The UK’s success to date in decarbonising its power sector should be applauded. The significant reduction in carbon intensity – a fall of over 60% since 2008 – driven in part by a rapid ramp up of renewable generation means that a net zero power sector by 2035 is a realistic, if still challenging, prospect.

The policies introduced through the Electricity Market Reform (EMR) package in the 2010s were successful in driving this change. However, a decade on, new challenges have emerged and old ones have persisted. As such, a comprehensive review of the electricity system is timely. Indeed, Energy Systems Catapult initiated its own programme of work – Rethinking Electricity Markets (REM) – to identify options for reform and we are pleased that much of its analytical basis has been considered as part of the Department for Business, Energy & Industrial Strategy (BEIS) work.

Review of Energy Market Arrangements (REMA) has the potential to transform our energy system for the better. Net Zero electricity is within sight. We have many of the technologies we need to produce zero carbon power and their costs are falling rapidly. The gas crisis has demonstrated that we can be stronger and more resilient if we can effectively harness our homegrown energy resources. But our electricity system needs modernising so we can make the best use of every “green” electron produced. A more efficient system will cost less, saving money for the end user.

This requires radical reform. We need to level the playing field and unlock the potential of demand side flexibility. We need greater cost-reflectivity such that the prices that users pay more accurately reflect the costs they impose and the benefits they receive. And we need to streamline policy to unleash innovation.

Key challenges

Since the last major electricity market from, the context for reform has changed in some significant ways. Our decarbonisation ambition has increased, with the signing into legislation of a Net Zero target by 2050 (2045 in Scotland), which will require more variable renewables and the earlier electrification of heat and transport. However, the rapid growth of variable renewables has led to new system issues and, despite the availability of new technologies, investment in flexibility solutions – such as demand-side response and storage – has not been able to keep pace.

REMA sets out the current challenges fairly and accurately. Crucial themes are:

• Price signals: The current framework delivers price signals that are not sufficiently granular by space and time, and do not accurately reveal the value of flexibility to the system.
• Disjointed policy: The centralised policy framework (Contracts for Difference and the Capacity Market) is biased towards generation and large assets. It crowds out smart, innovative solutions and dampens signals for flexible technologies. It also relies on the government’s capacity to deliver, perpetuating the requirement for policy support and stunting the development of financial markets / contracting to manage investment risks.
• Enabling architecture: Lack of strategic planning and coordination, as well as local planning constraints, risks missing opportunities to exploit local / regional energy opportunities. What’s more, approaches to network regulation are siloed, with network companies not incentivised to plan strategically from a whole system perspective. Faster progress is needed to harness data and digitalisation to enable more efficient operation and coordination of electricity systems, as recommended by the Energy Digitalisation Taskforce. Catapult chair, Nick Winser, was recently appointed as Electricity Networks Commissioner to accelerate the delivery of crucial electricity network infrastructure.

Principles and priorities for reform

REMA is right to specifically emphasise the need for system flexibility to best integrate intermittent renewables – this must be the top priority for reform. As well as delivering benefits to the energy system, it also offers significant economic growth opportunity – including in relation to aggregation, battery production and operation, market platform design and digital and data technical services.

It will be crucial to take a whole systems approach – to optimise across vectors (power, gas, heat, etc) – and identify policies that deliver the three objectives of decarbonisation, cost effectiveness and security of supply in mutually reinforcing ways.

The complexity of the power and wider energy system means that government’s ability to predict and choose the right solutions is limited. As such, a central challenge will be how to best unleash innovation in support of our objectives, removing barriers – including policy barriers – and, to the extent possible, creating a level playing field so that the most appropriate solutions come forward.

Key points

Two specific policy measures that could have a disproportionately beneficial impact are locational pricing and outcome-based measures (e.g. “supplier obligations”).

Locational pricing

REMA draws out the importance of locational signals across the electricity system to improve efficiency and promote consumer benefit. It also acknowledges that there is a strong case for change as the current market design and suite of interventions distorts effective locational signals. We agree with this analysis. Regardless of the precise mechanism ultimately taken forward, improving the accuracy of locational and temporal value across the electricity system is a top priority. We consider the greatest benefits will be achieved through locational marginal pricing (‘nodal pricing’), especially when combined with outcome-based measures.

Energy Systems Catapult analysis showed that reforming the UK electricity market so that wholesale prices reflect local supply and demand conditions could save consumers £30bn off the cost of electricity in the period to 2035 as the country transitions to a net zero grid.
Some commentators have suggested that locational pricing models are new and untested. However, it is important to note that location models been in place in various jurisdications around the world for decades, and they account for a significant proportion of global power capacity.

Outcome-based measures

A Clean Electricity Standard could, for example, require all suppliers to meet a level of decarbonisation across their entire portfolio of energy purchases – with the standard set by government to tighten over time and align with carbon budgets. This would provide stronger incentives for upstream contracting with low carbon generators and innovation in flexibility / demand response to drive down reliance on high carbon peak resources.
Other important considerations

The scope of REMA explicitly excludes retail market reform, although it explains that there is considerable crossover and officials will endeavour to join up and exploit synergies. However, consumers should be central to all aspects of REMA’s policy consideration. The driver for reform is to improve consumer outcomes, including affordable energy. Policy to ensure consumer benefits are realised and consumers are protected from harm must be designed and presented in parallel with wholesale market reform. The role of the energy retailer in this will be very important (see our report on Clean Energy Retail).

The need to rapidly digitalise assets across the energy system is implied throughout REMA but it should not be taken for granted. Implementation of the recommendations set out by the Energy Digitalisation Taskforce must be expedited.

Last but not least, process and implementation. Effective reform requires thought, evidence and consent and it is appropriate that time is taken to get it right. It will be important to avoid conflating short-term urgent priorities with the need for more fundamental longer-term change – and an explicit recognition of distinct timeframes for different policy options would be helpful. Maintaining investor confidence and protecting committed investment are as important as ever, and “grandfathering” schemes may be necessary. Policy experiments and trials – with which ESC can support through our Living Lab – can provide the “hard” evidence that BEIS would require to make some of the more difficult decisions captured in the consultation.