In early February, just before the Baltic states disconnected their power grids from Russia's electricity system, a joint Baltic frequency reserve market was launched. Through this market, the three Baltic system operators — Elering in Estonia's case — began purchasing reserves from electricity producers to keep production and consumption in balance and maintain the system frequency at 50 hertz.

The three Baltic system operators had forecast that securing reserves this year would cost them a few hundred million euros combined.

However, the first few weeks — and now three months — have shown that this forecast is likely no longer usable. For several reasons, some of which experts say could have been anticipated, the price of frequency reserves has fluctuated wildly. On some days, the hourly price hovered around a few dozen cents for several hours, only to exceed €2,000 per megawatt-hour a few days later. Several times, prices have even hit €4,000 — the maximum hourly rate allowed on the market.

Clearly, the system operators had not accounted for such extreme price volatility.

Market participants, namely electricity producers, were skeptical about the annual cost forecast from the beginning. They estimated that the cost this year would be at least double the conservative projection of €200 million for the three Baltic system operators combined, of which Elering's share would be €60 million.

For example, Alexela CEO Marti Hääl said that even based on February's results alone, the €60 million forecast already seemed overly optimistic.

Armen Kasparov, director of energy trading and portfolio management at Eesti Energia, said that the unexpectedly high costs of procuring frequency reserves in the first few months would inevitably impact both electricity producers and consumers.

The fact that prices have hit €4,000 suggests a shortage of new production and storage capacity, Kasparov noted.

Still, not everyone was surprised by the occasionally very high and volatile prices. Marko Allikson from Baltic Energy Partners said that given the short preparation time for the Baltic regulation market and the known lack of flexible production assets, it was immediately clear that prices would be volatile and system operator costs would soar.

"Market participants also made proposals to incentivize the earlier entry of new flexible assets into the market, but unfortunately, the sole priority of the desynchronization project was supply security, not the cost of balancing or regulation markets. System operators apparently assumed they could cover the risks stemming from the market's lack of preparedness with flexible assets they controlled themselves," Allikson said.

Based on hourly prices in the reserve market, Allikson has also calculated that from February 5, when the market opened, through the end of last week, the three system operators had spent about €168 million on the Baltic market. Elering's share would be roughly one-third or slightly less. Revenue earned by the system operators themselves (such as Elering's Kiisa power plant) would need to be subtracted from that total.

For context, the full-year cost forecast for the entire Baltic market was €200 million.

Elering has calculated its figures based on the methodology underpinning the frequency reserve tariff, but according to market participants, this methodology has not been shared with them. Therefore, it is difficult for anyone other than the system operators themselves to assess the actual costs.

Elering told ERR that its frequency reserve costs were €3 million in February and €11 million in March. According to Allikson, market prices were higher in April than in March, meaning Elering's April bill should be larger than March's €11 million.

"But even if we take Elering's March cost of €11 million as a baseline, moving forward at that rate would already result in total costs more than twice the initially projected €60 million," Allikson noted.

Price level shocking compared to Finnish market

Estonia and the other Baltic states had no prior history or experience with a frequency reserve market and the uncertainty was further compounded by the need to carry out desynchronization — the separation from Russia's grid — as quickly and urgently as possible. Nevertheless, the outcome has been that the Baltic system operators' costs have been dozens of times higher compared with their northern neighbors.

Allikson pointed out that between April 1 and April 27, the average price for Estonia's manual frequency restoration reserve (mFRR) upward capacity product was €161 per megawatt-hour, while the downward capacity product averaged €439. "Moreover, the price exceeded €1,000 per megawatt-hour a total of 101 times, including 40 instances when it hit €4,000," Allikson noted.

In Finland, the average mFRR upward and downward prices over the same period were €2 and €27 per megawatt-hour, respectively, with the maximum hourly price reaching €150.

Consumer picks up the tab

For market participants, the extreme price fluctuations in the frequency reserve market are not necessarily a bad thing, as they can generate more revenue than expected. The opening of the frequency reserve market has created new potential revenue streams for capacities managed by Eesti Energia, Kasparov said. However, for consumers and, for instance, renewable energy producers, this means an additional cost in the long term, which ultimately places a greater burden on society, he added.

In Estonia, at least until the end of this year, Elering is covering the frequency reserve costs using funds accumulated from congestion charges. As of the end of last year, Elering still had €337 million available in its congestion charge account.

Starting next year, however, producers and consumers will have to begin paying for frequency maintenance. This will be introduced as a balancing fee, which will be added to consumers' electricity bills. The initial calculation set the fee at €5.31 per megawatt-hour, or 0.53 cents per kilowatt-hour. However, this calculation was made based on an annual cost estimate of €60 million.

Producers are also unhappy about having to pay for frequency reserves and collect the so-called balancing fee from consumers. This could cast doubt on certain investment plans, such as new production capacities, and in the worst case, could even lead some producers to question whether it is worth producing electricity in Estonia at all. The issue is that it remains unclear whether and how Latvia and Lithuania will implement their own balancing fees.

"The implementation of frequency reserves impacts all electricity production development in Estonia. Therefore, we hope that the cost of maintaining frequency reserves will not be shifted onto local electricity producers. That would put our producers at a disadvantage compared to those in Latvia and Lithuania. Frequency reserves are needed even if there are no local producers and all electricity is imported," Kasparov said.

Kasparov noted that in Finland, the equivalent fee for electricity producers is €1.73 per megawatt-hour — about three times lower than what Estonia is planning.

"In addition, under the initial plans, a fee of €46.41 per megawatt-hour would be introduced in Estonia starting from July 2025 for the imbalance of electricity volumes within a system operator's area — the so-called imbalance fee. Again for comparison, the equivalent fee in Finland is €1.15 per megawatt-hour," he said.

That fee has also been postponed for now. To decide over the course of this year how the cost of frequency reserves will be covered — in other words, where the money will come from — Elering has commissioned an impact analysis.

When will the price stabilize?

No one can currently say how long the chaos in the Baltic frequency reserve market will last. There is no magic solution: there is simply a shortage of production and storage capacity.

To bring frequency reserve prices closer to levels seen in Finland, the region needs to add more flexible production and/or consumption capacity, Allikson said.

"To some extent, cross-border transmission capacities can also be used temporarily as reserves. However, depending on the direction of energy flows in the day-ahead market, restricting interconnection capacity could lead to higher electricity prices in the Baltic market, which already suffers from a major electricity production deficit. Therefore, it would be better to focus on adding new capacity within the Baltic states," Allikson said.

Elering has already occasionally restricted interconnection capacities, such as EstLink 1, though only temporarily and on a limited basis.

Kasparov similarly suggested that the market would stabilize once new production or storage assets, especially battery storage systems, come online.

The newest and most powerful operator on Estonia's frequency reserve market is a battery storage unit in Auvere, with a capacity of 26.5 megawatts and an energy storage volume of 53.1 megawatt-hours. However, it is the only entirely new production asset in the entire Baltic market.

Still, the situation is not hopeless in the near term, Allikson noted: for example, local renewable energy producers are already able to offer some of their output to the frequency reserve market. He added that Elering has responded quickly and cooperated well in this area.

"We have brought solar parks into the frequency reserve market, and in April, their revenues from the reserve market exceeded what they earned by selling electricity on Nord Pool's day-ahead market," Allikson said.

Allikson agreed that battery storage systems will be the next major factor in stabilizing prices. "With financing and available connection capacity, it is possible to deploy battery storage within 9 to 12 months. Some battery systems are already actively participating in the regulation market and today's attractive market prices should bring hundreds of megawatts of new battery storage projects to the Baltics as early as this year," he said.

Elering itself is currently running a procurement process to secure frequency reserve providers, seeking a total capacity of 500 megawatts. This likely means that a few new gas-fired power plants will be built in Estonia, which should also help lower prices.

The matter of the Kiisa plant

Estonia currently has one major gas-fired power plant, located in Kiisa, with a production capacity of 250 megawatts. However, there is a catch: the plant was built for emergency situations and belongs to the system operator Elering, meaning it should not be participating in the market. Yet even this condition comes with a caveat.

When the three Baltic states disconnected from Russia's electricity system this February, Elering secured an exemption from Europe allowing the Kiisa plant to be used as a frequency reserve until the end of 2028 — meaning it could, after all, participate in the market, though not in Nord Pool's electricity exchange but rather in the Baltic frequency reserve market. As a result, the volume of one procured reserve product (mFRR upward) was reduced by 190 megawatts, precisely the amount Kiisa contributed to the market.

Since the situation has grown critical within a few months — with reserve procurement costs exceeding all forecasts — Elering requested permission from the Competition Authority to use Kiisa's full 250-megawatt capacity.

Last week, it was announced that the Competition Authority had granted Elering permission to use the entire capacity of the Kiisa power plant in the frequency reserve market.

Elering estimated that this move could save €1 million to €1.2 million per day in reserve procurement costs.

Market participants, however, have mixed feelings. One market participant who spoke with ERR said that the Kiisa plant's 250 megawatts, combined with the 900-megawatt Kruonis pumped-storage hydroelectric plant owned by Lithuanian energy giant Ignitis, would effectively dominate the mFRR market, leaving little room for genuine competition.

Allikson described the full participation of the Kiisa plant as a double-edged sword.

"On one hand, looking at today's extreme market prices, there is clearly a lack of competition and any additional capacity would help improve the situation in the short term. On the other hand, the price signal is crucial for investors who decide whether to invest in new storage projects based on market conditions — and when market operators keep changing the rules on the fly, it reduces investor confidence and willingness to pursue necessary projects," he said.

According to Allikson, Kiisa's participation should have a clear time limit, perhaps three months, after which it could be reassessed whether the plant should continue in the market or if it is ultimately distorting market functioning.

In any case, the government has decided to sell the Kiisa power plant, with the auction expected to take place in the first half of 2028.

All of these decisions will also have an impact on the future of renewable energy. For example, there could be problems selling renewable electricity if the fixed cost of maintaining frequency reserves artificially inflates the price of balancing energy, forcing renewable producers to curtail production during periods of low market prices, Kasparov said.

"No one would benefit from that: consumers would face higher electricity prices and the share of renewable electricity production in Estonia would decrease," he noted.

A spokesperson from Utilitas, a company involved in wind farm development, said they were not yet ready to draw conclusions or provide figures based on just a few months of market activity.

Is a rules change in order?

This raises the question of whether the rules of the hastily launched frequency reserve market should be changed after the fact to help stabilize the situation.

Elering told ERR that they currently do not foresee any changes to market rules due to the wide price fluctuations and that they are instead working to increase market liquidity. "We also expect to see significant investments completed in the Baltic states this year and early next year, which should start to reduce reserve procurement costs," the system operator said.

Allikson disagrees. "The frequency reserve market definitely needs changes that would incentivize the faster entry of new market participants. First, market transparency must be improved by publishing offer curves, similar to Nord Pool, along with very clear principles on how the Baltic system operators submit offers to the market," he said.

In addition to clarifying the operation of the Kiisa plant, it is necessary to establish transparency regarding what battery systems the system operators themselves have and the logic under which Lithuania's Kruonis pumped-storage plant and Latvia's hydro plants are making their offers, Allikson said. "Without such clarity, investors will not trust the market price signals and investment decisions will be delayed," he noted.

Auction rules should also be updated to ensure that more new bidders can enter the market. "Currently, bids from larger producers are often selected over smaller, cheaper ones simply because their offers are indivisible, but without them, the market would lack sufficient capacity," Allikson said.

Third, he argued that administrative barriers — namely, the regulatory uncertainty surrounding battery storage investments — must be eliminated urgently.

"Otherwise, there is a risk that when investors are ready to bring such projects to Estonia without any subsidies, it will not be possible to execute them at the needed scale and speed because of unclear regulations. We must remember that all Baltic states are competing for these investments, and in Lithuania, for example, €180 million in state aid has been earmarked for storage projects, aiming to build at least 1,200 megawatt-hours of new energy storage capacity," he said.

What is a frequency reserve?

Currently, the Baltic market is divided as follows: according to data from Latvia's system operator AST, Lithuanian participants account for 79 percent, Estonian participants for 13 percent and Latvian participants for 8 percent. The same players who produce electricity for daily consumption also participate in the frequency reserve market.

For example, Eesti Energia offers a total of 930 megawatts of qualified capacity across various Baltic regulation markets.

The frequency reserve itself is divided into three categories: FCR (Frequency Containment Reserve), aFRR (automatic Frequency Restoration Reserve) and mFRR (manual Frequency Restoration Reserve).

FCR, or frequency containment reserve, is the primary mechanism for maintaining frequency — it is the first response if the frequency begins to deviate, even slightly, from 50 hertz. This is an automated service, meaning frequency reserve providers respond independently without intervention from the system operator, such as Elering.

aFRR is a reserve automatically activated by the system operator within five minutes when frequency fluctuations occur. It supports the FCR and is used until the electricity system is back in balance.

mFRR is used as a third and final measure to restore frequency when deviations are prolonged or larger in magnitude. To activate this reserve, the system operator sends a direct order to the reserve providers.

Both aFRR and mFRR are procured for two purposes — to regulate frequency upward and downward. Thus, the frequency reserve market is divided into five categories in total.

Although hourly prices in the frequency reserve market are publicly available, it is still significantly less transparent than, for example, Nord Pool's day-ahead energy market, Allikson said.

"This makes it harder to analyze how the market operates and the figures used to calculate frequency reserve tariffs are known precisely only to the system operators," he noted.

Frequency reserves are power plants and storage units ready to quickly respond to changes in the electricity grid, such as power plant failures that create surpluses or deficits, potentially threatening the maintenance of the 50-hertz frequency. Reserve providers must be capable of instantly activating additional production capacity when shortages occur or reducing the output of their operating units when there is oversupply in the grid.

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