Electricity markets under pressure

June 22, 2020


The Coronavirus has challenged all sectors of the UK economy, and electricity markets have been no exception. Electricity demand is down by as much as 20%, causing periods of negative electricity prices and unprecedented strain on the Electricity System Operator (ESO), run by National Grid. The ESO is responsible for ensuring that the system can respond to lightning strikes and faults at power stations, and that power lines don’t become overloaded. To do this, the ESO takes “balancing actions”, paying to turn down some generators and paying to turn up others. Lower demand has contributed to a record market share for renewables such as wind and solar, but the cost of balancing the system has skyrocketed. National Grid ESO is forecasting a near £500m increase in system balancing costs for the four summer months compared to last year. These costs will feed through to electricity bills, raising questions over how the electricity market should be reformed in anticipation of an even higher market share for renewable energy. With offshore wind capacity due to double by 2025 and to quadruple by 2030, now is the time to consider further reform of the UK’s electricity markets.

The ESO has traditionally relied on large gas power stations to balance the electricity system. When demand is low, such as during the Coronavirus lockdown, fewer large power stations operate, limiting the options available to the System Operator and increasing the costs of balancing the system. This summer, National Grid ESO has taken extraordinary actions to keep the system operating safely, including paying a nuclear power station to reduce output and taking emergency powers to allow the ESO to disconnect small-scale wind and solar farms. Importantly, there is no suggestion that periods of low demand cannot be managed, just that they lead to higher system balancing costs.

The recent increase in system balancing costs is not entirely due to the Coronavirus. Rising levels of generation from renewables, especially offshore wind farms, was already expected to lead to higher costs in summer 2020 compared to 2019. The question for the electricity sector is whether the exceptional costs this summer will become the norm as more offshore wind farms connect to the system. The UK’s abundant renewable energy resources, and falling costs for wind and solar, should be putting downward pressure on electricity bills. Without further market reform, there is a risk that higher balancing costs become standard and that customers don’t fully benefit from cheap, low-carbon renewables.

Further reforms are needed to the UK’s electricity market

The UK’s Electricity Market Reform (EMR) programme in 2013 made great steps forward for the UK’s electricity market. Between 2013 and 2018, carbon emissions from the electricity sector fell over 50%, whilst the lights stayed on and costs did not rise excessively. However, EMR left large parts of the market unreformed, particularly the wholesale electricity market. As wind and solar power continue to increase, this will need to change. There will be more times and more places where there is an abundance or even oversupply of cheap, low-carbon electricity and more times when electricity supply is stretched. The challenge for the Government is to encourage customers to respond to these changing conditions and to reward the deployment of new flexible technologies such as long-term energy storage, demand-side response, biomass, carbon capture and storage, and hydrogen.

The ESO has already committed to having the capability to operate a zero-carbon electricity system by 2025, meaning that the system should increasingly operate with only wind, solar, biomass and nuclear generators. This should put downward pressure on system balancing costs as gas power plants will no longer need to run to keep the system stable. The ESO has started a second phase of its “Stability Pathfinder”, which will harness new technologies and processes to allow the system to operate safely with higher levels of renewables generation. However, changes to market design are still needed to support the work of the System Operator.

In 2016, Policy Exchange advocated for changes to the UK’s electricity markets in our paper, Power 2.0. We argued for policies to support the rollout of battery storage, increased market participation for demand-side response, and reform to system balancing markets. Many of these recommendations have since been implemented. As we wait for the Energy White Paper, we are researching further reforms to the UK’s electricity markets, particularly the potential for locational pricing and the role of the Capacity Market in a low-carbon electricity system. With the right reforms, the Government can ensure that the UK continues towards a smarter, cheaper, and greener electricity system.

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