How to stop the current energy crisis happening again03 Feb 2023
To help build the evidence base to inform electricity policy decisions we commissioned leading academics from the University of Strathclyde to delve into controversial proposed changes to how the electricity market works.
Here Martin Pibworth discusses how those changes could impact the creation of a homegrown energy system - which is cheaper, cleaner and more secure.
The current energy crisis means we should focus on building a homegrown energy system that is cheaper, cleaner and more secure and that better protects families and businesses in the future.
Maintaining our position as a leading destination for investors in clean energy, when other regions are racing to catch up, is a key challenge for UK energy policy. How we respond will not only determine whether the current energy crisis is repeated in the future, but also in realising the long-term benefits of the clean energy transition in communities across the country.
We have the long-term solution to the energy crisis
Fortunately, there is consensus on what needs to happen: reduce our reliance on expensive imported gas.
Delivering the increased renewables ambition for 2030 of the British Energy Security Strategy (BESS) and in particular going big on wind power and transmission grids will play a major part in securing this – cutting the gas used in the GB electricity system by over 75%.
For the electricity system, there is no need for a tradeoff between our climate ambitions and consumer costs or maintaining security of supply. Accelerating the energy transition is no longer just a green imperative, but it is central to securing reliable and affordable energy supply.
However, competition for clean energy investment is increasing
The UK has been a very attractive location for low carbon investors over the last decade, but other regions are ramping up their investment needs whilst the availability of capital tightens.
In the face of the US Inflation Reduction Act (IRA) and the EU’s Net Zero Industrial Plan the UK Government will have to work to maintain its relative competitiveness in this global investment race.
Delivering on the BESS 2030 renewables ambition won’t be easy. Along with addressing bottlenecks such as a transformative change to the electricity network, the electricity market will need to evolve to ensure the energy transition is done cost effectively and fairly.
The UK’s Review of Electricity Markets Arrangement or ‘REMA’ is looking to do just that whilst maintaining investor confidence. It comes at a critical time.
Reflecting on REMA
I wanted to reflect on two particular points that have stuck with me through the process of developing our thoughts on REMA –you can see a summary of our REMA response here.
Firstly, REMA presents a real opportunity for the GB policy and regulatory framework, to learn from our successes and our mis-steps. For me, this means there needs to be a greater focus on long-term value in policymaking and regulatory decisions. Pinching pennies on renewable and network investment has cost us pounds and time – we can’t afford to make the same mistakes again.
Secondly, the energy transition will need a LOT of investment. The Climate Change Committee (CCC) suggest the UK will need £400bn of investment in low carbon generation to decarbonise the economy by 2050. The cost of capital for this will therefore have a big impact on the eventual cost to consumers.
From someone who works for a company planning to invest £24bn in low carbon infrastructure in Britain over the coming decade, the impact on the cost of capital is the greatest risk coming from REMA. Financial markets can move quickly on the back of what politicians say and do, and policymakers need to keep this in mind during their deliberations on REMA.
Jeopardising the decade of delivery
One of the most controversial changes being considered under REMA is moving away from a single GB electricity wholesale price into hundreds of ‘nodes’ across the country under ‘Locational Marginal Pricing’ or LMP. If it sounds complex, that’s because it is.
It would also be extreme. Changing an aircraft’s engines mid-flight is a fitting analogy which comes to mind. The 2020s need to be a decade of delivery not a time of radical textbook experiments to pursue uncertain outcomes.
To help build the evidence base to inform REMA policy decisions we commissioned leading academics from the University of Strathclyde to delve into LMP. Yesterday they published their comprehensive report:
This report gets under the bonnet of LMP. The authors conclude that the risks that come with a move to LMP outweigh the theoretical benefits it might deliver.
We agree and see particular a risk to the cost of capital. Splitting the GB electricity market makes it much more difficult to predict income over the life of assets that will operate for over 30 years. More uncertainty adds more risk, and that will feed through into capital costs.
Locational Marginal Pricing would add ‘at least £90bn’ cost to consumers
In analysis we commissioned to feed into the government’s REMA consultation, Frontier Economics put the potential impact of moving to locational pricing in GB at an additional 2-3 percentage points on the cost of capital for low carbon generation [the most recent cost of capital for wind and solar developments in GB was estimated by government at between 5 and 6%]. This would add at least £90bn to consumer costs by 2050. We can’t see how the benefits of such a change can outweigh the costs, nor the disruption.
This is not to say the GB electricity market arrangements do not need to change, they will need to evolve to address emerging challenges. However, less disruptive reforms can better address emerging issues, be it locational challenges or de-linking electricity prices from volatile gas markets.
Ultimately, these are key moments for building a new homegrown net zero electricity system and we need to build unprecedented volumes of infrastructure as cheaply as possible. Evolution of market design is the way to take investors with us, experiments will scare them away.