REMA: Reform is coming but the scale is up for grabs

The willingness of government to embark on reform of Great Britain’s electricity market arrangements has been applauded by the sector. However, as experts tell David Blackman, concerns remain about the pace of change and the ultimate appetite for a fundamental overhaul of the system.

It is probably safe to assume that the intricacies of the wholesale electricity market have never greatly troubled prime ministers in the past.

However, Boris Johnson described the current arrangements for the wholesale electricity market as “frankly ludicrous” in an interview ahead of the ministerial rebellion that terminated his time at No 10 Downing Street.

His ire was sparked by a concern that these arrangements mean currently sky-high marginal gas prices effectively set those of the wider wholesale electricity prices, inflating the costs of much cheaper renewables source of power, such as wind and solar.

While the PM is heading for the exit, a new and very wide-ranging consultation paper from the Department for Business, Energy & Industrial Strategy (BEIS) outlines steps for fixing this increasingly anomalous situation.

For starters, the Review of Electricity Market Arrangements (REMA) paper bluntly states that it is “unlikely that the significant investment needed to decarbonise the power sector will be delivered cost-effectively” by current market arrangements.

It says the most cost-effective route to meeting the government’s goal to decarbonise the power sector by 2035 will require changes because current arrangements are based on the needs of fossil fuel generation rather than renewables.

Alongside reforms to existing mechanisms, such as the Capacity Market and Contracts for Difference (CfDs), a whole chapter of the document is devoted to how to deliver a net-zero wholesale market.

The existing wholesale market, which has been in place since 2005, is based on the idea that all generators will receive the same price across Great Britain, irrespective of where they are located and the technology they use.

The reforms mooted in the document herald “fundamental redesigns” of the wholesale electricity market, with significant implications across the system that will take “a number of years” to implement, the document says.

All existing support schemes would need to be updated, including the CfDs and the Capacity Market as well as the recently introduced Regulated Asset Base model for large-scale nuclear power and the market arrangements used by interconnectors.

Market splitting or green pools

The document outlines a series of options for reforming the wholesale market.

The first of these is splitting the market into separate ones for variable renewables and firm power, such as gas, which is available all of the time.

Splitting the market in this way offers a potential alternative to continued government support for investment in generation over the long term by enabling investors to recoup their costs solely through market revenues, according to the document.

However, the mooted split could reduce liquidity within the two mini-wholesale markets, potentially depressing the scope for competition compared to now.

It is also unclear where particular technologies would fit, says the document, pointing out that interconnectors or biomass could conceivably be placed in either the variable or firm power buckets.

In addition, the transition to a split market risks creates the risk of a hiatus in investment, BEIS admits.

The alternative green power pool, which has been proposed by Professor Michael Grubb of University College London, offers a more incremental approach that could avoid some of these drawbacks and be implemented sooner.

The electricity system operator would manage the renewable power pool, which would operate alongside the existing wholesale market, in effect creating a “centrally co-ordinated” power purchase agreement market, according to the paper.

Renewable generators would contract with the system operator to sell their power into the pool at their long-run marginal cost, like having a CfD. Consumers, which Grubb envisages would be mainly industrial and commercial users, could then purchase electricity from the pool that would be cheaper than the main wholesale market but more variable.

Big signal to the market

Adam Bell, the BEIS department’s former head of energy strategy, is impressed by the sheer amount of work that his ex-colleagues have put into the REMA document.

“It covers off the entire entirety of the debate: a lot of work has clearly gone go into it,” he says.

It heralds major reform, he adds: “This points to a significant amount of reform because the current market will not deliver the mix and volume of assets that you need.

“BEIS is very clear that the existing suite of instruments will not deliver the 2035 target at least cost and that is a big signal to the market that change is on its way.”

Josh Buckland, a former government special advisor on energy, agrees that the analysis of the current market is correct.

“The statement is that the current structure results in costs being too high and not delivering the scale of low-carbon infrastructure that’s required quickly enough is absolutely sound.”

Change will mean higher costs of financing, warns Bell. “This document has created an enormous amount of political risk for anyone looking to invest in the UK. Prices will go up as a consequence of the risk attached to the market now.”

Reform cannot be ducked though, he says: “Unfortunately, they (BEIS) had very little choice. The alternatives would have been even more costly. They have made the right call, but everything’s a trade-off.”

Another risk is that by the time consultation has finished on this week’s publication, there will be a new prime minister and probably a new set of energy ministers too.

The flurry of announcements from BEIS as well as its secretary of state Kwasi Kwarteng’s failure to attend a grilling by the environment audit committee this week suggest that he knows his time in the role is running out.

“He will have wanted to ensure that he got something substantial out the door as part of his legacy. It’s a substantial document and a good legacy,” says Bell, who is now director of policy at consultancy Stonehaven.

Daniel Newport, BEIS’ former head of heat and buildings strategy, believes that the Treasury will want to see high energy prices resolved via market reform rather than continued handouts.

And the technical nature of the proposed electricity market design changes means they are “probably safe” from the wider political turbulence but are unlikely to “completely fly under the radar”, says Newport, who is now at the Tony Blair Institute for Global Change.

The main question now concerns the pace and scale of wholesale market change that BEIS is prepared to contemplate.

Buckland says: “They are definitely in the market for doing something quite significant but they know that there are risks doing that and they obviously want to take a cautious and sensible approach.

“They are clearly taking into account the impact of the current short-term crisis, but explicitly stating that that is not going to drive the reform programme, which is going to deliver the 2035 decarbonisation.”

Bell is more concerned about whether BEIS is prepared to act fast enough.

“Reform is now coming but the scale is still up for grabs. It’s entirely possible that at some point, BEIS will get frightened and opt for some tweaks to the CFD and possibly network charging. That would be a missed opportunity.

“What they do now is going to be really important for continued delivery of the pipeline of offshore and onshore wind and all those assets we are going to need for 2035.

“There’s a lot of value to be gained from the debate we’re about to have. The drawback is the timescales do not reflect the challenge facing us, especially when it comes to marginal pricing. The big challenge of UK marginal pricing is going to be this winter.”

He worries that BEIS isn’t really grasping the scale of the looming challenges surrounding energy costs, pointing to projections in the REMA document that show power prices returning to normal levels by 2025.

“Why BEIS assumes this is unclear,” he says, pointing to the less upbeat price trajectory recently outlined by the Office of Budget Responsibility.

Where is the urgency?

Grubb agrees that BEIS will have to come up what answers more rapidly than on the timescales outlined in the consultation paper, which suggests that the reforms will be developed by the end of next year.

The mismatch between headline energy bills and the costs of much generation will become increasingly glaring this winter, he says: “A big vulnerability is the politics. People are going to be paying over £3,000 when the actual average cost of generation is a hell of a lot less. The REMA document doesn’t take that seriously enough as a fundamental issue.”

He says the document suggests that BEIS is worried about the complexities involved in disentangling current arrangements.

However taking years to sort out the market in a context where people are having to choose between food and fuel won’t wash with public opinion, he says “It’s just not a good answer politically. If the government does not take strong action in this area, I would have thought any decent opposition party would tear them to pieces because of the bills crisis.

“It (REMA) makes the right noises about the depth of reforms and all the issues but it doesn’t give an impression of real urgency. Politicians are going to demand something be done. If BEIS have not managed to work out what can be done by next summer in time for the following winter, it could get quite messy.”