Contracting for wind generation

From four hours out the error in predicting wind output typically exceeds 10% MAE(perhaps 15% RMSE). Given the asymmetry in imbalance penalties from being short or long,the optimal forward contract of wind might be expected to be less than the expected output.This note derives the optimal ex ante contract position and …nds that if wind is uncorrelatedwith the system imbalance, this argument does not necessarily hold. For a symmetric errordistribution whether to under or over-contract depends on whether the expected long penaltyexceeds the expected short penalty for a risk-neutral producer. 1 The GB Balancing Mechanism In the GB Balancing Mechanism, balancing parties who are short (i.e. have contracted to delivermore than they actually produce, or have consumed more than they contracted to buy) will paythe System Buy Price (SBP). If the system as a whole is short, the SBP will be higher thanthe spot price (SP, i.e. the day-ahead price for that half-hour). If the system is long when thebalancing party is short, the party is helping to reduce the imbalance, and consequently is notpenalised (but nor is he rewarded) and buys at the spot price, SP. He therefore faces a penaltyequal to SBP-SP = PS if short when the system is short, and otherwise zero.Conversely, if the balancing party is long he receives the System Sell Price (SSP), and if thesystem is also long, the SSP will be below the SP, but if the system is short and the balancingparty is helping reduce the shortage, he is paid the SP and so faces no penalty (and again noreward). The relevant penalty is thus SP-SSP = PL if long when the system is long, and otherwisezero. The penalty when short is considerably higher than when long (i.e. PS >PL) and theratio of PS=PL was nearly 4 in 2006/7 and over 2 in 2008/9. One might expect that as it is morecostly to be short than long, balancing parties would aim to be long, and that is what we …nd, Research support from ESRC under project RES-189-250155 is gratefully acknowledged. I am indebted toDominik Ruderer for his comments.