The Energy Transition | UK government publishes second REMA review

This week we look at: the government's recently published second REMA consultation; the final version of Allocation Round 6 terms and conditions; and the House of Lord's long duration energy storage report.

REMA – Propositions for zonal pricing and a revamped CfD system

The UK government has launched the second consultation on its review of electricity market arrangements (REMA), which it hopes will set out a clear strategy for the future GB electricity market. One of the key proposals in the consultation suggests a move to zonal pricing within the established contracts-for-difference (CfD) scheme.

Zonal Pricing

The first REMA consultation presented two options for a locational pricing system: zonal pricing and nodal pricing. The government has decided to continue considering zonal pricing, but has discounted the possibility of nodal pricing. Zonal pricing was favoured due to it being able to provide a more efficient system overall, maximise whole-system flexibility and lower consumer bills.

According to modelling commissioned by the Department for Energy Security and Net Zero (DESNZ), zonal pricing could cut network operating costs by between £5 billion and £15 billion and provide consumer savings of between £25 billion and £60 billion through increased efficiencies.

The consultation acknowledges the "implementation challenges" with zonal pricing, including the need for concurrent trading arrangement reform and the impact on network access. The full impact of these challenges remains subject to the design of the zonal pricing system, which, according to the consultation, could range from "a light touch model which shields participants from certain risks and maintains current decentralised arrangements, to a more transformative model which might prioritise flexibility through sharper price signals and be more centralised in its operation.".

CfDs

The new REMA consultation also considers reforms to the Contracts for Difference (CfD) scheme. The CfD subsidy scheme has been in place since 2014 and aims to encourage investment into renewable energy generation. The government estimates that it will need between 140GW and 174GW of renewable capacity in 2035 to meet its decarbonisation commitments, which will require an increase of 150% to 200% in installed capacity.

The consultation confirms the government has committed to a "future-proofed" CfD scheme. Two CfD reforms options have been ruled out: "strike price range", as this could put price risk onto CfD assets; and "revenue cap and floor", which could increase the risk of 'gaming' the rules of the scheme, alongside potentially distorting operational behaviour. To determine the best CfD design, the remaining reform options for CfDs will be considered in conjunction with wider decisions on REMA.

Optimised Capacity Market

The government also intends to retain an "Optimised Capacity Market" to ensure adequate network capacity as it transitions towards decarbonisation. The government's view is that none of the alternative capacity mechanisms would offer better value for money or investment potential to face the challenges of the transition.

The government is taking forward the option of a single auction with multiple clearing prices, with the intention to introduce a minimum procurement target for desirable characteristics, with further consideration to be given to how the targets should be set. Further changes to the Capacity Market  will also be introduced, including strengthening rules and providing greater clarity on auction targets.

We have commented on the REMA in this Insight. For a more detailed analysis of the latest REMA consultation – please get in touch with your usual Osborne Clarke contacts or one of the experts below.

Government responds on amendments to the CfD Allocation Round 6 Contract

The government has published the standard terms and conditions (STCs) for Allocation Round 6 (AR6) of the Contracts for Difference (CfD) scheme, alongside the response to its consultation for amendments to the STCs and Private Network Agreements.

The consultation sought views on amendments designed to exclude generation that directly provides energy to offshore oil and gas facilities from the CfD scheme from AR6 onwards. This amendment implements the government's decision from July 2023 to ensure that energy consumers who fund the CfD scheme are not subsidising energy that is being consumed by offshore oil and gas companies.

The government's proposal to strengthen the Know Your Customer (KYC) process, which was designed to increase the monitoring of counterparty risk, was also supported by the consultation. Failure to provide the relevant KYC information will now mean that payments under the CfD may be suspended. A KYC notice must be sent to the Low Carbon Contracts Company (LCCC), the counterparty under the CfD scheme, if there is a material change in the company structure or the investors backing the relevant generators.

The government also proposed an amendment to the Change Control Procedure in the STCs so that a simple majority is required to trigger a dispute through the classification objection mechanism. This is the procedure under which generators can object to a material amendment to the STCs notified to them by the LCCC, on the grounds that the proposed amendment has been incorrectly classified as a material (rather than technical) amendment. In response to concern that this threshold would result in amendments to contracts without consent, the government has clarified that a generator can challenge an amendment before the decision becomes binding.

The government also noted the responses to the call for evidence on how the Milestone Delivery Date (MDD) has been operating in practice. The MDD is the deadline by which successful generators must demonstrate delivery progress, and is currently set at 18 months. The majority of respondents expressed the view that the MDD should remain at 18 months for all technologies. The government also confirmed in its response that the MDD will be extended in instances where the Ministry of Defence needs to ascertain whether onshore or offshore windfarms will interfere with air defence radar systems. The government has previously opened procurement competitions to find technical solutions to windfarm interference with radar which will conclude in 2026.

As we have previously reported, the budget for AR6 has been set at up to £1.025 billion, and applications open on 27 March 2024.

House of Lords report urges government decision on Centrica's gas repurposing proposals

As we previously reported, in March 2023 energy company Centrica announced plans to repurpose its Rough gas storage site to store hydrogen produced via its green hydrogen project in partnership with Lhyfe. The project focused on creating a pilot green hydrogen production site and the development of an end-to-end process involving hydrogen production, storage and distribution.

The House of Lords science and technology committee has recommended in its recent report that the government must act urgently  to ensure that Long Duration Energy Storage (LDES) technologies are scaled up and contribute to decarbonising the electricity system. As such, the committee has recommend that the government should work with Centrica to understand the repurposing project with a view to determining whether it should receive government support. The report noted that construction could begin within 12-18 months once a final decision is made.

The report commented that storage in forms such as hydrogen are an important part of energy independence and security, and called upon the government to set a target for how much LDES and generating capacity it wants to see operational by 2035 - the UK's target date for decarbonising its electricity system.

Notably, the report encourages the government to deliver details of its long-duration storage business model including the scale of funding, the amount of storage the scheme will support and how this interacts with hydrogen support mechanisms.

This article was written with the assistance of Luke Hopper, Jessica Sawford, Charlotte D'arcy, Hannah Bradley and Khushal Thobhani