Rushing into reform of the electricity market risks significantly inflating costs

The Review of Electricity Market Arrangements [REMA] announced by the government in its recently published Energy Security Strategy must be undertaken with a strong focus on protecting investor momentum if the government are to meet their net zero, energy security and consumer affordability objectives.

REMAs remit is wide and includes not just looking at wholesale market design but also balancing services, the capacity market, and the Contracts for Difference (CfD). There will be lots of ideas under review and it will be some months yet before we know the likely direction of travel and likely many years before implementation. Current ideas being proposed by key stakeholders in the sector include introducing locational pricing, splitting the low carbon and dispatchable generation markets, and broadening the role of the CfD.

There is real logic to deeply exploring policy and market design as a response to the changing physical characteristics of the electricity sector. But it is essential any reforms to the market must be based on more than economic and market theory. In addition, the specific backdrop of sunk investment in the UK today, the urgency of new investment demanded by the Energy Security Strategy, and how investors price the risk of radical market change are all critical factors.

Billions of pounds have been invested in the energy transition, and billions more are rapidly required to unlock net zero and energy security. As a result, the cost of capital is one of the biggest variables in the overall costs of transformation. Changes, which in theory are desirable but which in practice create unmanageable investor risks will be self-defeating, just at the time the government wants an acceleration in deployment in sectors such as offshore wind, new nuclear, and hydrogen.  

Gareth Miller, CEO at Cornwall Insight said:

“The GB energy market is in a state of transition as we aim to accelerate away from a reliance on fossil fuels towards renewable energy, with net zero as the ultimate goal. While thinking about reforms to the electricity market to accommodate physical changes to the system is required, it is important all options should be assessed before rushing to conclusions. This includes network investment, strategic capacity development, and adaptations to existing policy schemes, alongside wholesale market reform. Evaluation will need to be done consistently with the objectives of supporting investment in net zero and delivering energy security at the lowest cost both being put front and centre. At all times, policymakers will need to carefully balance reforms to ensure optimal system efficiency in theory, with manageable costs and risks of investment in practice

“People may ask why this is so important, but we must recognise current investors in the electricity market have calculated their returns based on the existing market rules. While they will have accounted for risks from volatile prices coming from variations in demand and supply, they will struggle to quantify or hedge radical changes to market arrangements. In the best-case scenario any reforms, no matter how benign, will require complex changes, including redrafting of legal agreements. Time consuming but doable. In the worst-case scenario, we are looking at a significant impact on investment returns, with investors across the board exposed to greater risks to the extent they rely on power prices or other related markets to support returns.

“If REMA reforms include these risks, then they will need to be thoughtfully addressed. Exempting certain groups from changes is a well-trodden path but will not necessarily work for whole-of-market reforms. Expansion and reform of schemes such as the CfD is another option, but without refinement, may in part defeat the objectives of certain reforms to expose actors to sharper market signals. In any event, if such risks are left unaddressed, then the cost of capital for investors would increase. This would push up the costs of deployment, reduce investor appetite, slow down investment to achieve energy security and net zero, and ultimately increase consumer bills.

“This is not to say that reform always damages investment. Indeed, the GB market has been in an almost continuous cycle of major reform throughout this century whilst still delivering investment and reduced emissions. However, policy implementation needs to move really quickly if the Energy Security Strategy ambition is to be met, and across a very broad agenda.  The tightrope here for policymakers is very precarious, and without much of a safety net. It is really important that in our haste, we don’t leave investors behind. Without them progress is impossible.”


Notes to Editors

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About the Cornwall Insight Group

Cornwall Insight is the pre-eminent provider of research, analysis, consulting and training to businesses and stakeholders engaged in the Australian, Great British, and Irish energy markets. To support our customers, we leverage a powerful combination of analytical capability, a detailed appreciation of regulation codes and policy frameworks, and a practical understanding of how markets function.