How To Fix The Broken Electricity Market
By Paul Homewood
The UK’s electricity market is well and truly broken.
We have seen how wholesale prices of electricity have rocketed in the last year, on the back of equally drastic rises in the international price of gas:
https://www.ofgem.gov.uk/energy-data-and-research/data-portal/wholesale-market-indicators
Year-ahead wholesale prices are now running at £375/MWh, and winter prices are even higher:
https://www.catalyst-commercial.co.uk/
However gas generation only accounts for only about a third of the UK’s electricity, so in an ideal world electricity prices should be largely cushioned from spikes in gas prices.
Unfortunately though, the electricity market does not work like that. The National Grid sum it up:
https://www.nationalgrideso.com/electricity-explained/how-electricity-priced
And this wholesale price is set by the last source of supply to meet demand, which is usually gas, or sometimes even more expensive coal power. This means that all electricity generators benefit from the high price.
It is true that those generators covered by Contracts for Difference have to repay the difference between the price earned and the CfD price, but these only produce about 20 TWh a year, 6% of the total.
The electricity market trading system dates back to the late 1990s, and you will note that the same system is adopted across the EU. (Some countries do not appear on the National Pricing list, but they are in the Regional Pricing structure instead).
The government has announced a review into the design of the electricity market – see here– but I suspect this will be a long winded affair, and dogged by vested interests. It will certainly not address the current problems facing energy consumers.
But there is short term, emergency action the government could take, which should include the following:
1) One of the most egregious scandals of the current market mechanism is that generators trading under the Renewable Obligation system not only benefit from these record high wholesale prices, but still receive massive subsidies funded via electricity bills and estimated to cost £6.6bn this year.
These schemes account for 80 TWh a year, a quarter of all generation.
Intermittent wind and solar account for 54 TWh of this. However their intermittency means wind and solar power have less value intrinsically, and therefore should not be allowed to participate in the electricity market. Instead they should be paid on a Feed-in Tariff basis, as smaller wind and solar farms already are.
I would suggest an FIT price of £20/MWh for this, which reflects historical wholesale prices prior to 2020, discounted to allow for the costs of intermittency imposed on the grid.
With 12-month forward wholesale prices now at £375/MWh, this could save consumers £19bn a year.
Generators would, of course, be allowed to retain their ROC subsidies.
2) The other main recipient of ROC subsidy is biomass, mainly Drax. As these generators are dispatchable, it would not be appropriate to switch them to FITs. Effort should however be put into switching these contracts over to the CfDs already employed at a third unit at Drax, which is paid £126/MWh this year.
Much of Drax’s output has been sold on forward contracts, so they have not yet fully benefitted from high market prices. A switch to CfD might be attractive to Drax, as it gives them long term security, while at the same time protecting consumers from gas price spikes in future.
If they refuse, I am sure there are plenty of threats to their long term business plans that could be employed!
3) Nuclear and other non-gas generators, such as coal and hydro, also benefit hugely from current wholesale prices. These account for about 60 TWh.
The same Drax approach could be used, with CfDs offered. A reasonable, guaranteed price, say around £100/MWh, would certainly be tempting for ageing nuclear plants. And any offers to coal power plants would have to come with an extended life guarantee, beyond the mandated shutdown in a couple of years time, which would make it worthwhile to them.
4) Finally, the UK Carbon Pricing system must be immediately suspended, as this artificially raises the cost of gas and coal generation.
All of these actions could save consumers in the region of £40 billion a year, about £1500 per household, a similar amount to the anticipated rise in the upcoming Energy Price cap.
This saving is based on a wholesale price of £375/MWh.
But even a lower assumption of £300/MWh would still generate savings of around £30 billion.
Comments are closed.
NOT A LOT OF PEOPLE KNOW THAT 
Government management of the electricity market has made a mess.
A new government scheme for managing the electricity market is not the answer.
The answer is for the government to butt out.
Ahhh . . . but government doesn’t butt out.
So y’all are screwed, blued, and tattooed.
Not correct. Most electricity is sold directly from generator to retailer or the large private users who buy at a whole sale level. a long term contract
What is sold through the energy market is the spot price for the retailers to top up their existing large contracts as electricity has to be made and used effectively the same time. This is a rules based trading exchange
Not too different to say the LME or London Metal Exchange but of course thats a physical product but can be bought in bulk ahead of time or ‘traded on the day’
No it isn’t. All suppliers pay the same price. You are confusing hedging with energy costs. Suppliers ( ie billing, customer services companies) hedge their exposure to the market by buying Cfds , but those financial instruments can be from anyone selling them, financial institutions as well as electricity companies ( who may own generation).
Paul is suggesting that generators , who sell Cfd’s to hedge their exposure to the market, are encouraged by government to sell cfd’s at certain strike prices, which the suppliers will be encouraged to buy.
With this is , by contract , you are re-introducing the old Bulk Supply Tariff, whereby the CEGB ‘sold’ its output to the Regional Electricity Boards.
I don’t see how you can do this without primary legislation. and without many legal actions!
Most electricity sales are more in the nature of framework contracts that guarantee offtake with pricing often decided on a rather different prompt basis. This is even more true in our current volatile markets, where the OFGEM cap has been blown apart by the lack of longer term fixed price sales to provide hedges.
If you are a nuclear generator you might have been very happy with profits made by selling at say £100/MWh, but if your plant has to shut down with problems then buying back those contracts at £400/MWh doesn’t look so clever. Same with wind farms. Pricing moves to a prompt basis.
Duker, I can see where the term market could be just retail sales. I should have said electricity business, to cover all aspects. The electricity business in UK is certainly not laissez-faire; it is highly regulated.
The solution to bad regulation is not new, improved, regulation II.
The question is do the politicians really care about high electricity costs? As they aren’t facing an election soon, nor have any understanding of the current mess but will be reluctant to admit they (collectively) have made a stuff up, and be pressured by various “interests” to do nothing, I think not.
I suppose they reckon death by electrocution is less likely. But if the cable isn’t carrying electricity perhaps it has a different use.
European politicians don’t seem to care about anything that is actually beneficial for the population; just look at all the regulations, outright bans and extortionate taxes (existing and threatened). They are sitting on a time bomb for record levels of unemployment
The chart for Natural Gas would benefit from being updated to more current prices. UK NG Futures for Sept. are near £5 per therm (Dec, futures: £6.40 )
Let’s not forget that, no so long ago, before the Genius Beloved Leaders had decided that Coal was SO 20th Century, Electricity was £25-£30 per MW/h.
And storing energy meant a big heap of coal which could be reclaimed easily rain, hail, snow or blow.
History.
Obviously, what we don’t need is “Solutions” that were never going to work, for a problem that almost certainly doesn’t exist.
I suggest that Lord Deben, Zak Goldsmith, Prince Chuckles, Tim Yeo, Boris, Theresa May, Dave Boy, Potato Ed Davey, Ed Miliband, Bliar, Gordon, Lucas, Veggie Benn, Dale Vince, him running Octopus and hundreds more should be chained to bicycle dynamo generators for the rest of their worthless lives.
It would be more entertaining than anything now on telly.
” And storing energy meant a big heap of coal which could be reclaimed easily rain, hail, snow or blow. ”
A big heap at the power station that could last for months, although the calorific value does fall over time.
Surely the global warming/climate change campaigners would say that high gas and electricity (from non renewable sources) prices are just what is needed to reduce consumption?
That is the real issue. They want high prices to force through net zero.
There are a large number of ways of “fixing” the electricity market but first you have to make two key decisions.
1. Do you want a market at all? The ideas proposed here all depend on a variant of a single buyer system – i.e. where electricity producers have contracts with a central buying agency. CfDs are no more than an element of this. However, once you have a single buyer you then have to decide how to organise dispatch – i.e. the existing balancing mechanism becomes the way in which all electricity generation is organised. Also it is difficult to have serious competition in supply once you have a single buyer (and in consequence a single seller). I am not sure whether NG ESO really wants to be a single buyer. In the short run there may be large gains from moving to contracts with a single buyer but in the long run there are all the usual disadvantages of relying on a monopoly.
2. Do you pay for electricity alone? We do – subject to a inept capacity arrangement – but it is downright stupid to do so. Many other parts of the world have learned that you need to pay for availability and electricity separately if you want to promote efficient ways of reconciling wide variations in demand with intermittent supply.
The overriding point is think hard first and learn from the rest of the world rather than just making the existing system worse in a panic. Occasional crises are a regular occurrence around the world and people have learned how to design electricity systems to deal with them – at least better than in the UK. The depressing feature is the sheer parochialism of discussion in the UK – classic Not Invented Here stuff. This mess has been long in the making and is not going to be fixed easily.
“Many other parts of the world have learned that you need to pay for availability and electricity separately”
Many? Examples?
In the U.S., large utility customers do indeed pay a demand charge, which can be quite large. They do get in return a guarantee that the power will be available. My factory in Richmond, VA, had a power outage ~1985, for which we we were reimbursed a million dollars by the power company.
Residential customers pay no such fees.
Arrangements I find reasonable.
” Residential customers pay no such fees. ”
As a residential customer I pay a “facility charge” of $25.50 per month and an “energy delivered” cost of $0.0982 per kwh. A minimum monthly charge is $30.50.
The utility’s web site shows how many (there are other schedules) customers pay what. I have no idea how many other utilities do it this way.
The electricity is provided via the Bonniville Power Authority from many generators, with much hydro.
Interesting. I haven’t seen that in the southeast.
John, let me not assume. Can you reduce the charge by lowering your peak consumption?
If you can’t lower your charge by reducing your peak, it’s not a demand charge. Just a hook up fee.
“However gas generation only accounts for only about a third of the UK’s electricity, so in an ideal world electricity prices should be largely cushioned from spikes in gas prices.”
A properly functioning market will seek the opportunity cost of production and consumption. If gas (or coal) is the opportunity cost of electricity production, the market price will be around that level. It doesn’t matter that some producers have lower price, they will take the same market price.
Market design will not change this. Plus, corporate governance measures will not tolerate market trades being entered into at a significant premium (for purchasers) or discount (for sellers) from the market price.
NETA/BETTA was supposed to remedy the same complaint about marginal pricing used in the earlier Pooling arrangements. It was argued that the market clearing by bilateral trades (“pay as bid”) would reduce average prices because the average is lower than the marginal price of the most expensive producer.
It didn’t happen. NETA/BETTA does the same as any market, and clearing sets price by “discovering” the opportunity cost.
But here we are again, running the same mistaken arguments from misunderstandings of market clearing. What is it they say about doing the same thing and expecting it to be different this time?
Exactly.
Central planning, nationalised industry OR market. And if its market it WILL clear at the marginal price.
But like every market it is surrounded by financial instruments, mostly cfd’s. But cfd’s can vary in type and can vary in strike price. Basically Paul is suggesting government imposes two or three strike prices for all cfd’s across the market determined by generation type. Its the reinvention of the Bulk Supply Tariff.
This would require a very strong government and primary legislation with no doubt a lot of legal actions. Determining the strike prices by High Court ruling?
If you interfere in markets with taxes and quotas, oligopolies and monopolies you will get a suboptimal outcome most of the time.
Commodities are generally priced thus. The producer at the highest point on the cost curve that satisfies demand sets the price. Bilateral trading never changes that. You solve this problem in the energy market by having alternative marginal generation that avoids price spikes in single fuels – and by not artificially restricting supply of any fuel. And by not locking down economies for months of course.
“However gas generation only accounts for only about a third of the UK’s electricity”
No
Past yr = 42% gas
Past mth = 54% gas
Past wk = 53% gas
Past day = 66% gas
see – https://grid.iamkate.com/
Paul: I don’t believe that anybody in government or any civil servant at BEIS has a clue and will understand what you are proposing.
Government and the Civil Service were solving a different problem – how to get investment in renewables. But as ever, solving any problem other than getting consumers the best deal possible ends up costing consumers. That governments and civil services refuse to learn this lesson is the tragedy that keeps causing us disaster.
I agree Phoenix. The switch away from coal was supposed to be the low-hanging-fruit of decarbonisation. With tedious predictability, people supported it on the belief that it was “doing good” and somebody else would pay for it.
The price of this low-hanging-fruit is now revealed in the form of energy bills heading towards £4k per year. With tedious predictability, a witch hunt is underway, looking for somebody else to blame and pay for it.
This witch hunt means people are not learning the hard lessons. If the low-hanging-fruit is so expensive, just think of the cost of the hard-to-reach-fruit. But that’s not the discussion we are having. The focus is shifted onto punishing energy producers for being profitable when their products are in short supply.
To achieve stability in the UK domestic energy market:
Defeat Russia
Build coal-fired power stations
Throw money at fusion power.
Russia is a red herring.
Not a red herring but “defeat” is the wrong verb. We need to be on friendly terms with Russia, but it is difficult to be friends with a thug. I think Putin now has too long a rap sheet for a real rapprochement with the West, so it will be up to the next leader, whenever they eventually take over, to thaw things. Whether they choose to do so is another matter.
” Not a red herring but “defeat” is the wrong verb. ”
The war in the Ukraine is a proxy war between the West and Russia; it will end in defeat for Russia, defeat for the West or a negotiated peace. My preference is for the defeat and dismantling of Russia; other contributors may have differing views.
Foremost, broker peace with Russia, stop the deliberate boomerang sanctions that hurt us more, and start fracking on a war-footing (not literally, but maximum facilitation.)
UK standing charges are doubling. In the summer the standing charge can be more than the energy usage charge. In Winter it adds significantly to the overall charge. Along with climate change charge then vat is added to the total.
The standing charge was to pay for operating costs mainly people to read the meters. Now we have smart meters that should be a huge saving to operators. Except for the cost of installing new smart meters.
But the huge increase in the standing charge is to pay for the energy companies that went bust and the operating costs in taking over these companies.
The bust energy companies were approved by Ofgem the government energy regulator. The government paid millions in advertising to get people to switch to these new low cost energy suppliers. Ofgem should have done proper due diligence on these poorly financed energy suppliers.
Normally when a company goes bust it is the creditors and investors that lose money. But Ofgem is making the public pick up the bill for the bust companies by increasing the standing charge.
Investors have lost their money, as have many creditors. That’s then the limit, as we have limited liability. The “losses” being paid by consumers are essentially the cost of what consumers have used, nothing more. The problem is the price cap and the utter irresponsibility of Ofgem to fail to ensure distributors had the financial wherewithal to withstand price spikes.
How did we get here?
Europe’s Gas Price Is Now Equivalent To $410 Per Barrel Of Oil
Aug 20, 2022
https://oilprice.com/Energy/Natural-Gas/Europes-Gas-Price-Is-Now-Equivalent-To-410-Per-Barrel-Of-Oil.html
Make that $500 per barrel now!
When I worked in the industry 20 years or so ago, our gas contracts were priced against the oil prices.
” How did we get here? ”
Incompetence and greed.
This is a large and complex issue. we leave it to Government and they in turn largely pass the buck to Ofgem. Ofgem seem clueless and ineffective at doing anything beneficial for the consumer. Costs of the system seem far to high. – Ofgem set these. We are paying for failures of suppliers that Ofgem approved. We have a energy supply deficit – we need more supply of gas and electricity. Fracking helps solve Gas supply and more power stations of any type help solve the electricity supply constraint. Net Zero was a dumb idea without a solid plan on how to achieve. This goes back to Milllerband and May times who between then had no clue of how or what is energy.
Ofgem used to be relatively good, when its clear mandate was to simulate a market for the good of consumers. But then Labour came along and the whole thing went to hell. And as with so many things, the Tories have completely failed to reset that.
OFGEM was entirely a Labour creation when they merged OFFER and OFGAS. It gave them the opportunity to create a different ethos. I have suggested that their responsibilities be moved mostly elsewhere, and restoration of an exclusive consumer interest mandate.
If anything comes out of the mess that we are in, it should be the demise of OFGEM, led by the writer of the climate change act, Johnathan Brearley. That organisation has totally failed to protect domestic consumers interests in its pursuit of net zero. In fact its basic incompetence in approving financially inadequate suppliers is now reflected in the doubling of the standard charge of electricity. Brearley freely admitted they increased the standing charge “to get their money back” (the costs of the bail out) and then claimed they had done a “good job” as no one had lost power.
Does he not realise that this action, puts the burden on the poor people, that the government is now giving grants to. A much simpler system would be to base price of domestic electricity on amount used. The average home (on which the cap is based) uses 10kWh per day, so charge the first 10kWh at £x per kW, then £2x for the next 10kWh and then £3x for the next, it should be possible to reduce the standing charge to £0. No need for the expensive and useless smart meters.
Seconded.
OFGEM has not been fit for purpose since it exceeded its original remit by pushing renewables.
I already told OFGEM not to implement the increased standing charge some of which is actually the result of switching charging for some network costs from a per kWh basis, which obviously hits smaller users hardest. I also pointed out that the beneficiaries of the fly by night companies who went broke were their customers on artificially low tariffs, who should therefore take more of the rap, rather than customers who avoided companies who OFGEM never should have authorised. Consultations provide excellent opportunities to tell home truths.
Whilst I can agree with the structure, it is the very fact that most people now have smart meters that should enable such a scheme.
Let’s get the smart meters earning their salt, they’ve anything but smart up to now.
I can’t pretend to understand the electricity market, let alone what pulls and pushes costs to the end users.
But yet again this morning the ‘experts’ on the BBC were saying wind and solar are cheap, and more will solve everything; unchallenged.
And yet the cracks are beginning to open up. Last week Dieter Helm was allowed to mention “intermittency” on R4. On Newsnight 11th August Malcolm ?Grimston? was able to talk about the lack of investment in “firm” capacity.
What I have not yet heard is a talking head on the BBC saying that the pivot to solar and wind was a reckless gamble (widely perceived as such by sceptics but as a no-brainer in most quarters), and that governments for the past 20 years are entirely to blame for the present crisis.
Good to hear, but seems like a rarity.
R4 this morning saying that covering quality farmland with solar panels makes no sense for food security reasons. More cracks appearing on BBC.
The games theory, that is at the heart of the balancing mechanism, that sets the marginal cost price is leveraged to make maximum money for the suppliers of electricity, in times of shortage the price will rise theoretically to infinity, a supplier with banks of Diesel generators or batteries will judge when to jump in and provide electricity (They also get something like 8% return on capital from National Grid on the investment.) It is a fact that in times of shortage they can make more money. National Grid encourage this and also have STOR (short term operating reserve) that is all the 50kW+ emergency generators at hospitals, airports etc can be started automatically to provide electricity. Whatever happened to reliable and affordable electricity?
The climate change act has to be repealed, it is driving the madness of net zero.
The main argument for replacing the pool was that large players with a portfolio of assets across the merit curve were able to game the system e.g. by late withdrawal of a marginal cost generator, forcing the use of higher cost generators and thus forcing up pool prices. The pool did have a capacity element to prices related to loss of load probability. NETA and its extension to Scotland under BETTA had no capacity element to pricing, and bizarre dispatch rules that favoured the most expensive renewables while also compensating curtailment. More bizarre dispatch rules were later included in CFDs.
EMR added CFDs and the Capacity Mechanism and the carbon floor price and the ban on new coal (and an effective ban on sensible nuclear has been in place since the ONR was established) to the mix which have been manipulated by BEIS to favour renewables and make other generation unprofitable to invest. Because of this and the fact that the capacity mechanism over credits renewables and interconnectors we now have a capacity shortage.
Alongside the impact in prices for power in the Balancing Mechanism we have also seen escalating costs for ancillary services for grid stabilisation and emergency backup as these become increasingly provided by high cost batteries.
None of this addresses the current causes of the problem. Gas prices have spiked because of lockdowns, compounded by Russia. That there has been no downward pressure on gas prices in Europe is due to the bans on fracking and traditional exploration. This is a long term policy failure brought to a head by short term extreme events – the response to Covid and a war. Renewables have meant electricity prices have been on a long term upward trend, helped by subsidies, arbitrary taxes on gas and other Green nonsense that have distorted the market. This is another long term policy failure brought into sharp relief by the gas price spike.
If we want lower prices we need plentiful supplies of fuel, no market distortions and fully costed renewables. Instead we have artificially restricted coal and gas supplies, large-scale market interference in prices/costs and some generation that doesn’t bear its full costs. Unsurprisingly we have high prices and very high vulnerability.
This is sadly classic government failure, where running after targets that have nothing to do with what consumers want in the end causes great pain for consumers. Yet again.
“running after targets that have nothing to do with what consumers want”
True, Phoenix. Government makes political decisions, not business decisions. And equally bad, they have no stake in the outcomes. If the business fails, it’s not government’s problem.
The UK Government’s Electricity Market Reform press release (linked in the article) gives an insight into the near mental retardation of those holding the wheel as civilisation veers towards a precipice. Someone needs to explain to them – and very soon – that magic batteries and anti-gravity reservoirs do not exist, and are unlikely to for the foreseeable future.
The purpose of REMA is to try to design a price system that supports the government’s decide pathway to future energy insecurity, instead of letting economics (including uncertainty and security) decide the sensible way forward. It will almost certainly entail ripping up existing CFDs which is why low bids are now completely irrelevant to deciding on the generation portfolio: the game has been to get approval to trough. It will also entail massive under the table subsidies for hydrogen, attempts at storage and wind curtailment, and support mega grid investment. All of which will simply drive prices higher and do nothing to solve our insecurity and lack of dispatchable capacity.
There is an introduction to some of the bonkers ideas being floated here
https://www.current-news.co.uk/blogs/the-reality-of-rema
I am puzzled as to why the standing charge rises with the cost of electricity. Also why it varies from one area to another. Does not work that way with delivering mail.
The main two costs in your standing charges are due operating and maintaining the power networks. They come from National Grid and your distribution company. Total costs are in the £billions, so they have accounted for around 1/4 of your total bill in past years when wholesale costs were lower.
Different distribution companies have different costs, so there is some geographic variation, depending on which distribution zone your are located in.
And different types of customers have different amounts of costs attributed to them (e.g. lower voltage supply involves the use of more assets to step-down from the extra high voltages of transmission), so charges partly depend on your connection.
The losses incurred due to the failure of Supply businesses (the Supplier Of Last Resort scheme) seem to have found their way into standing charges, and that’s one reason why standing charges will have gone up recently.
There are some variable costs in operating the network businesses as they consume a fair amount of fuel and electricity. An example would be fuel consumed in running the vehicles needed to inspect and repair network assets stretching over long distances and off-road locations. Or power consumed in operating electricity substations. These types of costs will have gone up with energy prices.
The network businesses are also fairly constantly replacing spent assets and expanding new networks. This could include connecting new housing estates, connecting new power stations and the like. The cost of these heavy industrial components also vary with energy prices. For example metals and concrete.
The network businesses collect their income through your Supplier, but they do not simply pass their costs onto you. Instead each network business has a 7 year business plan approved by Ofgem. It includes profit and performance elements. The allowed income will make provision for uncontrollable cost changes, and energy costs are likely to be among these.
On the UK gas and power prices, there are some opportunities for adjustments, imho.
We produce 50+% of our gas consumption and the potential to export that gas is relatively limited. Yet we are paying “market prices” for all of the gas we use.
Further, if I understand correctly, the cost of gas effectively sets the UK market price for electricity. Again we have many sources of power which can produce and sell at very much lower prices and did so for many years before this latest catastrophe.
My simple thinking is that there are some linkages which need – deserve – to be broken while this disruption persists:
> We should only pay market prices for gas we buy on the open market, whether that’s LNG or pipeline from Norway. Domestic production could be price-capped at a figure based on, say, the last 5 years pre-pandemic with a generous uplift and tax incentives to invest in more output.
> A similar approach to electricity generation would involve setting a price for all non-gas sources which do not have a set rate via CfDs. In crude terms the producers could be told….”you were happy to supply for years at £XX per MWh; we’re going to give you that plus a %age”. That would include renewables under the ROC system: the market price in previous years (or when contracts were signed) plus their ROC entitlement sets the benchmark for a “reasonable” price.
Obviously this sort of approach cuts across many free-market principles and abrogates contractual rights but this situation is so dire that war-time measures are warranted.