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.

The right electricity market reforms and market mechanisms will bring forward innovation and investment in a more efficient mix of low carbon generation, network enhancements and flexibility.

In developing proposals to reform electricity markets, the programme are to:

  • Work collaboratively and interactively with a range of stakeholders with different perspectives and expertise
  • Draw on our capabilities to analyse and understand the challenges of whole energy system decarbonisation
  • Draw on our experience in working with innovators and local energy projects
  • Share and test our emerging insights on a regular basis.

The Electricity System Challenge

A clean electricity system will form the centrepiece of the UK’s efforts to achieve Net Zero greenhouse gas emissions target by 2050. New and renewable forms of electricity generation will be crucial within a more decentralised and flexible system, serving more of our transport and heat energy demands.

Current electricity market arrangements are complex and market mechanisms do not fully reflect the value of different technologies to the system as a whole – in terms of how they impact on overall system costs or reduce carbon emissions. The value of different technologies depends on:

  • How flexible and reliable they are
  • Where they are located on the network
  • Their impact on carbon emissions.

Current market arrangements make it difficult to promote a balance of investment across different times, locations and solutions or to encourage long-term investment choices and innovation.

The Solution

Electricity sector policy reform is often focused on design details of particular mechanisms (e.g. network charging, auction mechanisms, capacity markets). There has been less focus on how these detailed mechanisms fit together to signal value, or on the strategic choices around how to ‘get prices right’ across the system and the value chain.

Rethinking Electricity Markets aims to fill this gap by focusing attention on the options for reforming the current complex mix of energy market and policy arrangements so that they stimulate innovation and investment in a flexible and resilient mix of zero-carbon electricity.

This means addressing issues such as policy fragmentation, integration of electricity into the wider energy system (heat/ transport), and interaction between regulatory and policy instruments.  A key emerging theme is the need for more granular price signals in both time and space, to ensure that markets reward actors who deliver flexibility in locations where it is most valuable.

Review of Electricity Market Arrangements (REMA)

In July 2022, the UK government launched a transformational review into Britain’s electricity market design, seeking views on a wide range of options to address the combined challenges of responding to higher global energy costs, the need to further boost energy security and move the UK to a cleaner energy system. REMA aims to deliver:

  • Major review into Britain’s electricity market design launched by UK government to radically enhance energy security and cut costs of electricity for consumers in the long term.
  • Proposals out for initial consultation include exploring changes to the wholesale electricity market that would stop volatile gas prices setting the price of electricity produced by much cheaper renewables.

Rethinking Electricity Markets - Main report

EMR2.0: a new phase of innovation-friendly and consumer-focused electricity market design reform

This paper sets out Energy Systems Catapult proposed reforms for GB power market design, including:

  • Five key challenges for a Net Zero electricity system.
  • Six key reforms for a Net Zero electricity system.
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Figure 1: Six key reforms for Rethinking Electricity Markets

Figure 1: Six key reforms for Rethinking Electricity Markets

REMA - consultation responses

Review of Electricity Market Arrangements: Response to the second consultation

Our key messages in relation to this consultation are:

  • A clear direction of reform centred on a granular zonal pricing will maximise consumer benefits and offer an unambiguously attractive signal to both innovators and investors.
  • The alternative is years of ongoing policy debates about minor tweaks that are never sufficient to deliver our Net Zero ambitions and that destabilise investor confidence.
  • The conditions for and form of investment protection should be set sooner rather than later – the clarity that they offer needn’t wait until the new market design is fully worked out.
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Letter to Minister on the Review of Electricity Market Arrangements

The government must take this opportunity to address some fundamental challenges to the energy system to ensure it can meet our ambitious Net Zero goals by:

  • Driving investment in renewables and other low-carbon technology
  • Efficiently building and operating a high renewables power system
  • Making the most of renewables by empowering all consumers to participate in, and benefit from, flexibility.

Review of Energy Market Arrangements: First consultation response

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Locational Marginal Pricing

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VIDEO: What is Locational Pricing?

The energy system that we have now was built for a very different world. As we move towards Net Zero we need to have a system that’s built for wind farms and solar power. To do that, we need to be able to integrate those into the power system. As wind and solar are intermittent, we need to be able to harness new forms of flexibility so that we can balance the system.

Locational Marginal Pricing (LMP, also known as ‘nodal’ pricing) sets out to resolve these challenges. Under nodal pricing the price paid for electricity varies across the grid to reflect how much it physically costs to deliver electricity to each ‘node’ or supply point.

Nodal pricing in markets has not only existed for decades, but it’s on the rise. Since 2000, there has been a 25% surge in Organisation for Economic Co-operation and Development member states using nodal pricing to structure their energy systems. Countries and regions such as New Zealand, Singapore, parts of Canada and the United States of America, and several South American markets all make use of nodal pricing.

Markets with nodal pricing have facilitated investment in both renewable generation and storage – two essential components of a decarbonised electricity system.

INSIGHT: Uber-good: making electricity markets fit for Net Zero 

The Review of Electricity Market Arrangements (REMA for short) turned one on 18th July 2023. A year on from the launch of REMA, we’re still waiting on the direction of travel from government. But a picture is starting to form: National Grid ESO is recommending a market design founded on LMP, and FTI Consulting found that LMP could deliver large savings for energy consumers – as much as £50 billion over 15 years.

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INSIGHT: Locational Pricing Puts Consumers in the Driving Seat

Citizens Advice have made a welcome contribution to the debate on locational pricing with their latest report, It’s all about location – Will changing the way we price electricity deliver for consumers?

The report delves into how reforms to the electricity market can deliver on sustainability and affordability for end-consumers and highlights the benefits that locational marginal pricing (also known as ‘nodal pricing’) can deliver.

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REPORT: International Learnings on Investment Support for Clean Electricity

This study reviewed the evidence from markets across the United States of America and in New Zealand that use locational marginal pricing, as well as European markets that use zonal pricing. While no electricity system can be said to have fully solved the challenge of how to integrate high volumes of intermittent renewables, we make general observations that are relevant to the GB debate.

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REPORT: Location, location, location: Reforming wholesale electricity markets to meet Net Zero

This study commissioned by Octopus Energy shows that reforms to make wholesale electricity markets reflect local conditions could save around £3bn per annum on average (circa £30bn in total) by 2035, as the UK transitions to a Net Zero grid.

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REPORT: Locational energy pricing in the GB power market 

Two reports exploring the role that locational price signals can play in minimising the cost of the future energy system and the case for nodal pricing.

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Conversations with industry

What do innovators in Great Britain believe is the future of locational marginal pricing? What impact will it have on business growth and innovation? Will introducing locational marginal pricing support consumers? These questions and more are discussed and debated by innovators – from SMEs to major organisations – in our latest series, ‘Conversations with…’.

Conversation with…Electron

We spoke with Jo-Jo Hubbard (CEO) and Nick Huntbatch (Head of Product) to hear more about their views on locational pricing.

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Conversation with…Solea Energy

We spoke with David Kozak, VP of Research, to hear his views on why he thinks implementation of locational marginal pricing works in other jurisdictions and why it is crucial for future GB markets.

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Conversation with…Amp X 

We spoke with John Prime, Head of External & Regulatory Affairs at Amp X, to hear more about the importance of stronger locational pricing signals for the future of flexible consumer propositions.

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Conversation with…ZUoS

We spoke with Alex Schlicke, Chief Executive Officer, to find out more about why greater locational pricing is so important.

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Conversation with…Octopus Energy

We spoke with Madelaine Brooks, Energy Markets and Regulation Lead at Octopus Energy, to find out more about locational pricing and its importance in future innovation.

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Retail Market Reform

CLEAN ENERGY RETAIL: The Role of Energy Retailers in the Net Zero Transition

Assesses the challenges and opportunities for how future energy retail companies can support consumers to navigate the Net Zero energy transition, focusing in particular on the period from 2025 to 2035.

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Electricity Market Design

Broad Model for a Capacity Remuneration Mechanism in an Energy Service Provider-led Market

Exploring alternative mechanism for approaching security of supply and sketching a model build on more decentralised responsibilities.

 

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Towards a New Framework for Electricity

This summary report provides a framework for assessing value in electricity markets and highlighting strategic choices for market design.

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Key Consultation Responses

Review of Energy Market Arrangements: consultation response

Key Recommendations:

  • REMA must be developed in concert with retail market reform – without clarity on what the REMA reforms would mean to different consumers, there is a risk of pursuing ineffective policies.
  • Improving the accuracy of locational and temporal value is a top priority – with the greatest net benefits achieved through locational marginal pricing.
  • Moving to an outcome-based framework – measures such as a clean electricity standard for suppliers would provide stronger incentives for upstream contracting with low carbon generators and innovation in flexibility.
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BEIS Select Committee call for evidence: Decarbonisation of the Power Sector

Our major report, Rethinking Electricity Markets, sets out the case for ambitious market reforms – focusing on the importance of more dynamic and granular wholesale market signals, and a move from centralised contracting (CfDs & CM) to outcome-based policy mandates. Our proposals are based around six key reforms.

 

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Review of Net Zero: call for evidence

The Department for Business, Energy and Industrial Strategy commissioned an independent review of the government’s approach to delivering its Net Zero target, to ensure we are delivering Net Zero in a way that is pro-business and pro-growth.

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Ofgem – Open letter on next network price control review process

Energy Systems Catapult recommendations to Ofgem is to take a whole systems approach, ensure wider strategic alignment and bolster incentives for innovation.

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Future of the energy retail market: call for evidence

We welcome this initiative to refresh the energy retail market strategy, with measures that are more ambitious and integrated with wholesale market reforms, and delivered at a faster pace with work to design and implement the reforms starting without delay.

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Rethinking Electricity Markets comment

Energy tariff diversity can empower consumers, lower bills, and cut carbon emissions 

The energy retail market – which was designed in the 1980s for a world in which energy needs were simpler – pushes retailers towards uniformity. The shift to Net Zero has turned this approach on its head. Energy tariffs should reflect this diversity of needs.

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REMA is too important to be kicked into the long grass

REMA is too important to be kicked into the long grass and it is crucial the government maintains momentum for change. Without reform, we risk getting locked into a high-cost power system and facing public backlash against Net Zero.

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New whole system metrics can improve the targeting of policy support for emerging zero carbon technologies

Policy makers need to ensure that they get value-for-money from the policy support they provide to promote innovation and early deployment of emerging (low carbon) technologies.

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Can we make electricity markets work better – or is ambitious reform all just too risky to contemplate?

Our most controversial reform proposal is our Rethinking Electricity Markets project is to phase out CfDs – which many see as a huge success story for UK policy over the past decade, and vital for access to low-cost finance for the new generation we need.

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Why we can’t wait for electricity market reform…

Will our current market arrangements get us there cost-effectively, meeting the huge influx of electrified transport and heating that the targets imply (while maintaining little things, like the grid stability and security that we are so used to)? That is the urgent question facing policymakers.

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Can we mandate electricity markets to deliver a decarbonised grid by 2035?

The government’s Net Zero strategy includes a commitment to fully decarbonise our power system by 2035, along with other commitments around nuclear power, offshore wind and CCUS. But major questions remain about the detail of how to adapt policy and market mechanisms so that they drive the right mix of investment for a zero carbon grid. In other words, the policy framework for delivering a balanced and efficient Net Zero electricity resource mix by 2035 remains unresolved.

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