Electricity market needs reform to stop ‘drift to central planning’

The government has been urged to “stop the drift to central planning” by phasing out the Contracts for Difference and Capacity Market schemes by the mid-2020s.

Both mechanisms were introduced as part of the government’s Electricity Market Reform (EMR) package in the Energy Act 2013. In a new report, the Energy Systems Catapult called for them to be replaced with a mandate on market participants to bring about decarbonisation as part of a fresh wave of reforms dubbed “EMR 2.0”.

The Energy Systems Catapult (ESC) said the current arrangements have “enabled the UK to achieve the fastest rate of decarbonisation in the world,” with renewables share of the electricity mix rising from 14 per cent in 2013 to 47 per cent in 2020: “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.”

The ESC said Contracts for Difference and the Capacity Markets are now “progressively undermining wholesale markets” and creating a situation whereby “policymakers effectively choose which technologies to support”. It said they risk inhibiting innovation, misallocating investment, causing system inefficiencies and unfairly weighting investment into generation over demand-side response.

The agency called for a “big bang moment” for 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.”

“The current government-directed approach to energy is like Boris Johnson telling Steve Jobs how to design the iPhone,” said ESC strategy and performance director Guy Newey.

“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.”

The ESC recommended six changes as part of “EMR 2.0”:

• Introduce dynamic and granular wholesale market signals to more accurately reflect system status and physics in real time.
• Phase out centralised contracting (Contracts for Difference and the Capacity Market) and replace them with a mandate on market participants to deliver decarbonisation through decentralised contracting and retail innovation.
• Promote private-sector led finance, risk management and forward contracting across a balanced resource mix, while reducing reliance on state-led contracting.
• Redesign support measures for immature technologies so they are ring-fenced and avoid distorting markets.
• Overhaul the governance of industry codes, system operation and energy data.
• Directly link sector strategy, regulation and policy mandates with carbon budget advice and the review cycle, whist strengthening independent market monitoring.

Electron founder and chief executive Jo-Jo Hubbard 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.”

Caroline Bragg, head of policy at the Association for Decentralised Energy, said: “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.”

Greg Jackson, founder and chief executive of Octopus Energy, commented: “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.”