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Southern Energy Watch

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Eo reporter Cai Yixuan

Editor Chen Yifang

Audit Feng Jie

On March 16, 2024, the UK launched the second round of consultations on the Review of Electricity Market Arrangements to propose new proposals for the reform of the electricity wholesale market.

Compared with the initial reform plan of 2022, the first round of consultations abandoned several controversial proposals.

The new plan drops a nodal pricing mechanism that was previously under discussion in favor of a zonal pricing mechanism; it also drops a proposal to split the market for fossil-fuel and renewable power. The new plan pledges to retain contracts-for-difference (CfD) as the mechanism for scaling up low-carbon electricity and will reform the capacity market to encourage more deployment of low-carbon flexibility resources. Separately, the UK Department of Energy Security and Net Zero (DESNZ) has set out new plans for energy supply that encourage new gas-fired power plants.

Regional pricing takes the lead

In the first round of consultations, the UK government proposed two pricing models - zonal pricing and nodal pricing. As previously reported by Energy Observer (EO), nodal pricing has been a source of controversy in the UK.

In 2022, the UK considered dividing the transmission network into about 850 nodes and determining market prices at a more microscopic level, with different prices for each node. However, users with concentrated loads, energy-intensive companies and power generators oppose the adoption of this mechanism, arguing that node pricing will increase their costs. (For details, see: [New trends in power reform in the UK:Marginal pricing at disputed nodes]()

Node pricing would take much longer to implement and may face greater resistance. Ofgem has said that moving to a nodal model for electricity pricing could take at least a decade, and risks deterring investment in generation, which will be vital to meet the UK’s 2035 decarbonisation target. By contrast, the government is looking at a zonal pricing system which it says will improve the efficiency of the electricity market, maximise flexibility in the power system and reduce costs for consumers.

In effect, zonal pricing is a compromise between uniform system marginal pricing (the current electricity pricing mechanism for Great Britain) and nodal pricing.

Uniform system marginal pricing does not usually consider system blockage; the electricity generation price for each generator and the price for each user are the same within the transaction area. Nodal pricing takes into consideration the blockage cost of each node; the electricity generation price is the electricity price of the node where the generator is located, and the price for the user side is the weighted average price of each node. Regional pricing divides nodes where blockage frequently occurs into the same price zone; all generators within this price zone use the same electricity price, namely the zonal marginal electricity price.

A survey report commissioned by consulting firm FTI Consulting by Ofgem shows that introducing more refined location signals in wholesale markets can encourage power producers to invest in renewable energy around load concentration areas, allowing users in load concentration areas to obtain cheaper renewable electricity. If the UK power grid is divided into seven price zones, the operating costs of the power grid can be reduced by 5 billion to 15 billion pounds between 2025 and 2040, and users can be saved by 25 billion to 60 billion pounds.

Reform capacity market

In order to enhance the flexibility and ensure the capacity adequacy of the power system, the second round of consultations also plans to reform the capacity market, encourage low-carbon technologies such as long-duration energy storage, hydrogen storage to participate in the capacity market, and retain the Contracts for Difference (CfD) mechanism.

The UK capacity market pays backup generators to be on standby through an auction process. Generators bid into regular auctions run by the UK government to qualify for capacity payments, which provide regular revenue with the generators having to provide back-up capacity when the system needs it. The UK government is reforming the existing auction design, introducing a number of different clearing price mechanisms to ensure the capacity market better supports the UK’s drive to reach net zero.

Meanwhile, the UK government has committed to retain the CfD mechanism as a key measure for driving renewable energy investment. Ofgem estimates that the UK will require 140GW-174GW of renewable energy by 2035 to meet its decarbonisation targets.

At present, the British government has rejected two CfD reform options. One is to set a range for strike prices, which DESNZ said would bring price risks to renewable energy power generation. The other is to set revenue ceilings and floors on the CfD of renewable energy power generation assets. DESNZ pointed out that this type of contract for difference scheme may increase the risk of power generators taking advantage of the rules to profit and may distort the market.

In order to design optimal CfD arrangements, the UK Government is currently in discussions about the remaining issues and will need to consider the implications for other reformed market rules.

The UK government wants to deploy a number of gas-fired generators to provide back-up capacity in the short term. Gas generation is currently the largest source of electricity in the UK, accounting for over a third of all generation. The consultation document suggests that extra gas capacity is needed to make sure the electricity system continues to operate securely and reliably.

Gas power generation technology is very mature and able to provide continuous flexible capacity, and it is a low carbon plant type. The UK government said that the UK needs to have 22GW-28GW gas turbine units by 2035, that is to say, at least 5GW of natural gas standby units need to be newly built or renovated.

The UK government has required new gas-fired power plants to be net zero-ready, with carbon capture, utilisation and storage (CCUS) and hydrogen-ready technology, enabling them to participate in the Capacity Market in the future.

The current consultation phase will close on 7 May 2024, and the UK government expects to complete the new policy framework by mid-2025.

Recommended reading:

• UK to launch new electricity reforms to tackle soaring gas prices

• [New trends in power reform in the UK:Marginal pricing at disputed nodes](