Managing the power system is a complex task. Supply and demand, as well as increases or decreases of the energy flows, have always to be perfectly balanced in every moment due to the characteristics of electric networks and to the costs and difficulties to efficiently stock electricity. For market participants this means continuous forecasting, recalculating and balancing their market positions, until real time.
The organization of the electricity markets regulates how economic players do it. Negotiations in the day-ahead market, which is by far usually the most relevant power market, fix the plan of injections and withdrawals of energy in each market zone for any hour of the following day. Negotiations close the day before the energy delivery takes place and are based on the supply and demand forecasts of market players, updated at that very moment. Then, market players can trade on the intra-day markets to adjust their commercial positions in order to better reflect real time conditions. Although gates closures of the intra-day markets differ widely within the European Union, ranging from several hours to only 45 minutes before the delivery of energy takes place, there is a clear tendency to move it closer and closer to real time.
In fact, the increasing development of variable renewable sources (wind and solar), which are dependent on weather conditions and are not easily (and sufficiently) predictable, challenges the reliability of the forecasts and increases the degree of supply volatility. As the European Commission puts in evidence in a recent report on the reform of wholesale electricity markets, trading electricity as close to real time as possible would help to efficiently integrate a large share of variable renewables into the power system. This will allow generators, wholesaler sand traders to rely on better forecasts on the amount of solar or wind energy production and, then, to better balance their trading positions. The closure of the intra-day market provides a clear picture of energy supply and demand into the system. However, errors in forecasts and unforeseen events may still occur and, at the time of delivery, the power system will anyway need to be balanced. System Operators are responsible for ensuring this and they do so through their dispatching role. In Europe, Transmission Grid companies do also act as System Operators. That’s why we call them Transmission System Operators (TSO).
TSOs are responsible for the efficient dispatching of electricity from each point of injection to each point of withdrawal, avoiding fluctuations in frequency, congestions and supply disruptions. This is a key market role consisting in translating into real “dispatching orders” the commercial positions of market actors. The European Network of Transmission System Operators (ENTSO-E) defines the electricity balancing as “the process through which the TSOs ensure that they are able to access a sufficient amount of energy to balance the differences between supply and demand that occur in every electricity transmission system and restore system security” . They do so through the balancing markets.
In the balancing markets, TSOs act as the central market counterpart contracting balancing energy, balancing reserves and other ancillary services that will allow them to coordinate supply and demand of electricity in real time, and to correct trading outputs that may be incompatible with the security of the power system and therefore being difficult or unsafe to be performed. This might allow some power stations to increase their generation so to upward balance the market, and might instead decrease or stop other power stations in case their electricity delivery is not needed for balancing purposes, with market players quoting the price at which they are willing to provide the service (in this case through pay-as-bid, as opposite to the day ahead market, typically organized as “marginal price”). Then, TSOs select the cheapest available offer on the basis of their own calculations and the system reliability needs.
To make an example, in Italy the balancing resources are negotiated in the “Mercato per il Servizio di Dispacciamento” (MSD). The MSD is currently divided in a planning phase, the “MSD ex-ante”, and the properly balancing market (MB). The day before the energy delivery, negotiations on the MSD ex-ante allow the TSO (in this case, Terna) to secure the amount of resources needed to ensure the resolution of congestions and to guarantee the effectiveness of the secondary and tertiary reserves. Then, in the balancing market, Terna activates the offers necessary to balance the power system in real time, to solve the congestions and finally to rebuild the necessary amount of reserves.
Fig.1 - Evolution of market and OTC negotiated volumes in Italy, 2009-2014. Source: “Proposta di Riforma del Mercato Elettrico”, Confindustria, data from GME elaborated by Poyri.
As shown in Figure 1, the balancing markets account for almost 8% of the energy traded in the Italian power system. Despite the generally decrease of energy consumption in Italy, the figure shows also that the percentage between consumption and the energy traded in the MSD is almost stable since 2010, around 8-10%, and that traded volumes are almost equal. This means that approximately 10% of electricity trading is in the hand of the TSO representing almost 2 billion euro of income, due to the high prices recorded on the balancing markets (see Figure 2).
In a context of depressed power markets, with prices decreasing on the day-ahead and intraday markets, it is easily understandable why balancing markets, and their revenues, are becoming fundamental not only for the security of power system but also for the profitability of conventional power plants. In fact, with day-ahead and intra-day prices dropping by 16-18% between 2013 and 2014, thus ranging from 52.08 €/MWh for day ahead to 51.03 €/MWh for MI2 and 59.46 €/MWh for MI4, conventional power plants find most of their net revenues in the balancing market as shown by the graphic in Figure 3.
Fig.2 - Evolution of upward and downward prices in the MSD and of day-ahead average price, 2011-2014. Source: “Proposta di Riforma del Mercato Elettrico”, Confindustria, data from GME elaborated by Poyri.
The decrease of revenues for conventional power plants is mainly due to the development of variable energy sources. On the one hand, the increasing part of RES in the generation mix pushes day-ahead and intraday average market prices down and, by reducing the running hours of conventional power plants like natural gas fuelled power plants, erases their margins. On the other hand, until now RES penetration has increased the need of reserve margins, provided by the same conventional flexible power plants, to compensate the variability of generation and to ensure system reliability. This forces TSOs to switch on or modify the input programs of those flexible power plants (as fossil fuels power plants) in the balancing markets. However, if today thermal power plants (mainly CCGTs) ensure flexibility and provide balancing resources to the system, tomorrow other technologies – maybe RES plus storage devices? – will be leveraged upon, to ensure those services in a better manner and at a lower cost.
Fig.3 - Recovery of fixed and investment costs of CCGT in 2014. Source: “Proposta di Riforma del Mercato Elettrico”, Confindustria, data from GME elaborated by Poyri.
The flexibility of storage technologies, such as hydro pumps, is already well known by market actors. That’s why some TSOs are already allowed under certain circumstances to run hydro pumping storages for system security reasons. In Italy, for instance, there are more than 7 GW of hydro pumps, which accounts already for more than 10% in the MSD ex ante and 30% in the MB of upward activation resources (out of secondary reserve), and 5% and 27% of downward activation resources . Moreover, the current development in electrochemical storage technologies allows us to predict that these will probably be the most profitable options in the balancing markets, acting as price maker. Allowing TSOs to develop large new storage stations and to operate them, as many would like and someone already are doing, could result in almost completely excluding generators from the balancing market. This would mean that, under the umbrella of dispatching needs and balancing requirements, TSOs will become the real domini of electricity markets. Is that an antitrust subject of interest?
TSOs must ensure two basic market conditions: system security and cost optimization. However, it is difficult to deny that TSOs are today the real “market makers” given their role on the balancing markets. In these markets they accept or reject capacity based on their own algorithms, almost “black boxes” that under regulatory rules legally run outside normal competition. In the name of system security, choices should be flexible and TSOs can decide on their own, despite market arrangements, on the effective share of import/export, or on the share of renewables, or on the preference for a certain technology which might prove less or more flexible than other thus providing a specific service to the system. Furthermore, to do so TSOs are normally remunerated by a regulated tariff, fixed every year by the Regulatory Authority. In Italy, this tariff has almost tripled since 2009, reaching 6.15 c€/KWh in 2013.
Moreover, under the system security umbrella TSOs can justify giant investments, which are typically remunerated by the so called RAB (Regulated Asset Base). As we have already put in evidence, RABs based investments attract capital through a mechanism that reduces risks for investors. This mechanism is based on the concept of Financial Capital Maintenance, which guarantees the exact capital recovery thanks to a regulated return on investment. The regulatory process on which RAB is based represents the risk that investors are taking. That’s why the stability of regulatory regime and the assumption that regulatory context will be maintained during all the duration of investment is essential for the success of the RAB model. TSOs have successfully adopted this model to finance grid developments, which guarantees them a stable return on investments often uncorrelated to markets volatilities and behaviors and, in some cases, not necessarily required.
In summary, thanks to the system security umbrella, TSOs take the lower risk share of the value of the electricity industry and the highest share of profits. In spite of being responsible of the efficient dispatching of energy, they earn rents for bottlenecks and congestions. In spite of ensuring parity grid access, they can define who has access to the most valuable market, the balancing one, and would become the main provider of balancing services, thanks to the ultra-flexible technology like new electro-chemical storage stations. Moreover, their responsibility to invest in grid reinforcement and maintenance, allow them to decide, mostly without counterparts, which are the key investments needed, and then negotiate the desired remuneration with the Regulatory Authority. From the above, it’s clear that in the vast majority of the cases, TSOs act as sole operators in a monopoly market, achieving the most valuable and stable share of profits.
Then, the question is: if a regulated monopoly, with guaranteed returns, is allowed to take the largest share of the value produced in the electricity industry, who can really consider the electricity market as really liberalized as every government claims it to be today?
This is a key question, considering the current European debate about the opportunity to separate system operators from grid owners.
 European Commission, "Energy Economic Developments - Investment perspectives in electricity markets", DG Economic and Financial Affairs, Institutional Papers 3, July 2015.
 ENTSO-E, Network Code on Electricity Balancing.
 Ricerca Sistema Energetico, "Energia Elettrica Anatomia dei Costi, 2014", RSEView, October 2014 (p. 119-120).
 AAEGSI, "Rapporto annuale dell'autorità per l'energia elettrica il gas e il sistema idrico in materia di monitoraggio dei mercati elettrici a Pronti, a termine e dei servizi di dispacciamento. Consuntivo 2014", Rapporto 630/2015/I/EEL, 17 Dicembre 2015.
 Ibidem, p. 48 and following.