Latest REMA consultation pivotal to British energy market investment

Shannon Urquhart of Pinsent Masons was commenting after the UK government opened a second consultation in its ongoing review of electricity market arrangements (REMA).

“We encourage stakeholders to respond to this consultation,” Urquhart said. “We need to get this right in order to ensure energy security and to make such a basic and essential commodity more affordable for everyday consumers. It needs to be delivered in a timely manner to ensure investor confidence isn't undermined and risk an investment hiatus in the UK’s energy sector.”

An initial REMA consultation was opened by the government in 2022. The main purpose of the consultation was to consider whether current market arrangements were fit for purpose and adequate to achieve decarbonisation of the power sector by 2035. The government sought views on a wide range of changes and options it should consider for the reform. The Department for Energy Security and Net Zero (DESNZ) published a summary of responses it received in March 2023, ruling out several options for reform at the time. It proposed to conduct a second consultation in 2023, but that was delayed – until now.

The opening of the second REMA consultation comes at a time when a cross-party group of MPs in the Energy Security and Net Zero (ESNZ) Committee will examine how the structure of the energy sector might be reformed in a parliamentary inquiry. The committee is to look closely at what changes and interventions are needed to encourage greater decarbonisation, keep prices affordable for customers and maintain a secure and reliable supply in the UK.

Ronan Lambe of Pinsent Masons said one area where reform is being considered through REMA concerns the way electricity is priced.

Currently, there is a single national wholesale price for electricity, no matter how, or where, that electricity is generated. In its initial REMA consultation, the government examined options for splitting the wholesale market, which could result in twin wholesale prices, splitting electricity generated from renewables from other generation types.

The government’s initial proposals received mixed responses from the respondents to its first consultation. Only 47% agreed that the government should continue to consider this option, while 38% disagreed. Those who agreed felt that a split market option might better pass on both the lower long-term costs but also the risks of higher variability of renewables to consumers directly, and further decouple wholesale electricity prices from international gas prices. However, respondents who argued against this option highlighted the market disruption it could create. These respondents contended that the limited evidence base, and continued uncertainty about the detail of how the schemes would work, could undermine investor confidence.

In its second REMA consultation, the government ruled out the “transformative market splitting options”, such as a Green Power Pool and split wholesale market. Instead, it proposes to retain the marginal pricing model across the wholesale market and ally this with changes to the way the ‘contracts for difference’ (CfD) scheme works, to keep the price of electricity down for end-users. It said the move would help with “accelerating the roll-out of renewables” and “ensure that a diminishing proportion of renewable and nuclear generation will be paid a marginal price set by gas” – i.e. that not covered by CfDs. It said the market splitting options would take too long to implement, not deliver benefits for consumers, and fall short of meeting its REMA criteria concerning deliverability and investor confidence.

In its initial REMA consultation, the government had also proposed introducing sharper locational signals into the wholesale market, by considering both nodal and zonal pricing. Those plans split opinion among respondents too.

The idea behind those plans would be to split the market into zones with different zones having different electricity prices applied, so the locational signals could drive efficient investment and dispatch decisions of generators, demand users, and storage. Concerns expressed with this option included that it would present a risk to investment in renewables, with some respondents saying there is limited ability of both new and existing generation and demand to respond to locational signals. Some respondents further argued that locational signals do not and would not significantly impact investor decisions for these market participants; or that to do so, such signals must not be volatile, short-term, or unpredictable.

In its second REMA consultation, the government has decided to retain the option of zonal pricing but “discount nodal pricing from further consideration”. It is also consulting on more incremental reforms to the existing system, which it could pursue instead of zonal pricing. Those reforms could include changes to the transmission network charge regime and extensions to the balancing mechanism, which National Grid uses to ensure demand for electricity can be met by sufficient supply.

“In the next stage of REMA, we will seek to work closely with industry, ESO/NESO, and Ofgem to develop both national and zonal models of wholesale market reform to enable a comparison between the two with the aims of designing models which can most appropriately allocate risk to market participants while delivering savings for consumers,” the government said.

“We will also continue to consider where reforms to status quo elements such as settlement periods, the balancing mechanism, and operability services can deliver benefits for the system and consumers. We will no longer consider the ‘local markets’ model; instead, we will continue to consider what further actions are needed in order to deliver open, dynamic and coordinated markets for distributed low carbon flexibility. We will also continue to monitor how REMA options may impact liquidity in electricity markets,” it said.

As well as seeking to promote low carbon electricity generation, the government said in its latest REMA consultation that it envisages a need for “a limited amount of new gas capacity” to be added to Britain’s energy system “in the immediate term”. It said a boost to gas power capacity is necessary “to ensure a secure and reliable system”, describing gas as “the only mature technology capable of providing sustained flexible capacity whilst low carbon long duration alternatives, such as [Power Carbon, Capture, Use and Storage (Power CCUS), Hydrogen to Power (H2P), and Long Duration Electricity Storage (LDES)] scale up”.

The government said, however, that it plans to broaden existing laws to require new gas plants to be built net-zero ready and able to convert to low carbon alternatives in the future, such as carbon capture and H2P.

With about a third of the UK's electricity currently generated by gas plants, the government believes that new gas plants are vital to prevent blackouts and ensure energy independence, but critics view the development as a potential setback in the nation's decarbonisation efforts, raising concerns over increased dependency on fossil fuels and the long-term viability of achieving the UK’s legally binding target of ‘net zero’ emissions by 2050.

The government has also confirmed it intends to retain and enhance the capacity market, which is an auction system designed to boost energy security by subsidising plants to be on standby for generation in times of additional need or peak demand, including additional winter demand. Energy suppliers and generators bid in regular auctions to provide a share of capacity when the system needs it in exchange for a regular revenue stream. The government said it plans to “better align” the capacity market to the UK’s net zero emissions target “by introducing multiple clearing prices in the auction in the form of low carbon flexibility minima”.

The second REMA consultation closes to responses on 7 May 2024.

For its inquiry, the ESNZ Committee is inviting submissions based on six questions, looking at the underlying principles of the UK energy market, the government’s approach to regulation, the REMA proposals, the major benefits the reform should deliver, any barriers to reform, and consumer impact. One of the committee’s questions seeks views on whether the government can deliver radical reform in the energy market.

The committee’s call for submissions ends on 19 April 2024.