Frequency control ancillary services (FCAS) price collapse: Inevitable or avoidable?

The recent collapse in Frequency Control Ancillary Services (FCAS) prices reflects market dynamics rather than a failure in design. Energy experts view the decline as beneficial for consumers, signalling a functioning market where increased supply has driven down costs.

Historically, FCAS costs were low - around $10-20 million annually - until a sharp rise in 2016 due to a shortfall in supply.

Many expected prices to normalise within a few years. Instead, they remained elevated for nearly a decade.

Now, growing participation in the service from virtual power plants (VPPs) as well as battery energy storage has led to falling prices, with only the lowest-cost providers remaining competitive.

The fall in FCAS prices “happened perhaps faster and to a greater extent than some expected,” said Wendel Hortop, Australian director at Modo Energy, a player in the grid-scale battery space.

In many ways, the price drop was inevitable as high prices encouraged new investments in large-scale batteries and VPPs.

While investors might be disappointed, the introduction of competitive FCAS markets in 2000 was not intended to create substantial revenue streams but to ensure system stability.

“These markets are shallow – roughly 400 MW of capacity clears in each of the markets, and there are several multiples of capacity available to bid into these markets on an average day,” said Alex Leemon, head of the Australian industry team at Gridcog.

“One could curmudgeonly argue that the markets were never really designed to support elevated prices, and the high prices of the last 8 years have been an anomaly in the broader history of the National Electricity Market (NEM).  

“Historically, generation plants provided ancillary services to the system gratis, and the introduction of competitive FCAS markets in 2000 wasn't done with the intention of creating large new revenue streams for participants.”

With battery energy storage systems (BESS) fast approaching gigawatt-scale capacity, there may be a need for localised FCAS requirements to balance supply, argues Ben Vanderwaal, partner at consulting firm Ernst & Young’s Perth office.

Ultimately, the FCAS price drop underscores the effectiveness of market mechanisms, where high prices attracted new entrants, leading to increased competition and lower costs.

Traditional players pushed out

FCAS market saturation and the fall in prices, driven by the entry of non-traditional players like VPPs and battery storage, has had the effect of pushing out traditional providers such as coal and hydro.

Future growth in VPPs and battery storage is likely to further dampen price spikes during events like islanding, according to Mitch O’Neill, principal consultant at Grids.

Despite falling prices, batteries still hold a competitive edge in FCAS, as they can provide services at little to no operational cost during large portions of the day, unlike thermal plants and industrial demand response, which often face material costs from interruption to supply or deviating from optimal operating conditions.

However, the viability of new entrants investing in additional FCAS-specific hardware and compliance measures depends on individual business cases.

Recent analysis from OptiGrid found that utility-scale batteries are already shifting away from FCAS due to diminishing returns.

Meanwhile, VPPs retain advantages in avoiding transmission and distribution costs when well-sited.

Interestingly, Leemon pointed out that many VPP and smaller battery operators have historically bid into these markets at the floor price of $0, while larger batteries and thermal and hydroelectric plant operators have taken a more strategic pricing approach.

Established VPPs - where registration fees have already been recovered - especially those incorporating demand response, benefit from lower installation and operational costs, positioning them to remain competitive despite FCAS price declines.

Alternative revenue streams for new entrants

While FCAS still holds value, the viability of FCAS as a revenue stream for new entrants is diminishing due to market saturation and increased competition, and it should not be the primary focus for market participants.

With many investors - in the battery space at least - now disregarding FCAS as a major revenue source, Hortop says the focus is now on energy trading - grid-scale batteries earned 94% of their revenue from it in February.

However, FCAS still delivered significant value for some batteries last year when prices spiked during islanding events. This was noticeable for batteries in Queensland especially.

According to O’Neill, battery players should prioritise wholesale spot market participation, as it will contribute more significantly to revenue.

The NEM wholesale market settings review, tabled for release this year, is expected to propose new market services and provide additional revenue streams to operators.

Vanderwaal emphasises that FCAS should be seen as one of several revenue streams alongside price arbitrage, innovative network support arrangements, and new contracting models for energy storage.

However, while FCAS alone is not a solid business foundation, it remains worthwhile for capable assets to participate and capture available earnings.

“If new entrants are utilising technologies capable of providing FCAS services, it would be crazy not to register these assets to participate in the markets and earn what revenue is available,” Leemon said.

FCAS market structure

The current FCAS market structure appears functional, with saturation indicating an efficient market rather than a flaw. Reforms may only be necessary if service delivery or new investment becomes an issue, which has not been observed so far.

While minor refinements to cost recovery and dispatch rules could enhance efficiency, experts agree the overall design is sound.

Despite this, some evolution is expected.

“The current FCAS market structure remains fit for purpose for now,” Vanderwaal says, but “market settings can and should evolve over time.” 

As coal generators retire - leading to FCAS demand increases and price fluctuations - security could be improved by the introduction of Fast Frequency Response (FFR) and adjustments to locational requirements.

“FCAS markets could have a few tweaks to their cost recovery and dispatch rules… but overall I think they're well designed,” O'Neill said.

FCAS price spikes tend to occur due to regional separation, particularly in South Australia and Queensland during interconnector maintenance or outages.

“It's important that market operators continue to make their procedures clear on what those regional requirements will be in different scenarios so new and existing entrants can understand how much locally procured FCAS would be needed,” O'Neill added.

The greatest source of FCAS volatility is separation - or risk of separation - between regions, which limits competition and drives up prices.

Increased interconnection between regions would address this issue, though it is “a rather optimistic pitch” to suggest that a reduction in FCAS costs alone would add much to the economics of building new interconnectors, said Leemon.

Overall, while refinements could improve predictability, the market remains largely effective, with future adjustments likely as market dynamics evolve.