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GETTING TO ZERO

Powering the Future: UK Review of Electricity Market Arrangements

Why the Review of Electricity Market Arrangements is so important.
Ed Birkett
July 4, 2022
Powering the Future: UK Review of Electricity Market Arrangements

Over the last 15 years successive governments have introduced a byzantine array of schemes to support different technologies. But as Onward’s new report sets out, with almost all new projects getting some taxpayer-funded support, it’s not hard to see why it’s created a boom for lobbyists, with all the costs ultimately being passed on to customers. We should let energy firms find answers for our newly-modernised wholesale electricity market so they can buy the best of whatever they’ve got, rather than politicians trying to pick winners.

John Penrose MP, Member of Parliament for Weston-super-Mare

The UK’s electricity system will be the backbone of a net zero economy. 

Between 2020 and 2050, demand for electricity is expected to more than double, whereas demand for oil and gas is forecast to fall by 85% and 70% respectively.

Rising electricity demand will be met by more offshore wind, nuclear, solar and other sources. Because the output from wind and solar farms is variable (“intermittent”), they pose new challenges for the electricity system.

When wind output is low, alternative sources of electricity are needed. Today, this backup is provided by gas-fired power stations. However, net zero means that gas usage must fall, so new technologies will be needed to fill gaps in wind output. 

The electricity sector also faces big challenges when it’s windy, particularly getting electricity from where it’s generated to where it’s used. The UK’s wind farms are concentrated in Scotland and off the east coast of England. This is far from where the bulk of electricity demand comes from, which is in the South of England.

To address these and other issues, the Government launched a “Review of Electricity Market Arrangements” (REMA) as part of the British Energy Security Strategy (BESS). REMA will consider structural reforms to Great Britain’s electricity market and will be joined up with the Government’s ongoing review of the retail energy sector.

Without reform, the Government’s 2035 target for 100% low-carbon electricity is at risk.

There are already warning signs that the current market isn’t designed to handle more renewables. In March this year, National Grid ESO issued a stark warning that:

“…the status quo will not deliver net zero cost effectively, as current market design creates inefficient behaviours, particularly in dispatch, resulting in dramatic and rising costs for consumers…”

In this context, the Government’s plans to build more offshore wind farms could inadvertently drive up bills rather than reduce them. Without reform, there is therefore a risk that the Government will have to delay its headline target of decarbonising the electricity sector by 2035, with gas-fired power stations having to run for longer and the Government missing its targets for new offshore wind farms and new nuclear power stations.

The challenge for the Government is to simultaneously reform electricity market arrangements whilst rapidly deploying new low-carbon energy projects.

Proposed aim for the Review of Electricity Market Arrangements (REMA):

Successive Governments have tried to develop an electricity system that is simultaneously secure, affordable and low carbon. These criteria are collectively known as the “energy trilemma”.

To meet these criteria, we believe that:

The Government should harness markets to signal investors to build a coherent mix of technologies. Markets should be designed to ensure that these technologies are financed cost-effectively and operated efficiently.

When developing new electricity market arrangements, the Government should try to move closer to Nigel Lawson’s original vision for the UK’s electricity market post-privatisation, with markets rather than the Government determining the future of the electricity system. Variations on Lawson’s philosophy have been reaffirmed by successive Energy Secretaries including Amber Rudd and Greg Clark in 2015 and 2018 respectively. As argued throughout this report, this approach is crucial to delivering net zero at least cost.

Jul 18
11:00-
12:15

Five questions that the Review of Electricity Market Arrangements (REMA) must answer:

Recommendations:

  1. How can the UK’s electricity system be operated affordably and securely with lots of renewables?
  2. How should markets fairly reflect the costs and benefits (“system value”) of different generators and customers?
  3. How can the link between gas prices and electricity bills be broken?
  4. What is the role for markets versus Government-run investment-support schemes?
  5. What is the role of customers in a net zero electricity system?

1. Reform wholesale and balancing markets. REMA must consider major changes to Great Britain’s wholesale electricity market to deal with rising network constraints, and to answer questions about the future of marginal pricing and how the location of customers and generators should be taken into account. Reforms are also needed to integrate the new balancing services that will help keep the electricity grid secure with more renewables.

2. Reform “investment-support schemes” (E.g. Capacity Market, Contracts for Difference). The current suite of investment-support schemes risks bringing forward the wrong mix of technologies, raising bills. These reforms should consider how to bring forward the optimal technology mix at an affordable cost, whilst encouraging companies to operate their assets efficiently.

3. Reform regulation of energy suppliers. In discussions of market design, the role of energy suppliers is often kept in a “downstream” bucket, with wholesale markets and investment-support schemes considered in a separate “upstream” bucket. New technologies like smart meters have blurred this distinction, and the growing importance of electric vehicles and heat pumps means that there’s huge potential for customers to participate in the “upstream” market.

 

Five questions that the Review of Electricity Market Arrangements (REMA) must answer:

  1. How can the UK’s electricity system be operated affordably and securely with lots of renewables?
  2. How should markets fairly reflect the costs and benefits (“system value”) of different generators and customers?
  3. How can the link between gas prices and electricity bills be broken?
  4. What is the role for markets versus Government-run investment-support schemes?
  5. What is the role of customers in a net zero electricity system?

Recommendations:

1. Reform wholesale and balancing markets. REMA must consider major changes to Great Britain’s wholesale electricity market to deal with rising network constraints, and to answer questions about the future of marginal pricing and how the location of customers and generators should be taken into account. Reforms are also needed to integrate the new balancing services that will help keep the electricity grid secure with more renewables.

2. Reform “investment-support schemes” (E.g. Capacity Market, Contracts for Difference). The current suite of investment-support schemes risks bringing forward the wrong mix of technologies, raising bills. These reforms should consider how to bring forward the optimal technology mix at an affordable cost, whilst encouraging companies to operate their assets efficiently.

3. Reform regulation of energy suppliers. In discussions of market design, the role of energy suppliers is often kept in a “downstream” bucket, with wholesale markets and investment-support schemes considered in a separate “upstream” bucket. New technologies like smart meters have blurred this distinction, and the growing importance of electric vehicles and heat pumps means that there’s huge potential for customers to participate in the “upstream” market.

 

REMA map - Current transmission charges for a typical wind farm across different regions

By exploring the questions above, we have identified 11 key issues that REMA needs to address, listed in the figure below. We believe that these issues should be addressed through three major programmes of reform targeting wholesale and balancing markets, investment-support schemes, and supplier regulation.

We have also identified six additional considerations for REMA. However, these other considerations, whilst important, are largely independent of the optimal design of Great Britain’s electricity market.

 

Electricity markets

Next steps

This research note does not attempt to provide a blueprint for the future of Great Britain’s electricity market. Instead, it aims to highlight the key questions that BEIS will need to answer through REMA.

In future work, Onward plans to publish a full suite of recommendations for the Review of Electricity Markets Arrangement. These recommendations will be published in a second report, expected in Q4 2022 or Q1 2023.

As we develop these recommendations, Onward is keen to engage with as many stakeholders as possible. Please do get in touch if you would like to discuss.

Click here to read more about Onward’s Getting to Zero programme

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