How does REMA impact energy generation, flexibility and consumers?

The Review of Electricity Market Arrangements (REMA) is the largest review programme of GB electricity market arrangements for a generation. It comes at a time when European energy markets are suffering extreme turmoil. Depending on the outcome there could be significant implications for generators, flexibility providers, and, indirectly, consumers.

REMA recap

As discussed in our previous blog REMA is at a very early stage The wide range of potential options under consideration vary from evolutionary improvements to revolutionary reform and so could the scale and direction of impacts on different market parties could be substantial but also show a wide level of variation.

BEIS has put forwards a very wide range of potential long term reform options. Energy market turmoil has seen some options in the consultation used as a springboard for discussion about more rapid market intervention. For example, the variety of Contract for Difference (CfD) reforms proposed in the consultation are likely to have influenced recent discussions in which CfDs are presented as an alternative to a potential windfall tax on generators.

Three of the main options are:

  • Splitting the wholesale market to twin wholesale prices, separating intermittent renewables from other generation types
  • Introducing locational marginal pricing (LMP) – potentially through zonal or nodal pricing
  • Evolutionary reform of existing markets – incremental change to existing markets and processes, including the CfD, Capacity Market, and system operation

Below, we consider the potential impacts on three key groups – renewables generators, flexibility providers, and consumers.

Renewables generators

LMP could have a significant impact on renewables generators – both for specific assets, but also between different technologies. Under LMP, prices will vary by geographic location, reflecting the underlying balance of demand and generation. This means that for generation assets in higher demand areas they may see increased wholesale prices (and therefore a positive benefit) and for those in areas with excess generation compared to local demand could see lower prices (and therefore a negative outcome).

For existing assets, this means that there could well be winners and losers compared to the current national wholesale price. Whilst it is too early to say what the exact impacts will be, one might expect that assets located in regions where demand is high (relative to power production) could see a neutral or positive impact and those located in low demand areas could see negative impacts.

More broadly, given these locational impacts this could also have serious repercussions by technology – with onshore wind seeing more potential for change than solar. For parties who have built and invested in portfolios based on a specific technology and current pricing mechanisms this could provide either a windfall or lead to serious losses – and this risk of stranded assets is one that any introduction of LMP would need to consider. For new generation asset development, this could also have significant consequences if investors perceive a new regime to favour particular technologies or locations.

Under a split wholesale market the impacts would fall differently, although they may still diverge by existing and new assets. The vast majority of new renewable assets in GB are deployed under the CfD which effectively sets prices on the same mechanism proposed for renewable element of the split market (based on their Long Run Marginal Cost (LRMC)). Therefore for new assets we expect to see limited impacts, beyond potential implications for the small percentage of overall revenues generated in the merchant nose and tail. For existing assets this may slightly lower returns by removing instances of high electricity prices from high gas prices (and renewables assets ability to capture these), but equally may increase revenue stability and bankability if prices stabilise.

Flexibility providers

Flexibility providers help balance the demand in the electricity system. They are unlikely to see significant impacts from a split wholesale market. Under the proposed approach flexible providers (such as batteries and gas peakers) would compete in a near term wholesale market priced according to short run marginal cost. This reflects how flexibility providers currently price and trade, with few trading beyond days ahead and prices set by the cost of the most expensive plant (and currently driven by gas fired generation).

Where larger impacts may arise is from LMP. As with generators, flexibility providers will see a mixed picture as a result of locational pricing depending on their location and therefore expected nodal or zonal price. This will once again create winners and losers. However, the impact may be smaller for battery assets than other flexible generators, as while a low price lowers export returns it also lowers import costs (and vice versa for higher prices), potentially supporting overall project returns. Compared to this, other flexible assets may risk seeing lower prices if they are in a generation heavy area, and therefore not being able to recoup their higher short run marginal costs.

Consumers

The retail market, and by extension, consumers are not included within the direct scope of REMA for reform. Instead any consumer impacts from REMA will be as a result of the trickle down of changes to the wholesale market – either through changing wholesale prices, behavioural signals, or attitudes to the technology mix seen.

Political rhetoric suggests the impact on consumers from a split wholesale market could be positive – especially if high gas and electricity prices continue. Currently the LRMC of renewable generation – which would set the price for longer term wholesale markets under this arrangement – is significantly below gas fired generation.

LMP’s impact is less clear, and like for the other groups will depend highly on consumers locations and the model introduced. Unlike the other groups though it is unlikely that we would see much in the way of demand response to LMP – i.e. consumers shifting location due to price locational signals – given the greater importance of aspects such as access to customers and staff. This therefore risks a situation where consumers are exposed to costs they have no way of responding too.

No matter what option is taken forwards it seems highly unlikely that REMA will provide near term relief to consumers from the current high energy prices. BEIS is not expected to respond to its consultation until 2023, therefore ruling out any REMA relief for this winter, and given the magnitude of the changes, their implementation before the end of the decade seems unlikely.

Common impacts

Regardless of the reform option chosen there are a number of impacts that we expect to occur across the industry as a result of workstreams being announced:

  • Pausing or reducing investment due to uncertainty – the potential scale of REMA’s reform and the uncertainty over expected outcomes will significantly increase investor uncertainty over future returns and therefore could lead to a scaling back of investment in new technologies and assets – including those needed to meet net zero
  • Loss of focus on other regulatory and policy workstreams – the focus on REMA, both from bodies with an official role such as BEIS, Ofgem, and the LCCC, and from commercial industry parties will likely result in a decrease in engagement and focus with other smaller workstreams as limited resource is prioritised onto the more impactful REMA work
  • Interest and engagement in the future of the market – as a major reform programme with the potential to substantially reshape the GB electricity industry, REMA is already (and likely to continue to) increase interest in and engagement with the market, including from academics, think tanks, investors, and consultants

Conclusion

Regardless of which reform option progressed the impacts of REMA will be far reaching and market defining. While the relative lack of detail and variety of models proposed to date limits the ability to quantitively forecast impacts it is critical for parties to understand the implications for their position and portfolio in the market and respond to the BEIS consultation on this basis.

In the near term, the models explored in the REMA consultation will continue to stimulate discussion about more immediate market intervention, particularly about splitting the renewable and gas/fossil fuel wholesale markets.

For a discussion on how Cornwall Insight can support you in understanding the impacts on your position and those of market parties contact Adam Boorman (a.booramn@cornwall-insight.com) or Kate Mulvany (k.mulvany@cornwall-insight.com).

Related thinking

Low carbon generation

Transforming the Energy Market: how change will work for consumers

The past two years have seen rocketing energy prices, as households and businesses grapple with bills far beyond pre-crisis levels. There is no way to turn back the clock, however, we can look to seize the many opportunities to reshape and future-proof the UK energy system, ensuring a brighter future...

Energy storage and flexibility

Off-peak electricity use and home generation could cut billions off energy costs

New analysis from Cornwall Insight and Smart Energy GB has revealed the substantial cost-saving potential of household flexible electricity initiatives such as time-of-use tariffs, smart meters, solar PV, and batteries. The has data revealed national wholesale and system electricity costs could be cut by an annual £4.6bn in 2030 and...

Regulation and policy

Capacity Market: Rule changes for upcoming auctions

The latest round of Capacity Market auctions is underway following the publication of the auction parameters on 18 July, with the prequalification window subsequently opening on 26 July. In this blog, we explore some of the changes made to the rules and regulations of the scheme ahead of this year’s...

Energy Market Design

Are prices going to rise in Contracts for Difference Allocation Round 5?

A number of factors may be about to put an end to the trend for falling energy prices in the Contracts For Difference (CfD) scheme. The CfD scheme has provided strong subsidy support whilst also providing consumers robust levels of protection. High investor confidence and steady reductions in capital costs...

Business supply and services

What happened in 2022 in the energy market?

The GB energy market never stands still and 2022 was no different. In this infographic, we look back at some key happenings from the past year in different segments of the GB energy market.  Click the image below to see our snapshot.

E-mobility and low carbon

2022’s most exciting ‘Charts of the Week’

Some of our team have looked back throughout 2022 and picked their most exciting ‘Chart of the Week’.​Their choices include exploring green tariffs, wholesale gas prices, CfD allocation round 4 and the MHHS Implementation Levy.  It’s My Birthday – Two years of Dynamic Containment Picked by Tom Faulkner, Head of...

Energy storage and flexibility

“Co-location, co-location, co-location”: Benefits and challenges

Key take-aways of the launch event   By Jamie Maule, Dr Matthew Chadwick & Nick Fothergill (Partner – Weightmans LLP) As part of the UK’s transition to net zero, the electricity generation mix needs to evolve, with increasing amounts of renewable capacity required to meet net zero commitments. To maximise...

Low carbon generation

Video podcast: What is REMA and why is it needed?

Join our energy experts, Senior Consultant, Kate Mulvany and Research Partner, Dr. Dan Atzori as they discuss the Review of Electricity Market Arrangements (REMA), why it is needed, how the energy market is reacting and responding to it and how Cornwall Insight can help businesses navigate REMA. Watch the full...