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Electricity market reform: it’s not what you do, it’s the way that you do it

As the government consults on a major overhaul of electricity market arrangements to reflect the large and growing influence of renewables, whilst also addressing the current gas crisis, E3G senior associate Simon Skillings says the UK must extricate itself from the pattern of “decadal leaps” that has emerged since privatisation and adopt a process of continual change that keeps up with rapid pace of technological developments in the sector.  

The UK government has decided that the electricity market arrangements are not fit for purpose and need to be reformed. Increased renewable generation has changed the nature of system operation – and now, the surge in gas prices has left politicians keen to explore ways to reduce costs to consumers.

The government has published a consultation setting out options for change as part of its Review of Electricity Market Arrangements (REMA). Over 250 people attended the consultation’s online launch, showing that energy industry professionals consider this issue highly significant.

The electricity market in the UK came into being in 1990. Since then, we have fallen into the pattern of taking decadal leaps in market design that then prove inadequate within a few years. The first major change (NETA – New Electricity Trading Arrangements) was introduced in 2001, following years of concern about lack of competition. Indeed, the core elements of today’s market, which seek to balance supply and demand, were introduced at this time.

The decarbonisation imperative brought about a new round of changes in 2014, once it became apparent that direct government intervention would be needed to decarbonise the electricity system. This initiative (EMR – Electricity Market Reform) introduced various mechanisms to drive investment, including in low-carbon technologies such as renewables.

Within a decade we are again contemplating major changes. As experts from academia and industry line up to advocate their preferred course of action, little attention has been paid to learning the lessons from previous reform processes.

One lesson stands out. The future is uncertain, and the challenges that market design is trying to address will continually evolve. The impact of climate change on energy policy development was barely considered at the time of NETA, and EMR was not designed to handle the rapid decarbonisation needed to meet current net zero targets.

Put simply, previous reform processes have been grounded in the problems of the day, rather than those that emerged subsequently. Big changes in market design take several years to design and implement, increasing the risk that solutions will be time-expired within a few years of implementation.

The UK government is rightly considering changes based on the need to efficiently operate an electricity system with large amounts of renewable energy. However, it fails to recognise the explosion in technological innovation that has the potential to revolutionise the way the system is run. New digital technologies will effectively remove current constraints on data processing and predictive capability. The UK will be missing a trick if it is not at the vanguard of employing these technologies to reduce costs and improve services.

The second problem with big reform ‘leaps’ is that other changes are put on ice during the policy process. Reducing the impact of high gas costs on electricity prices is an urgent issue – consumers cannot wait for three or even four years to feel the benefit. Government should be able to act now, with short-term remedies that are consistent with a longer-term trajectory of market design.

What is needed is not only a new market design but a new approach to market design. We need a process that continually drives change in electricity markets, towards a system in 10 or 20 years that is unrecognisable from what we have today. This change must be conducted within a framework that adequately and transparently manages policy risk for investors, and ensures investment in the broad range of zero-emissions technologies proceeds at pace.

Any market design will create prices for suppliers and charges for consumers. Investment support mechanisms can be designed to protect revenues and costs, regardless of the underlying mechanism. The need to turbo-charge investment is no excuse to retain the status quo.

Above all, reform must be driven to meet the evolving needs of consumers. Retail innovators should be constantly striving for new ways to provide comfort and convenience as cheaply as possible, and markets must adapt accordingly. Telling consumers that they must change to help the electricity system decarbonise is doomed to fail. The transition to a net zero electricity system must make lives better – this should be the focus of the electricity market reform process.