Energy market heading towards ‘ever more centralisation’

Unless the energy market framework is reformed, the UK’s carbon reduction goals will require a “massively expanded” role for government with knock on inefficiencies, a new report co-authored by a former top energy official has warned.

The report, published by the Tony Blair Institute for Global Change, said that while the government has so far carried out “small tweaks to existing systems”, the current market framework is “fundamentally incapable” of delivering the changes needed for the transition to net zero emissions.

The study, which was co-written by institute senior fellow and former director of clean growth at the Department for Business, Energy and Industrial Strategy, Tim Lord, said the proportion of electricity generated by plants supported through the Contracts for Difference (CfD) scheme is on track to rise from 7% currently to as much as 90% by 2035.

While this mechanism has successfully delivered an increase in renewable power, greater reliance on CfDs will mean electricity generation becoming “less and less responsive” to demand because they contain in-built incentives to generate as much electricity as possible at all times.

The institute’s report said some central planning is needed to deliver the scale of decarbonisation necessary over the next 30 years, giving as an example how the transition of domestic heating to low-carbon technologies will require national and local co-ordination.

However, this centralisation means the UK will have large amounts of excess power at some times and too little at others as the electricity market becomes “increasingly dominated” by assets that do not respond to supply and demand signals.

This will in turn have knock on impacts on the wholesale market with low, or even negative, prices much of the time and very steep peaks in times of scarcity.

The “deeply unstable” wholesale market will make the Capacity Market price “very unpredictable and probably very high” as providers of reliable capacity operate for fewer and fewer hours during the year.

“Without action, they are on a path to ever more centralisation and higher costs as the market frameworks we have are fundamentally incapable of adapting to the new system we need,” the report said.

“There is no scenario where we get to 2050 – or even 2035 – with the structures we have now, without requiring a massively expanded role for government and the inefficiencies that come with it.

“We are on a path to massively increased centralisation of decision-making in the energy market – taking it away from market participants and putting it in the hand of the government, system operator and regulator.”

The report said the burden of matching supply and demand, which has been historically borne solely by suppliers, must now be shared with consumers

However, the current state of the supply market, which it said has also become more centrally controlled following the introduction of the energy price cap, means that retailers are not incentivised to develop business models that enable long-term, technologically enabled relationships with customers.

The focus on prices means that retailers have been incentivised to avoid entering into long-term and well-hedged, but more costly, contracts for supply, and instead seek to “lower their costs by gambling on prices in short-term spot markets.”

While tight margins are a “good thing for customers in the short term,” the report said they make it more difficult for suppliers to develop new and different services, like those that have developed in the broadband and mobile phone markets.