Customers based in the UK overpaid on energy bills in 2021 to 2022 by around £7 billion which could have been avoided via a “split market” marginal pricing scheme, a report by Carbon Tracker has said.
The report, which was produced in response to a consultation into reforming the power market, indicates that policy measures such as utility hedging obligations for future fuel needs and a reformation to the contracts for difference (CfD) agreements could help reduce energy bills for consumers in the future.
One of investigations within the report explored an alternate marginal pricing scheme where prices are calculated via a “split market”, which separates the pricing of power produced by variable supply of renewables from other sources, as opposed to the marginal pricing design the market currently operates under.
This is something that had been touted as a potential avenue to explore for the UK government. Kwasi Kwarteng stated that consumer bills being set by marginal gas prices was a “problem that needs to be addressed” when speaking at the Aurora Spring Forum in July 2022 in his former role as business and energy secretary.
The government took immediate action with plans to sever the link between renewables, nuclear and gas prices in the new Energy Prices Bill. The Bill set out concrete plans to decouple the cost of low-carbon electricity from that of gas prices through a new temporary Cost-Plus Revenue Limit in England and Wales. This would reduce the impact of the unprecedented wholesale prices on consumers and the taxpayer, the government said.
However, Carbon Brief’s split method allows for a measure of prices that are more reflective of the operating costs of technologies supplying electricity, it said. It could also provide an estimate as to the extent to which global gas market influence can skew UK electricity prices under the current market design, therefore protecting consumers.
Under these market conditions, Carbon Tracker recognised that the savings from this method would have seen total net power procurement expenditure in 2021 and 2022 around £7.2 billion lower. This could have saved the losses witnessed across the UK.
“Our findings show the extent to which the global gas market has over the past two years skewed British power prices to levels unreflective of the technological makeup of today’s generation mix,” said Jonathan Sims, senior analyst at Carbon Tracker and author of the report.
“While continuing with marginal pricing for wholesale power market design is preferable to ensure significant changes do not dent investor confidence in the renewables sector at this crucial juncture, government must protect against any future gas price spikes pulling power market prices up with them.”
Despite this, Carbon Tracker does not recommend putting the split approach into effect as it could threaten goals to achieve a net zero power market by 2035. Instead, the UK should retain the marginal price system but introduce measures, such as utility hedging obligations, which could protect against future gas market price spikes skewing power market prices under this design.
In addition to this, reformation of the CfD agreement for clean technologies could help reduce costs. This could be achieved by removing existing loopholes that allow producers to delay onset agreements which in turn drive up power costs for consumers.
The suggested market reform approach would deliver benefits in terms of reduced consumer vulnerability to volatile gas prices as the UK power market decarbonises, without the major disruption and high upfront policy reform costs associated with migrating to an alternative design.
“A split market, by effectively putting a floor on wholesale prices, removes the price signals needed to deploy the flexible technologies that can ensure the stability of a renewable-based power system,” said Lorenzo Sani, power analyst at Carbon Tracker and report author.
“A net zero power market must provide incentives for the clean technologies that are currently struggling to be profitable: flexibility providers (e.g. battery storage and demand response) will support system stability while electrolysers would take advantage of the low-price periods to produce green hydrogen to be used during cold winter days.”