Second REMA consultation – moving closer to market reform

Yesterday the government published its long heralded second consultation on the Review of Electricity Market Arrangements (REMA). Key headlines will focus on further considerations of zonal pricing and the government’s press comments which placed a heavy emphasis on unabated gas generation.

This article provides a deeper dive into the consultation, including what key options remain on the table for market reform.

The four horsemen of the electricity market

The consultation is structured around four challenges facing electricity markets:

1. Passing through the value of a renewables-based system to consumers.
   
   
2. Investing to create a renewables-based system at pace.
   
   
3. Transitioning away from an unabated gas-based system to a flexible, resilient, decarbonised electricity system.
   
   
4. Operating and optimising a renewables-based system, cost-effectively.

We have summarised the key preferred proposals and remaining options, as illustrated in the figure below.

 

(Source: DESNZ, REMA Second Consultation Document)

Challenge 1: Passing through the value of a renewables-based system to consumers

• Single wholesale market: As alluded to in the months prior to the consultation’s publication, the government’s preferred approach is to maintain a single wholesale market for electricity and gas. The second consultation discounts a split market approach and a green power pool, citing these as novel options which would cause market uncertainty. A unified market for all technologies will be accompanied by a ‘future-proofed’ Contract for Difference (“CfD”) type support mechanism. The logic being that a CfD mechanism effectively decouples gas and electricity prices by supporting an increasing proportion of isolated renewable electricity generation.

• Corporate power purchase agreements (“CPPAs”): Following the first consultation, DESNZ considered if the government could help stimulate the CPPA market, including options such as standardised contracts, but has now concluded no intervention is needed given the current ‘early’ stage of the CPPA market. DESNZ will continue to monitor barriers to entry and are interested in views on: (i) the role CPPAs could play in supporting existing renewable projects entering their merchant tail and (ii) impacts of a larger corporate stake on the spread across consumers of the risks and benefits of variable power. Given increasing scrutiny of corporate sustainability credentials, it may prove difficult for large corporate offtakers to support merchant tails from a true additionality perspective.

• Demand reduction: DESNZ’s central view on demand reduction is that it is best addressed outside upstream electricity markets through wider government energy efficiency policies. The consultation does note however that more effective locational signals (see Challenge 4 below) could incentivise demand reduction.

Challenge 2: Investing to create a renewables-based system at pace

• Future-proofing CfDs: Complementing the ongoing CfD AR7 consultation, REMA is taking a longer-term view of how the CfD scheme will need to evolve. DESNZ has not put forward a preferred version of the future CfD in this consultation, but they have ruled out a CfD with a strike price range and a CfD with a revenue and cap floor.

Options which remain on the table for more detailed consideration include deemed payments or capacity payments which would pay for a CfD asset’s potential to generate or installed capacity respectively. This would mean that subsidy payments would be separate from an asset’s actual generation and activity in the market. Determining the deeming methodology and how it would work in a locational pricing scenario will be critical and the consultation proposes several options for stakeholders to consider.

Alongside the above payment structure reform, DESNZ is continuing to consider partial CfD payments and CfD price reference reform, for example a hybrid reference price that uses a longer reference price e.g. month-ahead in combination with a day-ahead price.

Challenge 3: Transitioning away from an unabated gas-based system to a flexible, resilient, decarbonised electricity system

• Optimised Capacity Market (“CM”): DESNZ proposes to maintain the CM as the primary scheme for supporting the deployment of low carbon flexibility. The ‘Optimised CM’ proposes introducing a minimum procurement target for desirable characteristics (known as ‘minima’) into the auction process. DESNZ has discounted split technology auctions and a single auction with multipliers. Further work is underway on developing the minima and DESNZ is seeking views on the same. The consultation also states that while government remains committed to introducing lower emission limits, this requires further consideration and will not be until the 2026 CM auctions at the earliest.
  
  
• New gas generation: The headline press release item from the consultation is framed as ‘breaking news’ but is more a reiterated view from government that a limited amount of new build gas capacity will be required into the 2030s. This is intended to complement the scaling up of power with carbon capture, usage and storage, hydrogen to power and long duration energy storage, all technologies which are subject to separate ongoing consultations. DESNZ is seeking views on the challenges in converting existing unabated gas plants to low carbon alternatives.

Challenge 4: Operating and optimising a renewables-based system, cost-effectively

• Locational pricing and national pricing ‘plus’: DESNZ have decided to continue to assess locational pricing, specifically in the form of zonal pricing and discount nodal pricing as an option.

Perhaps overlooked is that REMA will also continue to look at alternative options for sending locational signals under a national pricing scenario such as reviewing the locational elements of TNUoS charges as part of ongoing networking charging reform. Other options also include reviewing ‘firm’ access rights to the transmission network, expanding measures for constraint management and optimising the use of cross-border interconnectors. The consultation however effectively discounts introducing a locational element to the CM or the CfD allocation process.

• Shorter settlement periods: DESNZ will continue to consider shorter than 30 minute settlement periods such as 5 or 15 minute settlement periods, but shortening Gate Closure has been discounted as an option. A shorter settlement period would enable more flexible assets to participate in the wholesale market, which would be positive news for batteries.
  
  
• Centralised dispatch and a reformed Balancing Mechanism (BM): The ESO is currently assessing the case for reform to dispatch arrangements and will be publishing results in Spring 2024. DESNZ will therefore continue to consider different options for central dispatch going forward. The consultation highlights a ‘self-commit’ option where generators self-schedule their own units, the system operator issues dispatch instructions and generators are then compensated for deviations from their scheduled positions. This model could be adopted in both national and zonal pricing scenarios.

The consultation also highlighted that further work is necessary to reform the BM to address barriers such as: skip rate and dispatch transparency, improving baselining methodologies for Demand Side Response, simplification to improve revenue stacking, lowering participation thresholds and introducing closer to real time procurement. The ESO is already alive to these issues but battery operators in particular will welcome a co-ordinated approach and emphasis from DESNZ as well.

• Ancillary services: As part of system operability reform, REMA is continuing to assess (i) barriers to the provision of ancillary services from assets co-located with renewable generation and (ii) how to align ‘longer term’ ancillary service contracts with CfD and CM auctions to provide more revenue visibility to service providers. These would both be positive steps in promoting investment in low carbon ancillary services, and in turn a more flexible grid.

What’s next?

Zonal pricing or maintaining national pricing coupled with other means to sharpen locational signals will continue to dominate REMA discussions in the months ahead. Reforms to CfDs, the CM and centralised dispatch options however should not be overlooked, particularly given the level of detail in the consultation document that is open for stakeholders to engage with.

The consultation is seeking views on its specific proposals, the short-list of remaining options and options compatibility i.e. DESNZ’s initial assessment of how the remaining options could interact with one another. The consultation is open until 7 May 2024. DESNZ expects to provide a summary of responses in summer 2024 and conclude policy development by mid-2025 with ‘full-scale’ implementation from 2025 onwards, or earlier where possible. This consultation could therefore be the final opportunity for stakeholders to engage with a definitive redesign of the GB electricity system.

If you have any questions on the second REMA consultation and what it might mean for you please contact Shraiya Thapa, knowledge lead for our  Clean Energy Waste & Sustainability team.