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FROM “DAY AHEAD” TO REAL-TIME PROFIT: THE BUSINESS CASE FOR FLEXIBILITY

In recent weeks we have shown that flexible capacity not only generates value for utilities but is also a big money-saver for consumers, reducing their electricity costs. Now we turn our attention to the strong financial incentives and business logic for investing in flexible power generation.

It’s one thing to talk about the value of flexibility when we look at consumers in California who are saving money on their energy bills. But it’s another to convince investors that they, too, will profit in both the short- and long-term if they extract the value that is hidden in flexible capacity. Sometimes it’s hard to break from traditional ways of thinking about energy markets and profitability. In the past, for example, investors built power plants with the belief that the market price for electricity would be high enough also in future. That belief is what incentivized capacity.

But then the market changed, and with it, people’s beliefs. The surge in renewable power in recent years forced the industry to adapt in quicker ways than we once imagined. Now, as the rapid growth in renewables contributes to more volatile energy prices, investors are realizing it’s time to look to new sources for value. And flexible capacity, by creating value from real-time energy markets, ancillary services markets and flexible contract structures, has shifted the investment logic for power plants.

Here’s why.

As we know, the traditional energy market operates as a “day ahead market,” meaning that power utilities offer their capacity to the market with certain cost, while buyers indicate how much they are willing to pay for electricity tomorrow. The day ahead clearing price provides then an accurate estimate of what electricity is going to cost. For example, a utility could promise to produce 100MW at a wholesale energy price of 50 $/MWh, totaling $5,000. Let’s say that the operating cost of the plant is 40 $/MWh, so the utility makes a margin of $1,000. The higher the demand for electricity on any given day, the higher the price for wholesale buyers.  If a utility only operates in the day-ahead market in today’s and tomorrow’s market, the chances are that its profit margin is low. 

On the other hand, in the real-time energy market where prices rise and fall every five minutes, flexible capacity completely changes the financial equation. Sticking to the example above, we have a utility that received 50 $/MWh market clearing price for energy it produces. But what if tomorrow there is a little more wind or sun than was expected, lowering the need for thermal capacity? All of a sudden, excess power is being generated by renewables and less is being generated by gas, which drops the real-time market price to, say, 20 $/MWh.

    More information

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   Matti Rautkivi

   Sales & Marketing Director,
   Wärtsilä Energy Solutions
   
    Send Email 


Read more about how real time markets work in our infographic

 





Read more about how real time markets work in our infographic

If you’re fast enough to catch the price signal—that is, if you have flexible capacity and can respond in real-time by shutting down your plant—you’re looking at potentially half the operating costs and double the profit margin than you calculated the day previously. You promised to provide 100MWh of electricity  and you can still fulfill that commitment—only now you’ll do it more cheaply because you’re buying power on the real-time market, which is well below your operating cost. Now, the utility is able to make a margin of $3,000 per hour instead of $1,000. In other words, flexible capacity has just produced a higher return on your investment.

Another interesting source of revenue for flexible power plants is ancillary services market. In this market, the system operator purchases additional services to ensure system stability. These products are called Regulation, Responsive Reserve and Supplemental reserve.  Basically a power plant is able to provide these services if they operate at part load and provide the available capacity to system operator. Flexible plants that are able to operate with good efficiency at part load and have wide turn down ratio can benefit from the ancillary service market, which is getting more and more important with the increasing amount of renewables.

As a practical example of this, take the Electricity Reliability Council of Texas, or ERCOT, which has already earned value for investors through flexibility. As an “energy only” market, Texas is different from other U.S. states because its utilities get revenue only when they generate electricity; they don’t receive “capacity payment” from the state simply for being built. For this reason, the changing day-to-day price of electricity means everything in the ERCOT market. And when investors looked for enhancement possibilities in that market, they turned to flexibility. 

We analyzed the ERCOT market in the historical back-cast analysis while trying to find out the additional value of real time market and ancillary service market for an Independent Power Producer (IPP). As the day-ahead market prices have been relatively low, the day-ahead market operations were able to provide only 8.5 % leveraged internal rate of return (IRR). However, this return was still significantly higher than simple cycle gas turbines were able to receive (5.9%). When we add the real time market operations into the analysis, the IRR was increased to 12.3%, so there is significantly uplift from the Real-time market operations. The ancillary services market in ERCOT provided a second additional step to increase profitability. We optimized a flexible plant over day-ahead, real-time, and ancillary services market, and were able to see IRR numbers as high as 22.5%. Read the full analysis and very interesting comparison between reciprocating engines and gas turbines from Investment Opportunities And Technology Selection

Traditionally, the value of real-time market has been ignored, and there is a reason for that. There has not been technology available that can exploit these five minute opportunities and is able start and stop several times per day. Flexible gas reciprocating engines provide access to this market, and as our analysis shows there is a very good incentive to participate these markets.

While Texas may enjoy a unique market circumstance that promotes value from flexibility, similar analyses show that this type of success is replicable in markets across the country. In the large eastern U.S. markets of PJM for example, estimates for flexible power generation are yielding even greater results.

As more renewable power enters the mix, investors know they’ll be seeing lots of price spikes in the future. And during the “shoulder months” of spring and fall especially, inconsistent weather is making it hard to predict how much load a utility will have. The incentives to build power plants with flexible generation capacity are clear. Whether, and how quickly, the success in Texas proves to be a model for the nation has yet to be seen.







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