Market reform must be at heart of driving a clean energy system – Ben Shafran and Tom Luff

Comment by Ben Shafran, Head of Markets, Policy & Regulation, and Tom Luff, Practice Manager (Electricity Markets Policy) at Energy Systems Catapult.

Government published its second consultation on electricity market reform today. It has made progress in defining options for change, but much work remains to translate this into real improvements for consumers.

Energy Systems Catapult has been advocating for radical reform of Great British (GB) electricity markets for years. Our Rethinking Electricity Markets programme helped shape the government’s initial consultation on the ‘Review of Electricity Market Arrangements’ (REMA) in 2022.

We prioritised this work because the electricity system is going to be the backbone of a Net Zero economy, so it is essential that the electricity transition works for consumers. Phasing out carbon is non-negotiable but so is keeping the lights on and keeping costs down. Getting energy markets right is the only way we can achieve all three.

The latest REMA consultation agrees that the status quo is not an option. The current market design and overlaying policy schemes risks exacerbating energy insecurity and power outages, with interconnectors at times exporting when we need power and importing when we don’t. We face an increasing number of protracted planning battles, with new lines taking more than a decade to build, putting our 2035 Net Zero power target in jeopardy. And consumers paying – perhaps £8bn per year by late 2020s – for generators to turn-off when power can’t be used.

Recognition of the importance of location…

It is also encouraging that options being taken forward in today’s consultation recognise the value of market signals in achieving consumer outcomes: discounting “market splitting” and emphasising the need for stronger locational signals.

We are clear that a piecemeal approach – as set out in the “BAU-plus” package (now named “Options set 2 – Alternatives to locational pricing”) – will not achieve what we need. It is fragmented, making it more complex to implement. It also has greater risk of being derailed – as has happened to many other similar reforms – and so provides less certainty. And, ultimately, it is not ambitious enough. BAU-plus is just a different of flavour of BAU: but Net Zero requires us to be much bolder.

The REMA consultation does put forward an option of moving to a zonal electricity market. We agree with DESNZ’s conclusion that zonal pricing would enable consumer savings and locational operational signals that alternative options to locational pricing cannot deliver.

With that in mind, it is disappointing that DESNZ has decided to discount nodal pricing as an option to be implemented in the near-term, despite the extensive evidence of the additional consumer and operational benefits that nodal pricing would deliver over zonal pricing. Tellingly, the consultancy study that estimates that zonal pricing could deliver £25-60 billion in consumer savings during 2030-2050 did not include modelling of nodal pricing.

Figure 1: REMA consultancy study’s estimated consumer savings in 2035 under zonal pricing

Figure 1: REMA consultancy study’s estimated consumer savings in 2035 under zonal pricing

The precise design zonal market is left open, with the consultation identifying a wide variety of options that would need to be assessed further. One interesting possibility identified in the consultation is to firstly introduce zonal pricing with self-dispatch (as in today’s electricity market) before moving to central dispatch in future. The latter would enable more pricing zones and would effectively be a coarse form of nodal pricing.

…and time of use

There was plenty more than locational pricing in the consultation. With such a broad remit, it’s no surprise that it’s something of a mixed bag.

On the positive side is the acknowledgement that along with greater locational granularity we also need greater temporal granularity in wholesale market pricing. A study commissioned for the REMA consultation concludes that “a transition to a 5-minute settlement period would likely deliver higher benefits versus a 30-minute or a 15-minute period and would likely be better suited to future GB electricity market with greater flexibility requirements.”

There is also an acknowledgement of the growing challenge of system operation in the transition to a Net Zero electricity system, with government committing to work with the National Energy System Operator to develop an electricity system operability strategy to 2035. A key question for this strategy would be how to account for cross-vector operability challenges (e.g. potential future reliance on hydrogen).

Less positive, in our view, is the commitment to continuing to use Contracts for Difference and the Capacity Market for mature technologies. Alongside bespoke models for hydrogen-to-power, long-duration electricity storage, and power Carbon Capture Use and Storage (CCUS), this effectively entrenches the role of government in selecting the future energy technology mix.

But still a long way to go

Today marks an important milestone in the reform programme, but the overarching theme from the REMA consultation is of just how much more work is needed to turn any of the reform options that have been short-listed into reality and realise the benefits for consumers. We must be vigilant in resisting pressures for easy (and ineffective) options as part of this consultation. What’s more, supportive policies are needed to aid implementation, to make the reforms work well for all consumers, and not just those who are best at grabbing the opportunities.

Figure 2: Overview of the short-listed and discounted options in the REMA consultation

Figure 2: Overview of the short-listed and discounted options in the REMA consultation

Moreover, there is a need to genuinely link wholesale market reform to retail reform and to strategic planning.

If we can get it right, it will mean low cost, green power for all consumers, allowing everyone to benefit from the UK’s abundant, home-grown clean energy resources. Energy Systems Catapult will continue to push for ambitious change during and after the consultation period.

Rethinking Electricity Markets

Rethinking Electricity Markets is an Energy Systems Catapult programme that began in 2019 to develop proposals to reform electricity markets so that they best enable innovative, efficient, whole energy system decarbonisation.

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Markets, Policy & Regulation

Independent and technology-agnostic markets, policy & regulatory thought leadership tackling the hardest challenges on the way to Net Zero

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