The Review of the Electricity Market Arrangements (REMA) is underway, and DESNEZ recently reported back following the first industry consultation on setting out the scope.

In a nutshell, REMA seeks to put in place the rules necessary to deal with the changes in the electricity world to deal with an ever-growing amount of renewable generation to deliver net zero

The changing face of the electricity market is such that the rules that underpin it won’t work effectively in a more renewable dominated market of the future. There is a compelling need to do something to make the market more effective, although as with all change there are many ways of achieving the outcome (and different views on what the outcome should be).

The stated objective for the changes is ‘𝒕𝒐 𝒆𝒏𝒔𝒖𝒓𝒆 𝒕𝒉𝒂𝒕 𝒊𝒕 𝒊𝒔 𝒇𝒊𝒕 𝒇𝒐𝒓 𝒕𝒉𝒆 𝒑𝒖𝒓𝒑𝒐𝒔𝒆 𝒐𝒇 𝒎𝒂𝒊𝒏𝒕𝒂𝒊𝒏𝒊𝒏𝒈 𝒆𝒏𝒆𝒓𝒈𝒚 𝒔𝒆𝒄𝒖𝒓𝒊𝒕𝒚 𝒂𝒏𝒅 𝒂𝒇𝒇𝒐𝒓𝒅𝒂𝒃𝒊𝒍𝒊𝒕𝒚 𝒇𝒐𝒓 𝒄𝒐𝒏𝒔𝒖𝒎𝒆𝒓𝒔 𝒂𝒔 𝒕𝒉𝒆 𝒆𝒍𝒆𝒄𝒕𝒓𝒊𝒄𝒊𝒕𝒚 𝒔𝒆𝒄𝒕𝒐𝒓 𝒅𝒆𝒄𝒂𝒓𝒃𝒐𝒏𝒊𝒔𝒆𝒔.’

A noble desire, and one that is inherently difficult and will involve trade offs that politicians and regulators have avoided for much of the past 20 years (and have so far avoided in laying out the vision for what REMA needs to achieve).

Following the government’s consultation, the majority of feedback appears to favour evolution – as may be expected by incumbents, but will that satisfy those looking for something bigger, faster and more all-encompassing?

𝐓𝐡𝐞 𝐜𝐚𝐬𝐞 𝐟𝐨𝐫 𝐜𝐡𝐚𝐧𝐠𝐞 

The current market rules were put in place in 2001 when the physical make-up of the market was very different than today. The changes illustrate the underlying need for some kind of reform.

𝟐𝟎𝟎𝟏

𝐆𝐞𝐧𝐞𝐫𝐚𝐭𝐢𝐨𝐧 was dominated by few large generation units, split between coal, gas and nuclear in broadly equal portion

𝐃𝐞𝐦𝐚𝐧𝐝 was broadly passive. The supply market had already been fully deregulated so consumers of all sizes could choose a supplier of their choice, but their ability to actively engage with the market was almost zero.

𝐅𝐚𝐬𝐭 𝐟𝐨𝐫𝐰𝐚𝐫𝐝 𝐭𝐨 𝐭𝐨𝐝𝐚𝐲...

𝐆𝐞𝐧𝐞𝐫𝐚𝐭𝐢𝐨𝐧 – the largest share in 2022 was gas with 39% , but nuclear has reduced to 16%, renewables makes up 39% and coal a mere 4%

𝐃𝐞𝐦𝐚𝐧𝐝 – at the end of 2022 there were nearly 700,000 electric vehicles on the road, 1.2 million rooftops with solar panels, 280,000 heat pumps and a growing level distributed generation and demand side participation in the wholesale market.

𝐌𝐚𝐫𝐤𝐞𝐭 𝐈𝐦𝐩𝐚𝐜𝐭𝐬

The stresses and impacts of the changing face of the physical market are shown in the way the electricity market itself is acting:

1. 𝐓𝐡𝐞 𝐦𝐚𝐫𝐤𝐞𝐭 𝐩𝐫𝐢𝐜𝐢𝐧𝐠 𝐦𝐞𝐜𝐡𝐚𝐧𝐢𝐬𝐦 𝐢𝐬 𝐛𝐞𝐢𝐧𝐠 𝐜𝐫𝐢𝐭𝐢𝐜𝐢𝐬𝐞𝐝

Like many markets, electricity pricing at a wholesale level is based on an implicit marginal pricing regime. That is to say that as supply and demand must be matched in real time, the price is set by the most expensive generation at that point, providing potentially large returns to other generators.

In a market with a growing share of near zero marginal price renewables, but where price is notionally set by gas this is a bad look for some. Consumers that are underwriting the renewable schemes are not benefitting from their current relative cost-effectiveness goes the cry.

The reality is more complex, and is more about badly designed subsidy schemes than anything else. However, it is popular, and speaks to splitting the market into renewable/ non-renewable and also to send signals to generators to locate in the ‘right’ place for the network.

This is a complex and sometimes emotive subject, but one that is likely to be at the heart of any REMA change.

Any change made here will impact every generator and consumer in one way or another, whether they have a long or short-term contract in place.

2. 𝐋𝐢𝐪𝐮𝐢𝐝𝐢𝐭𝐲 𝐢𝐬 𝐟𝐚𝐥𝐥𝐢𝐧𝐠

Virtually all generation is now in receipt of some form of subsidy payment to underwrite its operation. This is reducing the importance of pure energy income, and also the term over which volumes can be fixed.

CfD generators are unlikely to ever sell more than 1 season (or even 1 day in the case of solar and wind) into the future as that is how their contracts work. Fossil fuel generators cannot be sure of how they will operate in the long run as they are increasingly marginalised by renewables, so have very limited ability to sell long-term hedges.

The drop in OTC liquidity shown in the graph below (Ofgem sourced) shows the falling trend in liquidity even accounting for Covid and the Ukraine impact on the levels of collateral required to trade. Overall market churn is no at less than 2 * physical demand, down from 3 /4 times only a few years’ ago.