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Ofgem proposes reform to electricity wholesale market amid high gas prices

Separating wholesale electricity prices from gas has been raised repeatedly in recent months, as gas price volatility continues to push up bills. Image: Getty.

Separating wholesale electricity prices from gas has been raised repeatedly in recent months, as gas price volatility continues to push up bills. Image: Getty.

Ofgem is eying a range of reforms to help accelerate the green energy transition in Britain, including decoupling the wholesale gas and power prices.

The regulator has set out two key areas of potential reform in a new discussion paper, Net Zero Britain, in an effort to make sure the system is geared to take advantage of the lowest-cost forms of generation.

“Record gas prices are driving the cost-of-living crisis, causing real harm to customers and the wider economy,” said Jonathan Brearley, chief executive of Ofgem.

“As well as doing everything we can to protect customers now, we must diversify Britain’s energy supplies away from gas as soon as possible. Recent months have demonstrated that the arguments for boosting our energy security and building a home-grown supply have never been stronger. The economics of energy have fundamentally changed with green energy no longer a desirable but costly alternative, instead, it is now the secure, more reliable, and cheaper option.”

First, the paper sets out potential reform of strategic planning for the energy system. This would be done by the new independent Future System Operator at a national level, with the potential of a similar model being explored at a local level.

The establishment of an FSO was announced by the government in April, following calls from Ofgem for an independent system as part of a review of Britain’s energy system’s operation in January 2021.

Next, the report sets out potential reforms to the electricity wholesale market. This could include limiting the price setting potential of natural gas by splitting the wholesale market, and instead using price signals to run the system more efficiently.

There has been growing consideration of the potential of splitting the wholesale market as such due to the impact the surging gas prices have had on customer bills and the wider energy system. In June, reports emerged that the government was looking to decouple energy bills from wholesale gas and electricity prices as part of a suite of ‘urgent’ electricity market reforms.

Following on from this, Prime Minister Boris Johnson pointed to market reform that would move Britain away from a system where the price of energy is set by the marginal gas price.

According to Ofgem, using price signals could include moving away from wholesale electricity prices being set on a national level, moving instead to a regional or local level. The regulator is looking into the possible benefits and feasibly of such a system as part of its wider work.

If brought in, the two reforms set out by the regulator could enable a smarter, more flexible system that could deliver more than £10 billion of savings per year by 2050 it noted.

Beyond these reforms, the paper also sets out a proposed framework for consumer interests designed to help focus Ofgem’s actions. It is looking to work with consumer groups and other stakeholders to further develop this framework.

The paper has been released in response to the change in economics of energy generation as well as the push for a faster transition to domestic, clean generation in response to the wider volatility driven in part by the Russian invasion of Ukraine.

In 2021, the government confirmed a 2035 net zero target for the electricity system in the UK. Further weight has been added to this target throughout the last six months with the increased renewables targets unveiled in the British Energy Security Strategy.

Currently however, market, regulatory and institutional arrangements are not set up to run a net zero power system in the most cost-effective way, with reform required to secure the benefits.

The Net Zero Britain paper follows a recent report from think tank Onward, which found that without market reform the country will not hit its 2035 electricity decarbonisation target. The government is also looking into reforming market arrangements, announcing its Review of Electricity Market Arrangements in the British Energy Security Strategy in April.

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