Ancillary market reform and harmonisation: what it means for price discovery

For a truly dynamic network to be created free from supply and demand issues, renewables must not only be integrated, but the priority placed on integrating them 'successfully, with all ancillary services streamlined also. Currently, the ancillary market takes a more localised approach, with most ancillary purchasing executed on a national level, but this is starting to change. As increasing levels of renewable energy become integrated into national networks, balancing service costs needs to be redesigned, with a more harmonised, international approach. To address this shift, EU balancing reforms are taking place in line with the goals of moving towards a unified national energy framework. 

But how can market participants prepare for these changes? Some traders are combating the negative effects of the reform through close policy tracking, while others are analysing cross-border market data to help identify alternative, international opportunities through cross-border procurement.

It's crucial that market analysts and strategic traders understand the impact of the ancillary market reform in Europe and how it affects the wider market, including strategies on how to mitigate the effects of these changes.

Why reform is happening

In the past, the energy market has relied on steady sources of energy such as fossil fuels, but Europe is evolving from this more traditional model to a modern electricity system. Reform drivers include the successful integration of renewable energy as well as the adoption of more decentralised resources. 

Another element to consider is how to streamline the objectives of the reform and what form this might take. Integration goals include increasing energy resiliency by reducing the dependence we have globally on fossil fuels, with the avoidance of associated price spikes. 

There are also efficiency objectives included in the reform to think about. Currently, there are large costs associated with the act of balancing thanks to disparate national markets: the reform could save hundreds of millions of euros if implemented correctly.

Harmonisation effects

But what are the harmonisation impacts of the reform? Harmonisation is the streamlining of ancillary services across different Transmission System Operators (TSOs), as well as the order lists and activation requirements that accompany them. The streamlining of these services across a number of different regions is hoped to help address differences in balancing fees and make the network overall more efficient, with fewer bottlenecks and energy shortages.

One financial tool being implemented is auction platforms, which streamline reserve purchasing across borders. Common auction platforms include PICASSO (aFRR), IGCC (Imbalance Netting) and MARI (mFRR). 

Another technique is volume pooling, which activates the lowest-cost resources available, wherever they are located regionally. 

Cross-border impacts

It's not just on their own national level that market participants should adjust to changes; special consideration should be paid to how the reform affects the energy market on an international level. Flow dependency could become a real issue under the reform, as integration can cause interdependence between certain regions.  Geopolitical shifts or imbalances can then cause shocks within the global market. 

Traders will therefore have to factor in the effect of regional price convergence, which is the exposure of local networks to the activity of larger networks in other regions. 

Short-term volatility

One of the key skills for traders operating under the reform is the ability to identify and react to volatility transitions. The hope is that security platforms that are more successfully integrated will allow traders the overview to more efficiently buy and sell energy and ancillary services, stabilising the market even during supply and demand issues.

Regulatory uncertainty will also be a real risk: different regions have different regulations, and as legislation is streamlined, it will result in temporarily volatile conditions. TSOs will need to work together across different regions to develop legislation that is appropriate and beneficial to all regions: a complex task that will take time to shape. execute and roll out. 

This transition period is what's known as transition period dislocation, and can be a result of merging systems and technical issues, which cause unexpected price spikes. 

Long-term price convergence

While the industry may know how the reform might affect energy market dynamics, determining trader implications is a more complex task. Traders should expect to see increased competition in the market: the Electricity Balancing Guideline (EBGL) dictates that to increase competition, platforms should be integrated. 

This reduced fragmentation in the market is hoped to become more commonplace, with a single market creating a more even playing field internationally than in a local setup. 

The hope is that a more efficient market will emerge, with more competitive markets, meaning competition is increased, creating stability in pricing. This is crucial in a market where intermittent sources of energy, such as renewables, are being integrated. With so many regions with such differing weather conditions, ideal generation conditions will occur at different times, plugging the gap where renewable generation in certain regions falls short. Access to cheaper energy in different regions will reduce the associated costs of system balancing. These savings are passed on to consumers, resulting in lower consumer costs. Once regulatory issues have subsided, cross-border issues resolved, and the ancillary costs on an international basis have been smoothed out, the harmonisation of the ancillary markets should lead to long-term price convergence.