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Industry cautious about REMA, particularly around nodal pricing

With the GB market set to undergo the largest market design shake-up in a generation, Cornwall Insight has surveyed the audiences of two recent webinars to understand what the market thinks about the upcoming reform and some of the options on the table.

A far-reaching reform

Since its announcement in the Energy Security Strategy back in April, the Review of Electricity Market Arrangements (REMA) has become one of the main discussion points across the energy industry. Launched in July, the REMA consultation is due to close on 10 October 2022, and its results are set to have a profound impact on the energy market.

Cornwall Insight has recently delivered two webinars on REMA. The first one took place on 12 July, and the second on 27 July. While the first webinar presented an overview of the issues under the discussion, the second event – broadcasted after the publication of the REMA consultation on 18 July – offered an opportunity to dissect in detail the key elements of the proposed reform. On both occasions, we asked our audience their opinions on aspects of the proposed reforms.

During our 12 July Financing Net Zero forum, focused on “Unpicking implications of electricity market reform”, we asked our audience “Do you think that the GB electricity market design needs to be reformed?”. The overwhelming majority of respondents suggested that it needs to be drastically reformed, with a further third identifying the need for minor improvements, and only 4% deeming the current market design good as it is.

Caution around LMP

With record high consumer prices aggravated by issues with the current generator planning and dispatch systems, there seems to be a consensus among energy practitioners about the need for market reform. However, not surprisingly, disagreements start to materialise when considering different options.

One of the core issues being debated across the market is the potential move away from GB-wide wholesale electricity prices to costing wholesale prices on a local basis, known as nodal or Locational Marginal Pricing (LMP). While some say this will encourage energy generation to locate to lower cost areas with fewer network constraints, level out the volatile consumer prices, and help ensure smooth dispatch, the majority of our respondents disagreed that this was the best option to proceed with.

There have already been several studies and position papers from different stakeholders in the energy industry on this reform option, some of which are supportive and some of which are not. However, almost all contributions on this model have rightly focused on concerns that such reforms, being reasonably radical, may halt investment in the short-term and damage sunk investments if not handled with care.

Some have gone further and argued that LMP could disrupt the energy market as it transitions, and even potentially disincentivise developers to build in places that are ideally suited to specific technologies. Our survey reveals that more traction is being gained from those who argue that LMP is not the appropriate reform option, despite this being favoured by the Energy System Operator, and recently featured as a possible reform option in an Ofgem positioning paper.

Caution around nodal pricing also emerged during our second event. During the 27 July “Understanding REMA” webinar, we asked our audience “Which pricing mechanism do you think could work best for your organisation?” While 45% of our respondents opted for “too soon to say”, 27% chose “national” and only 15% chose “nodal” and 13% “zonal” (Figure 3).

Evolution of revolution? 

Although LMP theoretically could help to locate new generation more efficiently, leading to optimal dispatch and more efficient transmission network investment, there are evidently concerns that this may not be how it plays out in practice. What is more, with every far-reaching reform there is a real risk of investment hiatus and disruption, or even negative impacts on sunk investments. It is clear that if LMP is an option that is pursued, there will need to be more work done to carry the industry and investors along for the ride, and in particular to convince people that returns will not be adversely impacted on existing projects.

More specifically, there are questions on whether new generation such as nuclear, offshore wind, and carbon capture, utilisation and storage (CCUS) could be economically developed in the most suitable places after the implementation of LMP, noting that location on the electricity system is not the only – or often the primary – driver for where to locate. Other less flexible constraints around planning, space and broader infrastructure, and consumer or supply integration exist for several key low carbon technologies. What is more, LMP would overlay non-locational policy support such as Contracts for Difference (CfDs), designed to help GB reach its net zero goals, leading to the need for reasonably involved changes to existing arrangements.

While the need for reform is certain, and the case for change is widely accepted, it is clear that most industry practitioners would prefer to avoid radical change that doesn’t properly account for practical and pragmatic pre-existing factors – or that doesn’t correctly weight, and thus attempt to mitigate for, possible negative impacts on investments.

This is an excerpt taken from our Industry Essentials (GB) service. If you are interested in learning more about the Industry Essentials (GB) service, please click here.

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