and the soon to be released Dynamic Moderation and Quick Reserve), the scope of incorporating opportunity cost into BM pricing strategies is large.

How precisely ancillary service opportunity costs will be used for pricing justification is still up for debate. However, given the current pricing levels of key ancillary services for BESS (~£20/MW/h for stacked DCH+DCL), this would seem to provide an awful lot of wiggle room if BESS faces investigation from Ofgem.

Operational risks and state of charge management

Ofgem’s guidance also details how the operational constraints of generation can be used to justify pricing behaviours. Section 2.17 states “We recognise that there are costs associated with starting up or ramping up a plant that impact on the economics of dispatch decisions and that such costs may be reflected in bid prices to turn down generation”.

While storage isn’t subject to the same start and ramp costs of traditional thermal, one important factor in the operation of storage is its duration limited nature. It’s plausible to think that batteries could justify pricing levels charging to avoid hitting state of charge limits.

Concluding thoughts

With a growing storage fleet, falling ancillary market opportunities and the transformation of the GB power system, the merchant case for BESS looks to be taking hold. With increased reliance on merchant revenues, the BM will play an increasingly important role in the monetisation of batteries, bringing with it a renewed importance for the TCLC.

Crucially the TCLC only applies to a reduction in generation, meaning importing power via the BM is not hampered by restrictions on pricing levels. Instead, the TCLC concerns itself solely with the reduction of generation during periods of transmission system constraints.

Currently, even detecting TCLC breaches for BESS would appear difficult and its limited impact on the consumer means that, even if it is detected, an investigation by Ofgem is (presently) unlikely. When BM activity increases, detection and investigation are likely to become more of a consideration for BESS owners.

One particularly interesting facet of the TCLC concerns the use of opportunity costs of ancillary services to justify pricing behaviour. If current high prices in frequency response services are any indication of the future, we’re likely to see this play an important role in any future investigation of TCLC breaches for BESS.

While the above discussion is largely hypothetical, it does illustrate some of the nuances of battery operations in light of the TCLC. But one thing is for sure, we’re entering something of unchartered territory as the BM becomes (even more) important to the BESS revenue stack.