WP EN2008-009

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KULeuven Energy Institute

TME Branch

WP EN2008-009

Analysis Of Balancing-System Design

And Contracting Behaviour In The NaturalGas Markets

Nico Keyaerts, Leonardo Meeus, and William D'haeseleer

TME WORKING P APER - Energy and Environment Last update: October 08

An electronic version of the paper may be downloaded from the TME website:http://www.mech.kuleuven.be/tme/research/

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side effects. In this paper, the authors look at the possible effects from the imbal-

ance charging price structure on the contracting behaviour of the shipper, who isthe balancing responsible party. For strategic reasons, i.e. cost optimality, shipperscan decide to engage in strategic overcontracting , defined as contracting more thanthe known total demand, or strategic undercontracting , defined as contracting lessthan the known total demand. So, overcontracting implies that at the end of theannual cycle too much gas will be entered in the system, whereas undercontractingleads to an end-of-year shortage of gas in the system. The strategic behaviour couldhave implications for the network (technical problems) or, more plausible, for themarket (price volatility).

1.1 Pipeline system integrity

So, this paper looks at the balancing-system design. The gas transportation system

is a dynamic system that is basically balanced if the sum of the gas that exitsthe system (Exitt [W or GWh/h]) and the gas that is consumed by the system(Systemt [W or GWh/h]), e.g. gas powered compressors, is equal to the gas thatenters the system (Entryt [W or GWh/h]). In the first order, equation 1 shouldbe met at any time (t). However, the constraint is relaxed by the dynamics of gastransport and the “line pack”, which is the inherent flexibility in the gas pipelinenetwork.

Entryt = Exitt + Systemt (1)

The gas transportation system is driven by pressure differentials: gas flows frompoints with higher pressure to points with lower pressure. The Renouard1 equation(Eq. 2) illustrates the relation between the pressure drop and the gas flow.

p21 − p22 = kρ

Q̇1.82LD−4.82 (2)

p1 and p2 are the absolute entry and exit pressure [Pa], respectively. Q̇st representsthe volume gas flow rate [m3/s] at standard conditions (pst = 1.01325×10

5 Pa,Tst = 288,15 K). L [m] and D [m]are the length and the internal diameter of therelevant pipe section. ρ is the relative density and is dimensionless. Finally, k is aconstant depending on the other units chosen, and is 4810 for SI-units.

Taking the pipeline dimensions as given, the larger the pressure differential, themore gas can be transported. However, the upper and the lower pressure are usuallyconstrained by technical and/or contractual requirements. For instance, a pipelinecan only sustain a certain maximal pressure to operate safely. The pressure in thesystem, which is the responsibility of the transmission system operator, dependson the system balance. If more gas enters the system than leaves the system, the

pressure will rise. If too much gas is taken from the system, the pressure will drop.Although the pressure is a critical factor for system integrity, the gas transportationsystem allows it to vary within certain limits: this network-based flexibility is called“line pack flexibility”2. The Renouard equation and the line pack flexibility are bothillustrated in figure 1.

1. The Renouard equation is only one of many gas flow equations available, and is mentionedhere to illustrate the relationship between the volume gas flow rate and the pressure drop on aconceptual level. Coelho & Pinho (2007) provide a thorough overview of this and other equationsfor steady state flow.2. Line pack is a term used to refer to the volume of gas that is present in the pipeline system.The line pack depends on the pressure levels and is not a static value: “line pack flexibility”is theappropriate term to refer to the property to store gas in the network by varying the pressure.

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0 50 100 150 200 250 300 350 400 450 5000

10

20

30

40

50

60

70

80

90

100

pipeline length [km]

p r e s s u r e [ b a r ]

LINEPACK BUFFER CAPACITY

PRESSURE DROP pemax

PRESSURE DROP pdmin

p1 p

emax

pdmin

p2’

p1’ p

2

Figure 1: Pressure drop required to transport 0.7 mcm through a 500 km pipeline. The unitsare km for the pipe length and bar for the pressure. The pressures pemax and pdmin representthe maximal entry pressure and the minimum delivery pressure, respectively. The pressure droprequired for transport corresponds to either [p2emax-p

22

] or [p21′

-p2dmin

]. So, any p1 between pemaxand p1′ is an acceptable entry pressure from a system integrity point of view. The maximal linepack flexibility is represented by the area between the two extreme pressure drop lines.

In the figure, the maximally allowable pressure at entry and the minimally requireddelivery pressure at exit3 are indicated by pemax and pdmin, respectively. To achievethe desired volume flow rate, the entry pressure p1 technically can take any value

between pemax and p1′ , which is the entry pressure corresponding to pdmin. Thearea enclosed by pemax p2 pdmin p1′ represents the line pack flexibility, which is theinherent flexibility of the pipeline system. As long as the pressure remains withinthe limits, the system integrity is ensured.

1.2 Balancing-system design

From the technical point of view, the transmission system operator (TSO) is respon-sible for ensuring the safe operation of the system. However, the parties decidingon the entries and exits in and from the network are the shippers4. So, to shiftthe responsibility to the balancing responsible parties, which are the shippers, theTSOs use balancing systems that provide financial incentives to shippers.

The imbalance charge pricing structure, such as illustrated for the Dutch system intable 1, is an important instrument for the TSO to incentivise shippers to balanceindividually. The table summarizes how shipper’s imbalances will be dealt with.Firstly, the table has two dimensions: the status of the overall transportation system,which is the aggregate of the imbalances of all the individual shippers active in thesystem, on the horizontal axis, and the individual shipper status on the vertical axis.Depending on the applicable quadrant for a given system and shipper status, theprice charged for an imbalance could change. However, the current Dutch balancing-

3. Entry and exit in this sentence indicate the starting point and the ending point of the discussedpipeline section.4. All parties that have signed a transportation contract with the transmission system operator

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system design does not explicitly differentiate prices according to the transportation

system status.Secondly, the shippers are subject to two types of imbalance costs. Penalties aresurcharges for imbalances and are always due by the shipper to the TSO. The Dutchbalancing system charges penalties on three levels. Hourly penalties are due for im-balances registered during a single hour. Cumulative hourly penalties are chargesbased on the cumulative imbalance, which is the aggregate of the hourly imbalances.The penalties are due for both the highest positive and lowest negative peaks overthe course of a day of the cumulative imbalance. The end-of-day cumulative im-balance is subject to the daily penalty. To alleviate the burden for the shipper,the Dutch balancing system requires the shippers to only pay the highest absoluteamount of the cumulative and daily penalties in case on a day both the positivedaily margin and the positive cumulative tolerance are exceeded. The same goes for

negative daily and cumulative penalties. Settlement, on the other hand, is the priceat which the gas commodity is settled and can be a receivable for the shipper for along position, or a payable to the TSO in case of a short shipper.

Thirdly, the Dutch system grants tolerances, which are explained in more detailin section 2.2.1, to the shippers. These tolerances are a function5 of the transportcapacity booked at entry and exit points. Imbalances that are inside the tolerancelevels of the shipper are charged with a zero penalty, as illustrated in table 1 by the“In” prices. So, tolerances represent flexibility that is available for the shipper inthe system, e.g. line pack flexibility. Tolerances are only valid for penalties, whereassettlement is always carried out for the full imbalance.

From this pricing structure all imbalance costs can be derived. An individual shipperthat knows how this system works will try to minimise his imbalance costs. The

TSO’s interest, however, lies in minimising the system imbalances and thus in havingthe shippers minimise their individual imbalance. So, the question is whether theprice structure provides the correct incentives to the shippers from the point of viewof the TSO.

1.3 The imbalance cash-out problem

From a pure optimisation modelling point of view, Kalashnikov & Rı́os-Mercado(2006) and Dempe & al. (2005) have already studied these kind of natural gascash-out problems. They used mixed integer bi-level programming to model thestrategic game between the shipper, which is the leader, and the pipeline operator,which is the follower, in order to minimise the former’s imbalance payments. Both

studies look at a typical US balancing system. This paper is different from the twoabove mentioned studies in that this paper does not explicitly aim to optimise theimbalance cost for the shipper. On the contrary, the focus of this paper is on thebehavioural effect of the current balancing-system design on a rationally behavingshipper that has to contract gas upstream to deal with its downstream contractualliabilities. Secondly, this paper looks at European gas markets, taking the Dutchbalancing system as an example.

5. The Dutch tolerance space becomes temperature dependent for gas days that have the averagedaily temperature below 0◦C. The effect of this temperature dependency for a typical Dutchweather profile is negligibly small (error < 0.01% underestimate of imbalance costs) and wastherefore not taken into account in the calculations.

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System imbalanceShort Long

S h i p p e r i m b a l a n c e

S h o r t

P e n a l t i e s

Hourly In 0 0

Out -15% APX TTF -15% APX TTF

Cumulative In 0 0


Daily In 0 0


Settlement In -100% APX TTF -100% APX TTF


L o n g

P e n a l t i e s

Hourly In 0 0


Cumulative In 0 0Out -100% APX TTF -100% APX TTF

Daily In 0 0


Settlement In +100% APX TTF +100% APX TTF

Out +100% APX TTF +100% APX TTF

Table 1: Overview applicable imbalance prices relative to the system imbalance status on thehorizontal axis and the shipper imbalance status on the vertical axis. So, four quadrants are defined:I. short system + short shipper, II. long system + short shipper, III. short system + long shipper,and IV. long system + long shipper. All prices are expressed as percentages of the reference price,which is the APX TTF [AC/MWh] for the Dutch balancing system. The negative sign indicates acost for the shipper, whereas the positive sign indicates a receivable for the shipper.

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In the next section, the methodology will be explained. Section 3 reports and ex-

plains the results of the calculations. Four scenarios are investigated. Section 3.1looks at the current Dutch balancing-system design and acts as the reference casefor the other results. In section 3.2 the effect of the penalty level in the price struc-ture is looked at, whereas in section 3.3 the price structure is made dependent onthe system imbalance. A last scenario that does include flexibility is dealt with insection 3.4. Finally section 4 summarises the main conclusions of this research.

2 Methodology for calculating imbalance costs

The point of view taken by the authors is that of the individual shipper. This shipperneeds to manage its supply and demand portfolio in order to minimise imbalancesbetween entries and exits. Otherwise the shipper will face imbalance charges. How-

ever, the shipper is active in the competitive parts of the liberalised European gasmarkets and its behaviour is not driven by physical imbalances, but by the result-ing imbalance costs. To establish whether strategic contracting behaviour, definedas either overcontracting or undercontracting, would be profitable in a natural gasmarket without flexibility, the imbalance costs for different supply contracts arecalculated.

2.1 Assumptions

The calculations are carried out taking a number of assumptions into account.Firstly, the single shipper is assumed to have no flexibility instruments available.Therefore, the shipper cannot modulate his supply contracts to his demand con-

tracts. This assumption leads to an extreme situation in which the exposure toimbalance costs is overestimated. However, given that many flexibility instrumentsare not readily6 available to new entrants or small shippers, the assumption is notcompletely unrealistic. Secondly, the shipper’s supply contract is assumed to beconstant throughout the year. This assumption is consistent with the rigidities inupstream gas markets where capital intensive infrastructure prefers high stable loadfactors. The assumption is also consistent with the previous assumption of no flex-ibility to modulate supply. The demand portfolio is uncertain and variable. As faras transport capacity bookings are concerned, an amount of capacity equal to theconstant hourly contracted supply is assumed to be booked at both entry and exit.Thirdly, the shipper is assumed to understand the dynamics of the price structureof table 1, and thus to anticipate on it. Finally, the shipper is assumed to know thetotal annual demand and to contract a multiple (ranging from 0.1 to 2.5) of this

amount at the supply side.

2.2 Data

2.2.1 Balancing rules

All calculations follow the rules of the Dutch balancing system that were in opera-tion in July 2008 (Energiekamer, 2008). For the calculation of the tolerances, whichare granted piecewise linearly based on the booked entry and exit capacity [m3/h],

6. Storage capacity that is sold under long term contracts, contractual production flexibility thatis lower for second-tier or third-tier gas wells etc.

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Dutch tolerances

tolerances % of (entry cap. + exit cap.)/2a

≤ 250,000 m3/h> 250,000 m3/h

> 1,000,000 m3/hand≤ 1,000,000 m3/h

Hourly 22.5% 13% 7.5%Cumulative hourly 92.8% 53.6% 22.8%Daily marginb 36% 36% 36%

a: below 0◦C tolerances decrease linearly to 2% (hourly) and 4% (cumulatively) at -17◦C.

b: the actual daily tolerance is equal to min{daily margin, cumulative hourly tolerance}.

Table 2: Tolerance parameters. Tolerances are expressed in m3/h and are calculated as a per-centage of booked capacity. Hourly and cumulative hourly tolerances are granted according todifferent capacity brackets, whereas the daily tolerance is a fix percentage for the whole bookedcapacity.

the applicable data, illustrated in table 2, were extracted from the website of theDutch TSO, Gas Transport Services7. There are three brackets with decreasingtolerances for increasing capacity portfolios. The cumulative tolerances for cumula-tive imbalances are equal to four time the hourly tolerances, which correspond tohourly imbalances. The daily tolerance, called “daily margin” in the Dutch system,correlates with the end-of-day daily imbalance and is granted linearly. However,the daily tolerance cannot exceed the cumulative tolerance applicable for that day.Tolerances granted are expressed as m3/h. As mentioned above, the temperaturedependency of the granted tolerances was neglected.

In line with the assumptions laid out in section 2.1, the tolerance space of theshipper was determined from its fixed supply contract. Therefore, the tolerancelevels remain constant throughout the year.

Another rule of the Dutch balancing system introduces a standard time shift. Thistime shift entails that exit-gas at time t is balanced with entry-gas at time t + 2.This shift is motivated by the Dutch TSO because the inherent flexibility in thesystem allows it and because the shippers can manage their imbalances, by adaptingtheir entries, on a better informed basis. As will be explained below in more detail,the entry profile is flat throughout the year. Therefore, in this paper the imbalancecalculations are independent of the time shift.

2.2.2 Entry, exit & imbalance profiles

Besides a set of balancing rules, the imbalance cost calculations require an appro-

priate imbalance profile as well. An imbalance profile is the result of the differencebetween an entry profile, which represents the supply side, and an exit profile, whichrepresents the demand side.

The exit profile is a typical residential demand contract portfolio for one calendaryear. The portfolio totals an energy demand of 11,969 GWh, which corresponds withan indicative commodity value of approximately8 200 million Euro. The demand9

7. http://www.gastransportservices.nl [Accessed 29 September 2008]8. For an average natural gas price of 17 AC/MWh9. Although this analysis is based on the Dutch system with data related to its balancing design,a typical residential gas demand profile originally from Belgium was chosen. The origin of thisdemand profile – which is basically genuine – is actually not fundamental.

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1000 2000 3000 4000 5000 6000 7000 80000

0.5

1

1.5

2

2.5

3

3.5

4

4.5

time [h]

p o w e r f l u x [ G W h / h ]

Entry & Exit profiles

EXIT

ENTRY 50 %

ENTRY 100 %

ENTRY 150 %

Figure 2: The hourly entry and exit pro-files for a typical calendar year (200x). Thehorizontal lines represents a constant supply

at the entry, with the green line, the red lineand the cyan line representing total contractedamounts of gas equal to 50%, 100% and 150%of the total annual gas demand, respectively;the blue fluctuations reflect the varying de-mand. The units are basically GWh/h .

7220 7240 7260 7280 7300 7320 7340 73600

0.5

1

1.5

2

2.5

3

time [h]


Entry & Exit profiles

EXIT

ENTRY 50 %

ENTRY 100 %

ENTRY 150 %

Figure 3: Zoom in on the hourly entry andexit profiles [GWh/h], for a 7-day period ina typical calendar year (200x). The horizontal

lines represents a constant supply at the entry,with the green line, the red line and the cyanline representing total contracted amounts of gas equal to 50%, 100% and 150% of the to-tal annual gas demand, respectively; the bluefluctuations reflect the varying demand.

profile was created based on historic distribution data retrieved from the Flemishenergy regulator, VREG10, data from the Belgian transmission system operatorFluxys11 and data from Indexis12, which is the Belgian metering company; and itrepresents simulated 2006 hourly gas deliveries from a certain distribution systemoperator (IGAO) for a specific area (Antwerp).

In line with the assumptions explained above, the entry profile

is a flat profile.Consequently, hourly supplies are constant over the whole year. Eq. 3 explains howthe supply profile was constructed. The hourly gas injections (supplyh [GWh/h]) are

equal to the hourly average of the total yearly demand (8760

1 demandh [GWh/h]).

supplyh =

87601 demandh

8760 (3)

So, the baseline supply contract covers 100% of the total annual demand. To sim-ulate undercontracted and overcontracted supply portfolios the baseline contract(Eq. 3) is multiplied with a factor ranging from 10% to 250%. The annual demandprofile and a sample of supply profiles are plotted in figure 2, all expressed in powerflux [GWh/h] on the vertical axis and time [h] on the horizontal axis. Figure 3provides a zoom in on the profiles for a 7-day period. It illustrates well the typical

daily cycle of a residential gas demand

Imbalance profiles result from subtracting the exit profile from an entry profile (Eq.4). As mentioned above, a time shift of two hours has to be taken into account.Figures 4 and 5 illustrate the annual imbalance profile, expressed in GWh/h forthe 100% demand covering supply contract for a typical year and a zoom in on thisprofile, respectively.

imbalanceh = entryh+2 − exith (4)

10. http://www.vreg.be [Accessed 12 March 2007]11. http://www.fluxys.be [Accessed 17 October 2006]12. http://www.indexis.be [Accessed 15 March 2007]

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1000 2000 3000 4000 5000 6000 7000 8000−3.5

−3

−2.5

−2

−1.5

−1

−0.5

0

0.5

1

1.5

h

G W h

Imbalance 100 %

Figure 4: Hourly imbalance profile [GWh/h]resulting from the difference between the en-try profile for the 100% annual demand cov-

ering contract and the exit profile for a typi-cal calendar year (200x). For the 50% and the150% annual demand covering contracts, theimbalances become predominantly short (pro-file shifts down) and long (profile shifts up),respectively.

7220 7240 7260 7280 7300 7320 7340 7360−1.5

−1

−0.5

0

0.5

1

time [h]


Imbalance 100 %

Figure 5: Zoom in on the hourly imbalanceprofile [GWh/h] for the 100% annual demandcovering contract and the exit profile for a 7-

day period in a typical calendar year (200x).For the 50% annual demand covering contractthe profile shifts down (predominantly shortimbalances), and for the 150% demand cov-ering contract the profile shifts up (predomi-nantly long imbalances).

Positive values correspond to long imbalances, i.e. entry exceeds exit, and negativevalues to short imbalances, i.e. exit exceeds entry.

2.2.3 Reference price

A last piece of input required for the calculations is the applicable reference price.The Dutch balancing rules appoint the APX TTF-Hi Day Ahead All day Index[AC/MWh], hereafter APX TTF, as the “neutrale gasprijs”13, which is the referenceprice for both penalty charges and settlement. This APX TTF daily index is avolume weighted average price of all day-ahead transactions on a specific day. Thecalculations in this paper use the real APX TTF of 2007, which is publicly availableon the APX website14. Figure 6 plots the 2007 index: the units are time [days] onthe horizontal axis and price [AC/MWh] on the vertical axis.

2.3 Imbalance cost calculation: example

In this section, the imbalance cost for one day will be calculated in detail for illus-trative purposes. Figure 7 plots the hourly [m3/h] and cumulative hourly [m3/h]

imbalances and the different tolerance levels [m3/h] for 24 hours of a typical day.To convert the imbalances from volumes [m3] to energy [Wh or kWh], or the otherway around, the applicable “gross calorific value” (GCV, 10.291 kWh/m 3) for thegas was retrieved from Indexis’ data. This conversion is required because tolerancesare expressed in gas flow rate [m3/h] and the APX TTF prices are expressed inenergy units [MWh].

Table 3 provides the detailed imbalance cost calculations for a single day. Totalcosts are thus the sum of the penalty costs and the settlement value. The latter can

13. Neutral gas price14. http://www.apxgroup.com [Accessed 22 August 2008]

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50 100 150 200 250 300 3505

10

15

20

25

30

time [d]

p r i c e [ E U R / M W h ]

APX TTF 2007

APX TTF−Hi DA All−day index

Figure 6: APX TTF-Hi Day ahead All day Index [AC/MWh] for Jan 1 – Dec 31 2007. The indexis a volume weighted average price of all single-day transactions.

be a positive value, i.e. a “revenue”, if the end-of-day imbalance is long. Costs arealways calculated on the absolute value of the imbalances. The negative sign in thecost-column indicates a cost born by the shipper. A positive sign would indicate areceivable amount and would occur when the daily imbalance to settle is long.

Table 3 illustrates well which optimality-criterion for the shipper portfolios is used inthe next sections of this paper: the shipper minimises penalty costs and settlementvalue.

3 Results

This section reports the results of the calculations carried out. There are four sub-sections, each representing a specific scenario. The first scenario (section 3.1) takesthe current Dutch balancing-system design as its starting point. In section 3.2 theeffects of asymmetrical penalties are investigated. Scenario 3 (section 3.3) takes alook at the effects of a shipper-system correlation. In a final scenario (section 3.4)the “no flexibility”-assumption is relaxed.

3.1 Scenario 1: benchmark

In this benchmark scenario the actual Dutch system, as explained above, is mod-elled. Figure 8 summarises the annual imbalance costs for shipper contracting be-haviour ranging from substantial undercontracting, only 10% of the total annualdemand, to massive overcontracting, up to 250% of the total annual demand.

From figure 8 it becomes clear that if a shipper has no flexibility to modulate hissupply to an uncertain demand, the shipper has an incentive to engage in strategicovercontracting. Contracting exactly (100%) the total annual demand results in im-balance charges amounting to approximately 180 million Euro, whereas contracting

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imbalance cumulative hourly chargeable penalty price costimbalance tolerance imbalance

[m3/h] [m3/h] [m3/h] [m3/h] [%] [AC/m3] [AC]

h1 75638.54 75638.54 29872.30 45766.23 10 0.1744 -798.31h2 75279.74 150918.28 29872.30 45407.44 10 0.1744 -792.05h3 73947.84 224866.13 29872.30 44075.54 10 0.1744 -768.82h4 68405.78 293271.91 29872.30 38533.47 10 0.1744 -672.15h5 36352.25 329624.17 29872.30 6479.95 10 0.1744 -113.03h6 -70270.46 259353.70 -29872.30 -40398.15 15 0.1744 -1057.01h7 -100475.59 158878.11 -29872.30 -70603.28 15 0.1744 -1847.32

h8 -76396.48 82481.63 -29872.30 -46524.17 15 0.1744 -1217.30h9 -34914.51 47567.11 -29872.30 -5042.21 15 0.1744 -131.93h10 -9176.58 38390.53 -29872.30 0 15 0.1744 0h11 1416.62 39807.16 29872.30 0 10 0.1744 0h12 1620.73 41427.90 29872.30 0 10 0.1744 0h13 12062.40 53490.30 29872.30 0 10 0.1744 0h14 17786.95 71277.25 29872.30 0 10 0.1744 0h15 10277.97 81555.23 29872.30 0 10 0.1744 0h16 -18320.19 63235.03 -29872.30 0 15 0.1744 0h17 -47302.63 15932.40 -29872.30 -17430.32 15 0.1744 -456.06h18 -68991.13 -53058.72 -29872.30 -39118.82 15 0.1744 -1023.54h19 -65083.47 -118142.19 -29872.30 -35211.16 15 0.1744 -921.29h20 -50356.97 -168499.17 -29872.30 -20484.67 15 0.1744 -535.98h21 -30228.55 -198727.73 -29872.30 -356.25 15 0.1744 -9.32h22 11111.86 -187615.87 29872.30 0 10 0.1744 0h23 46596.55 -141019.31 29872.30 16724.25 10 0.1744 -291.72h24 63500.94 -77518.36 29872.30 33628.63 10 0.1744 -586.59

cumulativetolerance

[m3/h]

Long peak 329624.17 119489.22 210134.95 100 0.1744 -36654.35Short peak -198727.73 -119489.22 -79238.52 100 0.1744 -13821.80

dailytolerance

[m3/h]

Dailya -77518.36 -47795.69 -29722.68 100 0.1744 -5184.60daily

imbalance[m3]

Settlement -77518.36 / -77518.36 100 0.1744 -13521.70

Total -75220.29

a The Dutch balancing rules specify that only the higher absolute value of the daily penaltyand the cumulative peak penalty with the same sign is due by the shipper. So, onlymax{5184.60, 13821.80 } is part of the total cost.

Table 3: Imbalance calculation for one day. The first part of the table lists the calculations of thehourly imbalance costs. In the second part the cumulative and daily penalty costs are calculated,whereas in the last part of the table the settlement value is calculated. Negative values indicateshort positions (m3/h-values) or shipper costs for AC-values. Positive values indicate long positions(m3/h-values) or shipper revenues (AC-values).

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2 4 6 8 10 12 14 16 18 20 22 24−2

−1

0

1

2

3

4x 10

5

time [h]

i m b a l a n c e [ m 3 / h ]

imbalance on day 289

hourly imbalancecumul. imbalance

daily tol.

hourly tol.

cum. tol.

Figure 7: The imbalance profile for a typical day for the 100% annual demand covering contract.The blue bars represent the hourly imbalance, expressed in m3/h. The red line represents thecumulative hourly imbalance and is thus the aggregated sum of the hourly imbalances. The unitsof the cumulative imbalance are basically also m3/h. The magenta, green and cyan dashed linesrepresent the hourly, daily and cumulative hourly tolerance limits, whereas the dotted black linesmark the maximal and minimal cumulative imbalances for the day.

150% of the total annual demand results in imbalance charges totalling 150 millionEuro.

To identify the deeper causes of these results, the penalty and settlement costs weregiven a closer look. This analysis revealed that for the Dutch balancing systemand for the used entry and exit profiles a trade-off is taking place between theincreasing costs of the combined daily and cumulative penalties and the increasingsettlement “revenue” for long imbalances. The hourly penalty costs are a factor 10smaller and are not decisive for the optimum due to the properties of the imbalanceprofile15. The combined cumulative and daily penalty costs increase rapidly withincreasing overcontracting, as can be seen in figure 9. However, as illustrated infigure 10, the settlement switches from a cost for undercontracting to a revenue forovercontracting. As a consequence, the rising penalty costs are initially offset bythe settlement revenue. The optimum is reached at the 150% contract, from whereon the costs rise more steeply than the revenues.

It can be argued that the settlement revenue is not a real revenue. Firstly, in aproperly designed balancing system, the reference price should reflect the costsincurred by the TSO in balancing the overall system and the price should be a“default price”, i.e. the price of last resort, and thus the price should be worsethan the regular wholesale trade price. Secondly, the excess gas that results fromovercontracting has to be paid as well. So, the payment for the excess gas wouldcancel out with the settlement revenue, at least to a certain extent depending onthe applicable prices.

15. Given the assumption of no flexibility, many days with persistenly long or short hourly imbal-ances occur, without those imbalances cancelling out. This results in relatively large cumulativeimbalances.

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50 100 150 200 2500

0.5

1

1.5

2

2.5

3

3.5

4x 10

8

contract size [% total annual demand]

c o s t [ E U R ]

Imbalance cost per contracted supply portfolio

Figure 8: Total annual imbalance costs per contracted supply portfolio. Imbalance costs on thevertical axis have 100 million Euro as units. The contracted supply portfolios on the horizontalaxis are expressed as percentage of the total annual demand. So, 200% means that the shipperhas contracted 200% of the total annual demand at the supply side.

50 100 150 200 250

0

0.5

1

1.5

2

2.5

3

3.5

4

4.5

5x 10

8


c o s t [ E U R ]

Combined daily and cumulative penalties per contracted supply portfolio

Figure 9: The combined cumulative hourlyand daily penalty costs per contracted sup-ply portfolio. Costs have 100 million Euro asunits. The contracts are expressed as percent-ages of total annual demand. Penalty costs riseincreasingly steeper with larger overcontract-ing. In case of undercontracting the costs donot vary substantially (on the used scale).

50 100 150 200 250

−3

−2.5

−2

−1.5

−1

−0.5

0

0.5

1

1.5

2x 10

8


c o s t [ E U R ]

Commodity settlement per contracted supply portfolio

Figure 10: The settlement value per con-tracted supply portfolio. The units are 100 mil-lion Euro on the vertical axis, whereas the con-tracts on the horizontal axis are expressed aspercentages of total annual demand. For con-tracts up to 100%, settlement is a cost for theshipper. For larger contracts, i.e. overcontract-ing, settlement becomes a revenue.

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System imbalance

Short Long

Shipper imbalanceShort

Cumulative -100% APX TTF -100% APX TTFDaily -100% APX TTF -100% APX TTF

Long Cumulative -70% APX TTF -70% APX TTF

Daily -70% APX TTF -70% APX TTF

Table 4: Favourable treatment penalties for long positions


Shipper imbalanceShort

Cumulative -70% APX TTF -70% APX TTFDaily -70% APX TTF -70% APX TTF

Long Cumulative -100% APX TTF -100% APX TTF

Daily -100% APX TTF -100% APX TTF

Table 5: Favourable treatment penalties for long positions

3.2 Scenario 2: asymmetrical penalties

In this second scenario the effect of the penalty levels is looked at. The benchmarkscenario makes clear that the combined daily and cumulative penalty cost is themost relevant penalty cost in these specific calculations. Therefore, asymmetricalpenalties for short and long cumulative and daily positions were introduced into themodel. Tables 4 and 5 present the changed penalties compared to the benchmarkprice structure from table 1.

When long positions received a more favourable treatment, i.e. only a 70% surchargefor daily and cumulative hourly imbalances (table 4), even larger overcontracting,the 190% contract, becomes optimal. This case is illustrated in figure 11 When thepenalty was increased further, the optimum shifted further to the right. Conversely,when the favourable treatment was granted to short imbalances (table 5), i.e. ashort shipper pays a 70% penalty and a long shipper a 100% penalty, no substantialdifference was established compared to the benchmark. As can be seen in figure 12the 150% remains optimal. Only when the short penalty is reduced even more, i.e.the asymmetry is increased, the optimum started shifting towards less overcontract-ing. The reason for this slow shift is the dominance of the unchanged settlementrevenue for overcontracted portfolios.

When both short and long imbalances were granted the same less restrictive treat-

ment, e.g. both sides penalised at 60%, then the settlement revenue becomes thedominant factor. In that case, the lower the penalty, the more overcontracting be-comes beneficial. If all penalties would become 0, a pure settlement based balancing-system design is obtained. Such a system, for which the cash-out comes down tofigure 10, seems to stimulate shippers to overcontract without limits in order to cashthe settlement revenue for long positions. This statement does not take into accountthe possible correlation between the shipper imbalance and the system imbalance.Such a relation will be looked at in a third scenario.

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50 100 150 200 2500

0.5

1

1.5

2

2.5

3

3.5

4x 10

8


c o s t [ E U R ]


Figure 11: The imbalance cost per contractportfolio with a favourable long penalty of 70%. Costs are expressed in 100 million Euro

on the vertical axis, whereas contracts are ex-pressed as percentages of total annual demandon the horizontal axis. The optimum shifts tothe right as the treatment of long imbalancesbecomes increasingly favourable.

50 100 150 200 2500

0.5

1

1.5

2

2.5

3

3.5x 10

8


c o s t [ E U R ]


Figure 12: The imbalance cost per contractportfolio with a favourable short penalty of 70%. Costs are expressed in 100 million Euro

on the vertical axis, whereas contracts areexpressed as percentages of total annual de-mand on the horizontal axis. The optimumshifts slowly to the left as short imbalances aretreated increasingly favourable.


Shipper imbalance Short reference price + X reference price - X

Long reference price + X reference price - X

Table 6: Overview price structure with applicable reference price depending on the system im-balance. So, four quadrants are defined: I. short system + short shipper, II. long system + shortshipper, III. short system + long shipper, and IV. long system + long shipper. Quadrants I and IIIhave a mark-up X because of high demand for gas, whereas quadrants II and IV have a mark-downbecause of excessive supply of gas. The units of the prices are AC/MWh.

3.3 Scenario 3: shipper’s effect on system imbalance

In this scenario, the effect of a positive or a negative correlation between the ship-per’s status and the system’s status will be investigated. Therefore, the referenceprice is assumed to be perfectly positively correlated with the system status, i.e.a perfectly operating balancing market. This means that when the system is shortand demand for gas to balance is high, the reference price will rise. Oppositely,when there is too much gas in the system, and thus, supply surpasses demand, thereference price will drop.

If the shipper imbalance is positively correlated with the system imbalance, theshipper will pay high penalties for short positions and receive less settlement valuefor long positions. For a negatively correlated shipper, counter-system imbalancesare “rewarded” with lower penalties for short positions and higher settlement rev-enues for long positions. The proposed new price structure is summarised in table6. The price structure in the table is simplified: tolerances were not inserted forreasons of clarity, though they were taken into account in the calculations for thisscenario. In the table “reference price” should be interpreted as an average pricefor gas depending on exogenous factors, whereas X represents an unknown valuedepending on the size and the sign of the actual system imbalance.

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50 100 150 200 2500

0.5

1

1.5

2

2.5

3

3.5

4

4.5x 10

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c o s t [ E U R ]


Figure 13: The imbalance cost per contractportfolio for a perfectly positively correlatedshipper and system imbalance. Costs are ex-

pressed in 100 million Euro on the vertical axis,whereas contracts are expressed as percentagesof total annual demand on the horizontal axis.Although overcontracted portfolios suffer fromlower settlement revenue, the resulting drop isoffset by the decreased penalty costs resultingin an optimal portfolio to the right of the ref-erence case.

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0.5

1

1.5

2

2.5

3x 10

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c o s t [ E U R ]


Figure 14: The imbalance cost per contractportfolio for a negatively correlated shipperand system imbalance. Costs are expressed in

100 million Euro on the vertical axis, whereascontracts are expressed as percentages of totalannual demand on the horizontal axis. Over-contracting raises the settlement revenue b e-cause of the short system mark-up. However,the penalty costs increase as well, resulting inan decreasing portfolio compared to the refer-ence scenario.

The correlation scenario was modelled using a fixed average gas price of 15 Euroincreased with a mark-up or mark-down for a system that is short or long, respec-tively. The mark-up and mark-down were calibrated with a factor16 to take the sizeof the imbalance into account. A positive correlation between the shipper and thesystem was modelled by having a mark-down when the shipper was long, and amark-up when the shipper was short. This implies that perfect correlation was as-sumed. To model the (perfectly) negative correlation, the mark-up was added whenthe shipper was long and the mark-down when the shipper was short.

For the perfectly positively correlated shipper and system, illustrated in figure 13,the 160% overcontracting portfolio becomes optimal. This is a slight increase com-pared to the reference case. Although the settlement revenue for overcontractingdecreases due to the mark-down, this drop is offset by the lowering of the penaltycosts resulting in an overcontracting optimum to the right of the benchmark case.The optimum continues to shift to the right when the mark-up and mark-down arefurther increased from their initial value of 10%, a value that was chosen arbitrarilyby the authors.

For the perfectly negatively correlated shipper and system the optimal overcon-tracting decreases to the 130% contract, as can be seen in figure 14. Although thenegative correlation implies that a shipper with a long position receives the mark-up that is induced by the shortness of the system, the mark-up significantly in-creases the penalty costs for intolerated imbalances as well. When the mark-up andmark-down were raised to 15% the optimal contract approached the neutral 100%contract. For even higher mark-ups and mark-downs undercontracting becomes op-timal, because the penalty costs for a short shipper position lower significantly dueto the mark-down caused by the long status of the system.

16. the absolute value of the daily imbalance divided by the mean value of the absolute dailyimbalances

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1

1.5

2

2.5

3

3.5

4x 10

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Figure 15: Total annual imbalance costs per contracted supply portfolio with access to flexibility.Imbalance costs on the vertical axis have 100 million Euro as units. The contracted supply port-folios on the horizontal axis are expressed as percentage of the total annual demand. With accessto flexibility the shipper has no longer an incentive to engage in substantial overcontracting.

3.4 Scenario 4: introducing flexibility

The fourth scenario looks again at the benchmark Dutch balancing system pricestructure (table 1). However, in this more realistic scenario, the shipper is assumedto have access to some flexibility to modulate his supply to the uncertain demand.

Thereto, the model had to be modified: now, the shipper can adapt its supply on adaily basis (Eq. 5). So, for every day (d) his hourly entry (supplydh [GWh/h])wasmodelled as 1/24th of the total daily demand (

h=24h=1 demanddh).

supplydh =

h=24h=1 demanddh

24 (5)

Figure 15 summarises the results of this calculation. A shipper who has access toflexibility no longer has an incentive to engage into substantial overcontracting asthe 100%-110% contracts seem optimal. This result is caused by the substantial de-crease of the penalty costs for the neutral 100% contract. The flexibility available tothe shipper allows reducing imbalances, whereas overcontracting or undercontract-ing would result in introducing new imbalances and thus penalty costs. Nevertheless,

the asymmetry between short and long hourly penalties implies that small overcon-tracting can still be favourable. This is clearly illustrated by figure 15: there is littledifference in the range from 100% to 120%.

4 Conclusions

The main conclusion of this research is that for a balancing-system design basedon the current Dutch design, it does pay for the shipper to engage into strategicovercontracting if the shipper has no access to other flexibility. The optimal supplyportfolio for a shipper without any other flexibility amounts to contracting 150%

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of the known total annual demand. A shipper that has access to flexibility has no

longer an incentive to engage in massive strategic overcontracting. Nevertheless,some small overcontracting might still be induced by the asymmetry between shortand long hourly penalties.

Introducing asymmetrical penalties shifts the optimal portfolio in the direction of the imbalance treated more favourably. When the penalty for long imbalances islower, overcontracting is stimulated even more. Similarly, when the short side re-ceives favourable treatment, decreasing the overcontracting becomes optimal.

When the shipper and the system are positively correlated, the optimum shiftsto the right, which means even more overcontracted portfolios than the referencecase portfolio become optimal. On the contrary, in case the shipper and the systemare negatively correlated, the need for overcontracting is reduced and the optimalportfolio shifts slowly towards the neutral 100% portfolio for increasing mark-up

and mark-down.

More detailed research on the effects of the balancing-system design on contractingbehaviour of a shipper that has flexibility is required. Furthermore, the upstream(acquiring the supply) and downstream (selling the gas) cash flows involved in theshipper business could be taken into account to correct for the settlement “revenue”of overcontracting.

In summary, the results reported in section 3 show that the balancing-system designpotentially has undesirable effects. Indeed, if all shippers would overcontract, thenthis behaviour would result in a system that is persistently long, giving wrongsignals to the transmission system operator, to other shippers and potentially tothe market.

References

Council European Energy Regulators (2003) Principles for Balancing Rules –September 2003

Coelho, P. & Pinho, C. (2007) Considerations About Equations for Steady StateFlow in Natural Gas Pipelines. Journal of the Brazilian Society of MechanicalScience & Engineering, Vol. XXIX, No. 3, p. 262-273

Dempe, S., Kalashnikov, V., Ŕıos-Mercado, R.Z. (2005) Discrete bilevel program-ming: Application to a natural gas cash-out problem. European Journal of Op-erational Research, Vol. 166, No. 2, p.469488

Energiekamer (2008) Transportvoorwaarden Gas – LNB. Version 1 July 2008. Avail-able at http://www.energiekamer.nlERGEG (2006) Guidelines of Good Practice for Gas Balancing – 6 December 2006,

BrusselsKalashnikov, V. & Ŕıos-Mercado, R.Z. (2006) A natural gas cash-out problem: A

bilevel programming framework and a penalty function method. Optimization &Engineering, Vol. 4, No. 4, p.403-420

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WP EN2008-009