How flexibility reshapes power price volatility and spreads

To trade successfully in a market involving flexible assets, traders and analysts need to identify structural shifts and understand how price movements affect the market. In this article, we'll aim to provide trading insights, including how changes in volatility can increase or decrease prices. We'll analyse how flexibility assets are reshaping market dynamics and pricing.

Flexibility and price formation

We're used to the energy market preferring stable forms of power over less reliable forms of generation. However, today, the market is turning to faster-response capabilities. 

Reducing extreme peaks

Previously, peaking plants were required to bolster energy grids, but modern setups allow us to utilise storage, heat pumps and demand-side response to address load issues.

Peak shaving also stabilises the grid by decreasing industrial demand through battery-banked energy, shaving off load demand and reducing the need for new infrastructure.

If zero-priced energy is available, flexible assets can bank it and dispatch it during higher-priced periods.

Shifting price patterns

Shifting price patterns allow flexibility - the ability to change generation or consumption to help stabilise the grid. Rather than being an intermittent energy source, renewable energy becomes a real contender to more dominant sources of energy, such as fossil fuels. They've helped to reshape price dynamics.

This can be seen in energy prices dropping while price swings increase. We call this diverging spreads. This allows energy to be banked and stored at lower prices and sold at higher prices.

One drawback of renewables is the gap between midday solar oversupply and evening demand spikes, known as the duck curve. Flexible assets allow this curve to be smoothed through banked energy.

With shorter trading windows - for example, on the EPEX SPOT market, which has been shortened into 15-minute intervals - more accurate bidding can take place. This switch to accuracy allows residential customers to adjust to lower-cost electricity periods.

Impact on volatility

Power markets need stability to run smoothly, but intermittent renewables often don't lend themselves well to it. Flexible assets can act as a safety valve for renewables' involvement in the grid, helping flatten peak pricing.

Lower volatility in some periods

Certain industries can adjust their demand in line with periods of high energy generation. For example, district heating systems can adjust their consumption to coincide with hot days with high solar output, which can stabilise the volatility associated with renewables.

Cannibalisation effects

Wind and solar are tied because they often peak at the same time, as their output is determined by the weather. This dual peaking is what's known as cannibalisation. This overloads the market with excess energy, pushing down the value and, therefore, the price of energy.

Long-term structural changes

As thermal assets are displaced during cannibalisation, the supply curve steepens, potentially pushing up energy costs.

This is where flexible energy comes into its own - banking energy during peak hours and dispatching during high-price periods makes flexible solutions a more desirable and cheaper source.

Forward curve adjustments

Short-term weather fluctuations are outpacing the techniques used in longer-term energy contracts, leading to the Samuelson Effect. To combat this, traders should look to more structured contracts, such as flexible or hybrid PPAs that accommodate frequent fluctuation in output. Traditional contracts, such as pay-per-use PPAs, tend to underperform relative to flexible assets because they don't include the flexibility built in.

New equilibrium pricing

The difference between real-time pricing and the Day-Ahead market is that flexible assets can find value, as they can rapidly ramp up to meet unexpected changes in demand. This is where we would expect to see equilibrium pricing.

Pricing in general will see a gradual restructure in relation to flexible assets as more flexible assets flood the market, for example, batteries and EVs. However, they also absorb excess when prices are low, creating a floor and a ceiling for energy prices. We call this peak-and-nadir capping.

Trading implications

It can be challenging for traders to adapt to new strategies for flexible assets because older models are so fixated on peaking plants and more traditional energy generation methods.

Adapting strategies

Speed is of the essence when trading in a flexible asset environment. This is because flexible environments incorporate close reporting, with 15- or even 5-minute granular variations. This is where automation and algorithmic bidding come into play, such as automated dispatch models, including Model Predictive Control, which eliminate the need for human reaction time accommodations. Real-time pricing data must also account for the limitations of battery and hydrogen technologies, which come with physical cycling constraints. We'll also see a movement towards hybrid portfolios that combine renewable energy generation with storage, such as batteries, which are less vulnerable to curtailment and negative pricing.

Identifying new signals

The trading signals of old will be replaced with more accurate forecasting to reflect these 5- and 15-minute data points, with high-granularity generation forecasts the norm for solar and wind. Forecasting errors need to be kept to a minimum, with short-term ramping to meet demand requiring this level of accuracy.

Transmission System Operator (TSO) imbalance prices will need to be fed via real-time data streams to support trading decisions by both human and automated decision-makers. Behind-the-meter signals should also be considered, with EV smart chargers indicating early demand levels and industrial twins indicating system stress.