Evolution not revolution will deliver an energy market fit for a low-carbon future

02/02/2023

Kate Turner, Policy and Regulation Director, ScottishPower Renewables 

Energy has been a consistent theme in headlines in recent months and will be an area of continued focus as the UK government’s Review of Electricity Market Arrangements continues. It aims to ensure that the design of the electricity market is fit for the purpose of maintaining energy security and affordability for customers alongside the transition to Net-Zero. 

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A low carbon-based energy market of the future will address some of the key issues we’re seeing today – improving energy prices, energy security, flexibility – and puts a low-carbon green electricity market as the backbone of the energy system.

While it sounds simple, this will be a mammoth undertaking and there are lots of differing views as to how we get there. One of the more controversial proposals is to move to Locational Marginal Pricing (LMP) – where wholesale electricity prices would vary between different network nodes or zones. 

While in some quarters, LMP is being presented as a silver bullet, a recent report from the University of Strathclyde (UoS) provides useful insights into the risks and challenges it would bring as part of wider GB market reform. Crucially, it highlights the need for careful consideration before any changes are made. 

LMP would mean moving away from the current uniform wholesale electricity price within GB. In addition to changing pricing, a transition of this magnitude would have knock on effects on many industry arrangements that incentivise investment in low carbon generation and security of supply via CfD and the Capacity Market. 

As the report highlights, with no ‘off-the-shelf' solution for a new LMP market structure, the system would essentially need to be ‘reinvented’, which would require some of the most radical reforms for more than 20 years. So, we need much more quantitative analysis of how this will impact generator investment costs and confidence, as well as investment in transmission infrastructure, before making any decision regarding the suitability of LMP.

As we know, the UK Government’s ambition is to decarbonise the electricity system by 2035. The level of change that would be required to support a move to LMP – scoping, developing and testing as well as time and resources to investigate its impact and implementation before any decision is made – could put this ambition at risk.

Current estimates suggest a timeline of between four and eight years to implement LMP, which could result in an investment hiatus.  So, where does that leave us in terms of our thinking about LMP? 

For all future reform options, it’s important to recognise the potential associated benefits as well as the risks and consider if there are less disruptive and cheaper alternate options available. 

LMP could theoretically deliver improved signals to generators about where to locate, which is contrary to the approach of the location of renewable generators being more dependent on the availability of natural resources. 

However, reform to the current Transmission Network of Use system charging methodology, improving current dispatch models to be more granular and developing flexibility markets could offer similar benefits, while improving cost reflectivity and predictability of charges at the same time without the same level of risk. 

So, there’s lots to think about and we need to ensure alternative reform options are also considered alongside wider debates – not least around planning reform and energy security. The UoS report as well as a recent Frontier Economics study are useful in adding depth to the ongoing discussion and it is essential this continues. 

Mindful of the significant impact on the overall GB electricity market, low-carbon investment and consumers of any potential reforms, it is clear we require additional quantitative analysis to further inform the debate. 

When considering future reform options, GB industry should not be seduced by radical and untested ideas, but should focus more on incremental improvements. That means evolution not revolution.   

 

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