• Making low carbon generators dependent on Contracts for Difference and Capacity Market is undermining wholesale markets and limiting competition and innovation.
• Energy Systems Catapult calls for a “big bang” moment for the energy sector akin to finance in the 80s and telecoms in the 90s – incentivising innovators to create new low carbon products and services that people want, and decarbonising the grid by 2035.
• Calls for reformed energy markets with more accurate, real time pricing and a new decarbonisation obligation – with sellers of electricity, including suppliers, would be obliged to source ever more low carbon energy.
• Report recommends six key reforms to create a more innovative, consumer-focused and cost-effective electricity market that can unlock decarbonisation across the whole economy by 2050.

The government needs to get out of the way to enable innovators to accelerate the shift to a carbon-free electricity grid well before 2050, according to a new report by Energy Systems Catapult.

Rethinking Electricity Markets calls for a new wave of reforms to create a zero carbon electricity grid that works for consumers. The report finds that the current government-directed system, where policy-makers effectively choose which technologies to support, stifles the potential of new ‘smart’ technologies. This risks making it more difficult and expensive for consumers and businesses to shift to green energy in their homes and workplaces.

The report calls for government policy to mandate clear outcomes for decarbonisation of the electricity grid and allow market forces to determine the best mix of generation, storage and smart technologies to achieve those outcomes. This would create a more innovative and consumer-focused energy system able to unleash innovation to accelerate a net zero economy.

Guy Newey, Strategy and Performance Director at Energy Systems Catapult, said: “The current government-directed approach to energy is like Boris Johnson telling Steve Jobs how to design the iPhone. The progress on renewables over the past 10 years has been extraordinary, but if we are to finish the job of decarbonising the power sector – and create new businesses and jobs – we need to unleash the potential of our brilliant digital energy innovators to create a more flexible and greener system.

“History shows that consumers and markets are the key drivers of innovation – and crucially its widespread adoption. Government should step back from micro-managing the electricity mix and empower electricity consumers and markets to drive demand and shape investment for the biggest impact.

“Centralised contracts were the right approach for the last decade to get renewables where they are today and innovation support will always be needed for new technologies. Government now faces a strategic choice; does it want to make more and more decisions about what the future electricity market looks like? Or does it want to trust British innovators to deliver a net zero economy that works for consumers?”

Today’s electricity market – based on the Energy Act 2013 and accompanying electricity market reforms (‘EMR 1.0’) – successfully accelerated the share of renewables from 14% in 2013 to 47% in 2020. It has also enabled the UK to achieve the fastest rate of decarbonisation in the world, with clean power as the largest form of generation. However, these mechanisms were designed for a far less mature market, where the technology and business case for renewable energy was not proven and still needed strong government support.

Evidence from the ESC report’s whole system analysis shows that the current framework is now progressively undermining wholesale electricity markets, and creating a perpetual reliance on government decision-making to drive technology choices. Current arrangements such as the Contracts for Difference (CfD) and Capacity Market (CM) risk inhibiting innovation, misallocating investment, causing system inefficiencies, unfairly weighting investment into generation technologies over demand-side technologies and restricting new entrants and innovation.

ESC’s analysis finds there is likely to be a need for around 87GW of offshore and onshore wind by 2050 in one cost-effective scenario, making it the workhorse of the future power system. Integrating this huge resource into the wider energy system requires a much more flexible demand-side, enabled by digital technology. If future markets do not enable such flexibility, the system is likely to be more expensive and less efficient than it could be.

The report calls for six far-reaching reforms – dubbed ‘EMR 2.0’ [see notes to editors] – that would see government gradually step back from its role in contracting for specific kinds of electricity generation. Instead, it would free the market to drive innovation, investment and consumer-focused services, with clear goals on decarbonisation, reliability and cost.

The Government’s recent Energy White Paper opened the door to further market reform over the coming decade.[i] The Climate Change Committee has also called for a ‘clear long-term strategy as soon as possible, and certainly before 2025, on market design for a fully decarbonised electricity system’. It also states that UK electricity production should be zero carbon by 2035.[ii] ESC’s report provides a blueprint for the future design of the market to achieve this.

Jo-Jo Hubbard, founder and CEO of Electron, said: “Markets are best placed to determine what technologies need to be built and where. Our experience developing local energy markets underlines the cost efficiencies and speed that this approach supports, but only if price signals are not dampened and distorted.

“We fully support this Energy Systems Catapult and urge Government to invest in market frameworks over large, individual capex projects.”

The end of Contracts for Difference and the Capacity Market

The report finds that CfDs and the CM favour large infrastructure, directly impact market prices and inhibit new business models for flexibility, small and distributed energy resources and consumer-led demand-side solutions.

In effect, policy-makers, rather than the market, are choosing what technologies get built, with potentially valuable alternatives excluded. This approach distorts wholesale and retail energy markets and crowds out innovation in financing, contracting and risk management. It is resulting in increasing system costs, concerns over negative prices and slow progress on flexibility.

The report calls on government to immediately adapt CfDs to end market distorting impacts, with the phase out of CfDs for mature technologies and the CM by the mid-2020s. They would be replaced with outcome-based policy mandates for decarbonisation and reliability. This can be complemented with industry-led initiatives that promote financial market development and risk mitigation.

Caroline Bragg, Head of Policy, The Association for Decentralised Energy (ADE): “The centre of gravity of the energy system is well and truly on the move – shifting from large generation and supply to energy users from industry, offices to our homes. To achieve the progress we need in decarbonisation, we need to lean into this with determination and a real optimism for the future.

“This very timely report sets out how we can unleash the vast, hardly tapped potential of innovative offerings across zero carbon heat, flexibility and energy efficiency. Being bold in these reforms is not a nice to have – it is crucial to ensuring that we decarbonise without breaking the bank.”

Making green energy work for consumers

The report finds that current market arrangements do not incentivise consumer-focused innovations and services, including energy efficiency or demand reduction, particularly with the lack of a market-pull policy driver for heat. Consumers face largely undifferentiated retail offers  and dynamic retail tariffs are the exception not the norm. Policy and market signals are failing to adequately incentivise retailers to offer more innovative and attractive services to consumers.

The report calls on the Government to create a level-playing field between different energy resources (energy demand, generation and storage) and between large and small assets, and to remove barriers to entry for new entrants. Along with the mandates, this will enable retail innovation that will deliver attractive service offers, providing more value to consumers would also unlock the demand-side flexibility that is vital to ensuring the power system can cope with the rapid growth in renewables, EVs and heat pumps necessary to achieve net zero.

Greg Jackson, Founder and CEO of Octopus Energy, said: “This is just the sort of market reform we need to drive down costs as we go renewable, to accelerate Britain’s green recovery and to make the UK the Silicon Valley of energy.

“Government subsidies have catalysed renewable power to rapidly scale up, and we are now ready to lose the training wheels and bolt on the rocket boosters. These reforms could build a joined up system that no longer subsidises renewables with one hand then taxes citizens on the other, but instead matches consumer demand with zero carbon, zero marginal cost, zero guilt electrons.

“Adopting this approach we can make the green revolution faster and cheaper than anyone imagined. But we need to act now – neither the climate, nor citizens, should have to wait.”

Unlocking flexibility to accelerate renewables

Technologies that enable a more flexible energy system – such as battery storage – are essential as renewables become the main source of power. The International Energy Agency (IEA) has said it is vital that the growth of flexible technologies keeps pace with renewables.

However, the ESC report finds this is not being achieved in the UK, risking increased reliance on network reinforcement, over-capacity of renewable power, curtailment costs (to switch renewables off when there is too much power compared to demand) and the need for inefficient and expensive measures to ensure system reliability. The end result is a more costly and carbon-intensive energy system.

Market barriers and inadequate price signals are hampering investment in low and zero-carbon flexibility and system integration. For example, current price signals do not sufficiently reward innovators delivering flexibility. EMR 2.0 would create stronger, more accurate price signals and unlock investment in flexibility, including in the residential sector.

Nick Kitchin, CEO, Cumulus Energy Storage: “Efficient use of our long-duration batteries to integrate variable renewables, is reliant upon price signals that accurately reflect what’s happening in the power system in real-time and by location. For example, enabling more windfarms in Scotland and the North sea to generate electricity, without being curtailed due to constraints in the transmission network, is just one of the valuable services energy storage can offer.

“In future, we expect more of our revenues to come from the wholesale electricity markets, so reforming EMR to work with markets based on the principles of decarbonisation, security of supply and lower consumer energy prices, is definitely something we endorse.”

Harnessing the power of digitalisation

There have been significant developments in technology, data and digitalisation since the last wave of energy system reforms in 2013. The report calls for faster progress to harness the power of this generational shift, enable more efficient operation and coordination of electricity systems and development of innovative consumer-focused services.

For example, technologies that enable domestic flexibility, particularly smart electric heating, could save £7bn a year.[iii] Smart charging of EVs, which could dramatically reduce the need for network reinforcement, could save up to £6.5bn by 2050.[iv]

Implementation of EMR 2.0 will allow digitalisation to transform the electricity market in the same way it has the financial and telecoms markets, delivering a win-win for consumers and net zero.

Laura Sandys, chair of the Energy Data Taskforce and author of Recosting Energy, said: “ESC’s thinking aligns with the ReCosting Project on many levels. We’ve got to start to get the market to do the heavy-lifting on mature technologies, while Contracts for Difference need to be focused on less mature technologies.

“Completely agree with ESC that outcome-based policy mandates, applied downstream in the retail sector, will provide greater certainty for developers and mandates have been extremely effective as drivers of investment. The big focus for markets now is to reflect the Whole System Costs to reward the full value of flexibility and optimisation of supply and demand for the benefits of consumers.”

[i] Energy White Paper: “We want to understand how generators can best be exposed to market signals which stimulate innovation and incentivise generators to minimise the overall system costs of large amounts of renewables. We will also be asking about the broader evolution of the electricity market (see ‘Energy system’ chapter). We will seek a balance between options for further reform of the market with maintaining the success of the CfD in deploying low-cost renewables at scale.” 

[ii] CCC 6^th carbon budget electricity sector report.

[iii] OVO Energy and Imperial College London, 2018.

[iv] Energy Technologies Institute, 2019.