Wholesale market reform vital to meet 2035 green grid goal

The government will be unable to achieve its goal of decarbonising the electricity sector by 2035 unless it pushes ahead with reform of the wholesale market, an influential think tank has argued.

In a new report, the centre-right think tank Onward warned that if the government fails to follow through on the Review of Electricity Market Arrangements recently unveiled in the British Energy Security Strategy, the UK will miss its targets for the deployment of offshore wind farms and nuclear power stations, leaving customers exposed to international gas prices for longer.

“The government can’t avoid the need to reform Great Britain’s electricity market any longer,” the paper stated. “The challenge for the government is to simultaneously reform the market whilst rapidly deploying new low-carbon energy projects.”

The report explored proposals to split the wholesale market into two – one for low-carbon generation and another for flexible ‘on demand’ power – as recommended by its former energy adviser Professor Dieter Helm.

A potential downside with splitting the market into two, the report explained, is that it could make Britain’s electricity market “less compatible” with those of neighbouring countries, harming cross-border trading.

This could become a “growing issue” as the UK becomes more reliant on cross-border trading via interconnectors to balance regional variations in renewable output.

Onward’s report suggested the government could alternatively implement a “green power pool” for renewables, as proposed by Professor Michael Grubb from University College London.

Under this proposal, larger customers would sign long-term, fixed-price contracts with renewables in the pool, only tapping the rest of the market when the supply of renewables is too low to meet their demand.

The report said the growth of Contracts for Difference (CfDs) may mean a “radical” move to a “two markets” model is not required to break the link between electricity bills and gas prices.
It said that by 2030, half of electricity could be supplied via CfDs, which would “significantly” weaken the link between with gas prices.

Onward added that, given the high levels of public subsidy offered by taxpayers to de-risk renewables investment over the last decade, there is “no justification whatsoever” for “price-gouging” by renewables generators, some of which recently delayed the start of their CfDs in order to take advantage of current more lucrative wholesale electricity prices.

The report said the existence of separate auction pots for different technologies in the CfD scheme means there is only “limited” competition between different types of generation.

It therefore suggested that a single consolidated, technology-agnostic, support mechanism should be created for all low-carbon technologies, except nuclear power.

Onward also said that demand-side response from households should be considered as a “central issue” when considering reform of the wholesale market.

Furthermore, the report warned that a move to more localised pricing of wholesale electricity, which is currently being considered by Ofgem, potentially exposes generators to “more volatile” local prices. This increased uncertainty for investors in wind and solar farms may have knock consequences for financing costs.

And it said it is “unlikely to be desirable or politically viable” to charge domestic customers different electricity prices depending on where they live, pointing to how localised pricing is limited to generators in many other countries.