How To Fix the Broken Electricity Market

Spread the love

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:

Year-ahead wholesale prices are now running at £375/MWh, and winter prices are even higher:

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:

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.


August 21, 2022