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Electricity market reforms risk inflated costs if investors are left behind, Cornwall Insight warns

The Review of the Electricity Market Arrangements must assess all options, Cornwall Insight said. Image: Getty.

The Review of the Electricity Market Arrangements must assess all options, Cornwall Insight said. Image: Getty.

Protecting investor momentum must be key to the government’s recently announced Review of the Electricity Market Arrangements (REMA), Cornwall Insight has said.

The REMA has a wide remit, which Cornwall Insight said includes not just looking at wholesale market design, but also balancing services, the Capacity Market and the Contracts for Difference (CfD) mechanism.

Current ideas for reform proposed by key stakeholders in the industry include locational pricing, broadening the role of the CfD and splitting the low carbon and dispatchable generation markets, the research and consultancy firm said.

Other suggestions surrounding the CfD to have been made recently include a shift to six monthly auctions, following the change to annual auctions announced earlier this year.

In the case of the CfD, Cornwall Insight said that while expansion and reform is an option, without refinement this may in part defeat the objectives of certain reforms to expose actors to sharper market signals.

Gareth Miller, CEO at Cornwall Insight, said: "In any event, if such risks are left unaddressed, then the cost of capital for investors would increase. This would push up the costs of deployment, reduce investor appetite, slow down investment to achieve energy security and net zero, and ultimately increase consumer bills."

"It is really important that in our haste, we don’t leave investors behind. Without them progress is impossible.”

While Cornwall Insight said there is “real logic” to deeply exploring policy and market design as a response to the changing physical characteristics of the electricity sector, it is essential any reforms to the market are based on more than economic and market theory.

All options should be assessed in the review, including network investment, strategic capacity development and adaptations to existing policy schemes alongside wholesale market reform.

Additionally, the urgency of new investment demanded by the Energy Security Strategy – where the REMA was announced – and how investors price the risk of radical market change are all critical factors.

Indeed, Cornwall Insight said that the cost of capital is one of the biggest variables in the overall costs of transformation, suggesting that changes that are in theory desirable but which in practice create unmanageable investor risks will be self-deflating.

Uncertainty in the overall costs of the transition to net zero pervade, with the Treasury's Net Zero Review highlighting how it is still challenging to forecast due to uncertainty over the technologies that will be used, with this also dependent on policy - although the review said the step change in investment required to reach net zero could provide a boost to the UK’s economy.

Miller pointed to how current investors in the electricity market have calculated their returns based on the existing market rules.

"While they will have accounted for risks from volatile prices coming from variations in demand and supply, they will struggle to quantify or hedge radical changes to market arrangements. In the best-case scenario any reforms, no matter how benign, will require complex changes, including redrafting of legal agreements. Time consuming but doable.

"In the worst-case scenario, we are looking at a significant impact on investment returns, with investors across the board exposed to greater risks to the extent they rely on power prices or other related markets to support returns," he said.

Cornwall Insight's suggestions on what the focus of the REMA needs to be follows Charles Wood, deputy director of policy for Energy UK, referencing the REMA in the most recent Current± Briefings webinar.

During this, he said there’s a need for a holistic look at the balancing markets, the wholesale markets and the Capacity Market to see if they’re fit for purpose and if the quantity of things such as energy storage and demand side response required can be delivered within the existing market framework - suggesting that currently, the answer is no.

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