In October last year, the UK Energy Minister Kwasi Kwarteng committed the UK to fully decarbonise the electricity system by 2035, subject to security of supply.
The British Energy Security Strategy of April 2022 promised a review of the British electricity market arrangements to see if they were still fit for purpose. Now, just in time for the summer holidays, here it is.
It is a wide-ranging review that affects anyone participating in British electricity markets, whether that be the wholesale market, the balancing mechanism, ancillary services, the Contract for Difference (CfD) or the capacity market. It will also affect the Dispatchable Power Agreement for power CCUS, the Regulated Asset Base model for large-scale nuclear, and the interconnector cap and floor. All of these could change. This means you will need to look again at your business models.
Vision for future market arrangements
The Government wants future market arrangements to:
- Deliver a step change in the rate of deployment of low carbon technologies, and reduce our dependence on fossil fuelled generation
- Provide the right signals for flexibility across the system
- Facilitate consumers to take greater control of their electricity use by rewarding them through improved price signals, whilst ensuring fair outcomes
- Optimise assets operating at local, regional, and national levels
- Ensure that the security of the system can be maintained at all times.
Current market arrangements
Chapter 2 of the Review looks at how the electricity market currently works and concludes that the market alone in its current form can't deliver the vision. The existing market is based on bilateral trading between generators, suppliers, customers and traders. There is national pricing, technology neutrality (all technologies are treated the same) and participants choose when to generate power ('self-dispatch') rather than the Electricity System Operator doing it centrally.
The price is based on short-run marginal cost: each generator bids their price to produce the next unit of electricity and the price is set at the level which ensures all demand is met. Renewables will bid a low price as it does not cost anything to produce electricity (wind and sun are free). Gas generators on the other hand have their fuel costs. If renewables cannot supply all the power needed, gas generators end up setting the prices, as they are brought in to make up the shortfall in supply. The steep rise in gas prices over the last few months has therefore had a knock-on effect on electricity prices, even though much of GB's electricity comes from renewables.
A market based on short-run marginal pricing doesn't help renewables. They need their long-run marginal costs covered: they cost a lot to build but once running, have low operating costs. When lots of renewables are generating together, they can meet demand so this drives the wholesale market price down towards their own short-run marginal costs, which are close to zero. This is known as 'price cannibalisation'.
Comment
At the moment, every part of the electricity market is eligible for reform. The Government have done a thorough job of assessing the limitations of the current market and the possible ways to solve these.
There are some key decisions to be made: whether to introduce locational pricing (this seems likely given that Ofgem and NGESO are in favour); whether to have central dispatch instead of self-dispatch (this would mean an enhanced role for the Future Systems Operator/Independent Systems Operator and Planner function that is currently being split off from National Grid – a move towards re-nationalisation?); and whether to have separate prices for firm and variable power.
What we do know is that the changes will affect all players in the electricity market and will mean recalculating financial models. In the short term, it is likely to make investors more nervous. When the world is on a deadline to decarbonise, anything that hinders investment in low-carbon power is detrimental. Do respond to the consultation with your views and contact one of us for help and advice.
