The Climate Scaremongers: The UK’s Electricity Market Is A Disaster

Nobody can deny that the UK’s electricity market is well and truly broken.

The new energy price cap, set to come into effect next month, will be £3,549 ($4,109) a year, meaning it has tripled since the start of last year. Even more horrific forecasts are being made about next April’s cap.

Year-ahead wholesale power prices, which historically averaged around £50/MWh ($58), reached £375/MWh ($434) at the end of July, and are even higher for this winter. [bold, links added]

This increase has occurred on the back of similarly drastic rises in the international wholesale price of natural gas.

Source: Catalyst Digital Energy

Gas generation accounts for only about a third of the UK’s electricity, so in an ideal world, electricity prices would be largely cushioned from spikes in gas prices.

Unfortunately, the electricity market does not work like that, as the National Grid explains:

‘At the highest level, there is national pricing. This is where there’s one price for electricity across the country at any given moment. For each settlement period in a national wholesale market, the wholesale price of electricity clears as a uniform price across the market’s entire geographical area. In each trading period, this provides a single wholesale price to all market participants – both demand and supply – regardless of their location on the network.’

So all sellers of electricity receive the same wholesale price in each ‘settlement period’, which is half an hour. And that price is set by the ‘last source of supply,’ in other words, the most expensive.

This, under current market conditions, is usually gas-fired generation; or occasionally coal, not because coal is intrinsically expensive, but because it costs a lot to fire up a coal power plant at short notice just for 30 minutes of generation.

Even electricity sold on forward contracts a month or a year ahead is effectively priced at what the spot price is expected to be at the time of sale.

This electricity market system has been in operation since the 1990s and is also used across most of Europe. It all sounds a bit arcane, but what it means is that all generators receive the same high price, even if their costs have not increased in the same way as gas power plants.

In an ideal world, the current wholesale price of £375/MWh ($434) would apply only to a third of the generation that uses gas. The rest would still be supplied at the historic rate of £50/MWh ($58).

It is true that those generators covered by Contracts for Difference (CFD) have to repay the difference between the price earned and the CfD price, but these produce only about 20 TWh a year, six percent of the total.

The government has announced a review into the design of the electricity market – see here – but I suspect this will be a lengthy affair, and dogged by vested interests. It will certainly not address the problems facing energy consumers now.

However, 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 that are estimated to cost £6.6 billion this year.

These schemes account for 80 TWh a year, a quarter of all generations. Intermittent wind and solar account for 54 TWh of this. 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 a 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 potentially save consumers £19 billion 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 Contracts for Difference, already employed at a third unit at Drax, which is being paid £126/MWh this year.

Much of Drax’s output has been sold on forward contracts, so they have not yet fully benefited 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 the 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 aging 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. Guarantees to buy all of their output for, say, the next five years would also be attractive for them.

4) Finally, the UK Carbon Pricing system must be immediately suspended, as this artificially raises the cost of gas and coal generation.

In total, these actions could save consumers in the region of £40 billion a year, about £1,500 per household, a similar amount to the latest 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.

The renewable lobby would doubtlessly kick up a fuss, as it is renewable generators that are profiteering most from our broken system. But they must be faced down.

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