Electricity is a unique product that cannot currently be stored in large amounts. Supply and demand for electricity must be matched, or balanced, at all times.
In Britain this is primarily done by suppliers, generators, traders and customers trading in the competitive wholesale electricity market.
Trading can take place bilaterally or on exchanges, and contracts for electricity can be struck over timescales ranging from several years ahead to on-the-day trading markets.
Electricity can also be imported or exported through interconnectors. Currently there are electricity interconnectors between Britain and France, the Netherlands and Ireland.
National Grid Electricity Transmission (NGET) has overall responsibility as ‘residual balancer’ of the electricity system, and takes actions to ensure that electricity supply and demand match on a second-by-second basis. NGET has a number of tools that it can use to do this, including the Balancing Mechanism.
The Balancing Mechanism allows NGET to accept offers of electricity (generation increases and demand reductions) and bids for electricity (generation reductions and demand increases) at very short notice.
If a market participant generates or consumes more or less electricity than they have contracted for, they are exposed to the imbalance price, or ‘cash-out’, for the difference. The cash-out price is the incentive on market participants to ensure electricity consumers’ demand is met, and the ‘residual balancing role’ of NGET it minimised. The cash-out price is based on NGET’s costs of balancing the system.