UK Government Launches Review of Electricity Markets

There is no doubt that the war in Ukraine has had sweeping impacts on a number of markets around the world from supply chains to commodity pricing. Perhaps the most immediate impact in the UK has been on energy prices, which have reached record levels and had massive impacts on both inflation and, of course, cost of living. It is therefore timely that the UK Government has recently launched a much-needed review of electricity markets intended to future-proof the current system and make it better able to accommodate the huge increase in renewable energy required to meet our net zero ambitions.

Broadly, the future shape of UK electricity supply is already clear with wind (particularly off-shore wind) and solar making up the bulk of energy supply, supported by nuclear and hydrogen. Battery and hydrogen are likely to provide the bulk of our storage needs alongside hydro, particularly in Scotland. The review recognizes that the current system, which was designed around large fossil-fuel based generators, is not well structured to accommodate the evolving generation mix. In particular, it identifies five key challenges:

• Increasing investment in renewables and other low carbon electricity capacity – with electricity demand expected to increase from around 100GW now to around 400GW by 2050 (think of all those cars that will no longer use petrol and diesel, and the transition from gas boilers to heat pumps), this is no small challenge. It will be important to ensure that any changes to the current system are designed to ensure that continued investment in renewables is sufficiently incentivized through long term price support to cover the relatively high capital costs of building out these assets.
• Increasing system flexibility – in particular around balancing supply and demand. Periods of excess supply will increase as more renewables come on line and it will be important to use that excess power wisely (for example by producing green hydrogen which can then be stored for those periods when the sun is not shining or the wind is not blowing). Also, the review recognizes the role that consumers can increasingly play going forward in managing demand as well as providing short term balancing to the system e.g. from rooftop solar or car batteries.
• Providing more efficient location signals – this is perhaps the biggest challenge as renewables are inevitably built far away from where electricity is required, resulting in capacity issues for the system as well as challenges in balancing supply and demand. It will be interesting to see how the government proposes to address this challenge. Given the importance of off-shore wind in the energy mix, there will inevitably be a need for further investment in grid capacity. Doing this in a way that minimizes curtailment of low carbon renewable sources will be vital.
• Retaining system operability – this is not straightforward as benefits such as inertia – a key element to grid stability and system balancing – are lost when not using gas-fired generation. Nuclear power and standalone synchronous stabilisers are likely to be part of the solution here and indeed work is already underway in this space with the National Grid stability pathfinder projects.
• Managing price volatility – this is obviously a hot topic right now given the current spike in prices. At the moment, the wholesale electricity price is based on marginal pricing so the market price is effectively determined by the most expensive generating asset (currently gas) dispatched, which means that the low cost of renewable energy is not being passed on to consumers. Whilst this is mitigated to an extent where CfDs (Contracts for Difference) are in place, and whilst prices may be expected to reduce over time as more renewables come on line, there is no doubt that the war in Ukraine has served to highlight the current system’s shortcomings.

The review now underway is set to conclude in October, following which there will be a period of consultation and engagement with the energy sector which will continue into 2023 with a delivery plan and implementation to follow. So, whilst this is an important piece of the net zero jigsaw, given the sweeping nature and scale of the review, don’t expect change to happen overnight. That said, if the government and regulators can get this right, it will mean that we have an electricity network that is truly fit for purpose and able to facilitate the transition to net zero that the UK sorely needs.