Poor electricity market design ‘landed Brits with £7bn in additional energy costs during 2021-2022′ 

The fact that the UK links all of its electricity prices to wholesale gas prices – including electricity generated by renewables and nuclear – resulted in £7.2bn of extra costs for homes and businesses in 2021 and 2022, making the cost-of-living crisis worse.  

Poor electricity market design ‘landed Brits with £7bn in additional energy costs during 2021-2022′ 

That is the conclusion of new analysis from think-tank Carbon Tracker this week, assessing the ways in which the UK’s energy market design could be altered to protect energy consumers from spikes in gas prices – especially as gas decreases its share in the electricity generation mix in the decades to come.

The organisation’s ‘Marginal Call’ report comes as the UK Government continues the long process of implementing its Review of Energy Market Arrangements (REMA), badged as the biggest shake-up to energy market design in a generation. Initial REMA consultations opened last summer and the progress of the review has doubtless been slowed by two changes in Prime Minister since its launch.

Under the REMA, the Government is proposing measures to de-couple global wholesale gas prices from wholesale electricity prices for electricity generated in the UK. This link, it has been argued, is becoming less and less sensible as Britain brings more renewable electricity generation capacity online and seeks to close the impending nuclear gap. The UK is seeking to host 50GW of offshore wind by 2030 and aiming for at least 25% of home-grown electricity generation to hail from nuclear by 2050.

Carbon Tracker welcomes this price decoupling move in its new report. It summarises how the UK consistently paid the second-highest spot prices for electricity during 2021 and 2022, partly due to this coupling of pricing. Only Italy, which uses marginal pricing itself, saw steeper price spikes.

The report states that when net UK power procurement expenditure in 2021 and 2022 is compared to what it could have been without marginal pricing, the difference is around £7.2bn.

Nonetheless, Carbon Tracker is advocating against a “complete change in market design” for electricity pricing. It emphasises the importance of maintaining and growing investor confidence in renewables and other energy transition activities in the coming years, given the UK’s commitment to ending unabated fossil-fuelled electricity generation by 2035, along with its 2050 net-zero commitment and supporting carbon budgets.

Carbon Tracker is instead calling for less bold changes to marginal pricing, coupled with other measures to protect electricity prices from future gas price spikes which can “skew” them. It floats the idea of new hedging obligations on utilities for their future fuel requirements. Under hedging obligations, generators agree to sell their future output at a set price, typically the price on the table for generation when the agreement is struck. This would prevent utilities from hiking prices and passing this on to consumers.

CfD reform

Additionally, Carbon Tracker recommends sweeping changes to the Contracts for Difference (CfD) auction scheme, which supports low-carbon generators by agreeing that they will receive a fixed, pre-agreed price for 15 years of generation. Generators sell their electricity into the market as usual and, when the market price is below the agreed ‘strike price’, they receive a top-up from the Government.

The Government has moved to increase the frequency of CfD auctions and to broaden the eligibility criteria to different kinds of generation. Carbon Tracker wants to see further changes, namely measures to base top-up payments on eligible firms’ combined overall revenue streams.

Such a move could be an alternative to the current temporary revenue cap on low-carbon generators. The cap was introduced because, due to the coupling of gas and electricity prices, low-carbon generators stood to reap excessive profits in 2022, just as fossil fuel firms did. The cap has proven unpopular with renewable industry bodies, who argue that it is offputting to investors.

The report also concludes that the CfD process should either be opened to – or replicated for – battery storage, demand response and green hydrogen.

Carbon Tracker’s analysis is timely, given that anglo-Dutch energy major Shell has this week reported record annual profits of almost $40bn globally – more than a 100% increase year-on-year. Critics in the UK are heaping pressure on the Government to increase tax on companies like Shell beyond the agreed windfall tax level and to further scale back tax-free allowances for energy majors. Shell has countered by stating that only a small minority of its profits (less than 5%) were made via UK activity.

The government’s windfall tax only applies to profits made from extracting oil and gas in the UK. The rate was originally set at 25%, but was subsequently increased to 35%. This, combined with their corporation tax and supplementary rate, means these firms should have as total tax rate of 75%. But companies can and do significantly reduce tax by factoring in losses, decommissioning spending and tax-free allowances.

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