Local electricity pricing key to a net zero energy system

Local electricity pricing holds the key to keeping costs down as the UK drives towards net zero, according to a think tank.

In early December, Policy Exchange released a report, Powering Net Zero, in which it set out how the UK is now on the cusp of a green revolution, underpinned by the government’s commitment to 40GW of offshore wind by 2030. However, citing cost increases observed during the coronavirus lockdown, it warned that Britain’s electricity market is not yet prepared for a future dominated by offshore wind and other renewables, as well as increases in electric vehicles (EV) and electric heating.

The summer, with the country in lockdown, saw electricity demand fall by 15%. It meant that wind farms and nuclear power stations generated more of the UK’s electricity, with the electricity system operator (ESO) having to pay them to turn off, while paying gas-fired power stations to turn back on, to ensure the grid continued to run safely. This saw system balancing costs rise two-thirds (£220mn) compared to the same period in 2019 and a preview of what is to come as, without reform, the cost of operating the electricity system is likely to rise higher, adding billions to bills each year, becoming a “new normal”.

It proposed local electricity pricing as a means of rectifying this, based on markets that operate successfully in Texas and California, which could potentially cut electricity bills by £2.1bn per year, or £37 per household. If implemented from 2025, it could save consumers £50bn by 2050 and see the full potential of offshore wind realised, in contrast to the ESO’s current plan for an integrated offshore grid, which could save £6bn by 2050.

Local electricity pricing would allow prices to vary across Britain, dependent on local supply and demand. It could also encourage energy intensive industries to build factories and data centres in the UK’s coastal industrial hubs where they could benefit from abundant offshore resources. Lower local energy prices could potentially serve as a catalyst for the UK’s green manufacturing sector in places such as Aberdeen, Grangemouth, Teesside, Humberside, Merseyside, East Anglia and South Wales.

As well as local electricity pricing, which would provide the foundations for a truly smart energy system, the report also stressed the need for the government’s main schemes to support new renewable projects – Contracts for Difference and Capacity Market – to evolve to keep the UK on track to net zero. Based on these three themes, it made a series of specific policy recommendations, putting the government on a path to less intervention in the electricity sector without risking investment in renewables.

Local pricing should be introduced into the GB electricity market from April 2026, it said, with residential and small business customers charged a regional price initially, unless opting in. Government should then look to extend local pricing to all customers over time. It should also offset differences in electricity prices in different regions of Britain using fixed credits and charges on customer bills, with this applying to residential and small business customers only.

While the Contracts for Difference (CfD) scheme has delivered “incredible reductions” in the cost of offshore wind, it should be reformed to offer a simplified floor-price CfD with the auction planned for 2021 the last under current rules. Auctions in future should be held annually, at the same time as the Capacity Market (CM), ensuring it is easier to combine both in future.

The report further recommended project developers are required to submit bid bonds when entering auctions, ensuring clean energy projects are delivered; existing renewable energy generators are able to compete for 1-year CfDs, once their existing contracts end, ensuring they are not decommissioned prematurely; and that the Delivery Years and price caps for established technologies are scrapped to “radically” simplify the scheme, with project developers also able to nominate their own load factor.

The Capacity Market, like the CfD scheme, has delivered on its original objectives, mainly supports high-carbon resources and must increasingly support lower carbon ones that can deliver firm power, such as low carbon hydrogen, gas or bioenergy with carbon capture and storage, geothermal and others. Based on this, it called for it to include a low-carbon quota for firm low-carbon generators, with this quota growing over time; for firm low-carbon resources to be able to receive contracts in both the CM and CfD schemes; and that the Capacity Market is amended to include regional capacity pricing, such as New York State.

It also called on government to introduce a stricter testing regime and higher penalties for non-delivery in the GB CM, while recommending the first CM auction including a low carbon quota is the T-4 auction for 2027/28, held in Q4 2023.

These recommendations, once implemented, would act as a second phase of Electricity Market Reform (EMR), following from successful reforms in the early-2010s. This would then lead to a “radical” EMR3 to deliver a net zero ready electricity system, where government reduces its role in the electricity sector, either through retail-led models or Equivalent Firm Capacity auctions led by an Independent System Operator (ISO).

It did note electricity market evolution is a continual process of trial and error, meaning that while tempting to move straight to the “perfect electricity market design”, it is key to put the building blocks in place. It reiterated its belief government should prioritise local pricing over the next five years as a foundation for any long-term, efficient electricity market design, as well as evolving the Capacity Market and Contracts for Difference schemes. Only then will government be in a place to consider longer-term policy options for the GB energy system.