Q3 2024: Forecasts and rule changes drive higher balancing costs

The cost of generating electricity has fallen two-thirds over the last two years, but the cost of keeping the grid stable has not followed suit. Balancing costs rose 30% over the same period, partly because lack of transmission increases congestion costs, but primarily because reforms have changed how consumers pay for balancing services.

Balancing costs were stable through the 2010s, averaging 5% of the wholesale power price. They rose gradually with the share of variable renewables, as these make balancing supply and demand more complex. However, while gas and electricity prices returned to pre-crisis levels in 2023, balancing costs continued climbing to new highs. NESO forecasts they will remain above £10/MWh until 2026, five times higher than their 2010s average.

Constraint payments have contributed to this rise. Wind farms are paid to reduce output when the grid cannot handle their generation due to congestion, while gas (and other) plants elsewhere in the country are paid to increase output to compensated. Constraints accounted for three-fifths of total balancing costs so far this year, and National Grid forecasts similar levels for next year. However, constraint costs have grown steadily since 2010, so they are not the cause of last year’s sharp rise.

Left graph: Balancing prices decoupled from wholesale prices after 2023, and National Grid forecasts see them remaining high for years.

Right graph: The share of total system balancing costs that come from constraint payments.

In April 2023, Ofgem made two reforms to the way balancing services are charged. First, all balancing costs are now paid by consumers, no longer split 50:50 between consumers and producers. This doubled the cost per MWh of energy as total costs are spread over a smaller group. However, as generators no longer pay for balancing, these savings could (in theory) be passed to consumers. Overall bills should remain unaffected, or may even fall as this change levels the playing field for smaller distributed and community generation projects.

The cost of balancing the electricity system as a share of wholesale electricity price (generation plus balancing).

Secondly, spot pricing was replaced with fixed charges across each half-year to increase transparency and reduce volatility on consumer bills. Charges are calculated 9 months in advance, based on a financial model forecasting wholesale prices 18 months ahead. This model expected wholesale prices hit record highs through to 2023, remaining above £150/MWh. In reality, prices fell sharply during 2023, reaching £64/MWh in 2024. As a result, NESO has overcharged for balancing services over the last year.

NESO estimated it held an £800m surplus as of April. This over-recovery of balancing charges will be returned to consumers over the coming years. NESO expects to return £270m during 2025/26, lowering balancing costs to £9/MWh. Ofgem will change how balancing costs are calculated from next year, shortening the notice period to reduce forecast errors.