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