The Energy Transition | Electricity Market reforms and Net Zero Strategy ruled unlawful

Government publishes consultation on reforms to electricity market

The government has published a consultation on the review of electricity market arrangements (REMA) to identify the reforms needed to deliver a decarbonised, cost effective and secure electricity market framework. The REMA consultation follows from the government's commitment in the British Energy Security Strategy (April 2022) to ensure the electricity market design is fit for purpose for businesses, industry and households in the transition to net zero.

The consultation is the first stage in a wider REMA programme working towards a decarbonised electricity system by 2035. A further two stages will follow the consultation: Stage Two seeks to determine what reforms are needed through extensive engagement with the energy sector (2022-2023) and Stage Three, beginning in the mid-2020s, will establish a full delivery plan and oversee implementation in time to meet the 2035 commitment.

The consultation seeks views on how best to improve market design to ensure that the key objectives of decarbonisation, security of supply and cost-effectiveness are met. The government has proposed various avenues for reform, grouped into the following five areas:

1. A net zero wholesale market
2. Mass low-carbon power.
3. Flexibility.
4. Capacity adequacy.
5. Operability.

(1) A net zero wholesale market

The wholesale market is currently designed for fossil fuels. However, as the electricity system decarbonises, the wholesale electricity market will also need to evolve to account for the increased use of renewable energy. Proposed reforms include different markets for variable and firm power, introducing locational pricing (either zonal or nodal) and changes to settlement periods, gate closure and the Balancing Mechanism.

(2) Mass low-carbon power

The consultation highlights the impact of the Contracts for Difference (CfD) scheme since it was implemented in 2014, but also recognises its limitations in light of the increased deployment of renewable energy. Alongside considering the merits of the existing scheme, REMA proposes different variants of the model, such as increased price exposure and decoupling payment from output. REMA also looks at a decentralised approach to choosing the capacity matrix which could be achieved through imposing an obligation on suppliers to procure green electricity directly on behalf of consumers.

(3) Flexibility

The consultation stresses the need for more accurate market signals to incentivise flexibility. Proposals include introducing a revenue cap and floor, flexible auctions to the Capacity Market and a flexibility-focussed supplier obligation.

(4) Capacity adequacy

On capacity adequacy, the government is not minded to consider a decentralised approach but proposes a reformed Capacity Market, a strategic reserve and a centralised reliability options model.

(5) Operability

The consultation reviews the role of ancillary services in maintaining the efficient and safe functioning of the electricity system. At present, most ancillary services are provided by fossil fuel thermal generators, a large proportion of which would need to be replaced with low carbon generation in order to meet the 2035 commitment to a decarbonised electricity system. Granting the ESO or Future System Operator the ability to prioritise low carbon procurement and aligning Capacity Market and CfD tenders with those for ancillary services are proposed solutions to incentivising investment in low carbon ancillary services.

In general, a key part of REMA will be the consideration of how individual policies relate to, and interact with, each other to ensure the wider package of reforms is coherent, consistent and comprehensive. The consultation opened on 18 July 2022 and the deadline for submissions is 10 October 2022. The government expects to publish a response in winter 2022.

High Court rules government's climate strategy is unlawful

The High Court has ruled that the government's Net Zero Strategy, which was published in October 2021, is inadequate and unlawful as it breaches the Climate Change Act 2008. The strategy outlines the government's plans to decarbonise the economy and reach net zero emissions by 2050. The High Court held that the strategy lacks sufficient quantifiable detail to demonstrate how legally binding targets will be met and consequently breaches sections 13 and 14 of the Climate Change Act 2008.

Separate judicial review proceedings were brought by Friends of the Earth, ClientEarth, Good Law Project and environmental campaigner Jo Wheatley, which were all heard together in the Royal Courts of Justice in June 2022. During proceedings, it emerged that the policies in the strategy would only achieve 95% of the reductions necessary to meet the sixth carbon budget. This leaves 5% of the emissions reduction target unaccounted for and there are concerns that this shortfall could in fact be greater due to the inaccuracy of calculations in the strategy. The judgment given by Mr Justice Holgate explained that the Energy Minister, Greg Hands, signed off on the strategy without the necessary information on how the carbon budget would be met.

The High Court has ordered that the government amends the strategy to provide a quantified account of how targets will be met and this must be presented to Parliament before the end of March 2023. Additionally, the government has been ordered to pay the claimants' costs and permission to appeal the judgment was refused.

Ofgem responds to high balancing costs

Ofgem has published an open letter to industry which outlines its plans to explore near-term interventions to address concerns over the high prices submitted by generators in the Balancing Mechanism (BM). The BM is the Electricity System Operator's (ESO) key mechanism for balancing supply and demand on Great Britain's electricity network. The ESO uses the BM to buy and procure the right amount of electricity, however, high offer prices have resulted in large increases in the costs incurred by the ESO. Ofgem has criticised market participants' offers for being inflexible and questions whether participants' behaviour has been a reflective response to the ongoing gas crisis.

Ofgem's open letter follows the ESO's release of its findings from an independent review of BM costs, which was commissioned following a record-high daily bill of over £60 million on 24 November 2021. The review concluded that there was no clear evidence of participants acting inconsistently with market rules and although Ofgem's investigation concluded the same, Ofgem remains concerned that evidence showed some generators' behaviour to be 'immoderate'. Such evidence included generators submitting persistently high and inflexible offers, as well as scheduling desynchronisation of units ahead of peak demand periods with little notice which exacerbated tight margins.

Ofgem therefore believes there is room for improvement within the existing market arrangements to better protect consumers' interests. Possible reforms suggested by Ofgem include introducing restrictions on BM offer prices, which could be achieved by implementing a price cap, and changing the rules for how participants structure their BM bids. Additionally, Ofgem has suggested limiting generators' ability to amend their schedules with little notice and restricting BM access for generation capacity that is withdrawn with short notice, as well as introducing new obligations that require generators to behave in line with the best interests of consumers'. Ofgem has stated that its final proposals for intervention will be shared in due course.

National Grid ESO publishes report on Future Energy Scenarios

National Grid ESO (NGESO) has published its Future Energy Scenarios (FES) 2022 report, setting out what it says are credible ways that the UK can achieve net zero by 2050 and a decarbonised electricity system by 2035.

The report recognises the continuing challenges posed to the energy system by the pandemic and the ongoing war in Ukraine, which it says highlight the importance of a faster transition to net zero in order to support energy security and reduce exposure to volatile international fossil fuel prices. Focus is also given to the cost-of-living crisis and the need to protect consumers whilst also delivering the broader societal benefits that come from the transition to net zero.

The report, published annually, uses four key messages to plot the energy system's journey to decarbonisation: (1) policy and delivery; (2) consumer and digitalisation; (3) markets and flexibility; and (4) infrastructure and the whole energy system.

(1) Policy and delivery

NGESO highlights how significantly accelerating the transition to a decarbonised energy system can help address security and affordability concerns at the same time as delivering net zero milestones. Key recommendations include:

• A demand side strategy that incentivises more flexible electricity consumption, long duration storage and early hydrogen uptake.
• A regional, rather than national, strategy, moving away from a "one size fits all" approach and focussing instead on availability of resources and proximity to energy infrastructure.

(2) Consumer and digitalisation

The report recognises that consumer behaviour is pivotal to decarbonisation and proposes that smart technology will be vital to reaching net zero. NGESO recommends:

• Support measures for suppliers to increase the availability of flexible time-of-use tariffs, enabling consumers to respond to market signals and benefit from low prices at times of high renewable output.
• Facilitating data sharing with innovators to enable accelerated developments in smart technology and a better understanding of regional trends.

(3) Markets and flexibility

NGESO flags the importance of unlocking flexible solutions to enable the efficient integration of renewables. This can be done through improving price signals. Recommendations include:

• Market reforms to allow better coordination of real-time locations signals and the dispatch of flexible capacity on the energy system.
• Market changes to allow for improved market participation, such as the facilitation of flexible tariffs, support for innovation and reducing barriers to entry for new market entrants from the industrial and commercial sector.

(4) Infrastructure and the whole energy system

In order to maintain the pace of the net zero ambitions and strengthen energy security, strategic investment in the whole energy system is urgently required. NGESO recommends:

• Investment in, and development of, large-scale geological hydrogen and electricity storage projects to balance inter-seasonal demand and increase resilience against the volatility of international supply.
• Increased competition in both large-scale projects and local-level developments. This will ensure the affordable delivery of new infrastructure whilst ensuring local regions can adopt the low carbon solutions that are most suited to the needs of their consumers.

NGESO will use stakeholder comments and questions from FES 2022 to inform further analysis and insights, with an increased focus on regional improvements. FES 2022 will form the basis of the next publication of FES - Bridging the Gap to Net Zero, a project that takes a close look at what needs to be done to reach the UK's 2050 net zero target.