Reality of Rima |  current news

Reality of Rima | current news

As the conservative leadership contest progresses, a few of those standing unaccounted have given an opinion on the future of the electric balancing mechanism. Arguably this topic – along with everything else about the future of the energy market – will have a greater impact on the UK’s future economic success than anything the candidates in this campaign have promised.

Despite the state of political debate in the UK, proper scrutiny of any energy market reform proposals is vital. The Government’s Review of Electricity Market Arrangements (REMA), published on July 18, is exactly this: consideration of pent-up problems and proposed fixes for those that have arisen since the Electricity Market Reform (EMR) process in early 2010.

The challenge facing REMA

The first – and perhaps most fundamental – challenge is to deliver the massive amounts of new infrastructure that will result in zero-carbon electricity by 2035. Future national grid energy scenarios see the UK’s total electricity generation capacity increasing by at least 150% from 2020 levels by 2020. 2035. This is equivalent to building ten gigawatts of new generation each year, or three Hinkley Point C.

The second has to do with the relative stability of the power system—or perhaps more accurately, the increased cost of making sure the system is stable. Net budget costs increased from £506 million in 2015 to £1.3 billion in 2020, and are expected to increase further in the future. These costs are driven in large part by the growing need to manage large amounts of generation, especially wind, that are stuck behind restricted areas of the grid.

The third challenge is related, but needs to be a specific goal in itself: cost. We are in the grip of the worst energy price crisis since the 1970s. Gas prices, if not kept high, are expected to be considerably more volatile over the next decade than they have been over the first decade of the twenty-first century. Any market reforms will be subject to a political test to see if they actually reduce costs, at a minimum in the medium term.

Options for meeting these challenges are varied, but they can be divided into two basic categories under which the government is developing some of its thinking. The first relates to the mechanisms that provide for investment in low-carbon energy.

investment solution

The government has an existing set of tools that it can use to offer certain types of assets. A Contract for Difference (CfD), which pays generators a guaranteed price for their power, has been used for the Hinkley Point C nuclear plant and to connect large quantities of renewables at low cost. The Detachable Power Agreement (DPA), which combines capacity payments with a degree of revenue certainty for assets capable of showcasing their production—primarily CCS-equipped gas-fired power plants—has yet to be implemented. The Regulated Asset Base (RAB) model, already used for grid infrastructure, is now being used to support new nuclear power on a gigawatt scale.

The focus of the debate in this space is whether CfD is the right mechanism to deliver the very large volumes of investment needed by 2035 at the lowest possible cost. The bulk of the generation required for this deadline is large renewables with variable production at a fixed cost. Although the co-finance contract has been effectively introduced, there are reasons to consider why it may not be appropriate in the long run.

The first is how it interacts with the main impact of renewables on the market: deconstruction of prices. The more renewables chase after the same consumer demand when the wind is blowing and the sun is shining, the lower the overall market price will be. While this does not matter to CfD generators, CfDs only last fifteen years. When these are over, these generators will only be able to receive this predatory price for their power. For some generators, this may mean shutdown.

The second is that it leaves the government responsible for scale risks. We don’t know exactly how much renewable generation we will need at a given point; We need a lot more, but there’s a risk in building it all up, not least the extra cost it might impose on consumers. The instincts of government will always be to over-construct; Alternative mechanisms may eliminate scale risks away from the payer of the bill.

The solutions to these challenges are varied:

Butzer

First put forward by UKERC, this proposal calls for a new CfD “pot” for existing renewables and low-carbon energy. Participation in this new auction will be voluntary – although some commentators have called for a “stick” in the form of a windfall tax on non-participants – and will provide current generators with price stability for 5-10 years and consumers while lowering the overall cost of energy. UKERC estimates of the value to consumers from this move range from £70 to £300 per household, although this analysis is clearly a high level. This BEIS is a short-term procedure outside the REMA process.

green energy pool

Proposed by Professor Michael Grob, he envisions the creation of a green energy pool. This will be a private entity set up by the government that will offer long-term contracts to all low-carbon factories, aggregate their production and sell it directly to consumers as well as any additional generation required to balance demand. Essentially, this involves creating a government-supportive electricity supplier with a dominant position in the market, theoretically capable of weakening other retailers with its exclusive access to cheap green energy.

The wholesale market branched out

Various versions of this approach have been proposed by a number of commentators, including iGov and the Oxford Institute for Energy Studies. It is based on the idea that different types of generation have different levels of capital intensity, and that for capital-high and low-cost factories, cheap financing through revenue stability is likely to lower costs. It removes these types of manufacturers from the existing wholesale market, which focuses on short-term costs, and instead puts them in a long-term cost market where generators compete for long-term price stability contracts in a similar way to CFDs, except at the market level. iGov’s proposal eliminates the risk of long-term market capture by obligating suppliers to source energy from it first before increasing its market size in the short term.

Delegate clean electricity

This solution proposed by Energy Systems Catapult involves moving away from the CfD mechanism and shifting contracting for low carbon generation entirely to suppliers. They would be obligated to contract with this generation by virtue of a legal obligation to sell only energy with a certain carbon intensity, regressing each year until it hits zero in 2035. While the contracting method is left to the supplier, this approach assumes a long-term PPAs will be the path that is taken take it. This would take low-carbon energy out of the wholesale market.

stability solution

Restructuring the market to reduce the cost of integrating all these new assets is clearly a priority, and there are multiple solutions on the table. In general, it implies an increase in the positional price signals of the generation. This helps ensure that the burden of managing network constraints can be managed more effectively, and there are stronger signals to invest in certain locations – or, conversely, to reduce investment where there is not enough connectivity for power output.

nodal pricing

This model replaces the current UK national wholesale price for energy with hundreds of local prices set in places such as where the transmission network delivers power to the distribution system. Already used in a range of markets including Texas, California, Ontario and New Zealand, this would change the way generators transmit from the current model in which they produce power in response to their contract or market conditions, and instead produce power based on instructions from the system operator. Proponents argue that it allows for more efficient operation of thermal power plants and removes the need to pay for restricted generators; Critics claim that it discourages investment in assets such as the wind that must be located on the edge of the system.

Domestic budget markets

Currently the UK’s energy supply is balanced nationally every half hour. This approach instead creates a new equilibrium market segmented into local areas. This could result in steeper asset prices such as the aggregate demand-side response, potentially encouraging more consumer participation in the system. It would also involve less market disruption than nodal pricing.

Granular transmission pricing

The costs of using electricity transmission in the UK are usually set up front on an annual basis. Since these charges are directly related to the use of the physical assets needed to take power out of a site, changing these charges to a more granular level can improve the use of the existing connection. This fee can be determined either by some kind of standard methodology or by auctions for certain lengths of cable – the so-called “wired by wire” charging.

Next steps

REMA will likely take several years, as EMR did before it. Consultations on this wide range of options are now open and will end in October. While officials prefer to take the time necessary to arrive at the correct answer, we assume that the neo-conservative leader will have an urgent need to cut costs as soon as possible. This autumn will likely have an impact on UK energy policy, which will reverberate for many years.

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