WP EN2008-009

Analysis Of Balancing-System Design

And Contracting Behaviour In The Natural
Gas Markets
Nico Keyaerts, Leonardo Meeus, and William D'haeseleer

TME WORKING PAPER - 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/
KULeuven Energy Institute
TME Branch

Revised October 31, 2008

Work in progress

Analysis of balancing-system design and

contracting behaviour in natural gas
markets
Nico Keyaertsa , Leonardo Meeusb , and William Dhaeseleera,
a

University of Leuven (K.U.Leuven) Energy Institute, branch Applied Mechanics &

Energy Conversion, Celestijnenlaan 300a P.O.Box 2421 B-3001 Heverlee
b
University of Leuven (K.U.Leuven) Energy Institute, branch ESAT-ELECTA,
Kasteelpark 10 P.O.Box 2445 B-3001 Heverlee

Corresponding author: Tel +32 16 32 25 10; fax: +32 16 32 29 85;

William.Dhaeseleer@mech.kuleuven.be
Nico.Keyaerts@mech.kuleuven.be

Abstract
Recently, balancing-system design has been receiving much attention from the different natural gas market stakeholders in an attempt to come up with some guidelines for a good balancing design. Although this attempt resulted in the European
Regulators Group for Electricity and Gas (ERGEG) guidelines of good practice
for gas balancing, the optimal balancing-system design is far from established. In
order to understand where the design needs to go to, this paper takes a look at
the current designs to identify design flaws. Based on the Dutch balancing system,
imbalance costs for different portfolios are calculated for a number of scenarios.
The results indicate that the current Dutch balancing-system design could incentivise shippers to engage in strategic overcontracting if they have no access to other
flexibility instruments.

Keywords: gas balancing; strategic behaviour, overcontracting

Introduction

The optimal design of the balancing system is a major issue in the liberalised
European natural gas market. Starting with some basic principles (CEER, 2003) in
the early 2000s, we have arrived at some non-binding guidelines of good practice for
gas balancing (ERGEG, 2006). Nevertheless, the optimal balancing-system design
is far from established and in the framework of the European Regulators Group of
Electricity and Gas different regional initiatives are developed.
If the market parties believe that the ideal balancing-system design is not yet established, it implies that they recognize that the current designs still have undesirable

This paper has been written in the context of the project Fundamental study of the macroscopic feed back loops and basic uncertainties in pipe and wired based unbundled energy markets
with the aim of global, flexible optimisation from different viewpoints funded by Fonds Wetenschappelijk Onderzoek Vlaanderen (FWO)

Nico Keyaerts

Please cite as TME-working paper 2008-009

available on http://www.mech.kuleuven.be/energy

side effects. In this paper, the authors look at the possible effects from the imbalance charging price structure on the contracting behaviour of the shipper, who is
the balancing responsible party. For strategic reasons, i.e. cost optimality, shippers
can decide to engage in strategic overcontracting, defined as contracting more than
the known total demand, or strategic undercontracting, defined as contracting less
than the known total demand. So, overcontracting implies that at the end of the
annual cycle too much gas will be entered in the system, whereas undercontracting
leads to an end-of-year shortage of gas in the system. The strategic behaviour could
have implications for the network (technical problems) or, more plausible, for the
market (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 exits
the 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 that
enters the system (Entryt [W or GWh/h]). In the first order, equation 1 should
be met at any time (t). However, the constraint is relaxed by the dynamics of gas
transport and the line pack, which is the inherent flexibility in the gas pipeline
network.
Entryt = Exitt + Systemt
(1)
The gas transportation system is driven by pressure differentials: gas flows from
points 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 = kQ 1.82 LD4.82

(2)

p1 and p2 are the absolute entry and exit pressure [Pa], respectively. Qst represents
the volume gas flow rate [m3 /s] at standard conditions (pst = 1.01325105 Pa,
Tst = 288,15 K). L [m] and D [m]are the length and the internal diameter of the
relevant pipe section. is the relative density and is dimensionless. Finally, k is a
constant depending on the other units chosen, and is 4810 for SI-units.
Taking the pipeline dimensions as given, the larger the pressure differential, the
more gas can be transported. However, the upper and the lower pressure are usually
constrained by technical and/or contractual requirements. For instance, a pipeline
can only sustain a certain maximal pressure to operate safely. The pressure in the
system, which is the responsibility of the transmission system operator, depends
on 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 transportation
system allows it to vary within certain limits: this network-based flexibility is called
line pack flexibility2 . The Renouard equation and the line pack flexibility are both
illustrated in figure 1.
1. The Renouard equation is only one of many gas flow equations available, and is mentioned
here to illustrate the relationship between the volume gas flow rate and the pressure drop on a
conceptual level. Coelho & Pinho (2007) provide a thorough overview of this and other equations
for 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 flexibilityis the
appropriate term to refer to the property to store gas in the network by varying the pressure.

LINEPACK BUFFER CAPACITY

100
90

p p
1

emax

80
p

pressure [bar]

70

60
50

pdmin p2

40
30
20
PRESSURE DROP p

emax

10
0

PRESSURE DROP p

dmin

50

100

150

200
250
300
pipeline length [km]

350

400

450

500

Figure 1:

Pressure drop required to transport 0.7 mcm through a 500 km pipeline. The units
are km for the pipe length and bar for the pressure. The pressures pemax and pdmin represent
the maximal entry pressure and the minimum delivery pressure, respectively. The pressure drop
required for transport corresponds to either [p2emax -p22 ] or [p21 -p2dmin ]. So, any p1 between pemax
and p1 is an acceptable entry pressure from a system integrity point of view. The maximal line
pack 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 required
delivery pressure at exit3 are indicated by pemax and pdmin , respectively. To achieve
the 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 . The
area enclosed by pemax p2 pdmin p1 represents the line pack flexibility, which is the
inherent flexibility of the pipeline system. As long as the pressure remains within
the limits, the system integrity is ensured.
1.2

Balancing-system design

From the technical point of view, the transmission system operator (TSO) is responsible for ensuring the safe operation of the system. However, the parties deciding
on the entries and exits in and from the network are the shippers4 . So, to shift
the responsibility to the balancing responsible parties, which are the shippers, the
TSOs use balancing systems that provide financial incentives to shippers.
The imbalance charge pricing structure, such as illustrated for the Dutch system in
table 1, is an important instrument for the TSO to incentivise shippers to balance
individually. The table summarizes how shippers 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 the
system, 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, the
price charged for an imbalance could change. However, the current Dutch balancing3. Entry and exit in this sentence indicate the starting point and the ending point of the discussed
pipeline section.
4. All parties that have signed a transportation contract with the transmission system operator

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 are
surcharges for imbalances and are always due by the shipper to the TSO. The Dutch
balancing system charges penalties on three levels. Hourly penalties are due for imbalances registered during a single hour. Cumulative hourly penalties are charges
based 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 over
the course of a day of the cumulative imbalance. The end-of-day cumulative imbalance 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 absolute
amount of the cumulative and daily penalties in case on a day both the positive
daily margin and the positive cumulative tolerance are exceeded. The same goes for
negative daily and cumulative penalties. Settlement, on the other hand, is the price
at which the gas commodity is settled and can be a receivable for the shipper for a
long position, or a payable to the TSO in case of a short shipper.
Thirdly, the Dutch system grants tolerances, which are explained in more detail
in section 2.2.1, to the shippers. These tolerances are a function5 of the transport
capacity booked at entry and exit points. Imbalances that are inside the tolerance
levels 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 in
the system, e.g. line pack flexibility. Tolerances are only valid for penalties, whereas
settlement is always carried out for the full imbalance.
From this pricing structure all imbalance costs can be derived. An individual shipper
that knows how this system works will try to minimise his imbalance costs. The
TSOs interest, however, lies in minimising the system imbalances and thus in having
the shippers minimise their individual imbalance. So, the question is whether the
price structure provides the correct incentives to the shippers from the point of view
of the TSO.
1.3

The imbalance cash-out problem

From a pure optimisation modelling point of view, Kalashnikov & Ros-Mercado

(2006) and Dempe & al. (2005) have already studied these kind of natural gas
cash-out problems. They used mixed integer bi-level programming to model the
strategic game between the shipper, which is the leader, and the pipeline operator,
which is the follower, in order to minimise the formers imbalance payments. Both
studies look at a typical US balancing system. This paper is different from the two
above mentioned studies in that this paper does not explicitly aim to optimise the
imbalance cost for the shipper. On the contrary, the focus of this paper is on the
behavioural effect of the current balancing-system design on a rationally behaving
shipper that has to contract gas upstream to deal with its downstream contractual
liabilities. Secondly, this paper looks at European gas markets, taking the Dutch
balancing system as an example.
5. The Dutch tolerance space becomes temperature dependent for gas days that have the average
daily temperature below 0 C. The effect of this temperature dependency for a typical Dutch
weather profile is negligibly small (error < 0.01% underestimate of imbalance costs) and was
therefore not taken into account in the calculations.

Cumulative

In
Out

0
-100% APX TTF

0
-100% APX TTF

Daily

In
Out

0
-100% APX TTF

0
-100% APX TTF

Settlement

In
Out

-100% APX TTF

-100% APX TTF

-100% APX TTF

-100% APX TTF

Hourly

In
Out

0
-10% APX TTF

0
-10% APX TTF

Cumulative

In
Out

0
-100% APX TTF

0
-100% APX TTF

Daily

In
Out

0
-100% APX TTF

0
-100% APX TTF

In
Out

+100% APX TTF

+100% APX TTF

+100% APX TTF

+100% APX TTF

Penalties

In
Out

Penalties

Short
Long

Shipper imbalance

Hourly

System imbalance
Short
Long
0
0
-15% APX TTF
-15% APX TTF

Settlement

Table 1:

Overview applicable imbalance prices relative to the system imbalance status on the
horizontal 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 [A
C/MWh] for the Dutch balancing system. The negative sign indicates a
cost for the shipper, whereas the positive sign indicates a receivable for the shipper.

In the next section, the methodology will be explained. Section 3 reports and explains the results of the calculations. Four scenarios are investigated. Section 3.1
looks at the current Dutch balancing-system design and acts as the reference case
for the other results. In section 3.2 the effect of the penalty level in the price structure is looked at, whereas in section 3.3 the price structure is made dependent on
the system imbalance. A last scenario that does include flexibility is dealt with in
section 3.4. Finally section 4 summarises the main conclusions of this research.

Methodology for calculating imbalance costs

The point of view taken by the authors is that of the individual shipper. This shipper
needs to manage its supply and demand portfolio in order to minimise imbalances
between entries and exits. Otherwise the shipper will face imbalance charges. However, the shipper is active in the competitive parts of the liberalised European gas
markets and its behaviour is not driven by physical imbalances, but by the resulting imbalance costs. To establish whether strategic contracting behaviour, defined
as either overcontracting or undercontracting, would be profitable in a natural gas
market without flexibility, the imbalance costs for different supply contracts are
calculated.
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 contracts. This assumption leads to an extreme situation in which the exposure to
imbalance costs is overestimated. However, given that many flexibility instruments
are not readily6 available to new entrants or small shippers, the assumption is not
completely unrealistic. Secondly, the shippers supply contract is assumed to be
constant throughout the year. This assumption is consistent with the rigidities in
upstream gas markets where capital intensive infrastructure prefers high stable load
factors. The assumption is also consistent with the previous assumption of no flexibility to modulate supply. The demand portfolio is uncertain and variable. As far
as transport capacity bookings are concerned, an amount of capacity equal to the
constant 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 structure
of table 1, and thus to anticipate on it. Finally, the shipper is assumed to know the
total 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 operation in July 2008 (Energiekamer, 2008). For the calculation of the tolerances, which
are 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 that
is lower for second-tier or third-tier gas wells etc.

Hourly
Cumulative hourly
Daily marginb

Dutch tolerances
tolerances % of (entry cap. + exit cap.)/2a
> 250,000 m3 /h
250,000 m3 /h
and
> 1,000,000 m3 /h
3
1,000,000 m /h
22.5%
13%
7.5%
92.8%
53.6%
22.8%
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 percentage of booked capacity. Hourly and cumulative hourly tolerances are granted according to
different capacity brackets, whereas the daily tolerance is a fix percentage for the whole booked
capacity.

the applicable data, illustrated in table 2, were extracted from the website of the
Dutch TSO, Gas Transport Services7 . There are three brackets with decreasing
tolerances for increasing capacity portfolios. The cumulative tolerances for cumulative imbalances are equal to four time the hourly tolerances, which correspond to
hourly 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 temperature
dependency of the granted tolerances was neglected.
In line with the assumptions laid out in section 2.1, the tolerance space of the
shipper was determined from its fixed supply contract. Therefore, the tolerance
levels remain constant throughout the year.
Another rule of the Dutch balancing system introduces a standard time shift. This
time 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 the
system allows it and because the shippers can manage their imbalances, by adapting
their 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 imbalance
calculations 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 appropriate imbalance profile as well. An imbalance profile is the result of the difference
between an entry profile, which represents the supply side, and an exit profile, which
represents the demand side.
The exit profile is a typical residential demand contract portfolio for one calendar
year. The portfolio totals an energy demand of 11,969 GWh, which corresponds with
an 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 A
C/MWh
9. 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 this
demand profile which is basically genuine is actually not fundamental.

Entry & Exit profiles

Entry & Exit profiles

4.5

3
EXIT
ENTRY 50 %
ENTRY 100 %
ENTRY 150 %

power flux [GWh/h]

power flux [GWh/h]

3.5

EXIT
ENTRY 50 %
ENTRY 100 %
ENTRY 150 %

2.5

2.5
2
1.5

1.5

1
0.5
0.5
0

1000

Figure 2:

2000

3000

4000
5000
time [h]

6000

7000

8000

The hourly entry and exit profiles for a typical calendar year (200x). The
horizontal lines represents a constant supply
at the entry, with the green line, the red line
and the cyan line representing total contracted
amounts of gas equal to 50%, 100% and 150%
of the total annual gas demand, respectively;
the blue fluctuations reflect the varying demand. The units are basically GWh/h .

7220

7240

7260

7280
7300
time [h]

7320

7340

7360

Figure 3:

Zoom in on the hourly entry and

exit profiles [GWh/h], for a 7-day period in
a typical calendar year (200x). The horizontal
lines represents a constant supply at the entry,
with the green line, the red line and the cyan
line representing total contracted amounts of
gas equal to 50%, 100% and 150% of the total annual gas demand, respectively; the blue
fluctuations reflect the varying demand.

profile was created based on historic distribution data retrieved from the Flemish
energy regulator, VREG10 , data from the Belgian transmission system operator
Fluxys11 and data from Indexis12 , which is the Belgian metering company; and it
represents simulated 2006 hourly gas deliveries from a certain distribution system
operator (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 how
the supply profile was constructed. The hourly gas injections (supplyh [GWh/h]) are
P8760
equal to the hourly average of the total yearly demand ( 1 demandh [GWh/h]).
P8760
demandh
supplyh = 1
(3)
8760
So, the baseline supply contract covers 100% of the total annual demand. To simulate undercontracted and overcontracted supply portfolios the baseline contract
(Eq. 3) is multiplied with a factor ranging from 10% to 250%. The annual demand
profile and a sample of supply profiles are plotted in figure 2, all expressed in power
flux [GWh/h] on the vertical axis and time [h] on the horizontal axis. Figure 3
provides 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 for
the 100% demand covering supply contract for a typical year and a zoom in on this
profile, 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]

Imbalance 100 %

Imbalance 100 %
1

1.5
1

0.5

0.5

power flux [GWh/h]

GWh

0.5
1
1.5

0.5

2
1

2.5
3
3.5

1000

2000

3000

4000

5000

6000

7000

8000

1.5

7220

Figure 4:

Hourly imbalance profile [GWh/h]

resulting from the difference between the entry profile for the 100% annual demand covering contract and the exit profile for a typical calendar year (200x). For the 50% and the
150% annual demand covering contracts, the
imbalances become predominantly short (profile shifts down) and long (profile shifts up),
respectively.

7240

7260

7280
7300
time [h]

7320

7340

7360

Figure 5:

Zoom in on the hourly imbalance

profile [GWh/h] for the 100% annual demand
covering contract and the exit profile for a 7day period in a typical calendar year (200x).
For the 50% annual demand covering contract
the profile shifts down (predominantly short
imbalances), and for the 150% demand covering contract the profile shifts up (predominantly long imbalances).

Positive values correspond to long imbalances, i.e. entry exceeds exit, and negative
values 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
[A
C/MWh], hereafter APX TTF, as the neutrale gasprijs13 , which is the reference
price for both penalty charges and settlement. This APX TTF daily index is a
volume weighted average price of all day-ahead transactions on a specific day. The
calculations in this paper use the real APX TTF of 2007, which is publicly available
on the APX website14 . Figure 6 plots the 2007 index: the units are time [days] on
the horizontal axis and price [A
C/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 illustrative 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 other
way around, the applicable gross calorific value (GCV, 10.291 kWh/m3 ) for the
gas was retrieved from Indexis data. This conversion is required because tolerances
are expressed in gas flow rate [m3 /h] and the APX TTF prices are expressed in
energy units [MWh].
Table 3 provides the detailed imbalance cost calculations for a single day. Total
costs are thus the sum of the penalty costs and the settlement value. The latter can
13. Neutral gas price
14. http://www.apxgroup.com [Accessed 22 August 2008]

APX TTF 2007

30

price [EUR/MWh]

25

20

15

10
APX TTFHi DA Allday index
5

50

100

150

200
time [d]

250

300

350

Figure 6:

APX TTF-Hi Day ahead All day Index [A

C/MWh] for Jan 1 Dec 31 2007. The index
is 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 are
always calculated on the absolute value of the imbalances. The negative sign in the
cost-column indicates a cost born by the shipper. A positive sign would indicate a
receivable 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 in
the next sections of this paper: the shipper minimises penalty costs and settlement
value.

Results

This section reports the results of the calculations carried out. There are four subsections, each representing a specific scenario. The first scenario (section 3.1) takes
the current Dutch balancing-system design as its starting point. In section 3.2 the
effects of asymmetrical penalties are investigated. Scenario 3 (section 3.3) takes a
look 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 modelled. Figure 8 summarises the annual imbalance costs for shipper contracting behaviour ranging from substantial undercontracting, only 10% of the total annual
demand, 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 his
supply to an uncertain demand, the shipper has an incentive to engage in strategic
overcontracting. Contracting exactly (100%) the total annual demand results in imbalance charges amounting to approximately 180 million Euro, whereas contracting

10

imbalance

hourly
tolerance
[m3 /h]

chargeable
imbalance
[m3 /h]

penalty

[m /h]

cumulative
imbalance
[m3 /h]

[%]

[A
C/m ]

[A
C]

75638.54
75279.74
73947.84
68405.78
36352.25
-70270.46
-100475.59
-76396.48
-34914.51
-9176.58
1416.62
1620.73
12062.40
17786.95
10277.97
-18320.19
-47302.63
-68991.13
-65083.47
-50356.97
-30228.55
11111.86
46596.55
63500.94

75638.54
150918.28
224866.13
293271.91
329624.17
259353.70
158878.11
82481.63
47567.11
38390.53
39807.16
41427.90
53490.30
71277.25
81555.23
63235.03
15932.40
-53058.72
-118142.19
-168499.17
-198727.73
-187615.87
-141019.31
-77518.36

29872.30
29872.30
29872.30
29872.30
29872.30
-29872.30
-29872.30
-29872.30
-29872.30
-29872.30
29872.30
29872.30
29872.30
29872.30
29872.30
-29872.30
-29872.30
-29872.30
-29872.30
-29872.30
-29872.30
29872.30
29872.30
29872.30

45766.23
45407.44
44075.54
38533.47
6479.95
-40398.15
-70603.28
-46524.17
-5042.21
0
0
0
0
0
0
0
-17430.32
-39118.82
-35211.16
-20484.67
-356.25
0
16724.25
33628.63

10
10
10
10
10
15
15
15
15
15
10
10
10
10
10
15
15
15
15
15
15
10
10
10

0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744
0.1744

-798.31
-792.05
-768.82
-672.15
-113.03
-1057.01
-1847.32
-1217.30
-131.93
0
0
0
0
0
0
0
-456.06
-1023.54
-921.29
-535.98
-9.32
0
-291.72
-586.59

h1
h2
h3
h4
h5
h6
h7
h8
h9
h10
h11
h12
h13
h14
h15
h16
h17
h18
h19
h20
h21
h22
h23
h24

price
3

cost

cumulative
tolerance
[m3 /h]
Long peak
Short peak

329624.17
-198727.73

119489.22
-119489.22
daily
tolerance
[m3 /h]

210134.95
-79238.52

100
100

0.1744
0.1744

-36654.35
-13821.80

Dailya

-77518.36
daily
imbalance
[m3 ]

-47795.69

-29722.68

100

0.1744

-5184.60

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 penalty
and the cumulative peak penalty with the same sign is due by the shipper. So, only
max{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 the
hourly 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 indicate
short positions (m3 /h-values) or shipper costs for A
C-values. Positive values indicate long positions
(m3 /h-values) or shipper revenues (A
C-values).

11

imbalance on day 289

x 10

hourly imbalance
cumul. imbalance
daily tol.
hourly tol.
cum. tol.

imbalance [m /h]

10

12
14
time [h]

16

18

20

22

24

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 the
cumulative hourly imbalance and is thus the aggregated sum of the hourly imbalances. The units
of the cumulative imbalance are basically also m3 /h. The magenta, green and cyan dashed lines
represent the hourly, daily and cumulative hourly tolerance limits, whereas the dotted black lines
mark the maximal and minimal cumulative imbalances for the day.
150% of the total annual demand results in imbalance charges totalling 150 million
Euro.
To identify the deeper causes of these results, the penalty and settlement costs were
given a closer look. This analysis revealed that for the Dutch balancing system
and for the used entry and exit profiles a trade-off is taking place between the
increasing costs of the combined daily and cumulative penalties and the increasing
settlement revenue for long imbalances. The hourly penalty costs are a factor 10
smaller and are not decisive for the optimum due to the properties of the imbalance
profile15 . The combined cumulative and daily penalty costs increase rapidly with
increasing overcontracting, as can be seen in figure 9. However, as illustrated in
figure 10, the settlement switches from a cost for undercontracting to a revenue for
overcontracting. As a consequence, the rising penalty costs are initially offset by
the settlement revenue. The optimum is reached at the 150% contract, from where
on the costs rise more steeply than the revenues.
It can be argued that the settlement revenue is not a real revenue. Firstly, in a
properly designed balancing system, the reference price should reflect the costs
incurred 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 worse
than the regular wholesale trade price. Secondly, the excess gas that results from
overcontracting has to be paid as well. So, the payment for the excess gas would
cancel out with the settlement revenue, at least to a certain extent depending on
the applicable prices.
15. Given the assumption of no flexibility, many days with persistenly long or short hourly imbalances occur, without those imbalances cancelling out. This results in relatively large cumulative
imbalances.

12

Imbalance cost per contracted supply portfolio

x 10

3.5
3

cost [EUR]

2.5
2
1.5
1
0.5
0

50

100
150
contract size [% total annual demand]

200

250

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

x 10

Combined daily and cumulative penalties per contracted supply portfolio

3.5

0.5

3
2.5
2
1.5

0
0.5
1
1.5

0.5

2.5

Figure 9:

Commodity settlement per contracted supply portfolio

1.5

cost [EUR]

cost [EUR]

4.5

x 10

50

100
150
contract size [% total annual demand]

200

250

The combined cumulative hourly

and daily penalty costs per contracted supply portfolio. Costs have 100 million Euro as
units. The contracts are expressed as percentages of total annual demand. Penalty costs rise
increasingly steeper with larger overcontracting. In case of undercontracting the costs do
not vary substantially (on the used scale).

50

100
150
contract size [% total annual demand]

200

250

Figure 10:

The settlement value per contracted supply portfolio. The units are 100 million Euro on the vertical axis, whereas the contracts on the horizontal axis are expressed as
percentages of total annual demand. For contracts up to 100%, settlement is a cost for the
shipper. For larger contracts, i.e. overcontracting, settlement becomes a revenue.

13

Short

Cumulative
Daily

System imbalance
Short
Long
-100% APX TTF -100% APX TTF
-100% APX TTF -100% APX TTF

Long

Cumulative
Daily

-70% APX TTF

-70% APX TTF

Shipper imbalance

Table 4:

Favourable treatment penalties for long positions

Short

Cumulative
Daily

System imbalance
Short
Long
-70% APX TTF
-70% APX TTF
-70% APX TTF
-70% APX TTF

Long

Cumulative
Daily

-100% APX TTF

-100% APX TTF

Shipper imbalance

Table 5:
3.2

-70% APX TTF

-70% APX TTF

-100% APX TTF

-100% APX TTF

Favourable treatment penalties for long positions

Scenario 2: asymmetrical penalties

In this second scenario the effect of the penalty levels is looked at. The benchmark
scenario makes clear that the combined daily and cumulative penalty cost is the
most relevant penalty cost in these specific calculations. Therefore, asymmetrical
penalties for short and long cumulative and daily positions were introduced into the
model. Tables 4 and 5 present the changed penalties compared to the benchmark
price structure from table 1.
When long positions received a more favourable treatment, i.e. only a 70% surcharge
for daily and cumulative hourly imbalances (table 4), even larger overcontracting,
the 190% contract, becomes optimal. This case is illustrated in figure 11 When the
penalty was increased further, the optimum shifted further to the right. Conversely,
when the favourable treatment was granted to short imbalances (table 5), i.e. a
short shipper pays a 70% penalty and a long shipper a 100% penalty, no substantial
difference was established compared to the benchmark. As can be seen in figure 12
the 150% remains optimal. Only when the short penalty is reduced even more, i.e.
the asymmetry is increased, the optimum started shifting towards less overcontracting. The reason for this slow shift is the dominance of the unchanged settlement
revenue for overcontracted portfolios.
When both short and long imbalances were granted the same less restrictive treatment, e.g. both sides penalised at 60%, then the settlement revenue becomes the
dominant factor. In that case, the lower the penalty, the more overcontracting becomes beneficial. If all penalties would become 0, a pure settlement based balancingsystem design is obtained. Such a system, for which the cash-out comes down to
figure 10, seems to stimulate shippers to overcontract without limits in order to cash
the settlement revenue for long positions. This statement does not take into account
the possible correlation between the shipper imbalance and the system imbalance.
Such a relation will be looked at in a third scenario.

14

Imbalance cost per contracted supply portfolio

x 10

3.5

3.5

Imbalance cost per contracted supply portfolio

x 10

3
2.5

cost [EUR]

cost [EUR]

2.5
2

1.5

1.5
1
1
0.5

0.5
0

50

100
150
contract size [% total annual demand]

200

Figure 11:

250

The imbalance cost per contract

portfolio with a favourable long penalty of
70%. Costs are expressed in 100 million Euro
on the vertical axis, whereas contracts are expressed as percentages of total annual demand
on the horizontal axis. The optimum shifts to
the right as the treatment of long imbalances
becomes increasingly favourable.

Shipper imbalance

50

100
150
contract size [% total annual demand]

200

250

Figure 12:

The imbalance cost per contract

portfolio with a favourable short penalty of
70%. Costs are expressed in 100 million Euro
on the vertical axis, whereas contracts are
expressed as percentages of total annual demand on the horizontal axis. The optimum
shifts slowly to the left as short imbalances are
treated increasingly favourable.

Short

System imbalance
Short
Long
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 imbalance. 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. Quadrants I and III
have a mark-up X because of high demand for gas, whereas quadrants II and IV have a mark-down
because of excessive supply of gas. The units of the prices are A
C/MWh.
3.3

Scenario 3: shippers effect on system imbalance

In this scenario, the effect of a positive or a negative correlation between the shippers status and the systems status will be investigated. Therefore, the reference
price 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 short
and 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, the
reference price will drop.
If the shipper imbalance is positively correlated with the system imbalance, the
shipper will pay high penalties for short positions and receive less settlement value
for long positions. For a negatively correlated shipper, counter-system imbalances
are rewarded with lower penalties for short positions and higher settlement revenues for long positions. The proposed new price structure is summarised in table
6. The price structure in the table is simplified: tolerances were not inserted for
reasons of clarity, though they were taken into account in the calculations for this
scenario. In the table reference price should be interpreted as an average price
for gas depending on exogenous factors, whereas X represents an unknown value
depending on the size and the sign of the actual system imbalance.

15

4.5

Imbalance cost per contracted supply portfolio

x 10

Imbalance cost per contracted supply portfolio

x 10

4
2.5
3.5
2
cost [EUR]

cost [EUR]

3
2.5
2
1.5

1.5

1
0.5
0.5
0

50

Figure 13:

100
150
contract size [% total annual demand]

200

250

The imbalance cost per contract

portfolio for a perfectly positively correlated
shipper and system imbalance. Costs are expressed in 100 million Euro on the vertical axis,
whereas contracts are expressed as percentages
of total annual demand on the horizontal axis.
Although overcontracted portfolios suffer from
lower settlement revenue, the resulting drop is
offset by the decreased penalty costs resulting
in an optimal portfolio to the right of the reference case.

50

100
150
contract size [% total annual demand]

200

250

Figure 14:

The imbalance cost per contract

portfolio for a negatively correlated shipper
and system imbalance. Costs are expressed in
100 million Euro on the vertical axis, whereas
contracts are expressed as percentages of total
annual demand on the horizontal axis. Overcontracting raises the settlement revenue because of the short system mark-up. However,
the penalty costs increase as well, resulting in
an decreasing portfolio compared to the reference scenario.

The correlation scenario was modelled using a fixed average gas price of 15 Euro
increased with a mark-up or mark-down for a system that is short or long, respectively. The mark-up and mark-down were calibrated with a factor16 to take the size
of the imbalance into account. A positive correlation between the shipper and the
system was modelled by having a mark-down when the shipper was long, and a
mark-up when the shipper was short. This implies that perfect correlation was assumed. To model the (perfectly) negative correlation, the mark-up was added when
the 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 compared to the reference case. Although the settlement revenue for overcontracting
decreases due to the mark-down, this drop is offset by the lowering of the penalty
costs 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 are
further increased from their initial value of 10%, a value that was chosen arbitrarily
by the authors.
For the perfectly negatively correlated shipper and system the optimal overcontracting decreases to the 130% contract, as can be seen in figure 14. Although the
negative correlation implies that a shipper with a long position receives the markup that is induced by the shortness of the system, the mark-up significantly increases the penalty costs for intolerated imbalances as well. When the mark-up and
mark-down were raised to 15% the optimal contract approached the neutral 100%
contract. For even higher mark-ups and mark-downs undercontracting becomes optimal, because the penalty costs for a short shipper position lower significantly due
to 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 daily
imbalances

16

Imbalance cost per contracted supply portfolio

x 10

3.5
3

cost [EUR]

2.5
2
1.5
1
0.5
0

50

100
150
contract size [% total annual demand]

200

250

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 portfolios on the horizontal axis are expressed as percentage of the total annual demand. With access
to 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 price
structure (table 1). However, in this more realistic scenario, the shipper is assumed
to 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 a
daily basis (Eq. 5). So, for every day (d) his hourly
P entry (supplyd h [GWh/h])was
modelled as 1/24th of the total daily demand ( h=24
h=1 demanddh ).
P h=24
h=1 demanddh
(5)
supplydh =
24
Figure 15 summarises the results of this calculation. A shipper who has access to
flexibility no longer has an incentive to engage into substantial overcontracting as
the 100%-110% contracts seem optimal. This result is caused by the substantial decrease of the penalty costs for the neutral 100% contract. The flexibility available to
the shipper allows reducing imbalances, whereas overcontracting or undercontracting would result in introducing new imbalances and thus penalty costs. Nevertheless,
the asymmetry between short and long hourly penalties implies that small overcontracting can still be favourable. This is clearly illustrated by figure 15: there is little
difference in the range from 100% to 120%.

Conclusions

The main conclusion of this research is that for a balancing-system design based
on the current Dutch design, it does pay for the shipper to engage into strategic
overcontracting if the shipper has no access to other flexibility. The optimal supply
portfolio for a shipper without any other flexibility amounts to contracting 150%
17

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 short
and 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 is
lower, overcontracting is stimulated even more. Similarly, when the short side receives favourable treatment, decreasing the overcontracting becomes optimal.
When the shipper and the system are positively correlated, the optimum shifts
to the right, which means even more overcontracted portfolios than the reference
case portfolio become optimal. On the contrary, in case the shipper and the system
are negatively correlated, the need for overcontracting is reduced and the optimal
portfolio 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 contracting
behaviour of a shipper that has flexibility is required. Furthermore, the upstream
(acquiring the supply) and downstream (selling the gas) cash flows involved in the
shipper 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 design
potentially has undesirable effects. Indeed, if all shippers would overcontract, then
this behaviour would result in a system that is persistently long, giving wrong
signals to the transmission system operator, to other shippers and potentially to
the market.

References
Council European Energy Regulators (2003) Principles for Balancing Rules
September 2003
Coelho, P. & Pinho, C. (2007) Considerations About Equations for Steady State
Flow in Natural Gas Pipelines. Journal of the Brazilian Society of Mechanical
Science & Engineering, Vol. XXIX, No. 3, p. 262-273
Dempe, S., Kalashnikov, V., Ros-Mercado, R.Z. (2005) Discrete bilevel programming: Application to a natural gas cash-out problem. European Journal of Operational Research, Vol. 166, No. 2, p.469488
Energiekamer (2008) Transportvoorwaarden Gas LNB. Version 1 July 2008. Available at http://www.energiekamer.nl
ERGEG (2006) Guidelines of Good Practice for Gas Balancing 6 December 2006,
Brussels
Kalashnikov, V. & Ros-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

18