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Delivering a cheaper, cleaner and more secure energy system

18 Mar 2024
A photo taken from a distance showing three electricity transmission pylons/towers and two onshore wind turbines with a row of trees at the bottom of the image

If you are an energy geek, as I am, the UK Government’s Review of Electricity Market Arrangements (REMA) is a big deal and this week the long-awaited second consultation was published.

It has the potential to accelerate the UK’s transition to clean energy. In doing so, it can boost energy security, create and support thousands of good jobs, and confirm the UK’s status as a global leader in one of the fastest growing and most important industries in the world.

So, it is important we get this right.

Let’s start with the good stuff.

What the latest REMA consultation gets right

Firstly, I wanted to mention a few of the good things in the latest consultation:

  • The ruling out of a nodal pricing model – due to impacts of this confusing and volatile pricing system on investor confidence and deliverability of our 2035 targets – whilst further consideration of zonal pricing across is to be weighed up against a set of alternative evolutionary options under the current national pricing arrangement.
  • A recognition that introducing locational pricing has an impact on the risk of investments and associated cost of capital as well as market liquidity – which concurs with our critique of the zonal pricing concept.
  • Affirming the importance of the successful Capacity Market scheme as the primary mechanism for ensuring capacity adequacy – and ruling out the ‘Centralised Reliability Option’ and ‘Strategic Reserve’.
  • Affirming the importance of the world-leading Contracts for Difference scheme as the primary and most effective mechanism for driving investment in renewable generation to deliver net zero.

But there is unfortunately a big cloud hanging over this process.

Why locational pricing in GB electricity is a bad idea

The most controversial reform considered in REMA remains Locational Marginal Pricing (LMP). Whilst splitting the electricity market into hundreds of different nodes each with a different electricity wholesale price has been thankfully ruled out – and has been welcomed by most in the industry – splitting GB into several price ‘zones’ remains on the table. It shouldn’t for much longer.

Zonal reviews are not new, they have happened periodically when GB was part of the EU’s Internal Energy Market (IEM) with the latest review, as recently as 2019, concluding that “overall, consumers are well served by the single GB bidding zone”.

To date, the debate on locational pricing methodologies has been characterised by ‘overstated’ benefits and ‘underappreciated’ risks, with the most underappreciated risk being the impact on the cost of capital of low carbon investments. Put simply, the uncertainty of locational pricing leads to riskier and more costly investments putting critical delivery of energy infrastructure at risk. The UK Government’s analysis by LCP Delta and Grant Thornton shows that the purported benefits of zonal pricing could be wiped out by a 0.3 to 0.9 percentage point increase in the cost of capital, while a 1 to 2 percentage point increase results in a net system cost – up to £12bn or £30bn respectively. These are significant sums and should not be taken lightly.

Putting this into perspective, Frontier Economics estimated that the impact of a move to LMP in GB could add 2-3 percentage points to the cost of capital. If zonal pricing was introduced, GB would have a more expensive energy system – a cost ultimately borne by consumers.

The focus should be on delivery, not distractions

The UK Government has a target of delivering a decarbonised power system by 2035. A Labour government is currently even more ambitious, targeting 2030. Whichever you choose the next few years will need a massive ramp-up in investment.

To be successful the companies who will do the work will need certainty. The more time we spend being distracted by concepts like LMP, the less focus we can give to building the renewables, electricity networks and flexible power technologies we know we need. And we have a good example of what this kind of certainty can do.

The benefits of providing increased certainty

Building on the success of the Electricity System Operator’s (ESO) – soon to be the National Energy System Operator (NESO) – Pathway to 2030 Holistic Network Design, which sets out the blueprint for the transmission infrastructure required to the UK Government’s 50GW by 2030 offshore wind target, we’ll shortly see the publication of the ESO’s transitional Centralised Strategic Network Plan (tCSNP). This could bring forward 10’s of billions of additional investment in the electricity transmission network across GB required to further deliver net zero and energy security targets. Alongside the tCSNP, we are also expecting more detail on the Strategic Spatial Energy Plan (SSEP) due later in the year.

These are two examples of a move to strategic deployment of energy infrastructure that is extremely welcome.

Deploying the technologies we know we need in the places we know we need them will deliver consumer savings. It will also reduce environmental impacts and community disruption, and support long-term clarity which will support investment in skills development and domestic supply chains. With the location of energy assets increasingly determined by geography, we must ensure that locational signals are genuinely additive and useful for a strategically, coordinated energy system – your trusted ally, not an unexpected guest.

Build on what works

At SSE, we could invest more than £40bn in the next decade in clean energy infrastructure. We’d like to get on with it, but it will require a supportive policy environment. And we are not alone.

The vast majority of industry, believes that incremental changes to existing market arrangements – a ‘Reformed National Market’ – alongside strategic deployment of energy infrastructure could address the issues that zonal pricing is aiming to resolve without the disruption to investment.

The longer that zonal pricing remains on the table without a decision, the longer investment uncertainty is maintained – making many investments more expensive and putting others at risk. Efforts should now be turned to a speedy decision for delivering incremental changes that constitute a Reformed National Market.

REMA can be a game changer, but only if it’s done right. Now is the time for evolution, not revolution. We need pace over perfection.

SSE will actively participate in the consultation process, and we look forward to working closely with policymakers on objectively designing practical reforms needed to speed up delivery.

Read the consultation and supporting documents on the website.