Rethinking Electricity Markets

Rethinking Electricity MarketsEMR20 a new phase of innovationndashfriendly and consumerndashfocused electricity market design reform

AuthorsSarah Keay-BrightGeorge Day

This report was written by Sarah Keay-Bright and George Day Contributions from ESC staff Guy Newey Amir Alikhanzadeh Phil Lawton Daniel Mee Eric Brown Richard Dobson Matt Lipson Vilislava Ivanova Susie Elks Tim Chapelle and Danial Sturge

We would like to thank the experts that provided feedback throughout developing this report Providing feedback does not imply endorsement and the content of the report remains solely that of Energy Systems Catapult

BEIS Ofgem LCCC Gareth Davies and Simon Bradbury AFRY Mike Hogan The Regulatory Assistance Project Phil Baker The Regulatory Assistance Project Paul Troughton ENEL X Nick Eyre University of Oxford Thomas Pownall University of Exeter Laura Sandys Challenging Ideas William Blyth Oxford Energy Kirsty Hamilton Chatham House Alifa Starlika and Joseph Underwood Energy-UK Alastair Martin Flexitricity David Sykes and Clementine Cowton Octopus Energy William Steggals SSE Marzia Zafar Kaluza Caroline Bragg ADE Simon Skillings E3G Jeff Hardy Imperial College London Tom Pakenham Ovo Energy John Twomey National Grid ESO

About Energy Systems CatapultEnergy Systems Catapult was set up to accelerate the transformation of the UKrsquos energy system and ensure UK businesses and consumers capture the opportunities of clean growth The Catapult is an independent not-for-profit centre of excellence that bridges the gap between industry government academia and research We take a whole systems view of the energy sector helping us to identify and address innovation priorities and market barriers in order to decarbonise the energy system at the lowest cost We have more than 200 staff based in Birmingham and Derby with a variety of technical commercial and policy backgrounds We work with innovators from companies of all sizes to develop test and scale their ideas We also collaborate with industry academia and government to overcome the systemic barriers of the current energy market to help unleash the potential of new products services and value chains required to achieve the UKrsquos clean growth ambitions as set out in the Industrial Strategy

Rethinking Electricity MarketsRethinking Electricity Markets is an Energy Systems Catapult initiative to develop proposals to reform electricity markets so that they best enable innovative efficient whole energy system decarbonisation

As part of the project we worked alongside AFRY to

identify and characterise key sources of value within electricity markets and how they are reflected in current GB arrangements

review approaches taken in other jurisdictions and identify the main strategic choices for GB electricity policy for improving market signals across time and space

consider how to strengthen the evidence base to inform decision-making about improving the coherence of the existing UK market framework

Building on the insights from our Rethinking Electricity Markets initiative this report also pulls together relevant evidence from across Energy Systems Catapultrsquos various teams and capabilities including modelling power systems engineering system architecture and consumer insights Using this evidence base we have developed credible policy options for the power sector that will drive socially beneficial innovation This is the latest of a number of reports that we have published available on our website

Acknowledgements

Rethinking Electricity Markets 3Rethinking Electricity Markets 2

The case for a new phase of electricity market reform (lsquoEMR20rsquo)It is nearly a decade since the UK Government began to implement its Electricity Market Reform (EMR) EMR introduced Contracts for Difference (CfD) to support investment in low carbon generation alongside a new Capacity Market (CM) to ensure resource adequacy These two major mechanisms were complemented by the Carbon Price Support and an Emissions Performance Standard (Hereafter we refer to these as the lsquoEMR10 policiesrsquo)

In combination EMR10 policies have driven extraordinary innovation and cost reduction especially in offshore wind and transformed Great Britainrsquos (GB) power sector as illustrated below EMR has kickstarted the rapid decarbonisation of the GB power mix

While the EMR10 policies have been successful in transforming the cost of renewables the context has changed in important ways since they were first introduced including

the new goal of Net Zero greenhouse gas emissions by 2050 Partly because of the success in cost reduction this is likely to drive even higher penetrations of variable renewables and an earlier role for electrification of transport and heat

the emergence of new system issues as a result of the rapid growth of variable renewables (eg a more variable and decentralised system makes the operational dimension of security of supply more important) which we know more about today compared with 2012 and

the inability of demand-side response and storage (lsquoflexibilityrsquo) to keep pace with variable renewables growth despite the availability of new technologies

Executive summary

From this perspective we summarise the positive and negative outcomes of the EMR10 policy instruments in the Table below

Summary of EMR10 positive and negative outcomes

EMR policy Positive outcomes Negative outcomes

Low carbon generation support policy Contracts for Difference (CfDs)

bull Major unit cost reductions for various renewable energy technologies

bull CfD revenue support has lowered the cost of capital

bull Complementing carbon pricing the CfDs have delivered targeted investment in low carbon capacity to successfully meet environmental targets

bull CfD design has incentivised bidding and dispatch of variable renewables even during periods of oversupply causing price cannibalisation and raising CfD payments

bull CfDs shield generators from market signals removing incentives to pursue different routes to market or contribute to efficient system integration This in turn inhibits market-led development of risk mitigation instruments and contracting

bull The cost of CfDs is transferred to consumers via levies on energy bills that distort retail energy markets

bull Auction lsquopotsrsquo are not technology neutral policy is the dominant influence on what gets built Small generators aggregated resources and non-generation are disadvantaged

Capacity Market (CM)

bull Procured targeted volumes of firm capacity at low cost achieving reliability standard

bull Restored lsquomissing moneyrsquo for existing resources

bull Driven some new investmentbull Scheme gradually amended to

procure a wider range of resources including DSR storage variable renewables interconnection

bull Focus on procuring cheapest capacity creates unintended consequences in carbon intensity criteria air pollutants and neglect of the capabilityflexibility needs of a high VRE power system

bull Conservative CM methodology and demand projections have resulted in oversupply and wholesale price suppression

bull Distortion of wholesale market prices (scarcity effect) negatively impacts the business case for flexibility

bull Scheme is administratively burdensome for small and aggregated resources

bull Technology neutrality undermined by prescriptive eligibility criteria and administrative burden Permanent demand reduction and energy efficiency are excluded

Carbon Price Support (CPS)

bull Reduced the price differential between wholesale gas and coal prices leading to a significant reduction in coal burn

bull Distorts operation of interconnectors (increasing imports and carbon leakage)

bull Can disproportionately raise costs for consumers per tonne of carbon reduced through inframarginal rent paid by consumers to generators (RAP 2015)

bull Politically vulnerable the original trajectory was altered because of concerns about energy costs

bull Has increased the imbalance between effective carbon prices for electricity and gas

Emissions Performance Standard (EPS)

bull Ensured no more new coal plant built

bull Energy Act sets emissions limit at 450gkWh until 2045 which makes tougher standards on existingnew fossil plant difficult The CCC recommends phase out of unabated gas for power production by 2035 (Climate Change Committee 2020a)

Rethinking Electricity Markets 4 Rethinking Electricity Markets 5

1 httpswwwthecccorgukpublicationsixth-carbon-budget2 httpswwwgovukgovernmentconsultationsenabling-a-high-renewable-net-zero-electricity-system-call-for-evidence

Current indications suggest that emerging policy thinking focuses to a large degree on retaining key elements of the EMR10 policy framework for the foreseeable future

The Governmentrsquos 5-year review of the CM confirmed its continuation to at least 2024 when it will be subject to the 10-year review (BEIS 2019a) The Energy White Paper (EWP) sets out a commitment ldquoto ensure that the mechanism acts in concert with other markets to incentivise investment in the right type of capacity in the right place at the right timerdquo suggesting some recognition of the limitations of the current mechanism (BEIS 2020a p75)

For CfDs the Government confirmed in its recent Ten Point Plan (HM Government 2020) that regular auctions will be held every two years to bring forward investment in a range of renewable technologies including established technologies such as onshore wind solar photovoltaics and fixed offshore wind The recent Energy White Paper (BEIS 2020a) confirmed that the next CfD auction in 2021 will target 12GW of renewables contributing to the specific aim of deploying 40GW of offshore wind and 1GW of floating offshore wind by 2030

The Climate Change Committee (CCC) Sixth Carbon Budget report (December 2020)1 recommends full decarbonisation of the power sector with phase-out of unabated gas-fired power by 2035

The inclusion of established renewable technologies in the next CfD auction implies that the role of CfDs extends beyond innovation support for immature technologies as a financing instrument for mature technologies The CCC appears broadly supportive describing long-term contracts as ldquoan appropriate investment mechanismrdquo given the success of CfDs the capital-intensive nature of low-carbon technologies and the need for bankable revenue streams (Climate Change Committee 2020b p53)

However both the Government and the CCC invite immediate debate on longer term electricity market design The Governmentrsquos Call for Evidence invites views on how the CfD scheme and wider electricity market design should evolve beyond the 2021 auction to better expose generators to price signals and enable cost-effective integration of variable renewables While the CCC also states in its 6th carbon budget sector report for electricity that the Government should develop ldquoa clear long-term strategy as soon as possible and certainly before 2025 on market design for a fully decarbonised electricity systemrdquo (Climate Change Committee 2020b p52)

Executive summarycontinued


In this context we set out in this paper our view that continued use of the EMR10 policies (ie lsquocentralised contractingrsquo through CfDs and the capacity market) risks inhibiting competition and innovation across the power sector particularly on the demand-side and for distributed energy resources3 We make the case for a market-pull approach to drive investment in decarbonised energy resources and shape a least cost optimal power mix This approach rests on EMR20 reforms to

develop more accurate granular market signals impose outcome-based policy mandates on market players (for decarbonisation

and systemservice reliability) put in place key enabling conditions mdash agile governance more effective network

regulation market monitoring and measures to enable digitalisation etc

As set out above CfD and CM mechanisms are increasingly in tension with development of well-functioning and competitive electricity markets as the shares of variable renewables and distributed energy resources (DER) grow The symptoms of this tension include the rising costs of system balancing growing concerns about negative pricing and wholesale price cannibalisation and the relatively slow progress in enabling demand-side response and storage (for example analysis by NGESO (National Grid ESO 2020c) and BEIS (BEIS 2020d) shows that participation of demand-side response (DSR) and storage is extremely low in flexibility markets compared with fossil-fuelled generators)

This tension as well as the adoption of the Net Zero policy objective and the emergence of new distributed and digital technologies has created a new imperative for electricity market reform This report makes the case for initiating a wave of further electricity market reforms mdash which we call lsquoEMR20rsquo mdash to create a more innovative consumer-focused market and unlock the deeper decarbonisation of both electricity and the wider economy

3 (OVO Energy and Imperial College London 2018) estimate the potential benefits of demand-side flexibility at pound7bnyear


The five key challenges for a net zero electricity system EMR20 has a very different context to that which existed a decade ago

a high share of variable renewables already in the power mix a number of zero carbon generation technologies reaching maturity considerable evidence of innovation on the demand-side and at distribution level

enabled by new technology and digitalisation and the adoption of Net Zero requiring more rapid and comprehensive investment

in zero carbon energy resources and complementary flexibility

While many of the drivers underpinning EMR10 still hold (DECC 2014 Imperial College London 2019) this new context brings additional challenges The evidence from our whole system analysis and our engagement with the innovation challenges around system integration and flexibility highlights five key challenges for net zero electricity market reform

We consider each of these five challenges in turn and

examine why successfully addressing each of them is important to achieving Net Zero set out the issues and risks associated with each challenge under the current market

framework and show how key lsquoEMR20rsquo reforms can be implemented to effectively address each challenge


EMR20 the 5 key challenges

1 Consumer focus challenge

To unlock flexibility through smart low carbon energy products and services that are attractive optimised and convenient for all consumers

2 Zero carbon energy resource investment challenge

To ensure a sufficient pace and volume of investment in zero carbon electricity resources and technologies delivering a cost-optimal power mix

3 System integration challenge

To efficiently integrate a high share of distributed and variable energy resources into the electricity system while maintaining reliability at least cost

4 Network investment and coordination challenge

To coordinate investment efficiently across the energy value chain particularly in networks and for different energy vectors

5 Policy governance challenge

To rebalance and substantially improve the whole system coherence of policy-making regulation market governance and system operation


The key risks of continuing to rely on EMR10 policies and failing to introduce more fundamental market reforms include

failure to unlock sufficient flexibility particularly on the demand side and to bring forward consumer friendly service innovation

a perpetual reliance on government decision-making to drive technology choices less effective integration of zero carbon electricity with other low carbon energy vectors failure to optimise the combination of technologies and resources resulting ultimately

in higher costs and less reliable service outcomes

More specifically the risks relevant to each challenge are summarised below

Risks of continued reliance on EMR10 an overview of risks for the five challenges continued

Risks relevant to the consumer challenge

bull Consumers currently face largely undifferentiated retail offers This limits both their incentive and their ability to offer flexibility to the system

bull The current framework (eg supplier hub code complexity etc) creates multiple barriers to entry for innovative new entrants or service offers

bull Accumulation of levies and charges in retail bills ndash reflecting the growing out-of-market roles of the Government and ESO mdash is regressive hampering energy vector-switching and demand-side flexibility

bull Policy drivers in the retail market are weak and current market signals are distorted and relatively blunt muting the incentives for retailers and service providers to develop propositions that unlock value by releasing and aggregating demand side flexibility or reducing demand

bull This means that current arrangements risk inhibiting demand side innovation which risks leading to an unbalanced electricity technology mix (biased towards supplycapacity investment) AND inefficiency in how zero carbon electricity is matchedbalanced with other networks (eg heat networks hydrogen)

bull Unbalanced stakeholder engagement and lack of consumer focus characterises current governance arrangements which risks lock into status quo Poor consumer focus raises the risk of lack of public acceptance or support for actions to achieve Net Zero

Risks relevant to the zero carbon energy resource investment challenge

bull GBrsquos current market design model is undermined by the distorting impacts of the CfD and CM schemes inadequate internalisation of marginal costs into energy prices and weak incoherent carbon price policies This drives a self-perpetuating requirement for policy support

bull Under the current market framework most new generation investment receives policy support resulting in the under-development of financial markets and contracting to manage investment risks

bull The current centralised policy framework comprising CfDs and the CM is technology-biased towards generation and large assets CfDs apply to generation with no access for aggregated resources The CM applies restrictive eligibility criteria and is administratively burdensome for small or aggregated loads

bull Continuation of the centralised policy approach locks in a sizeable and self-perpetuating out-of-market role for Government and the system operator (SO) while crowding out smart innovative solutions

bull Current carbon pricing policies are insufficient to drive full decarbonisation of electricity A credible and investable policy driver is needed to complement carbon pricing and innovation support to decarbonise electricity

bull Inefficient price signals raise risk of inefficient investment and a capacity mix with suboptimal capabilities ultimately leading to worse outcomes for consumers in terms of costs reliability and service quality

Risks relevant to the system integration challenge

bull Flexibility in both supply and demand and investment in system integration are not keeping pace with growth in variable renewables because multiple market barriers exist and current market signals are inadequate

bull The current framework delivers price signals that are not sufficiently granular by space and time and do not accurately or fully reveal the value of flexibility to the system hampering investment in well targeted system integration

bull The strong current focus of the CfD regime on delivering revenue stability and lowering the cost of capital reduces incentives for CfD-supported projects and investors to innovate or invest in complementary system integration and flexibility technologies

bull The design of the CM scheme dampens wholesale market signals for flexible technologies that would otherwise be able to capture greater price spreads and scarcity premia enabling more effective system integration

bull Incoherent carbon price signals across vectors risks preventing or slowing down the development of mechanisms to flex energy demand efficiently across different low carbon energy vectors

bull Lack of strategic planning and coordination risks missing opportunities to exploit local or regional energy resourcesysteminfrastructure opportunities

bull Faster progress is needed to harness data and digitalisation to enable more efficient operation and coordination of electricity systems including transforming DNOs to DSOs and ESO to ISO as well as improving ESO(ISO)-DSO coordination

bull Without change this framework will lead to an increasingly sub-optimal electricity technology mix AND inefficiency in how zero carbon electricity is matchedbalanced including integration with other networks (eg heat hydrogen)

bull This may lead to increased reliance on network reinforcement investment capacity enhancement and out of market system operator interventions to maintain overall system reliability mdash at added cost and reduced quality of service for consumers

Risks relevant to the network investment and coordination challenge

bull The current framework lacks a full set of mechanisms for strategic planning and coordination of energy infrastructure at both national and localregional levels

bull Current approaches to network regulation are siloed with network companies not clearly nor strongly incentivised to think and plan strategically from a whole system perspective Risk of miscoordination of planning and investment and of network companies failing to engage fully with net zero agenda

bull A combination of the low granularity of market signals (that obscures value) and potential lag in adopting new methodologies to adopt non-network solutions risks reinforcing a bias towards investments in network enhancement over alternative options (flexibilitydemand sidealternative low carbon vectors such as heat networksstorage etc)

bull Taken together this means that the current framework risks unnecessary andor poorly targeted investment in network infrastructure missed opportunities for major cost savings and the network being insufficiently prepared for variable renewables and DER growth slowing decarbonisation and hampering innovation

Risks relevant to the policy governance challenge

bull Industry governancecode processes are complex slow and risk capture by incumbentsbull Consumers and local communities lack agency under current governance policy and market

arrangements mdash which are structured according to industry categories rather than outcomes for consumers or society This risks undermining the ability of the electricity system to meet consumer needs or to adapt to reflect local priorities

bull Insufficient emphasis on whole system interactions risks constraining innovation and preventing the unlocking of synergies across portfolios of assets different energy vectors

bull Lower market visibility and lack of clear focus on market performance risks a self-perpetuating cycle of poor market performance followed by regulatory intervention or inaction

bull Risk that siloed and unresponsive governance and policy-making leads to short-termist market and policy intervention with consequent low levels of innovation

Risks of continued reliance on EMR10 An overview of risks for the five challenges


Enable market to unlock innovation in consumer-focused

energy services

Sector strategyevaluation and improved market monitoring Performance based monopoly regulation

Open data digitalisation interoperability standardisation

Smarter consumer protection

Dynamic granular system reflective prices by time amp location in short-term wholesale electricity markets

Deep liquid forward amp futures markets to de-risk and stabilise revenues for long term investment

Outcome based decarbonisation obligation on suppliersrsquo and large offtakersrsquo resource portfolios

Reliability requirement on suppliers (obligationsoptions) backed by ESOISO using strategic reserves

Sectoral carbon performance standards eg on building owners

The five key challenges set out above need to be addressed to enable electricity markets to drive the competition and innovation needed for an efficient and effective transition to Net Zero The risks associated with the current market and policyregulatory arrangements will potentially worsen unless reforms are introduced to enable markets to more effectively integrate further growth in variable renewables and DER This requires a new wave of electricity market reforms informed by a comprehensive whole system strategy

The broad choice is between two models

a Continued reliance on centralised contracting (essentially a development of the EMR10) This model requires more and more decisions to be made by central Government or institutions acting on behalf of central Government This approach is broadly the current direction of travel revealed in the Governmentrsquos 10 Point Plan and EWP supported by CCC

b Adopting a more decentralised outcome-based market framework where policy mandates require outcomes from the market such as decarbonisation and reliability but more decisions on how to achieve those outcomes mdash such as investments technology choices business models and innovation mdash are made by market actors based on market signals that reflect the physics of the power system and the need to decarbonise Under this approach the Government should be able to take a reduced role reducing the risk of Government ldquogetting it wrongrdquo through procuring a sub-optimal power mix and increasing the possibility of unlocking innovation potential

ESC proposals for EMR20 align with the decentralised model mentioned above and are based on three foundational pillars

1 more accurate granular market signals2 outcome-based policy mandates on market players (for decarbonisation and system

service reliability)3 key enabling conditions including agile governance more effective network regulation

market monitoring and measures to enable digitalisation etc

We propose six key reforms each of which in turn comprises a more detailed set of linked policy steps and actions which may take several years to implement in full Clearly this would constitute a major reform programme requiring substantial and ongoing work to design detailed policy steps and introduce reforms over time

The phased implementation can begin immediately with reform of CfDs for established technologies while a new legislative framework is developed for implementation in the mid-2020s

EMR20 Six key reforms for a net zero electricity system

EMR20 the three pillars of ESCs proposals

Overview of a decentralised outcome-based market framework for zero carbon electricity


EMR20 six key reforms for a net zero electricity system continued


Outcome- based policy mandates

CfD reform and phase-outOutcome based decarbonisation obligation on suppliersrsquo and large offtakersrsquo resource portfolios

Immediate integrated market design assessment develop legislation for outcome-based policy mandates

Replace CM with decentralised CRM that evolves with market performance + Strategic Reserves as backstop

Carbon standards on DSOESOISO procurement (eg ancillary services congestion services)

Levelise carbon prices in economy + sectoral carbon performance standards on actors that drive markets (eg on building owners ) to drive demand for lowzero carbon energy services

Enabling conditions

Implement Energy Data Taskforce recommendations open data digitalisation interoperability standardisation

Overhaul governance arrangements

Implement new governance arrangements sector strategyevaluation independent power market monitoring

Smarter consumer protection that complements retail innovation target energy poverty with decarbonisation solutions

Ambitious performance-based monopoly regulation (RIIO) LAEP accelerated DSO and ISO transition ISO-DSO coordination

Market signals Assess locational energy pricing options

Implement quality prices roadmap mdash increasingly more efficient and granular prices by time and location in short-term markets

Develop quality prices roadmap

Support contracting innovation and development of deep liquid forward and futures markets

Financing Task ForcePotential targeted support for low carbon contractingfinancial market development (eg new Infrastructure Bank)

2021 2025 2030 2035

EMR20 The six key reforms EMR20 Reforms Phasing of implementation

Make electricity markets work more accurately in time and space

Phase out centralised contracting (CfDs amp CM) by mid 2020s and replace with outcome-based policy mandates

Align sector strategy and policy mandates with carbon budgets

Redesign support for immature technologies to avoid distorting markets

Overhaul governance for industry codes system operation and energy data

Evolve policy to support financial market development and contracting for investment

2

3 4

5 6

1Introduce dynamic and granular wholesale market signals to more accurately reflect system status and physics in real time

Mandate market participants to deliver decarbonisation and reliability outcomes through decentralised contracting and retail innovation

Promote private-sector led finance risk management and forward contracting across a balanced resource mix while reducing reliance on state-led contracting

Ring fence innovation and early deployment support measures to maintain technology neutral energy market signals through transition

Update sector and digital governance codes platforms and standards rebalance industry representation and accelerate DSOESOISO reforms

Link sector strategy regulation and policy mandates directly to carbon budget advice and review cycle strengthen independent market monitoring


Mapping of ESCrsquos EMR20 proposals to the 5 key challenges

ZeroC energy resource investment

System integration

Consumer focus

Network investment

Policy governance

1 Make electricity markets work more accurately in space and time

2 Phase out centralised contracting (CfDs and CM) by mid-2020s and replace with outcome-based policy mandates on market participants

3 Evolve policy to support financial market development and contracting for investment

4 Redesign innovation and early deployment support for immature technologies to avoid distorting markets

5 Overhaul governance and role definitions for industry codes system operation data and digital interoperability

6 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle

Potential outcomesGovernmentrsquos current direction of travel

Decarbonisation but sub-optimal costbenefit for society

Digitalisation partial not fully exploited Decentralisation partial exploitation of economically

viable local energy demand reduction flexibility Democratisation decisions taken upstream

determine outcomes downstream for consumers Innovation partial innovation hampered as

government decides inputs Reliability more costly more issues with operational

stability at distribution level

Potential outcomesESCrsquos proposals

Decarbonisation optimal costbenefit for society Digitalisation fully exploited with policy driver on retail market

Decentralisation policy compatible with local energy storage DER and demand-side

Democratisation inclusive of all resources technologiesactors

Innovation policy market pull drives innovation in technologies and business models

Reliability least cost both resource adequacy and operational stability addressed

Resilience greater innovation increases diversity


Outcomes

bull New technologies enter the market via RO + FiTs + EU ETS

bull Growth in RES insufficient as regulatory risk too high investor confidence too low

Outcomes

bull Market primed with renewables and major cost reductions via CfDs

bull Coal exits market via EU ETS + CPS + EPS

bull Policy interactions with markets become unsustainable

Pre-EMR EMR10Scale up Decarbonisation by 2035EMR20

EMR10+

EMR20

Which way for scale up and full decarbonisation of the power sector


ContentsContentscontinued

Acknowledgements 2About Energy Systems Catapult 3Executive summary 4Risks of continued reliance on EMR10 An overview of risks for the five challenges 10EMR20 Six key reforms for a net zero electricity system 12Contents 16Acronyms 20Glossary 2110 Introduction 2420 Consumer focus challenge 3221 Why is this challenge important 3422 Risks under the current framework associated with this challenge 3623 How our proposals address this challenge 4230 Zero carbon energy resource investment challenge 4631 Why is this challenge important 4832 Risks under the current framework to meeting this challenge 5033 How our proposals address this challenge 5940 System integration challenge 7041 Why is this challenge important for Net Zero 7242 Issues and risks under the current framework for this challenge 7443 How our proposals address this challenge 8250 Network infrastructure and investment challenge 9051 Why is this challenge important for Net Zero 9252 Risks under the current framework to meeting this challenge 9353 How our proposals address this challenge 9660 Policy Governance Challenge 10261 Why is this challenge important for New Zero 10462 Risks under the current framework to meeting this challenge 10563 How our proposals address this challenge 11070 Summary of ESCrsquos proposals for EMR20 116Bibliography 126

Annex 1 ESC modelling evidence 135Annex 2 Economics of market design 148

and price cannibalisationAnnex 3 ESC system architecture for consumer 159

engagement and energy servicesAnnex 4 Innovation in forward and 161

futures marketsAnnex 5 Changing roles of CfDs and carbon 162

pricing to decarbonise powerAnnex 6 The 5C framework mdash analysis 164

of sources of valueAnnex 7 Locational differentiation in energy prices 173Annex 8 Comparison of CRMs and compatibility 175

with energy servicesAnnex 9 The impact of the Renewable Obligation 186

and Contracts for Difference schemes on bidding behaviour and markets

Annex 10 ESCrsquos Energy Data 188 Taskforce recommendations and interoperability analysis

Annex 11 ESODSO coordination 190Annex 12 Electric Vehicle Energy Taskforce 192

recommendationsAnnex 13 Systems Engineering and Enabling 193

Frameworks for more balanced stakeholder engagement in a whole systems approach

Table of FiguresFig 1 The four policy pillars of EMR10 25Fig 2 Change in UK power mix 1998ndash2019 26Fig 3 ESC heat trials demonstrated 37

the potential consumer appeal of service offerings

Fig 4 ESCrsquos vision of highly active retailers 38 and decentralised contracting

Fig 5 Rising costs of third parties passed 39 through to customers by the supplier

Fig 6 The benefits of a decentralised 43 downstream approach to policy for power markets

Fig 7 Signals needed for delivering and 50 operating in envisaged future power mix

Fig 8 Modelled capture prices for wind 51 and solar UK (2018 money)

Fig 9 Causes and consequences of 53 inefficient market design

Fig 10 Current trading arrangements 54 under BETTA

Fig 11 EMR10 (left) and ESCrsquos proposed 68 EMR20 (right) mdash interactions of interventions with market signals

Fig 12 The package of reforms needed to 67 restore and retain confidence in the GB power market

Fig 13 Australiarsquos National Energy 69 Guarantee proposals

Fig 14 Energy Transition Readiness 75 Index 2019 ranking

Fig 15 EDTF recommendations mdash ESC view 83 on progress to date

Fig 16 Comparing the outcomes from 86 a LCOE and WESC analysis including demand assets

Fig 17 Comparison of system coordination 87 scenarios

Fig 18 Four key elements for Local Area Energy 101 Planning according to Local Area Energy Planning The Method Guidance

Fig 19 Market monitoring as part of 115 a continuous evaluation process

Fig 20 ESCrsquos proposals for consumer-focused 119 market design

Fig 21 Mapping of ESCrsquos EMR20 proposals 126 to the 5 key challenges

Fig 22 Phasing and coordination of ESCrsquos 127 EMR20 proposals

Fig 23 Clockwork Power generation capacity 136 (left) electricity supplied (right) electricity consumption (below)

Fig 24 Patchwork Power generation capacity 137 (left) electricity supplied (right) electricity consumption (below)

Fig 25 Deployment of cars in Clockwork (left) 138 and Patchwork (right)

Fig 26 Space heat production in Clockwork 138 (left) and Patchwork (right)

Fig 27 Baringa Net Zero Base Case to 2050 140 for capacity (left) and energy (right)

Fig 28 Technology roles expected to evolve 141 with time impacting load factors


Contentscontinued

Fig 29 Modelling results for different scenarios 143 for 2030 (left) and 2050 (right)

Fig 30 Cross-scenario system costs for 145 Net Zero by 2050 (pound total cost left and poundMWh right)

Fig 31 System requirements for the 147 cost-optimal 70GW OSW scenario (left) and for the lsquoforcedrsquo 125GW OSW (right)

Fig 32 Electricity price (left) and market 151 value for VRE (right) for increasing VRE penetration under different policy scenarios

Fig 33 Comparison of US markets with 153 and without capacity markets

Fig 34 Explicit DR has greater impact 157 on price formation than implicit DR

Fig 35 Clearing price impacts in peak periods 158 for three scenarios

Fig 36 Question Which of the following do 160 you see as the biggest obstacles holding back the development of subsidy support-free projects for the OSW

Fig 37 Question How well do you think 160 the financing market is adapting to a greater degree of merchant risk

Fig 38 Question How well do you think the 161 developerinvestor market is adapting to a greater degree of merchant risk

Fig 39 Post 2030 mdash potential of high and 162 volatile carbon prices and diminishing impact on merit order

Fig 40 5Cs framework for value 164Fig 41 The 5C sources of value for todayrsquos 164

market arrangementsFig 42 Annual monetary value attached 169

to each 5C source of value using 2018 data

Fig 43 Stronger role for the wholesale market 170 in future mdash temporal dimension

Fig 44 Stronger role for the wholesale market 171 in future mdash spatial dimension

Fig 45 ESC proposalsrsquo impact on future 172 5C sources of value

Fig 46 The mechanics of decentralised 181 reliability options

Fig 47 Comparison of RO and CfD schemes mdash 187 revenues and routes to market

Fig 48 Cumulative discounted cost savings 191 compared to the lsquocurrent positionrsquo framework to 2050

Fig 49 Enabling Frameworks for improved 195 energy sector governance

Table of tablesTable 1 Summary of EMR10 positive 27

and negative outcomesTable 2 Cross-sector customer satisfaction metrics 35Table 3 Significant changes underway for 73

connected resources and risksTable 4 Value size and carbon intensity of 75

GB electricity markets 2019Table 5 Faster and more accurate short-term 77

markets for variable renewables status of the GB

Table 6 Cost comparison for heat pumps 88 and gas boiler

Table 7 Comparison of hypothetical network 108 charge reforms for electricity and gas

Table 8 Selection of interactions between 163 value components (not exhaustive)

Table 9 Value mapping of the 5 Cs 164Table 10 Commonly cited arguments relating 172

to locational pricing approachTable 11 Key requirements for a consumer- 174

centric market-led CRM modelTable 12 Assessment of compatibility of 175

different reliability approaches with consumer-centric markets and energy service provision

Table 13 Summary of CRM concepts and building blocks for different options 176

Table 14 Summary of differences between ESCPoumlyry frameworks and ENA worlds 188


Acronyms

BEIS Department of Business Energy and Industrial StrategyBETTA British Electricity Trading and Transmission ArrangementsBTM Behind-the-meterCCC Climate Change CommitteeCCGT Combined Cycle Gas TurbinesCfD Contracts for DifferenceCFE Call for EvidenceCM Capacity MarketCPS Carbon Price SupportCRM Capacity Remuneration MechanismDER Distributed Energy ResourcesDNO Distribution Network OperatorDSO Distribution System OperatorDSR Demand-Side ResponseEDTF Energy Data TaskforceEMR Electricity Market ReformEPS Emissions Performance StandardESC Energy Systems CatapultESME Energy System Modelling EnvironmentESP Energy Service ProviderETI Energy Technologies InstituteEU ETS European Union Emissions Trading SystemEV Electric VehicleEVET Electric Vehicle Energy TaskforceEWP Energy White PaperFiT Feed-In TariffFPSA Future Power Systems Architecture programmeISO Independent System OperatorLAEP Local Area Energy PlanningLCOE Levelised Cost of ElectricityLMP Locational Marginal PricingLoLE Loss of Load ExpectationLV Low VoltageNAFLC Network Access and Forward-Looking ChargesNGESO National Grid Electricity System OperatorOSW Offshore WindPFER Prospering from the Energy RevolutionRIIO Revenue = Incentives + Innovation + OutputsRO Renewables ObligationRSVP Reserve Scarcity PriceSCR Significant Code ReviewSFM Storage and Flexibility ModelSRMC Short Run Marginal CostsTCR Targeted Charging ReviewTEC Transmission System Entry CapacityTO Transmission OwnerUK ETS United Kingdom Emissions Trading SchemeVFM Value-for-Money analysisVoLL Value of Lost LoadVRE Variable Renewable EnergyWESC Whole Electricity System Cost

Glossary

Balancing Mechanism (BM) A mechanism that follows gate closure and enables the Electricity System Operator to instruct generators and suppliers to vary electricity production or consumption close to or in real-time to maintain safe operation of the system

Baseload capacity The minimum level of demand on an electrical system over a span of time such as a year Also refers to generating capacity normally operated at all times to serve load

Capacity Market (CM) Government scheme to ensure the security of supply through competitively let contract where capacity providers receive a regular revenue in exchange for being available at times of system stress

Carbon Intensity The carbon dioxide a utility emits divided by its energy sales typically expressed in tonsmegawatt-hour

Contracts for Difference (CfD)CfD is a long-term contract between an electricity generator and Low Carbon Contracts Company (LCCC) The contract enables the generator to stabilise its revenues at a pre-agreed level (the Strike Price) for the duration of the contract Under the CfD payments can flow from LCCC to the generator and vice versa Under the CfDs when the market price for electricity generated by a CfD Generator (the reference price) is below the Strike Price set out in the contract payments are made by LCCC to the CfD Generator to make up the difference However when the reference price is above the Strike Price the CfD Generator pays LCCC the difference

Demand-Side ResponseDemand-Side Response (DSR) can be defined as the capacity to change electricity usage by end-use customers (including residential) from their normal or current consumption patterns in response to market signals such as time-variable electricity prices or incentive payments or in response to acceptance of the consumers bid alone or through aggregation to sell demand reductionincrease at a price in electricity markets or for internal portfolio optimisation The valuation of DSR can be done either explicitly or implicitly explicit DSR is sold as a product on a market (it appears explicitly on the market) and therefore

requires a specific control (ex-ante andor ex-post check based on baseline etc) implicit DSR on the other hand does not need such a process since it is not sold to anyone and remains only for the benefit of the final consumer and the corresponding retailer or the Balancing Responsible Party an optimisation respectively of its sourcing costs or imbalances

Energy ArbitrageThe practice of exploiting price differentials between different markets times products or locations

Gate ClosureIn relation to a Settlement Period Gate Closure is the spot time 1 hour before the spot time at the start of that Settlement Period The Settlement Period is a period of 30 minutes beginning on the hour or the half-hour

Imbalance priceELEXON apply these prices to parties imbalances to determine their imbalance charges A party is out of balance when its contracted energy volume does not match its physical production or consumption The imbalance process settles discrepancies for each half hour trading period

Load factorThe ratio of average load to peak load during a specific period of time expressed as a percent

Long-Run Marginal CostsThe long-run costs of the next unit of electricity produced including the cost of a new power plant additional transmission and distribution reserves marginal losses and administrative and environmental costs Also called long-run incremental costs

Loss of Load Expectation (LoLE)Loss of Load Expectation (LOLE) LOLE represents the number of hours per annum in which over the long-term it is statistically expected that supply will not meet demand

Market-led approach to power sector policiesA market-led policy approach focuses on driving markets by setting the boundaries that market participants must work within and the outcomes that they must achieve This contrasts to market-based mechanisms like CfDs and the CM which are limited to encouraging competition within the mechanisms creating a sub-market or mini-market within a much wider market


Net ZeroNet Zero requires elimination of all greenhouse gas emissions wherever feasible with any remaining sources offset by the removal of carbon dioxide from the atmosphere

Peak demandA point in time (usually annually) where demand for energy is at its highest It is often to understand the need for system-wide resource adequacy and network requirements

Power Purchase Agreement (PPA)A contract between two parties one which generates electricity (the seller) and one which is looking to purchase electricity (the buyer)

Price controlThe process through which the regulator establishes the maximum revenue that a monopoly (eg network company) can collect from users Also known as the revenue requirement

Renewable Obligation (RO)A tradeable green certificate scheme introduced in 2002 (in GB power market) as the then main policy measure to encourage the development of electricity generating capacity using renewable generation technologies

Sector-led approach to carbon policyA sector led approach can enable the stepwise creation of a coherent economy-wide carbon policy framework by bull Progressively introducing or strengthening

tailored sectoral carbon policies such as incentives or standards to drive required emissions reductions in major emitting sectors

bull Enabling sectoral price or regulatory policies to be supported by packages of complementary policies (eg innovation support or access to finance) specifically designed to address key sectoral challenges and barriers (eg transitional or distributional impacts)

bull Linking sectoral carbon policies by introducing trading and validated carbon credit market mechanisms to enable the emergence of a balanced economy-wide framework of decarbonisation incentives

A sector led approach can pragmatically and progressively improve the low and imbalanced current pattern of effective carbon prices across major emitting sectors It also recognises that increasing effective carbon prices will not be sufficient to drive innovation and private investment on its own A range of complementary policies will also be required to address the variety of sector specific barriers characteristics and transition challenges

Short-Run Marginal CostOnly those variable costs that change in the short run with a change in output including fuel operations and maintenance costs losses labour insurance return on equity taxes and environmental costs

Systems engineering approachSystems engineering is a structured multidisciplinary approach to problem-solving that transforms a set of needs into a practical plan for implementation and a solution that satisfies a range of stakeholders

Time-of-Use (TOU)Variable tariff based on the use of electricity at different times of the day and day of the week

Value of Lost Load (VoLL)The Value of Lost Load is the estimated amount that customers receiving electricity with firm contracts would be willing to pay to avoid a disruption in their electricity service

Whole energy systems approachThis considers bull All parts of the physical system that transforms

primary energy (eg wind solar fuels) into usable energy or services

bull All end users (eg households and businesses) of energy

bull How the entire system is controlled and shaped by policy markets and digital arrangements

A whole energy system approach also recognises specific sectoral challenges and seeks to address them

Glossary continued


It is not far off a decade since the UK Governmentrsquos Electricity Market Reform (EMR) policy was established The Government introduced EMR (which shall hereafter be referred to as EMR10) as it did not have sufficient confidence that it would be able to meet its objectives for the electricity system which at the time were stated to be

Security of supply ensure diverse reliable and resilient electricity suppliers to keep the lights on

Affordability minimise costs to taxpayer and keep energy bills down and Climate change help the UK in meetings its goal of an 80 reduction in carbon

emissions across the economy relative to 1990 levels and its interim goal to achieve 15 of energy from renewable sources by 2020

This lack of confidence related to the following concerns and identified challenges (Imperial College London 2019 DECC 2012)

Security of supply threatened by existing plant closures with a fifth of 2011rsquos total electricity generation capacity set to close by 2020 and with much of its replacement set to be intermittent such as windsolar or inflexible such as nuclear

Demand for electricity expected to rise with electrification of heat and transport Electricity prices expected to rise The social cost of carbon not fully reflected in market prices and the carbon price volatile

and hard to predict The current market price for electricity driven by fossil plant and investors in non-gas fired

generation disadvantaged by being exposed to more volatile and uncertain returns when compared to gas and

Uncertainties in the underlying economics of all forms of electricity generation including gas renewables CCS and nuclear

Designed to address these concerns and challenges the EMR strategy enacted in the Energy Act (2013) comprised two core policy interventions

1 Feed in tariffs with Contracts for Difference (CfDs) for all forms of low-carbon generation aimed at de-risking investment in low-carbon generation

2 A capacity mechanism or market (CM) to ensure a key measure of reliability is maintained

In addition other complementary measures were introduced with the following being particularly important in shaping the development of the power mix

3 A floor price for carbon the carbon price support mechanism (CPS) to ensure the CfD price is not too distant from wholesale prices and to encourage coal to gas switching

4 An emissions performance standard (EPS) setting maximum CO2 emission levels per unit of electricity generated if operated at baseload for new power stations to act as the backstop against new unabated coal-fired power stations

The key objectives and policy pillars of EMR10 are set out in Figure 1 below

10 Introduction10 Introductioncontinued

Figure 1 The four policy pillars of EMR10

The EMR objectives (DECC 2012)

1 Ensuring a secure electricity supply by providing a diverse range of energy sources including renewables nuclear CCS equipped plant unabated gas and demand side approaches and ensuring we have sufficient reliable capacity to minimise the risk of supply shortages

2 Ensuring sufficient investment in sustainable low-carbon technologies to put us on a path consistent with our EU 2020 renewables targets and our longer term target to reduce carbon emissions by at least 80 of 1990 levels by 2050

3 Maximising benefits and minimising costs to the economy as a whole and to taxpayers and consumers mdash maintaining affordable electricity bills while delivering the investment needed EMR minimises costs compared to the current policies because it seeks to use the power of the markets and competition and reduce Ministerial intervention and support over time

Contracts for Difference Fixed price 15 year contracts

Capacity Market Capacity payments on availability

Carbon Floor Price Emissions Performance Standard

4 Policies


To a large extent the interventions have been successful in achieving their objectives (Imperial College London 2019 Poumlyry 2015) CfDs have been highly effective in reducing the costs of and achieving scale up of onshoreoffshore wind and solar generation technologies The CM has secured capacity to meet peak demand at lowest cost within the auction though with unintended consequences (Grubb amp Newbery 2018) The CPS has changed the relative economics of gas and coal generation securing the phase out of coal The combined impact of these measures can be seen in Figure 2 below

While EMR10 interventions have been successful in transforming the cost of renewables the context has changed in important ways since they were first introduced including




From this perspective we summarise the positive and negative outcomes of the EMR10 policy instruments in the Table opposite

10 Introductioncontinued

125

100

75

50

25

0Tera

wat

tndashho

urs (

TWh

qua

rter

)

Q1

1998

Q4

1998

Q3

1999

Q2

200

0

Q1

2001

Q4

200

1

Q3

200

2

Q2

200

3

Q1

2004

Q4

200

4

Q3

200

5

Q2

200

6

Q1

2007

Q4

200

7

Q3

200

8

Q2

200

7

Q1

2009

Q4

201

0

Q3

201

1

Q2

201

2

Q1

2013

Q4

201

3

Q3

201

4

Q2

201

5

Q1

2016

Q4

201

6

Q3

201

7

Q2

201

8

Q1

2019

Q4

201

9

Q1

2020

Coal Oil

Figure 2 Change in UK power mix 1998ndash2019

Gas Nuclear

Hydro(naturalflow) Wind and solar

Bioenergy Pumped storage (net supply)

Other fuels Net imports (interconnectors)

Source Ofgem 2020a


Table 1 Summary of EMR10 positive and negative outcomes



bull Auctions have delivered major unit cost reductions for various renewable energy technologies



bull CfD design has incentivised bidding and dispatch of variable renewables below their SRMC even during periods of oversupply causing negative wholesale prices at times and price cannibalisation raising CfD payments and costs to consumers

bull CfDs shield generators from market signals and so generators are not incentivised to maximise their revenues by pursuing different routes to market so market-led development of risk mitigation instruments and contracting is supressed not incentivised to contribute to system efficiency so system integration costs are higher than they need be

bull The cost of CfDs is transferred to consumers via levies linked to energy consumption with various distorting impacts on retail energy markets

bull The cost of capital is readily internalised in the cost of a turbine or solar panel but poorly reflected in the broader system consequences of transferring risk to tax payers and consumers

bull Through auction lsquopotsrsquo technologies are treated differently and Government strongly influences what gets built Small generators aggregated resources and non-generation have not been eligible

bull CfDs combined with the CM (over)supply the market supressing prices that impacts other competitive resources in the market and increases CfD and CM payments

bull CfDs do not pay any attention to the capability of low carbon technologies needed for a high VRE power system eg flexibility inertia




bull Driven some new investment

bull Scheme gradually amended to procure a wider range of resources including DSR storage variable renewables interconnection

bull Exclusive focus on procuring cheapest capacity creates unintended consequences in terms of carbon intensity criteria air pollutants and capabilityflexibility

bull Over-procurement due to conservative methodology and demand projections combined with CfDs the EMR schemes (over)supply the market and suppress average wholesale electricity prices

bull Significant distorting impact on wholesale market prices (scarcity effect) impacting flexibility business case

bull Scheme is administratively burdensome for small and aggregated resourcesbull Technology neutrality undermined by prescriptive eligibility criteria

that must be regularly updated to keep up with innovation Permanent demand reduction and energy efficiency are excluded

bull The CM is dominated by carbon intensive capacity bull The CM does not pay attention to the capability of capacity needed for

a high VRE power system eg flexibility inertia



bull Distortive impact on EU Emissions Trading Scheme (EU ETS) and operation of interconnectors

bull Raises costs for GB market consumers compared to EU consumersbull Cost per ton carbon reduced can be much higher for consumers

compared to polluters due to inframarginal rent that consumers pay generators through the pay-as-clear market (RAP 2015)


bull Increased gap between effective carbon prices for different energy vectors (eg residential gas)





The Governmentrsquos 5-year review of the CM confirmed its continuation to at least 2024 when it will be subject to the 10-year review (BEIS 2019a) In its EWP the Government sets down the commitment ldquoto ensure that the mechanism acts in concert with other markets to incentivise investment in the right type of capacity in the right place at the right timerdquo This might indicate an intention to further amend the existing mechanism so it rewards the capability of capacity (eg flexibility) as well as its location

For CfDs the Government confirmed in its recent Ten Point Plan for a Green Industrial Revolution (HM Government 2020) that regular CfD auctions will be held every two years to bring forward investment in a range of renewable technologies including established technologies such as onshore wind solar photovoltaics and fixed offshore wind The recent Energy White Paper (BEIS 2020a) confirmed that the next CfD auction in 2021 will target 12GW of renewables contributing to the specific aim of deploying 40GW of offshore wind and 1GW of floating offshore wind by 2030

The Climate Change Committee (CCC) also issued its Sixth Carbon Budget report at the end of last year4 recommending a reduction in UK greenhouse gas emissions of 78 by 2035 relative to 1990 (a 63 reduction from 2019) By 2035 the CCC recommends full decarbonisation of the power sector with phase-out of unabated gas-fired power

With Government now including all established renewable technologies in the next CfD auction the role of CfDs has been extended beyond innovation support for immature technologies to a financing instrument for mature technologies The CCC is supportive describing long-term contracts as ldquoan appropriate investment mechanismrdquo given the success of CfDs the capital-intensive nature of low-carbon technologies and the need for bankable revenue streams (Committee Climate Change 2020b) ESC is concerned that continuation of this upstream market-push approach mdash using CfDs and the capacity market mdash to scale up investment will hamper competition and innovation across the power sector particularly on the demand-side and for distributed energy resources A market-pull approach is more appropriate to drive scale up of investment in decarbonised energy resources if a least cost optimal power mix is to be achieved

Both the Government and the CCC however invite immediate debate on longer term electricity market design The Government has issued a Call for Evidence (CFE) 5 on how the CfD scheme and wider electricity market design should evolve beyond the 2021 auction in order to better expose generators to price signals and enable cost-effective integration of variable renewables While the Governmentrsquos immediate attention may be on adapting CfDs for existing technologies the CFE invites views on wider GB power market design

In its 6th carbon budget sector report for electricity CCC states that the Government should develop ldquoa clear long-term strategy as soon as possible and certainly before 2025 on market design for a fully decarbonised electricity systemrdquo (Committee Climate Change 2020b) The committee goes further and sets out three principles for future market design 1) the need for certain and predictable signals 2) the need for a whole-market approach 3) the need to ensure security of supply The first principle however could be interpreted to support continuation of a centralised and upstream approach In its EWP the Government also indicates a tension in moving away from the current approach as it aims to ldquoseek a balance between options for further reform of the electricity market with maintaining the success of the CfD in deploying low-cost renewables at scalerdquo

The GB electricity market design model is based on bilateral trading with most trading and contracting taking place in the forward markets In the short-term markets security-constrained economic dispatch applies and prices are supposed to reflect the full marginal costs of providing electrical energy and reserves to a consumer at a certain moment in time in a certain location When the output of variable renewables is high the systemrsquos marginal costs can also be high Bids can also reflect opportunity costs It is also crucial that all market actors are fully exposed to these price signals

However many costs are currently socialised renewable generators are shielded from price signals by CfD contracts prices are distorted by policies such as CfDs and the CM new entrants and non-traditional technologies face many market barriers and consumers do not have access to the full value of their flexibility and are not enabled to provide it The pound7bnyear potential benefits of demand-side flexibility from the GB market (OVO Energy and Imperial College London 2018) are still far from being fully unlocked

For example if the full marginal costs relating to energy losses and congestion would be fully reflected in near real-time prices with sufficient granularity by location local energy resources could be revealed to be much more valuable to the system A recent study by Aurora for the Policy Exchange estimates that introduction of local energy pricing by 2026 could reduce the GB marketrsquos total system costs by pound21bnyr delivering consumer savings of pound50bn by 2050 (Policy Exchange 2020)





ESC works with innovators to test new business models and technologies that could contribute to a Net Zero future (eg Innovate UKrsquos PFER projects) Many innovators developing local energy solutions currently struggle to be economically viable under current market arrangements largely because

value in the power system is highly fragmented across multiple mechanisms many of which are undergoing poorly coordinated reforms that directly and negatively impact the business models of these innovators

GBrsquos current market design despite current reforms fails to produce sufficiently coherent dynamic and granular price signals that fully incorporate marginal costs to accurately reflect the status of the power system by time and location

CfDs and the CM are inherently biased towards large generating assets and they distort the wholesale and retail electricity markets that these innovators operate within creating an anti-competitive environment

there exists an absence of decarbonisation policy drivers in the retail market particularly for heat for electricity CfDs are the primary complement to carbon pricing to the detriment of technologies that are not eligible for CfD auction lsquopotsrsquo or cannot access CfDs in aggregate

non-traditional technologies and business models still face many market and regulatory barriers

their voice as for consumers is very weak compared to incumbents and larger companies

The key EMR10 policy mechanisms which currently drive investment mdash CfDs and the CM mdash are increasingly in tension with development of well-functioning and competitive electricity markets as the shares of variable renewables and distributed energy resources (DER) grow The symptoms of this tension include the rising costs of system balancing growing concerns about negative pricing and wholesale price cannibalisation and the relatively slow progress in enabling demand-side response and storage Analysis by NGESO and BEIS shows that participation of DSR and storage is extremely low in flexibility markets compared with fossil-fuelled generators


The five key challenges to be addressed by EMR20EMR20 has a very different starting point to that which existed a decade ago

a high share of variable renewables already in the power mix a number of zero carbon generation technologies reaching maturity considerable evidence of innovation on the demand-side and at distribution level and the adoption of Net Zero which means a more rapid and comprehensive

decarbonisation imperative to scale-up investment in zero carbon energy resources including variable renewables and complementary flexible energy resources

While many of the drivers underpinning EMR10 still hold (DECC 2014 Imperial College London 2019) this new context brings additional challenges The evidence from our whole system analysis and our engagement with the innovation challenges around system integration and flexibility highlights five key challenges for future electricity market reforms

This report considers each of the five challenges in turn and examines the importance of addressing each challenge to the delivery of Net Zero sets out the issues and risks associated with each challenge under the current market

framework and discusses how a set of proposed reforms can combine together to effectively

address each challenge

Our approach to rethinking electricity markets draws from ESCrsquos many previous research programmes and commissioned studies and is also guided by the following core principles that ESC applies to market policy and regulatory analysis1 Adoption of a whole system approach will much increase the chances of successfully

transforming the UK energy system in a cost-effective and timely manner2 Policy design should wherever possible enable open and competitive markets to drive

innovation and reveal the value of clean energy resources and technologies aligning markets as much as possible with the underlying physics of the system

3 Greater understanding of and focus on consumer needs is a crucial input for the redesign of markets and the regulatory and policy reforms that will enable innovation to flourish

















20 Consumer focus challengecontinued

21 Why is this challenge important

Consumer focus is the first of the five key challenges that we argue needs to be addressed by EMR20 Radically improving consumer propositions across the sector is critical to making low carbon choices more attractive for consumers and unlocking system benefits (particularly through greater demand side flexibility) that will ultimately reduce costs for all consumers

ESCrsquos work with consumers highlights the current challenges that many consumers face in getting what they need from energy services and the potential for substantial improvement Consumers currently face undifferentiated offerings based on supply of electricity and pass through of costs (including levies for the CfD and CM schemes network charges VAT) with few suppliers offering reward for flexibility through time-varying tariffs or service-based packages

Consumer satisfaction in the energy sector is relatively low compared to other sectors such as telecoms water and banking as illustrated in Table 2 opposite which compares the UK Customer Satisfaction Index (UKCSI) for different sectors The energy sector also scores poorly compared to the water and telecoms sectors for the Net Promoter Score (NPS a standard measure of the net proportion of customers likely to recommend a product or a company) Scores tend to be better among medium sized entrants to energy supply but worse on average for the lsquoBig Sixrsquo suppliers and small energy suppliers

Electricity demand is expected to at least double relative to todayrsquos levels despite energy efficiency improvements due to electrification of heat and mobility ESCrsquos modelling shows that in a cost-optimal Net Zero system nearly all cars are electric by 2050 and electric heating (mainly heat pumps) account for well over half of space heat production (see Annex 1 ESC modelling evidence)

Much of this new demand is potentially highly flexible We will also need much more flexibility and demand side optimisation to cost-effectively integrate zero carbon variable renewable generation Cost reductions from domestic flexibility particularly smart electric heating have been estimated at around pound7bn a year in the transition to a low carbon future (OVO Energy and Imperial College London 2018)

Smart charging has the potential to deliver significant savings in reinforcement costs for DNOs and system operation costs of NGESO in the range of pound27bn to pound65bn in present value by 2050 (Energy Technologies Institute 2019) Major innovation in new demand-side business models exploiting data and digitalisation could deliver win-win outcomes for the power system and all consumers

Attractive consumer offerings however will be key to unlocking flexibility Consumers will make zero carbon choices and investments if their experience of new products and services is preferable to the status quo and if their expectations of service quality and value for money are met Our consumer insights work suggests there is appetite for potential radical changes in the interface between energy markets and consumers through energy services

Policy reforms however will be needed to incentivise innovative retailers and service providers to invest in the innovation needed to develop new consumer offerings that meet consumersrsquo needs while also delivering key market outcomes (particularly carbon reduction and system reliability)

Section summary

Attractive products and services for consumers will be key to delivering net zero To deliver net zero electricity supply and demand reduction need to be optimised and we will need

zero carbon electricity to serve an increasing proportion of heat and transport energy demand This will interact with consumersrsquo daily lifestyles much more intimately in future Consumers will make zero carbon choicesinvestments if products and services are attractive

(eg switching from gas heating) To fully decarbonise the electricity system cost-effectively we will also need much more flexibility

and demand side response to complement variable renewable generation resources Heat and mobility energy demands are potentially highly flexibleresponsive mdash but this can only be

unlocked through innovative products and services that are attractive to consumers

Source Sector scores from the UKCSI survey published by The Institute of Customer Service reported in the UKRN Performance Scorecard (UKRN 2020) UKSCI scores are expressed as an index score out of 100 The Average NPS Score for Telecoms and Media shown is for mobile services (30) The scores for broadband and landline are lower at 12 and 16 respectively

Headline definition of challenge

TounlockthebenefitsofDERandthedemand-sideforconsumersincludingconsumersrsquoflexibilitythroughsmartlow carbon energy products and services that are attractive optimised and convenient for all consumersrsquo


Table 2 Cross-sector customer satisfaction metrics

90

80

70

60

50

40

30

20

10

0

-10

-20

UKCSI (13 sectors) average

Banks and Building Societies

Telecoms and Media

Water

Energy

UKCSIScore

Experience ComplaintHandling

CustomerEethos

EmotionalConnection

Ethics AverageNPS Score



22 Risks under the current framework associated with this challenge

Focus on price competition and undifferentiated retail offers limit consumersrsquo incentives

Current market arrangements have resulted in an energy supply market that focuses mainly on price competition rather than service innovation or value adding The policy preoccupation around retail market performance has focused on switching rates for very similar products and services and consequently business models focus on providing the cheapest electricity and passing through costs

Service and business model differentiation has been limited Many suppliers have been slow to develop time-varying tariffs or offer their customers the chance to be settled on a half hourly basis Companies such as Octopus with its Agile tariff (Octopus Energy 2020) are the exception Ofgem has stated that it expects to have to require all suppliers to settle customers half-hourly (Ofgem 2020b) The lack of service-based offers in the market may reflect a combination of factors including barriers to entry regulatory constraints insufficient policy drivers within the retail market and resulting weak incentives for energy supply business models

ESCrsquos Smart Systems and Heat Trial carried out in its Living Lab (Energy Systems Catapult 2020a) highlighted the potential of energy service offers About half of the participants chose to buy Heat-as-a-Service (HaaS) rather than plain kwh Figure 3 reveals the motives of the half who chose to buy HaaS the majority focused on comfort and the rest focused on cost or value for money

Section summary

Consumers currently face largely undifferentiated retail offers This limits both their incentive and their ability to offer flexibility to the system

The current framework (eg supplier hub code complexity etc) creates multiple barriers to entry for innovative new entrants or service offers

Accumulation of levies and charges in retail bills mdash reflecting the growing out-of-market roles of the Government and ESO mdash is regressive hampering energy vector-switching and demand-side flexibility

Policy drivers in the retail market are currently weak Market signals are distorted and relatively blunt muting the incentives for retailers and service providers to develop propositions that unlock value by releasing and aggregating demand side flexibility or reducing demand

This means that current arrangements risk inhibiting demand side innovation which risks leading to an unbalanced electricity technology mix (biased towards supplycapacity investment) AND inefficiency in how zero carbon electricity is matchedbalanced with other networks (eg heat networks hydrogen)

Unbalanced stakeholder engagement and lack of consumer focus characterises current governance arrangements which risks lock into status quo Poor consumer focus raises the risk of lack of public acceptance or support for actions to achieve Net Zero


Figure 3 ESC heat trials demonstrated the potential consumer appeal of service offerings

ESCrsquos Smart Systems and Heat Trial carried out in its Living Lab (Energy Systems Catapult 2020a) tested the hypothesis that consumers would find service-orientated retail propositions (related to heat) appealing The trial highlighted that customers value services differently The trial showed that around half the consumers liked the idea of buying their heat as a service (HaaS) instead of kwh It also showed that they preferred different types of service Of those opting for HaaS some wanted to maximise their thermal comfort (61) others to minimise their bill (21) and the remainder (17) wanted value for money

At present knowledge regarding consumer response to market signals is limited underlining the importance of consumer trials and in-market innovation with continuous feedback to policy-makers

62Comfort focussed

Liked he experience of comfort from new controls

More likely to sign up for a heat plan

Preferred FlexiTime plan mdash the extra hours gave reassurance they could stay comfortable

17Value focussed

Loved the feeling in control of both cost and comfort mdash though they were less likely to change their settings

Like to know what they are paying

Not afraid to haggle (eg over summer payments)

21Cost focussed

Know what they pay now and compare prices to this

Switch frequently so more open to something new

Preferred FixedTime plan helped them to fix costs

However many used significant extra hours



ESCrsquos analysis of system architecture (Energy Systems Catapult 2017) points to the potential of retail propositions based around experience-based services models to unlock innovation Digitalisation however is a necessary enabler for unlocking a range of smart services that could combine and optimise variable energy resources storage and demand side flexibility This experience-based services model involves decentralised contracting and establishing resource service level agreements between retailers and consumers as illustrated in Figure 4 This model however depends on drivers in the form of outcome-based policy mandates on retailers

Supplier hub concept creates multiple barriers to entry limiting innovation

Ofgemrsquos Call for Evidence (CFE) on Future Supply Market Arrangements found that the existing regulatory framework based on the supplier-hub model is preventing innovation and the current market design is not ldquofit for purpose for energy consumers over the longer termrdquo (Ofgem 2018 p4) Evidence submitted by stakeholders pointed to the supplier hub rules which include those in the supply licences and codes as being extremely complex difficult to change and presenting constraints for propositions that do not align neatly with traditional supplier business models and tariff offerings (Ofgem 2018)

Some industry codes mdash have the potential to unlock market access for new entrants motivated to provide DSR but their development and implementation are extremely slow under current industry code governance arrangements

Accumulation of levies is regressive and limits consumersrsquoretailersrsquo opportunities

The share of non-energy costs in electricity retail bills has been rising as shown in Figure 5 The breakdown of a typical electricity bill is currently (as of August 20206) wholesale energy costs 34 network costs 22 supplierrsquos operating costs 16 environmental and social obligation costs 23 and the remainder covers VAT supplier pre-tax margin and other direct costs Ofgem recently approved transferring all Balancing Services Use of System (BSUoS) charges which continue to increase from generators to consumers7 Following recent network charging reforms8 the residual charges of network charges will now be fixed though the remaining forward-looking charges to be decided through the current Network Access Forward Looking Charges (NAFLC) reforms9 are expected to be variable Only a small share of the retail bill can potentially vary by time andor location Rising fixed or unavoidable costs can further reduce this share

The Energy White Paper identifies fairness and affordability as priorities for energy policy BEIS will publish a CFE by April 2021 to begin a strategic dialogue between government consumers and industry on affordability and fairness The recent reforms to residual network charges and non-locational embedded benefits were driven by Ofgemrsquos concerns for fairness with the objective of ensuring all consumers contribute to the sunk costs of the network BEIS has introduced a CFE on licence exemptions which indicates the intention to prevent evasion of policy costs Policy costs are also much higher for electricity than residential gas hampering decarbonisation through energy-vector switching


6 Source Ofgem mdash httpswwwofgemgovukdata-portalall-charts 7 httpswwwofgemgovuksystemfilesdocs202012cmp333_final_version_031220pdf8 httpswwwofgemgovukelectricitytransmission-networkschargingtargeted-charging-review-significant-code-review9 httpswwwofgemgovukelectricitytransmission-networkschargingreform-network-access-and-forward-looking-charges Source Cornwall Insight presentation at LCCC autumn conference November 2019

2010ndash11 2011ndash12 2012ndash13 2013ndash14 2014ndash15 2015ndash16 2016ndash17 2017ndash18 2018ndash19

Transmission

BSUoS

HDCAAAHEDC

Distribution

RO

FiTs

CfDs

Capacity Market

CERTCESPECO

WHD

9

8

7

6

5

4

3

2

1

0pkW

h

Figure 5 Rising costs of third parties passed through to customers by the supplier

Figure 4 ESCrsquos vision of highly active retailers and decentralised contracting

ESOTSODNOs Network costspayments

Energy supply and aggregation (power markets)

DER techequipment eg PV heat pump EV EV charger controllers software

Energy efficiency solutions

Cons

umer

s and

ow

ners

of t

heir

asse

ts

bull Data bull Asset optimisation

and control

bull Financing bull Localnational government

grants and initiativesbull Legal requirements

Flexibility offer service level requirements

FacilitatingIntegrating

Contracting

eg Warmth

Highly dynamic retail sectorRetail business models that integrate and optimise energy resources

eg Mobility



Absence of policy drivers and quality market signals limits consumersrsquoretailersrsquo incentives

The current efforts to reform the retail market risk being undermined if the upstream policy framework of centralised contracting and risk transfer to consumers through CfDs and the CM remains unchanged The risk here is that there will be insufficient market signals and incentives to drive innovation and investment in smart system integration and optimisation

Price signals in the spot markets are currently distorted by the presence of the capacity market (CM) and the contracts for difference scheme (CfDs) (see Annex 2) which essentially provide compensation outside of the wholesale market to some market participants The CM and CfDs in effect muffle market signals While the CM restores lsquomissing moneyrsquo for existing resources it creates lsquomissing moneyrsquo for flexible resources which is exacerbated if these resources are not able to access the CM or are significantly de-rated as is the case for batteries The two schemes undermine the case for investment and innovation in business models involving DER

Furthermore consumers have no choice but to pay for the support costs of these interventions through their retail bills on a volume basis per kWh the costs cannot be avoided through flexibility The Government justifies transferring risk from generators to consumers on the basis that the cost of capital is reduced so providing consumers with cheaper electricity than would otherwise be the case While the cost of capital is readily internalised in the cost of a turbine or solar panel it is poorly reflected in the broader system consequences of transferring risk to taxpayers and consumers The design of CfDs causes price suppression and cannibalisation of variable renewables revenues which increases CfD payments and the levies that consumers must pay via the supplier obligation

The Future Energy Retail Market Review aims to ensure that retail electricity markets ldquopromote competition and drive innovation by allowing innovative business models to capture system benefits including flexibility in consumersrsquo demand while ensuring that all consumers receive a fair dealrdquo (BEIS amp Ofgem 2019a p 1) The joint BEISOfgem consultation on Flexible and Responsive Energy Retail Markets (BEIS amp Ofgem 2019b) that closed in September 2019 set out emergent thinking on targeted outcomes for the retail market which include wide choice of energy services minimal market distortions competitive prices for all and ensuring consumers in vulnerable situations receive services they need However BEIS and Ofgem have yet to explore the potential of applying policy drivers to the retail market to achieve market outcomes relating to decarbonisation and reliability

The current policy framework mdash CfDs and CM mdash are upstream and by their nature tend to favour large generating assets Aggregated DER cannot access the CfD scheme and the CM is too administratively burdensome for aggregated BTM assets NGESO monitoring through its Power Responsive Programme (National Grid ESO 2020c) of DSR participation in the mechanisms it manages such as the Balancing Mechanism non-frequency ancillary services and the CM shows that this remains dominated by large commercial and industrial loads A survey of customers (end-users) carried out by The Energyst in 2019 (The Energyst 2019) also showed that DSR providers tend to be large companies with large loads Rather than attempt to incorporate the demand-side into CfDs and the CM the established DER and BTM technologies would be better off with a decentralised outcome-based policy framework and higher quality price signals in an open competitive market

Multiple factors hampering demand-side innovation risk inefficient power mix and energy system

Continuing with incremental improvement to the current upstream input-based policy framework risks limiting innovation in attractive consumer propositions for low carbon heat and transport options mdash slowing the overall pace of decarbonisation in these demand segments This risks leading to an unbalanced electricity technology mix biased towards supplycapacity investment and also inefficiency in how zero carbon electricity is matchedbalanced with other networks (eg heat networks hydrogen)

Without wider reforms to the current centralised contracting and upstream policy framework retail market reforms risk having limited impact on the level of innovation and differentiation in consumer propositions This risks permanently constraining the role of DER and demand-side resources in enabling decarbonisation of the wider electricity system at a pace consistent with net zero Higher retail bills than necessary are the likely result

A lack of focus on consumer outcomes in market design risks locking consumers into the status quo and therefore reduced acceptance of the Governmentrsquos Net Zero strategy

Also at risk is public support for actions to achieve Net Zero that might result if consumers are not listened to supported or rewarded and if the extent of risk transfer from industry to government (consumers) is not evolved in an appropriate and timely manner

Consumers and local communities lack agency under current governance policy and market arrangements which are structured according to industry categories rather than outcomes for consumers or society The governance of the energy sectorrsquos regulatory framework was identified by the Competition and Markets Authority (CMA) as a barrier to the nature and form of competition in its investigation of the sector (Competition and Markets Authority 2016) This view is confirmed by the ESCIET Future Power Systems Architecture Programme (FPSA) (Energy Systems Catapult and The Institution of Engineering and Technology 2017 Energy Systems Catapult and The Institution of Engineering and Technology 2018) which pointed to lsquoinertia generated by current social norms around customer engagement with the energy systemrsquo as a significant barrier to change and innovation in the system





23 How our proposals address this challenge

Our proposals ensure market design and policies combine to drive retail innovation and reduce total whole system costs

Market reforms are needed to strengthen consumer focus and unlock energy resource optimisation across the mass market This requires

price signals that accurately reflect power system status and all marginal costs a level-playing field for different energy resources and market actors with

removal of market barriers a policy framework that can strongly incentivise consumers and retailers reforms to governance arrangements

A more decentralised policy model with a greater focus on consumer outcomes could lead to a lower cost more innovative market as

the centralised policy approach is too administratively burdensome for aggregated small loads and DER with consequent high transaction costs

suppliers and aggregators are much closer to the needs preferences and assets of consumers compared to the Government and

a decentralised policy framework based on outcome-based policy mandates is genuinely technologyresource-neutral

Section summary

Taken together the reforms we propose will substantially increase both the openness of markets to innovative propositions and the rewards for innovators who bring to market consumer-focused propositions that deliver wider value to the system Below we set out how our six proposals will address the lsquoconsumer challengersquo

1 Make electricity markets work more accurately in time and space This will improve rewards for innovative consumer-focused demand side propositions both flexibility and demand

reduction and local energy resources that offer genuine system value

2 Phase out centralised contracting (CfDs and CM) by mid-2020s and replace with outcome-based market obligations This will

remove price distortions and increase the rewards to innovators who are able to aggregate and deliver optimised and reliable energy solutions from distributed portfolios of small assets and residential customers

drive up demand for demand-side flexibility to complement (lsquofirm uprsquo) variable renewable generation assets and portfolios

achieve reliability at lower total cost compared with the CM ensure electricity decarbonises at needed pace with greater competition between all resources more

innovation and consequently a least cost power mix and better consumer outcomes

3 Evolve policy to support financial market development and contracting for investment This will enable suppliers and retailers to efficiently realise value manage risk and deliver desirable services for consumers

4 Enable early deployment and innovation in immature technologies through mechanisms that do not distort markets and using Value-for-Money (VFM) analysis This will

reduceminimise total costs for consumers

5 Overhaul industry code digital and system operation governance This will ensure much greater consumer focus in marketpolicy design and decision-making reduce barriers to entry for retail and service innovators

6 Align electricity sector strategy institutions and associate policy mechanisms with the carbon budget process and trajectory to net zero (with enhanced and independent market monitoring) This will

protect consumers from market manipulation and inappropriate market behaviour and provide reassurance that markets perform as intended corrective actions are being taken by relevant parties the demand-side is effectively accessing marketvalue

The benefits of a decentralised approach are illustrated in Figure 6 The two key market outcomes required of the power sector relate to carbon reduction and reliability and we set out below our detailed proposals for the policy design that could deliver these outcomes

Most consumers will have limited appetite to engage with the complexity of upstream operations and the many varying sometimes conflicting pricing signals Some consumers may be motivated to respond to a dynamic price contract facilitated by automationcontrol technologies but with wholesale energy costs only accounting for a third of the typical consumer bill the strength of the price signal and the savings might not be particularly significant10 This is why the value of flexibility must be fully reflected in prices and aggregators should be able to stack value from multiple sources and manage price response on behalf of the consumer (ie explicit demand response see Annex 2) The value would then be passed on to the consumer as a simple regular payment or charge

Furthermore ESC anticipates that local authorities will in future play a much more active role in exploiting the benefits provided by local energy resources and infrastructure and so retailers would play an important role in connecting consumers to local energy programmes initiatives or trading opportunities

The Smart Systems and Flexibility Plan (SSFP) co-developed by Ofgem and BEIS has achieved considerable progress in progressing a more flexible power system but challenges remain in all areas (BEIS amp Ofgem 2018)11 and OfgemBEIS are due to release an updated version of the plan in Spring It is important that the new SSFP builds on some of the thinking in the Energy White Paper and considers options for market design reform ie EMR20

Figure 6 The benefits of a decentraliseddownstream approach to policy for power markets

10 Wholesale costs in the average consumer electricity bill account for 32 of the total For typical electricity bill breakdown see httpswwwofgemgovukdata-portalbreakdown-electricity-bill

11 Presented in a PowerPoint at joint BEISOfgem ldquoRewarding flexibility for the value it provides the electricity systemrdquo workshop held 7th February 2020 in London

Guarantee policy outcomes ie carbon reduction reliability

Simplify and reduce regulation

Unleash innovation on the demand-side amp in local energy

Achieve scale through mass market

Remove price distortions reveal flex and demand-side value reduce bills

Force incumbents and all resources to compete and adapt

Motivate retailers to deliver value and services for consumers

Public acceptance as Gvt action and benefits more visible




Coordinated actions are needed to address marketprice distortions both upstream and downstream including the accumulation of levies and charges with attention to distributional impacts on consumers The key to improving fairness and affordability however is successfully unlocking the multiple benefits of the demand-side both through flexibility and demand reduction The downward impact of either temporary or permanent demand reduction on price formation in the power markets means that all consumers benefit alongside the individual causing the impact In addition decarbonisation solutions such as energy efficiency and DSR need to be integral to strategies and measures to tackle energy poverty

Our proposals require smarter consumer protection It is necessary that retailers have the capability and credit-worthiness to properly

meet consumersrsquo needs Experience in other jurisdictions with competitive electricity markets points to the importance of credit-worthiness The highly competitive ERCOT market in Texas USA for example has much higher credit-worthiness standards compared to other US states such as Maryland New Jersey and Pennsylvania This combined with removing the privileged position of the incumbent from the electricity market (ie default tariffs) means that retail suppliers in the ERCOT market have both the ability and incentive to procure power and hedge in wholesale markets on behalf of the customers they serve (Gramlich amp Lacey 2020 Wind Solar Alliance 2020) ESC foresees that some market consolidation may be inevitable and the regulator would need to ensure developments are compatible with better consumer outcomes

Market reforms orientated towards a more demanding role for retailers will need to incorporate new safeguards in relation to market concentration and market power High quality market monitoring is key to preventing market manipulation or abuse of market power and also to ensure progress with market design reforms to improve market performance and participation of the demand-side in markets (see section 63 for more detail)

Of significant importance will be the provision of acceptable levels of service to consumers A decentralised policy approach will need to be accompanied by minimum standards and quality assurance schemes for service offerings as part of the consumer protection framework (Energy Systems Catapult 2018a) In an active service market consumer ratings and social media would also play an important role Developing these new consumer protections in a smarter world benefit from environments ndash such as ESCrsquos Living Lab 12 mdash to rapidly test new products and services as well as policy design Much innovation however will take place in the market and so enhanced monitoring of the retail market (see section 63) will be crucial to ensure that any issues are promptly addressed by the regulator Consumer risks and challenges also need to be integral to the design of policies and schemes though must be addressed in a way that does not hold back the necessary and urgent need to empower and engage consumers through more innovative retail markets

Governance reforms should be consumer-focused Relative to industry consumers have less resources information and expertise to engage in

policy-making processes Both balanced stakeholder engagement and greater consumer focus underpinning the development of policyregulation could be achieved through a systems engineering approach recommended by the ESCIET FPSA programme (Energy Systems Catapult and The Institution of Engineering and Technology 2017 Energy Systems Catapult and The Institution of Engineering and Technology 2018) (see Annex 13) This proposed approach is based on an lsquoemergent architecturersquo and lsquoprinciplesoutcome-based governancersquo driven by consumersrsquousersrsquo needs

Consumersrsquo representation can be increased or improved in various ways but more important is to place consumer focus at the heart of the definitions of roles responsibilities and objectives of decision-makers and delivery bodies and also the principles that underpin the design of markets and policy

12 httpsescatapultorgukservice-platformsliving-lab


30 Zero carbon energy resource investmentchallenge


30 Zero carbon energy resource investment challengecontinued

13 httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile568982An_analysis_of_electricity_flexibility_for_Great_Britainpdf

14 These results apply for costs of enabling DSR of less than pound100kW It is not until an unlikely pound5000kW that the savings are nullified The savings from substituting wind for carbon capture and storage remain substantial even if the anticipated reduction of cost of wind in 2040 does not materialise Cost savings from the flexibility provided by SLES are affected by realisation of domestic DSR through other means outside SLES A 20 uptake level of non-SLES DSR in 2040 still allows SLES to create cost savings of pound68bnyear at 50 penetration (a 20 fall from pound87bnyear)


Achieving Net Zero is likely to involve a near doubling of electricity demand compared to todayrsquos levels In its recent Sixth Carbon Budget report the Climate Change Committee estimates that around 400TWh of new low carbon generation will be required by 2035 with 50TWh of this capacity being dispatchable flexible generation and with 20 of demand being flexible by this date (Climate Change Committee 2020a) The committee adds that up to 140GW of new variable renewable capacity may need to be built by 2050

ESCrsquos modelling sees a major role for variable renewables (providing at least 45 of both capacity and generation by 2030 and more than 50 by 2050) across a range of future scenarios of varying optimism about the potential for other technologies such as CCS hydrogen nuclear or flexibility (see Annex 1) (Energy Systems Catapult 2020c) This analysis suggests that the reliance on variable renewables will be higher if cost reductions do not result for other technologies such as nuclear Our modelling also suggests that a cost optimal power mix is characterised by diversity in energy resource type with sufficient flexibility including a considerable amount of storage and DSR to cost-effectively integrate variable renewables

Section summary

Achieving net zero will involve a near doubling of electricity demand compared to todayrsquos levels with a major role for variable renewable energy under all scenarios

To meet this demand we will need in addition to variable renewable generation sufficient firm and flexible zero carbon energy resources

If barriers can be removed the demand-side and distributedlocal energy resources could play a major role in reducing total system costs ensuring affordable bills and delivering multiple benefits

It will take time to build up supply chains for both firm zero carbon generation and flexible resources that are capable of delivering at pace scale and with substantial cost reduction (cf offshore wind)

A pipeline of projects enables supply chains to build scale and deliver cost reductions and for finance to be made available

This can be delivered through an efficient technology-neutral market design and evolving complementary policy framework that investors and stakeholders have confidence in

Local distributed energy resources including demand response can offer highly cost-effective flexibility and many other multiple benefits Imperial College London and the Carbon Trust estimate the benefits of flexibility to be pound17-40bn over the period to 205013 A recent study by EnergyRev (EnergyRev 2020) illustrates that smart local energy markets (SLES) could unlock DSR and local storage to deliver consumers significant savings14

Current signals however do not reveal the true value of flexibility or other benefits as some costs are socialised and marginal costs or externalities such as network congestion are not internalised in energy prices

It will take time to build up the supply chains required to deliver this diverse technology mix at the pace and scale required while also driving cost reduction Past experience including that with offshore wind points to the importance of developing a pipeline of projects to enable supply chains to build scale and deliver cost reductions and to bring forward sufficient investment finance The Governmentrsquos 10 Point Plan (HM Government 2020) and Energy White Paper (BEIS 2020a) give attention to this in relation to low carbon generation such as next generation flexible nuclear gas with CCUS and hydrogen but far less attention to local energy and the demand side

Meeting the zero carbon energy resource challenge requires a market and policy framework that can accurately reveal the value of flexibility unlock the multiple benefits of the demand side and local energy and mobilise affordable finance for a cost-optimal mix of zero carbon technologies and resources


Ensureasufficientpaceandvolumeofinvestmentinzerocarbonelectricityresources and technologies delivering a cost-optimal power mix


With a 100 gCO2kWh emissions target in 2030

10 penetration of SLES could reduce total costs by pound12bnyear relative to no SLES

50 penetration of SLES could reduce total costs twofold to pound28bnyear

With a more stringent emissions limit of 25 gCO2kWh in 2040

savings rise to pound29bnyear for 10 SLES uptake

savings rise threefold to pound87bnyear at 50 uptake

25gCO2kWh

100gCO2kWh

The flexibility of SLES means that

variable renewables such as offshore wind can displace firm but more expensive low-carbon sources such as CCS



32 Risks under the current framework to meeting this challenge

GBrsquos current market design model is undermined Market design for a high variable renewables future needs to deliver coherent incentives

for both efficient operation and investment This means market signals that can

remunerate investments in the mix of energy resources required and provide operational incentives across different timescales market participants

energy vectors and technologies mdash which in turn shape the development of service offers for consumers

Efficient market signals not only enable efficient short-term operation decisions but also efficiently influence investment decisions in the low and zero carbon resources capable of responding to these short-term price signals and therefore deliver the cost-optimal power mix with the right blend of capabilities This cycle is illustrated in Figure 7 If short-term price signals are distorted or fail to accurately reflect real time physics this cycle can break down mdash as is happening under EMR10

Section summary GBrsquos current market design model is undermined by the distorting impacts of the CfD and CM

schemes inadequate internalisation of marginal costs into energy prices and weak inconsistent carbon price policies This drives a self-perpetuating requirement for policy support

Under the current market framework most new generation investment receives policy support resulting in the under-development of financial markets and contracting to manage investment risks

The current centralised policy framework comprising CfDs and the CM is technology-biased towards generation and large assets CfDs apply to generation with no access for aggregated resources The CM applies restrictive eligibility criteria and is administratively burdensome for small or aggregated loads

Continuation of the centralised policy approach locks in a sizeable and self-perpetuating out-of-market role for Government and the system operator (SO) while crowding out smart innovative solutions

Current carbon pricing policies are insufficient to drive full decarbonisation of electricity A credible and investable policy driver is needed to complement carbon pricing and innovation support to decarbonise electricity

Inefficient price signals raise risk of inefficient investment and a capacity mix with suboptimal capabilities ultimately leading to worse outcomes for consumers in terms of costs reliability amp service quality

Free price formation including scarcity pricing is crucial for the efficient functioning of the market design model Under the current market design and policy framework EMR10 modellers project declining average wholesale prices (often referred to as baseload prices) as the share of VRE grows resulting in declining revenue capture for variable renewable generators For example modelling by Cornwall Insight (Cornwall Insight 2018b) projects that under current market arrangements capture prices of offshore wind could decline to around 25 of average wholesale prices by 203031 15 (see Figure 8)

Market design experts across the globe debate the potential risk of this lsquoprice cannibalisationrsquo trend its causal factors and how it should be addressed as the share of VRE rises16 Some argue that this cannot be fully addressed through an energy-only market design This view suggests that variable renewables will not be able to recover their fixed costs in the long-run because wholesale prices are likely to be increasingly set by variable renewable generation with low or near zero short run marginal cost (SRMC) It is argued that the combination of high fixed costs and low marginal costs and correlated generation outputs that are largely independent of demand will inevitably lead to missing money without policy support or intervention


Figure 7 Signals needed for delivering and operating in envisaged future power mix

Opernational signalsIs market capable of supporting efficient short-term operation decisions for available resource

Investment signals Is market capable of delivering efficient investment in terms of resource type location and timescale

Today Future

15 Assumptions regarding increase of power system flexibility are not known including increased interconnection and cross-border trading

16 We set out the issues in more detail in Annex 2 Economics of market design and price cannibalisation Source Cornwall Insight 2018b

Solar price captured Wind price captured Modelled baseload power price

45

40

35

30

25

201819 201920 202021 202122 202223 202324 202425 202526 202627 202728 202829 202930 3031

poundM

Wh

Figure 8 Modelled capture prices for wind and solar UK (2018 money)




17 The reliability standard for the GB power market is 3 hours but the GB power market achieved a Loss of Load Expectation (LOLE) of 001 hours for 201718 and 0001 hours for 201819 (BEIS 2019a) While some might interpret this to mean the market is highly lsquosecurersquo from a resource adequacy point of view it also means the market is oversupplied

18 The compensation awarded to generators outside of the wholesale market via the schemes directly impacts the value available in the wholesale market In 20192020 pound1803m was paid out under the CfD scheme while for the CM the payments were pound9873m for delivery year 201819 and pound460m for delivery year 20192020 (LCCC 201920)

Any discussion of the lsquoprice cannibalisationrsquo effect in a UK context however should take account of how market signals particularly at times of both peaks and troughs in demand are currently distorted by policy interventions including CfDs and the CM These effects make merchant investment riskier and therefore more costly to consumers

When CfDs and CM mechanisms add capacity to the market wholesale prices reduce mdash the mechanisms are contributing to price suppression especially when too much capacity is procured (ie more than the lsquomissing moneyrsquo) 17 the market is well supplied by the EMR mechanisms and so there is no need for further investment in any other capacity which is unfortunate for developersproviders of capacity not eligible for or restricted by the schemes Price suppression always occurs in markets when compensation is provided through mechanisms mdash even if market-based and highly competitive as for CfDs and the CM mdash that are outside of (or put another way in addition to) the main wholesale market 18 (see Annex 2 and Brown amp Reichenberg 2020)

CfD design distorts the bidding behaviour of CfD recipients and their response to market signals contributing to cannibalisation of their own revenues raising CfD payments and costs to consumers through levies collected via the supplier obligation (see Annex 9)

The GB model is based on marginal pricing and for the market to function effectively all system marginal costs should be incorporated in prices including those due to network constraints under the current market arrangements this is not the case mdash which can manifest via action by the SO outside the wholesale market (eg to resolve network constraints)

The existence of CM contracts distorts the bidding behaviour of contract recipients in the short-term wholesale electricity markets and tends to dampen price volatility and the scarcity pricing effect (see Newbery 2016 Hogan 2016 and Annex 2) Without scarcity pricing neither the market nor system can be efficient

Current market arrangements are therefore unable to fully reward flexibility and DSR thus inhibiting a potential counter influence against variable renewablesrsquo price cannibalisation

Cross-border trading can help address price cannibalisation mdash but this is distorted under current carbon pricing and accounting arrangements as well as divergent policies between the UK and neighbouring markets

The above-mentioned inefficiencies of GBrsquos current market design and consequences are summarised in Figure 9

Figure 9 Causes and consequences of inefficient market design

Inflexible demand

Externalities not internalised costs

not reflected

Compensation outside market

(CFDs CM)

bull Market signal distortionbull Poor confidence in short-term wholesale marketsbull Under-development of forwardfuture marketsbull Indefinite Government interventions



The design of the CfD scheme currently transfers significant risk from industry to consumers (via Governmentndashorganised contracts) This risk transfer is a form of subsidy A competitive market providing a level-playing field for mature zero carbon technologies should be free of such risk transfers

CfDs suppress the demand of the renewables industry for forward contracting and risk mitigation products and services from the private sector This gives rise to missing futures and insurance markets (Newbery 2016) Under current market conditions there is a mismatch between the short duration of hedging and insurance products currently available and the length of energy contract that retailers are willing to sign up to on the one hand and the tenor of debt that investors in generation assets likely require for final investment decisions on the other

However there is evidence of innovative developments such as new types of Power Purchase Agreements (PPA) use of energy resource portfolio diversification and aggregation of offtakers (see Annex 4) This suggests the potential for financial markets to develop and supply financial products from new risk bearing financial intermediaries A broadening range of market risk management strategies can be expected to emerge as financial markets develop but only if the demand is there

On the lender and investor side the CCCrsquos carbon budgets set clear long-term demand for zero carbon electricity To date the CfD scheme has been the credible mechanism that complements carbon pricing to drive sufficient investment in zero carbon generation technologies to align with the carbon budget Continued use of CfDs to support scale up of investment in selected technologies that are now starting to mature however risks delivering a suboptimal power mix This is because the CfD scheme selects the specific technologies to be supported and determines the amount of capacity to be procured which is not conducive to establishing a level-playing field An alternative credible technology-neutral policy driver will be needed to complement carbon pricing to drive the needed investment for Net Zero

A survey of senior level investors financiers developers and independent power producers and utilities based across Europe identified a range of barriers holding back the deployment of offshore wind without Government support with unsupportive policy being a key reason why the developerinvestor and financing markets are not adapting fast enough (see Annex 4) The risk under current arrangements is that demand for innovation in contracting PPAs and other financial and risk mitigation products will fail to emerge This lack of risk-bearing opportunities ultimately results in an environment less likely to attract new types of investor and less supportive of innovation in financing


19 See for example httpswwwofgemgovukdata-portalelectricity-trading-volumes-and-churn-ratio-month-and-platform-gb Source BEIS 2020c

Under-developed financial markets as most new generation investment supported

While short-term market signals can and should influence investment decisions they do not on their own bring forward investment even if they are not distorted GBrsquos wholesale electricity trading and transmission arrangements known as BETTA (British Electricity Trading and Transmission Arrangements) are based on bilateral trading between generators suppliers customers and traders over different timeframes (Figure 10)

In the GB power market a very high proportion of electricity is already traded through bilateral contracting in forward markets19 Forward contracting can play a key role in driving investment in fixed assets in many markets but current electricity market arrangements risk inhibiting this role for forward contracting as low carbon technologies mature and the resource mix adapts

Forward bilateral contracts link to prices in the short-term markets with the terms of the contract negotiated such that generators cover their costs and risks are allocated between the contracting parties and priced accordingly Market participants use the short-term markets to fine tune their position having previously negotiated bilateral contracts in the forward markets to buy and sell energy resources along with risk mitigation products and services The nature of these contracts however needs to adapt to reflect the risk profiles of the new technologies

Figure 10 Current trading arrangements under BETTA

Up to several years ahead Tndash24 hours Tndash1 hour gate closure

Tndash0 T+29 days

T+14 months

Time

Forward markets Settlement

Other financial instruments

OptionsSwaps

PX trades

Standardised OTC products

Bespoke bilaterals

Bala

ncin

g M

echa

nism

Imba

lanc

e se

ttlem

ent

Trad

ed p

erio

d

Financial markets

Fina

ncia

l se

ttlem

ent



Large out-of-market role for Government and ESO In the GB power market the SO has a significant out-of-market role NGESO takes

over managing the system following gate closure procures resources for the balancing mechanism and ancillary services conducts the resource adequacy assessment that determines the amount of capacity Government will procure through the CM and administers key elements of the CM and CfD schemes Balancing costs have risen from pound215m in 2010 to pound941m in 2020 with the rise in costs being particularly steep over the last three years driven by an increasing share of variable renewables in the power mix22 Balancing actions have been dominated by curtailment of variable renewables and turn-up of gas plant with limited use of storage and demand-side flexibility Consequently the carbon intensity of the Balancing Mechanism is high in early lockdown in response to the Covid pandemic carbon dioxide emissions of the Balancing Mechanism reached 15-25 of total GB electricity emissions (BEIS 2020d) Improvements to market design could enable much greater participation of the demand-side and for the private sector to play a greater role in balancing the system reducing reliance on the Balancing Mechanism and the volume of reserves that needs to be procured

Carbon policies insufficient to decarbonise and cost-optimise power mix

The transition to net zero will almost certainly require decarbonisation of the electricity system at a faster pace than other sectors The UKrsquos current carbon pricing is insufficiently strong to drive full decarbonisation of the electricity system at the pace required The room for manoeuvre in increasing the stringency of existing carbon pricing for example through tightening the cap set for a UK Emissions Trading Scheme is limited by potential international competitiveness tensions for traded industrial sectors also covered by such an ETS It is also necessary to levelise the effective carbon price signal across energy vectors and sectors

In the absence of CfDs however a mechanism would still be needed to complement the UKETS to drive private investment in zero carbon energy resources at the pace needed for Net Zero The pace of investment needed is likely to exceed the demand for reliable supplies of energy arising from load growth and retirement of generation Assets with years of technically useful life in them may need to be replaced This means that new zero-carbon technologies will have to compete with the variable operating costs of legacy fossil assets

Policy will therefore need to force the turnover of legacy fossil assets But relying on existing carbon pricing mechanisms would be risky Carbon prices are expected to have less influence on the merit order as the power mix decarbonises They are also more vulnerable to political pressure High carbon prices could also have unacceptable impacts on prices for consumers (see Annex 5)


20 De-rating factors which are determined by National Grid reflect technology-specific plant availability21 See also httpwatt-logiccom20200409capacity-market-restart

CfDs and CM not technology neutral The Government strongly influences the power mix by determining the inputs for the CfD

scheme and the CM For both schemes the Government decides how much capacity to procure For the CfD scheme it decides which technologies can take part in each auction round Offshore wind has dominated recent CfD auctions The CM is open to any resources so long as they meet the eligibility criteria which can be restrictive However fossil fuelled energy resources continue to dominate the CM auctions with 70 of the CMrsquos contracted value for delivery year 202122 being awarded to fossil fuels (BEIS 2020d)

Participation in the CM is based on detailed eligibility criteria and de-rating factors which inherently hamper innovation as they are based on existing technologiessolutions These criteria can also treat certain technologies very differently and are or risk being discriminatory For example the same de-rating factor 20 is applied to both onshore and offshore wind even though offshore wind typically has higher average load factors compared to onshore wind

In the case of storage technologies the de-rating factors for batteries are based on minimum lifetime capacity and so do not allow for the fact that battery capacity changes over time through its life This has caused batteries to register as DSR By locating behind the meter (BTM) batteries are able to achieve the DSR de-rating factor of 86 while in front of the meter short duration batteries are de-rated at between 10 and 20 (National Grid ESO 2020b)

Despite this participation of DSR (including BTM storage) in the CM is generally low achieving a small fraction of the total awarded capacity for example less than 2 of total capacity procured through the most recent T3 and T4 auctions (National Grid ESO 2020c)21 A key factor explaining low DSR participation is the administratively burdensome qualification process Generally it is mainly large companiesloads that participate in the CM and other GovernmentSO-led procurement (National Grid ESO 2020c)

Energy efficiency is not eligible to participate in the CM even though it successfully participates in CMs of other jurisdictions such as ISO New England and the PJM power markets based in the USA (Liu 2016) ESC would not recommend adapting the CM to include energy efficiency and demand reduction instead we recommend removal of the CM and replacement with alternatives that are compatible with well-functioning short-term markets DER and the demand side (see Annex 8)

22 httpswwwnationalgridesocomindustry-informationindustry-data-and-reportssystem-balancing-reports



Make electricity markets work accurately in time and space Our EMR20 proposals aim to substantially sharpen the accuracy of price signals in

reflecting system value through a focus on moving wholesale pricing closer to real time and with greater locational resolution As illustrated in Figure 7 efficient market signals not only enable efficient short-term operation decisions discussed in more detail in the system integration chapter but also efficiently influence investment decisions in the low and zero carbon resources capable of responding to these short-term price signals The ability of short-term price signals to simultaneously provide operational and investment signals is crucial to delivering a least cost power mix with the right blend of capabilities

While short-term price signals are not enough on their own to drive the needed investment they constitute an essential market design feature that is increasingly important as the shares of variable renewables and DER increase Also an essential feature of market design and complementary to the short-term markets are the forward and futures markets Most bilateral trading already takes place in the forward markets and so renewable generators developers and investors will need to transition to contracting in the forward markets as CfDs are phased out (discussed later)



Risk of inefficient investment and sub-optimal consumer outcomes

The growing tension between the EMR interventions and the development of efficient market signals gives rise to a number of risks

The problem of lsquomissing moneyrsquo in wholesale power markets (a key factor justifying existence of the CM (BEIS 2020c)) is likely to persist as long as the CfDs and CM are in place particularly for energy resources not able to access these schemes

Suppression and distortion of short-term wholesale price signals is likely to persist undermining the business case for innovation and investment in flexibility efficiency and efficient integration of DER and demand-side response

There is a risk that residential demand in particular (as larger loads are more able to access the CM) will remain inflexible if the price signals remain relatively blunt and EMR interventions continue to distort them

Continuing to support competitive technologies through long-term CfDs in order to facilitate low cost finance even if CfD reforms address price cannibalisation and involve zero subsidies risks impeding the establishment of a level playing field for all energy resources and technologies (demand supply distributed or centralised) Consumers may benefit from lower financing costs for individual investments delivered through the centrally administered CfD mechanism But this could come at a considerable cost from a wider systemmarket perspective by distorting the energy resource mix and inhibiting innovation in a wider range of technologies and business models particularly on the demand side which are vital for cost-effective system integration This risk should be fully considered based on whole systems analyses

Section summaryThe reforms we propose will drive investment to decarbonise the power system in guaranteed alignment with the carbon budget process giving investors the certainty they need The proposals will secure the market outcomes of decarbonisation and reliability while allowing power markets to deliver better quality prices and forwardfutures markets to deliver the need contracting innovation and market-led risk mitigation Below we set out how five of our six proposals will address the lsquozero carbon investment resourcersquo challenge1 Make electricity markets work more accurately in time and space This will provide more accurate closer to real time and locational prices mdash fully incorporating all marginal

costs ensuring free price formation free of distortions allowing scarcity pricing mdash which will sharpen incentives to invest in capacity and system integration resources where they are most valuable in supporting decarbonisation of electricity or the wider energy system

2 Phase out centralised contracting (CfDs and CM) by mid-2020s and replace with outcome-based policy mandates This will

more effectively and efficiently deliver required market outcomes with greater innovation and consumer benefits because consumers via retailers drive markets

create a credible investable market signal for investors in portfolios of zero carbon generation and flexibilityDSR assets as the decarbonisation obligation would be aligned with the carbon budget process

restore value and confidence in wholesale market price signals drive demand for and investment in a balanced portfolio of clean energy resources including much greater

uptake of DSR and demand-side storage which will provide energy flexibility and least cost reliability3 Evolve policy to support financial market development and contracting for investment This will help investors to transition to a more market-driven environment as innovation support is phased

out with financial markets and contracting instruments developing to support investment4 Redesign innovation and early deployment support for immature technologies to avoid distorting markets This will restore value and investorsrsquo confidence in wholesale market price signals as well as attract investment in new

innovative technologies including those on the demand-side6 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle This will help investors better manage risk as enhanced independent market monitoring with improved timely

communications and sufficient resourcing will provide quality information on the performance of markets and the policyregulatory framework and assurance that decision-makers are taking appropriate corrective actions

in combination with adoption of local energy planning and reforms to the DSO role provide a clearer framework for project developers to identify high value opportunities and locations for connection and new asset location


The GB electricity market design model is based on bilateral trading with most trading and contracting taking place in the forward markets In the short-term markets security-constrained economic dispatch applies and prices are supposed to reflect the full marginal costs of providing electrical energy and reserves to a consumer at a certain moment in time in a certain location When the output of variable renewables is high the systemrsquos marginal costs can also be high Bids will also reflect opportunity costs

Considerable costs however are currently socialised and major marginal costs such as those associated with network constraints are not yet reflected in energy prices Prices varying by location will influence capacity value in different locations and therefore investment decisions If the full marginal costs relating to energy losses and congestion would be fully reflected in near real-time prices with sufficient granularity by location investment in DER in certain areas such as the South-East could be revealed to be more cost-efficient than in for example offshore wind

Locational energy pricing can yield considerable efficiency gains and considerably reduce costs for consumers (Green 2007 Graf et al 2020 Wolak 2011 Zarnikau et al 2014) A recent study by Aurora for Policy Exchange estimates that introduction of local energy pricing by 2026 could reduce the GB marketrsquos total system costs by pound21bnyr delivering consumer savings of pound50bn by 2050 (Policy Exchange 2020)

Some locational value is currently reflected in network charges but the value is fragmented and revealed through weak blunt and relatively static price signals (see Annex 6) Ofgem is currently reforming network charges and it seems likely that a dynamic element will be introduced to the forward-looking network charges (Ofgem 2020d) While we think such reform is important improving the granularity of energy price signals by time and location has greater potential to realise system efficiencies and unlock consumer benefits rather than how charges are recovered This is because

The key objectives of network charges are to recover costs while being cost-reflective and avoiding distortions (Energy Systems Catapult 2019c) Other objectives and principles are also applied and so multiple trade-offs are typically necessary in the design of charges Network charges only recover a DNOrsquos allowed revenues and no more

Ofgem recently decided that residual charges will in future be fixed charges in network tariffs They will typically account for a significant proportion of the total network charge reducing the impact of the dynamic forward-looking part of the charge (Ofgem 2019)

While locational price signals need to support decision-making in investment timescales they also need to support decision-making in operational timescales and so need to be highly granular More sophisticated options for the forward-looking charges have already been dismissed by Ofgem due to insufficient network monitoring capability lack of data and insufficient understanding of consumer response (Ofgem 2020d)

The Balancing Service Use of System Charges (BSUoS) could be varied by locationtime our market reform proposals including locational energy pricing however would considerably reduce these charges as much more balancing would be achieved through the market rather than via ESO(ISO)DSOs



Allowing scarcity pricing A key reason for lack of scarcity pricing used to be that imbalance prices did not reflect

the full cost of the balancing actions taken by NGESO This has been much improved through reforms to the imbalance settlement methodology and introduction of the Reserve Scarcity Pricing Function (RSP) Further improvements however are needed as the share of variable renewables in the power mix continues to grow NGESOrsquos proposal to review the RSP methodology is therefore timely 23 though wider reforms based on a whole market analysis are necessary

Efficient scarcity pricing will not occur in a market that is subject to significant price distortions as under current market arrangements If our proposals for reform would be implemented however then prices would freely form and reflect the scarcity of energy resources or network capacity when it occurs By the time our proposals would be implemented the key enablers for demand response mdash largely due to implementation of measures in the BEISOfgem Smart Systems and Flexibility Plan including half-hourly settlement reform the roll out of smart meters and provisions to unlock the supplier hub - should have been implemented and so consumers will be much more able to express both their willingness to pay and their reliability expectationsrequirements

Despite this there may still be a risk that the Government or regulator will intervene if prices are perceived to be too high and the existence of this possibility can concern investors and cause them to hold back investment Enhanced market monitoring ideally by an independent body can play a crucial role to prevent inappropriate or unnecessary interventions by providing high quality and timely information and analysis to decision-makers investors and other stakeholders (further detail below in the final section of this chapter)

If market power exists remedial action can be taken including the introduction of administrative scarcity pricing mechanisms (eg Operating Reserve Demand Curve as in ERCOT Texas) which would give operators and regulators reassurance that the scarcity pricing reflects legitimate scarcity and not the abuse of market power The recent power system crisis in ERCOT Texas also points to the need to have clear procedures in place for exceptional circumstances when the market can not deliver (eg common-mode or system-wide failures) with a circuit-breaker to safeguard market participants against sustained extreme prices if the market can not respond For example in Australia for exceptional conditions that are clearly defined administered prices can be applied to cap the spot price at a lower level for a defined period This may result in energy suppliers incurring a loss and so the national electricity rules allow suppliers of energy services to claim compensation in accordance with specified conditions (though this provision has hardly ever been used)

Incorporate all marginal costs including network constraints The reforms we propose would over time substantially improve the degree to which

wholesale electricity prices reflect the full system marginal costs associated with delivering power to consumers Inflexible supply combined with inflexible demand and CfDsrsquo shielding of variable renewable generators from market signals are significant contributors to the variable renewablesrsquo price cannibalisation issue (see Annex 2 for more detail) and so key to enabling the effective functioning of the market design model is to ensure that missing value be restored to the short-term wholesale energy markets by incorporating all marginal costs and that all market participants including variable renewable generators be exposed to the resultant prices

23 httpswwwelexoncouksmg-issueissue-92 httpswwwaemcgovaurule-changescompensation-arrangements-following-application-of


Strategic planning needed to complement prices Along with more efficient locational energy prices strategic planning could play an

important role in influencing the siting of new generation andor storage assets or indeed demand (eg new industry) An independent system operator (ISO) as proposed by Ofgem could play an important role in strategic planning of the powerenergy system

ESC advocates the national rollout of a process of Local Area Energy Planning (LAEP) under the leadership of relevant local bodies to identify balanced strategies for the energy transition mdash including building and heat decarbonisation mdash at local level These plans should underpin a clearer more evidence-based process to identify key collective investments and strategic choices (eg the locally calibrated balance of energy resources required to decarbonise heat or support low carbon mobility)

Higher quality market price signals combined with reforms to the DSO role and the introduction of LAEP will provide a clearer framework for project developers to identify high value opportunities and locations for connection and new asset location

Phase out centralised contracting and replace with decentralised policy mandates

Our proposals for EMR20 involve adopting a decentraliseddownstream policy approach which allows demand pull from consumers via retailers to drive markets The logic here is that a cost optimal power mix is more likely to be achieved if investment is shaped more strongly by demand from retailers (acting on behalf of consumers while also obligated to deliver public policy outcomes around decarbonisation and service reliability) Under this market concept it is retailers (or bulk purchasers of electricity) who contract upstream for energy resource adequacy and risk mitigation while complying with policy mandates that are designed to guarantee market outcomes The long-term contracts for established technologies with Government as counterparty through both CfDs and the CM would be phased out

Drive demand for zero carbon investment through market-pull A policy mandate to internalise the decarbonisation imperative into both wholesale

energy prices and energy demand makes it possible to levelise the effective carbon price across the economy while driving investment to decarbonise the power sector at a faster pace than the rest of the economy aligned with CCCrsquos carbon budget cycle A decarbonisation obligation will create a credible investable market signal for investors in portfolios of zero carbon generation and flexibilityDSR assets as the decarbonisation obligation would be aligned with the CCCrsquos carbon budget cycle It could take the form of carbon intensity performance standards obligations or targets (that could be tradable) applied to retailersrsquo portfolio of energy resources or sales (Energy Systems Catapult 2020b Buchan amp Keay 2015)



It is necessary to consider how much resource should be invested in improving the dynamism of network charges given the shortfalls mentioned above the long time it takes to reform network charges and the relative costsbenefits of more sophisticated options such as locational differentiation in energy prices

With much higher ambition and fast growth in variable renewables and DER the need for locational value to be revealed for the purposes of achieving efficient and cost-effective system development and investment is becoming increasingly pressing In the near-term ESC recommends that the Government undertake a comprehensive assessment of the costs benefits and trade-offs of the potential options for efficiently revealing locational value in energy prices (eg nodal pricing zonal reconfiguration or local energy trading models)

Market participants would benefit from clarity on how locational value in the GB power system will be more efficiently and fully revealed in future and how the quality of price signals will be improved over time The Government should therefore require NG ESO (or ISO) to develop and implement a roadmap for improving the quality of short-term wholesale energy price signals Among other aspects (see proposals in next section on system integration) this roadmap should include for example an indication of the mechanisms (ie locational energy prices network access charges use of network charges local flexibility markets) through which locational value will be revealed in the power system in future and how these mechanisms are expected to be improved or reformed over time as the system changes and decarbonises

24 See also CMA (2015) Energy market investigation Locational pricing in the electricity market in Great Britain which references multiple studies pp9 httpsassetspublishingservicegovukmedia54eb5da5ed915d0cf7000010Locational_pricingpdf


Drive the market to deliver reliability and reduce costs Working closely with AFRY ESC analysed various capacity remuneration mechanisms

(CRM) (Energy Systems Catapult 2019a) that could support the development of energy services and mobilise use of demand-side energy resources The study concluded that a decentralised CRM (either reliability obligations or options with the system operator using Strategic Reserves as a backstop mdash explained in more detail in Annex 8) would create the potential for energy service providers (and the market more broadly) to deliver security of electricity supplies via decentralised contracting solutions rather than relying on centralised interventions for delivering resource adequacy as through the current CM model

Compared to the upstream and centralised approach of the current CM a decentralised market-led solution is expected to both incentivise and accommodate a more flexible approach to delivering security of supplyservice with greater use of DER within retailersrsquo resource portfolios with market participants taking decisions based on their own positions in respect of

the nature and blend of resource needed to deliver reliability to meet their consumersrsquo needs

the quantity of resource needed taking into account the reliability requirements of consumers and within-portfolio sources of reliability

a wider range of innovative solutions and evolution of consumer-focused offerings in the energy sector and broader

technological and societal changes

Under a decentralised approach to reliability suppliers would have primary balancing responsibility The role of NGESO and DSOs would be limited to taking action when the market would fail to clear Their reduced role as lsquoreserve operatorrsquo would be to provide for example stabiliser mechanisms and contingency overrides

A decentralised approach can be evolved over time to reflect market development and maturity with the Government initially adopting a stronger role in the short-term by setting the capacity procurement requirement and obligating suppliers to procure a certain amount of capacity eg Decentralised Reliability Obligations As the retail market matures the responsibility for determining the capacity requirement can shift from Government to suppliers with the Government instead monitoring contracting and stepping in to obligate suppliers to contract more resources if assessments reveal insufficiency The Government could also obligate suppliers to purchase options to hedge consumers against high prices eg Decentralised Reliability Options The latter will force development of the retail market and an options market and reduce reliance on the Government for risk mitigation while ensuring that consumers are hedged against high prices



Carbon performance standards aligned with CCCs carbon budget cycle will also need to be applied to procurement of services (eg ancillary congestion) by system operators ESO and DSOs To drive investment in energy resource optimisation by combining decarbonised supply and flexibility with demand reduction or energy efficiency carbon performance standards must also be placed on buildingasset owners

Various renewable and low carbon technologies are now competitive and well-established but a strategy and market design reforms are needed to gradually expose these technologies to market As an interim measure the CfD scheme should be reformed urgently for competitivemature technologies in order to incentivise generators developers and investors to adapt their bidding behaviour and strategies to minimise exposure to price cannibalisation particularly through forward contracting Reforms must aim to remove or minimise harmful distorting impacts on the short-term wholesale electricity markets and must at the same time give affected generators the freedom to pursue different routes to market and to be able to access revenues in all markets and mechanisms if they are capable of providing the needed products or services

In parallel and without delay the Government should develop legislation to introduce a decarbonisation obligation This would eventually replace CfDs for competitivemature technologies removing the need for subsidies and complementing carbon pricing

Learning from the experience of CfDs future innovation support policy must be designed with attention to potentially distorting impacts on markets and competition given that many lowzero carbon technologies are now getting well established in markets In addition support policy for early deployment of promising technologies needs to be designed using clear evidence-based prioritisation based on value-for-money analysis that includes the full costs and benefits as well as the implicit support and risk transfers under current policy (LCP and Frontier Economics 2018) New metrics and cost-benefit methodologies should be used to better capture the multiple benefits of DER and the demand-side (Frontier Economics 2020 Sandys amp Pownall 2021)

25 Premium-free means no revenues provided by Government but it does not mean subsidy-free as the risk transfer from industry to Governmentconsumers is an implicit subsidy


The Government could set up a Zero Carbon Electricity Financing amp Contracting Task Force (this could be set up as a sub-group of the wider Green Finance Taskforce) involving representatives of the power and finance sectors and relevant trading platforms The task force would help industry adapt to the withdrawal of government-led long-term contracts by identifying mechanisms or measures that could develop the forwardfuturesretail markets through contracting innovation providing new routes to market and attracting new types of investor Such measures might include offtaker-generator matching facilitation service credit-worthiness standards insurance productsservices standardisation knowledge exchange and raising awareness guidance sector analysesstudies The task force should draw from learning and experience in other countries and sectors

Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle

Enhanced power market monitoring key to better performing markets Enhanced market monitoring with improved timely communications and sufficient

resourcing will provide information of the quality needed for decision-makers to take appropriate action investors to better manage policyregulatory risk market participantsrsquo decision-making and policymedia to understand prices and state of the markettransition

If short-term wholesale market prices are free to reflect system physics and reserves scarcity or surplus politicians and consumers need to have confidence that prices are the product of well-functioning and high-performing markets and that they are not the result of market abuse or poor market design In its Implementation Plan (BEIS 2020c) BEIS states that even if short-term wholesale market prices would rise to high-levels investors could be concerned that the Government or market regulator would act on a perceived abuse of market power (eg introduce a price cap)

High quality market monitoring involving deep analysis and timely communications is therefore key for the development of high-performing markets and stakeholder confidence in the prices they produce The depth of information gathered analysis and regularity of communications should be orientated around decision makersrsquo needs so they can be confident they are making sound well-informed decisions and can be timely and appropriate with their responses and actions This requires that the market monitoring function has advanced capabilities in a wide range of disciplines including power systems engineering economics finance legal and communications Enhanced market monitoring necessary for both the wholesale and retail electricity markets would require a significant increase in resources but the benefits could far outweigh the costs (RAP 2016)



The recent 5-year review of the CM did not assess whether an alternative model to the CM may be needed despite accepting the fact that the power system is evolving rapidly (BEIS 2019a p26) ESC recommends that assessment of alternatives for the CM is urgently needed particularly given

the negative impact of the current CM model on the ability of the wholesale markets to signal value and drive investment in the next phase of electricity system decarbonisation

the long time period that an alternative form of capacity remuneration mechanism may need to be in place while reforms to improve the functioning of the retail and wholesale electricity markets take effect and for sufficient confidence in the markets to be restored ndash there is perhaps limited appetite to move directly from the existing CM to Strategic Reserves

the need to evolve policy interventions as progress is made in restoring lsquomissing moneyrsquo and as markets mature requiring policy change to support the further development of markets

that EU State Aid approval for the current model expires in 2024 and the long time it would take to put an alternative in place - the earliest could

be post 2030 if the next review is 2024 followed by several years to develop proposals consult with stakeholders amend legislation and coordinate phase-in of the alternative with phase-out of the CM (considering capacity is contracted 4 years forward)

Evolve policy to support financial market development and contracting for market development

Futures and forward contracting markets are under-developed for non-traditional technologies such as wind solar and storage largely due to CfDs suppressing the demand for market-led risk management products and services The Government can facilitate the transition to a more market-driven environment by reforming policy support mechanisms and by using a combination of innovative policies tools and instruments to facilitate the flow of private finance help reduce risks remove barriers and mobilise finance at large scale (BNEF Chatham House amp FS-UNEP 2016)27 When assessing and comparing policy or regulatory interventions BEIS should include assessment of their impact on development of the financial markets

Development of non-regulatory interventions requires detailed analysis of technology risk profiles issues and options and can be discussed in consultation with key stakeholders in both the power and finance sectors Though there are promising developments in the financial markets (see Annex 4) greater attention needs to be given to strategies to stimulate under-developed forward hedging and insurance markets and other longer term financial products or contracts

27 See various IRENA briefings mdash httpswwwirenaorgfinanceinvestment




Our proposals will ensure policies and markets work together to deliver investment needed for Net Zero and better outcomes from a whole systems perspective

Together the decarbonisation obligation and reliability requirement applied to the retail market will drive demand for and investment in a balanced portfolio of clean energy resources including much greater uptake of DSR and demand-side storage to provide energy flexibility and least cost reliability As ESCrsquos proposed policy framework is designed to work with the market rather than against it mdash as illustrated in Figure 11 mdash it has the potential to restore confidence in the wholesale energy market

Figure 12 summarises how our proposals aim to reform the policy framework in a way that will best support development of well-functioning power markets that can produce efficient price signals and provide effective risk mitigation products services that investors would have confidence in

A range of evidence and analysis points to the potential benefits of decentralised and retail market-led approaches (eg examples from highly competitive markets such as ERCOT USA in the lsquoNational Energy Guarantee (NEG)rsquo proposals of Australiarsquos Energy Security Board (Energy Security Board 2018)) as well as expert and academic literature (Gramlich amp Hogan 2019 Keay amp Robinson 2017 Liebreich 2017 Natural Resources Defence Council et al 2020 Sandys amp Pownall 2021)

The proposals of Australiarsquos Energy Security Board presented in Figure 13 identified significant benefits for consumers Modelling showed that under the NEG average wholesale prices would be over 20 lower over the 2020s (on average compared to without the NEG) with the average household estimated to save around $550 AUSD a year (real $2018) on their retail bill These savings would be the result of greater long-term contracting and use of DSR within retailersrsquo portfolios as well as more competitive bidding in the spot market (Energy Security Board 2018)

Figure 11 EMR10 (left) and ESCrsquos proposed EMR20 (right) mdash interactions of interventions with market signals

The National Energy Guarantee (NEG) was a mechanism originally designed by the Energy Security Board in Australia to integrate both energy and emissions policy in such a way that encourages new investment in both low emissions technologies and in dispatchable energy so that the electricity system operates reliably The NEGrsquos design is fuel and technology neutral with no revenue being collected from the NEG and no certificate trading scheme The NEG was planned as a flexible mechanism that can accommodate different levels of emissions ambition over time Such a design aimed at providing a clear investment signal so that ldquothe cheapest cleanest and most reliable generation (or demand response) gets built in the right place at the right timerdquo The two main parts of the NEG were the requirements on the retailers known as the reliability requirement and the emissions reduction requirement The Guarantee was designed to provide 5 key drivers that would work together to lower retail prices

policy stability unlocking new investment policy stability reducing the risk (and therefore the cost) of new investments increased contracting unlocking new investment increased contracting in deeper and more liquid contract markets

to reduce the level and volatility of spot prices and increased voluntary demand response

Emissions reduction requirement This was designed as an annual obligation on market customers in the National Electricity Market (NEM) whereby market customers must ensure the average emissions intensity of their load for each compliance period is at or below the prescribed lsquoelectricity emissions intensity targetrsquo as legislated by the Australian Government Each market customer must manage its own reporting and compliance Under the initial design compliance would be assessed annually by the Australian Energy Regulator (AER) with the Australian Energy Market Operator (AEMO) administering an emissions registry to facilitate compliance assessment The emissions registry allows market customers to be allocated a share of a generatorrsquos output and its associated emissions The performance of the market customer in meeting the emissions intensity target is determined as the average emissions associated with its generator allocations from the registry per MWh of its load The emissions reduction requirement has been designed as a lsquowhole-of-marketrsquo mechanism This means that every megawatt-hour (MWh) of generation that occurs in a compliance year will be recorded in the registry and will then be allocated against every MWh of market customer load in that compliance year

Reliability requirement This requires retailers to contract with generationstoragedemand response so that contracts are in place to support a minimum amount of dispatchable energy to meet consumer and system needs The energy market operator (AEMO) will forecast annually whether the reliability standard is likely to be met (or not) in each national electricity market (NEM) region over a 10-year period If AEMO identifies a reliability gap the market has the opportunity to invest to close that gap If the gap persists (or emerges three years from the period in question) then the reliability obligation is triggered Liable entities may be required to demonstrate their future compliance by entering into sufficient qualifying contracts for dispatchable capacity (including DR) to cover their share If the energy regulator confirms a material gap in resources remains one year from the forecast reliability gap then AEMO will use its safety-net Procurer of Last Resort to close the remaining gap This means that liable entities must disclose their contract positions to the AER and those whose required share of load is not covered by qualifying contracts for the specified period are non-compliant and charged an amount that contributes to the costs of AEMO exercising its Procurer of Last Resort function

Figure 13 Australiarsquos National Energy Guarantee proposals

The proposals were published in 2018 Due to change in Government the NEG was not adopted in full mdash just the reliability requirement not the emissions requirement Source COAG Energy Council website

Figure 12 The package of reforms needed to restore and retain confidence in the GB power market

Investors confident in

market

Deeper forwardfutures

markets

Government commitment

to market development

Nolimited compensation outside market

Obligation on retailers for carbon

reduction

Retailers responsible for reliability with

backstop

RaiseRemove price caps review

RSP

High quality market monitoring

Externalities internalised costs

reflected

EMR10 EMR20

Market signals

Market signals

Investment driver CFDs and CM

Investment driver

bull Decarbonisation obligation on electricity offtakers portfolios

bull Reliability requirement on suppliers + Strategic Reserves backstop

Market signals Distorted by CFDs and CM

Market signalsbull Free non-distorted price formation

bull Granular prices by time and location




New challenges will emerge in an electricity system with high shares of variable renewables and distributed energy resources Investment in system integration will need to keep pace with the increasing flexibility needs of the power system The transformation of DNOs to the role of DSO and the coordination of DNOs and NGESO must also keep pace as system operators must send coherent signals to market participants and efficiently use networks and resources from a whole systems perspective

Modelling analyses suggest that a cost-optimal power mix is likely to contain diverse technologies including a greater role for lsquoflexiblersquo technologies such as batteries and hydrogen turbines as well as an expansion of interconnectors gas+CCS (operating as a mid-merit low carbon CCGT replacement) and a portion of demand-side load flexibility from electric vehicles

Progress in digitalisation mdash advancing with implementation of the Energy Data Taskforcersquos recommendations (Energy Systems Catapult 2019b) mdash is starting to open up options and potential for innovation and new business models to emerge enabling better system integration and control Standardisation and interoperability also needs to advance at pace in order not to become bottlenecks (Energy Systems Catapult 2018b) Maximising the benefits of digitalisation and data however depends on efficient and well implemented market design supported by a market-friendly policy framework

To drive innovation and efficient outcomes it is necessary to effectively incentivise and reward system integration investment without excessive reliance on a system operator and through markets rather than policy We also need to ensure efficient and safe operation in real time In addition more consideration needs to be given to how the power sector interfaces with other sectors and enable effective integration of zero carbon electricity with wider heat and transport systems and infrastructure

40 System integration challengecontinued

41 Why is this challenge important for Net Zero

Our emerging lowzero carbon electricity system will increasingly rely on variable renewable resources progressively displacing remaining fossil generation Modelling by ESC and Baringa reveals that a New Zero target means a robust and significant role for variable renewables providing at least 45 of both capacity and generation by 2030 and more than 50 by 2050 in a range of different scenarios where different technologies such as CCS hydrogen nuclear or flexibility may play a lesser or greater role (see Annex 1) The share of variable renewables will be higher if cost reductions do not result for other technologies such as nuclear

Net Zero means much greater electrification of energy demand with millions of new low voltage (LV) and behind-the-meter connections While electricity demand may double by 2050 from todayrsquos levels much of this new demand is potentially flexible ESCrsquos modelling shows that in a cost-optimal Net Zero aligned system nearly all cars are electric by 2050 and electric heating (mainly heat pumps) accounts for well over half of space heat production (see Annex 1)

We can expect transformational change in both energy supply and demand raising a new set of system security risks that need to be managed through effective system integration These are summarised in Table 3 This requires market design and a policy framework that can support efficient system integration in a broad interpretation not just with respect to integrating variable renewables but with respect to enabling whole system solutions that focus and balance different stakeholdersrsquo needs28

Section summary Our emerging lowzero carbon electricity system will have a significantly higher reliance on variable

renewables resources progressively displacing remaining fossil generation All scenarios envisage higher variable renewables shares Net Zero means much greater electrification of demand with millions of low voltage (LV) and behind the meter (BTM) connections

New challenges are emerging in a high variable renewables and DER electricity system mdash to effectively incentivise and reward system integration investment without excessive reliance

on a system operator and through the market rather than policy mdash to ensure efficient and safe operation in real time and mdash to enable effective integration of zero carbon electricity with wider heat and transport systems and infrastructure

Huge progress has been made to create supply chains and drive investment in renewables but to date reforms to market design and investment in system integration (flexibility) have not kept pace increasing integration costs

At the same time there has been substantial progress in digitalisation which opens up options and potential for innovation and new business models to enable better system integration and control mdash but this depends crucially on the market and policy framework

Source Energy Systems Catapult 2019a

Future changes

Resource bull Significant presence of renewables (mixture of large scale and small scale wind and small scale solar) bull Significant presence of smaller scale decentralised resource connected

at lower voltages or behind the meter bull Larger presence of controllable resource across appliances electric heating electric vehicles

domestic generation domestic storage bull Lower share of large scale conventional transmission connected generation

Operational risks bull Intermittency variability bull Potentially significant demand variabilityforecast error bull Largest decentralised resource in-feed lossout-feed increase bull Failure of or compromised IT infrastructure connectingcontrolling assets

numbering in multiple millions

Table 3 Significant changes underway for connected resources and risks

28 For ESCrsquos perspective on systems integration see httpsescatapultorgukcapabilitiessystems-integrationsystems-engineering-and-integration


Efficientlyintegratethephysicaldigitalandmarketsystemsinordertobringahighshareofdistributed and variable energy resources into the system while maintaining reliability at least cost



Flexibility in both supply and demand and investment in lowzero carbon system integration not keeping pace

Significant progress has been made to create supply chains and drive investment in variable renewables but to date investment in lowzero carbon system integration (flexibility) has not kept pace This means that system integration costs are higher than they need to be

An analysis of Northern European countries conducted by (REA 2019) revealed that the UK scores poorly compared to other countries on the performance of its electricity flexibility markets Figure 14 There is a strong policy commitment to decarbonisation but changes in GB regulation and market arrangements to enable flexible distributed energy are complex and slow Under the current framework there is a risk that new demand connecting to the electricity system will fail to be designed to offer flexibility to the system Factors are numerous and include

lack of access to a smart meter which is a precondition for having access to a time-varying tariff

many suppliers not offering time-varying tariffs nor settling consumers on a half-hourly basis

consumersrsquo lack of awareness that such tariffs exist and why flexibility is important and

low financial rewards available through time-varying tariffs

Analysis conducted by BEIS officials reveals that many flexibility markets still remain strongly dominated by high carbon assets despite the existence and growth in aggregators DSR storage and other low carbon technologies (BEIS 2020d) For example fossil fuels provide more than 99 of turn up in the Balancing Mechanism and more than 99 of STOR contracts (see Table 4)


42 Issues and risks under the current framework for this challenge

Source BEIS 2020d


Section summary Flexibility in both supply and demand and investment in system integration are not keeping pace with growth

in variable renewables because multiple market barriers exist and current market signals are inadequate The current framework delivers price signals that are not sufficiently granular by space and time and do not accurately

or fully reveal the value of flexibility to the system hampering investment in well targeted system integration The strong current focus of the CfD regime on delivering revenue stability and lowering the cost of capital

reduces incentives for CfD-supported projects and investors to innovate or invest in complementary system integration and flexibility technologies

The design of the CM scheme dampens wholesale market signals for flexible technologies that would otherwise be able to capture greater price spreads and scarcity premia enabling more effective system integration

Incoherent carbon price signals across vectors risks preventing or slowing down the development of mechanisms to flex energy demand efficiently across different low carbon energy vectors

Lack of strategic planning and coordination risks missing opportunities to exploit local or regional energy resourcesysteminfrastructure opportunities

Faster progress is needed to harness data and digitalisation to enable more efficient operation and coordination of electricity systems including transforming DNOs to DSOs and ESO to ISO as well as improving ESO(ISO)-DSO coordination

Without change this framework will lead to an increasingly sub-optimal electricity technology mix AND inefficiency in how zero carbon electricity is matchedbalanced including integration with other networks (eg heat hydrogen)

This may lead to increased reliance on network reinforcement investment capacity enhancement and out of market system operator interventions to maintain overall system reliability mdash at added cost and reduced quality of service for consumers

Source REA 2019

Figure 14 Energy Transition Readiness Index 2019 ranking

1 2 3 4 5 6 7 8 9

Net

herln

ds

Finl

and

Swed

en

Den

mar

k

Irela

nd

Nor

way

Ger

man

y

Gre

at B

ritia

n

Fran

ce

Table 4 Value size and carbon intensity of GB electricity markets 2019

Market Value (2019) Size (2019) Carbon Intensity

Balancing Mechanism pound590m Abs 20000 GWh Net 630 GWh Fossil fuels gt99 of turn up

Short Term Operating Reserve (STOR) (excl spin gen) pound50m 2000 GWh gt99 fossil fuel contracts

Fast Reserve pound90m 220 GWh 85 fossil fuel contracts

Firm Frequency Response pound40m 3250 GWh 20 fossil fuel contracts

Mandatory Frequency Response pound30m 2500 GWh Large units only Will be primarily fossil fuel generation

Capacity Market (20212022) pound500m (but varies by year) 55 GW (de-rated) 70 fossil fuel contracts

DNO Tenders pound15M c850MW (MWh unknown) gt80 fossil fuel contracts

Wholesale Market pound13000m3 219000 GWh ~40 fossil fuel generation



Ofgem and BEIS co-developed the Smart Systems and Flexibility Plan (SSFP) which aims to remove barriers to smart technologies (including storage) enable smart homes and businesses and make markets work for flexibility (BEIS amp Ofgem 2017) Considerable progress has been achieved over the three years since the planrsquos publication in 2017 but challenges remain in all areas and OfgemBEIS are currently undertaking an extensive stakeholder consultation exercise regarding future development of the plan (BEIS amp Ofgem 2018) Industry has also conducted their own evaluation of the SSFP calling for several areas to be urgently addressed and for a more systematic and quantitative approach Monitoring conducted by NGESO through its Power Responsive Programme (National Grid ESO 2020c) also reveals limited participation of DSR and storage in the markets that it facilitates and the need for improvement in several areas Priority areas identified by these sources include the following

price distortions should be minimised barriers remain to participation of DSR and storage (especially small assets

and newsmall market participants) in existing markets and should be removed flexibility is not always fully valued new markets (local flexibility voltage inertia) require development whole system co-ordination to system operation needs to be improved the negative externalities of carbon need to be internalised across all markets the monitoring of flexibility needs to be improved needs to be easier to stack value across markets greater transparency and clearer rolesresponsibilities for ESO and DNOs need for review of market design and policy interdependencies including

the need for locational elements

The design of CfDs and the CM schemes aggravate system integration issues The EMR interventions CfDs and CM are unhelpful for system integration in three

significant ways

30 EU Regulation 20172195 establishing a guideline on electricity balancing note that derogations to the 15 minute rule can be requested under certain conditions the UK obtained a derogation announced May 2020


29 Presented in a PowerPoint at joint BEISOfgem ldquoRewarding flexibility for the value it provides the electricity systemrdquo workshop held 7th February 2020 in London For stakeholder responses see also Smart Systems Forum PowerPoint 9th September 2020 httpswwwofgemgovukpublications-and-updatessmart-systems-forum-slides-9-september-2020

Generators shielded from price signals

By linking the design of CfDs directly to the day ahead market prices the current framework shields generators from market signals that would incentivise system integration and exceeding market expectations (see Annex 9 for further explanation)

Operational stability dimension of security of supply ignored

The design of the CM focuses only on resource adequacy requirements it does not define any parameters to influence the capability of the capacity to provide operational stability It primarily incentivises cheaper sources of kW without regard for the capability of the capacity in relation to operational stability which is also crucial for service reliability The supported firm capacity may therefore not have the needed capabilities to integrate variable renewables and may indeed worsen operational stabilitysecurity

Price supression and dampened scarcity

The CfDs and CM cause price suppression and the CM dampens the scarcity effect that negatively impacts market signals for flexibility - this topic is covered extensively in section 3 and Annex 2

Price signals not sufficiently granular by space and time hampering system integration

The more reflective the prices are of the short-term market conditions the better the price signals sent to generators and consumers which can quickly alter their output or demand as appropriate Faster short-term markets based on more granular time signals will help achieve the following outcomes

increased flexibility in system operation reduced short-duration reserve requirements and enabling integration of more variable renewables in the grid

optimised capacity planning incentivising investments in flexible generators and ultimately reduced costs to consumers

Shortening dispatchscheduling time intervals the pricing of market time units and financial settlement periods would result in more granular imbalance prices sharper signals and improved flexibility incentives Ideally gate closure forecasting horizon and dispatch interval align within an electricity market to maximize the economic benefits of achieving fast operations while allowing time for the System Operator to intervene when necessary The current status for the UK in relation to these aspects is captured in Table 5 below and comparison with best practices reveals there are opportunities for the GB market design to be improved

Table 5 Faster and more accurate short-term markets for variable renewables status of the GB

What Why Best practices GB

Market time units and dispatchscheduling time interval

Power generation schedule is changed more frequently enabling generation to follow actual load more closely and vice versa

New Zealand ndash nodal prices 5 minutes USA FERC Order No 764 ndash 15 minutes EPEX ndash 15 minute contracts in intraday market and 15-minute auction 3pm in day-ahead market EUrsquos XBID (cross-border intraday) supports 15 minute and 30 minute contracts

Half-hourly products are traded in the continuous intraday markets

Time span between gate closure and real time delivery of power

Reducing the gate closure to delivery timeframe can reduce the reserve requirements improve market efficiency and reduce costs However for Physical Notifications gate closure is a compromise between maximising the opportunity for the market and allowing time for the System Operator to intervene when necessary

ACER Decision No 042018 harmonised gate closure time to maximum 60 minutes though promotes shorter timeframes (eg 30 minutes for Estonia-Finland border) In some TSO areas of Austria Belgium and GermanyLuxembourg the local intraday gate closure time is 5 minutes before physical delivery

Gate closure to delivery in real-time is 60 minutes for Physical Notifications but 0 minutes for Contract Notifications

Financial settlement periods

Shorter time settlement periods reduce volatility within a settlement period and so reduce actions the NGESO may need to take to balance the system

The EUrsquos EBGL harmonises the imbalance settlement period to 15 minutes in all scheduling areas of Europe applicable by the end of 2020 and all boundaries of the market time unit must also coincide with boundaries of the imbalance settlement period

UK continuing with 30 minute financial settlement period UK obtained derogation from EU law based on CBA30


Sources for map and Table 5 Published market data IRENA innovation landscape briefs (spacetime) httpswwwirenaorgpublications2019JunMarket-Design-Innovation-Landscape-briefs and NREL httpswwwnrelgovdocsfy19osti72665pdf



USA FERC 764 15 minute

scheduling PJM (13 states)

LMP since 1998 ERCOT (Texas) 4000+

pricing nodes NYISO (New York)

11 price zones ISONE (New England)

1000+ price nodes

Great Britain Dispatch and

settlement mdash 30 min 1 price zone Gate closure ndash 60 minutes

for Physical Notifications and 0 minutes for Contract Notifications

European Union Settlement mdash 15 min Harmonised gate

closure mdash 60 min max Gate closure in some

internal TOTSO areas mdash 5 min in Austria Belgium France Netherlands Germany Luxembourg

Nordpool Multiple bidding zones

Denmark mdash 2 Finland mdash 1 Norway mdash 5 Sweden mdash 4

Epexspot 15 min contracts in

intraday market and 15 min auction in day-ahead market

Australia Dispatch and settlement

mdash 5 min from Oct 2021 5 price zones

New Zealand 5 min nodal prices and

30min average pricessettlement

259 pricing nodes

Italy 6 price zones

GB and global best practices on temporal and spatial granularity of power markets



The importance of location is expected to increase in future with more decentralisation of energy resources and greater heat and transport related load with consequences for the variability of network flows and the capabilities of the networks to handle this In GB the sources of value reflecting congestion costs or network constraints are numerous complex and not fully coherent (see Annex 6) The source of most locational value is currently provided through network charges while there is no locational value in the wholesale electricity market and capacity market Some balancing services such as constraint resolution and voltage support do attach importance to location

The current complex and incoherent framework has given rise to increasing constraint payments which have risen from less than pound20m per year in 2011 to pound80m in 2016 and increasing every year to just under pound140m in 2019 (Renewable Energy Foundation 2019) Scottish onshore wind farms have received the majority of these payments (eg 94 in 2019) for turning down while the costs are socialised across all electricity customers as part of the Balancing Services Use of System (BSUoS) charge The current price signals perversely encourage the siting of new generation in network constrained areas and the demand-side and storage are clearly not tapping into this value by turning up or down though NG ESOs introduction of the Operation Downward Frequency Management (ie a temporary service outside the Balancing Mechanism) demonstrated that demand can be flexible The situation is not helped by the payment of renewable support subsidies when prices are negative (up to maximum of 6 hours) Also unhelpful are the Transmission System Entry Capacity (TEC) charges (ie costs for connecting generators to the grid) that treat batteries as generators so the batteries are not incentivised by the charges to play a demand role in areas of surplus generation

To limit system integration costs much more efficient and granular price signals with a locational dimension are needed to influence the location of investments and to encourage efficient real-time production and consumption by location

Incoherent carbon price signals across vectors risk preventing vector-switching

Achieving Net Zero economy-wide has major implications for the power sector as other sectors decarbonise with rapid scale-up of the electrification of heat and transport expected along with a significant role for hydrogen as time-shifting energy demand (for electrolysis production) and as a vector for peakingflexible generation Based on modelling using ESME (Energy Systems Catapult 2020c) the ESC finds that by 2050

A new low carbon hydrogen economy will need to be created delivering up to 300TWh per annum roughly equivalent to electricity generation today

Electricity generation itself may have to double or even treble if most hydrogen is to be produced by electrolysis

Efficient switching between energy vectors in time and by location will play an important role in decarbonising sectors either permanently or on a temporary basis (eg hybrid gaselectricity heat pumps) Coherent market signals and incentives are crucial to enable efficient vector switching In addition to the issues relating to inefficient price signals mentioned in the previous section there also exists considerable variation in carbon price signals across different sectors and energy vectors (Energy Systems Catapult 2020b)


31 httpseceuropaeuenergytopicsenergy-strategyclean-energy-all-europeans_en

Lack of strategic planning and coordination risks missing opportunities

It is already necessary to consider other vectors such as heat and gas (including hydrogen) given the long lead times for infrastructure Strategic planning and coordination may facilitate exploitation of multi-vector opportunities and yield cost reductions and significant benefits

ESC has worked with numerous local authorities and stakeholders in recent years in order to develop the concept of Local Area Energy Planning (Energy Systems Catapult 2018c) The concept is well developed with the process and tools sufficiently mature to support local decision-making for Net Zero that can unlock the system integration benefits of local infrastructure and energy resources Much more now needs to be done to enable implementation and scaling

Rapid development of clean energy resources at scale needs coordination in order to minimise environmental and social impacts and to exploit efficiencies In recent years the offshore wind industry has rapidly expanded and the Offshore Wind Industry Council (OWIC) has identified a number of examples of poor coordination including insufficiently integrated transmission system planning and design and lack of frameworks to integrate offshore wind transmission and interconnectors between TSO areas and to support co-location of technologies

Greater interconnection with neighbouring countries makes it possible to exploit negative correlation between wind speeds at locations that are far apart (eg 1000 miles) as weather fronts move across Europe While increased interconnection brings substantial overall (net) benefits these are not necessarily shared evenly across countries or regions often due to lack of harmonisation in market design and policies between countries There is a risk that GB customers can be worse off due to price convergence resulting from cross-border trading if prices in neighbouring countries would be higher compared to prices in the GB market in the absence of trading and if GB consumers are paying for out-of-market interventions such as the capacity market (Baker amp Gottstein 2013) Prices will be higher in markets with greater internalisation of externalities incorporation of all marginal costs and minimised out of market compensation The EU legal framework 31 and the specific market and policyregulatory frameworks in neighbouring countries are therefore important considerations when developing GBrsquos market design and policyregulatory framework Post-Brexit arrangements and the extent to which the GB power market will align with the EU legal framework going forwards is clearly an important factor



Faster progress needed to digitalise and transform system operation

At present digitalisation and modernisation of the energy sector is hindered by poor quality inaccurate or missing data while valuable data is often restricted or hard to find for the market participants able to deliver value to the power system using this data In 2019 the Energy Data Taskforce (EDTF) mdash commissioned by Government Ofgem and Innovate UK chaired by Laura Sandys and supported by ESC mdash delivered a strategy aimed at modernising the UK energy system and driving it to a Net Zero carbon future through an integrated data and digital strategy for the sector (Energy Systems Catapult 2019b) (see Annex 10) In a short time considerable progress has been made against the recommendations as outlined in Figure 15 below but much more remains to be done and needs to be achieved at pace

It is well recognised that the role of future Distributed System Operators (DSOs) and their coordination with NGESO will be pivotal to the efficient effective use of energy resources to support the system With electricity flowing two ways and with NGESO managing residual system peaks and DSOs managing network constraints through use of flexible energy resources there is a risk that the system operators might provide market participants with conflicting signals and this needs to be avoided

Multiple factors present significant potential risks and consequences for system integration

Without change the current framework will lead to an increasingly sub-optimal electricity technology mix by capability and inefficiency in how zero carbon electricity is matchedbalanced including integration with other networks (eg heat hydrogen)

A sub-optimal power mix combined with inefficient market signals poor system operator coordination and lack of strategic planning will result in major inefficiencies and could increase operational stability risk All of this may lead to increased reliance on network reinforcement investment capacity enhancement and out of market system operator interventions to maintain overall system reliability mdash at added cost and reduced quality of service for consumers


Figure 15 EDTF recommendations mdash ESC view on progress to date

1Digitalisation of the

energy system

2Maximising the

value of data

3Visibility of data

Data catalogue

4Coordination

of asset registration

5Visibility of

infrastructure and assets

Digital system map

Principles

Building blocks

NG ESO included digitalisation as one of their 4 key messages in FES2020

Industry are engaging experts to deliver robust deliverable plans

Code bodies are adopting presumed open

Electralink have launched FlexR to standardise DNO data

ENA have developed an Data Working Group and Open Data Triage sub group

Data Best Practice to become part of RIIO2 Licence conditions

Ofegem have requested networks to publish their digitalisation strategy

Innovate UK have funded 3 projects to explore a common data architecture for energy

BEIS Ofgem and UK commissioned the Energy Data Best Practise Guidance to help implement the recommendations consistently

NG ESO included open data as one of their 4 key messages in FES2020Industry are

driving forwards with multiple projects

The ENA have trialled multiple digital system map prototypes

BEIS are leading the development of a coordinated registration strategy

ONS have completed a discovery project and are progressing to Beta




Focus on establishing efficient and granular market signals and remove market barriers

To enable the efficient integration of variable renewables and DER short-term price signals need to be highly granular by time and location and free to reflect the true value of flexibility to the system This requires free price formation scarcity pricing and locational differentiation in prices as detailed in the investment chapter To complement this enhanced market monitoring will be needed to ensure stakeholdersrsquo confidence in the performance of markets and the prices they deliver


Ensuring greater temporal granularity and dynamism in short-term prices right is particularly important in order to effectively support the integration of variable renewables and DER into the power system Improvements could include shortening

dispatchscheduling time intervals financial settlement periods the time span between gate closure and real time delivery of power

Alongside getting price signals right it is crucial to ensure that any energy resources able to provide the needed flexibility to the system at any point in point in time should be able to do so including pooledaggregated resources The OfgemBEIS Smart Systems Flexibility Plan has made great strides in systematically identifying and removing barriers to flexibility across all sources of value (eg wholesale market balancing mechanism ancillary services network regulation) The good work in implementing the SSFP must continue at pace ESC recommends however that in future the SSFP should be broadened in scope to include market design reforms (ie reforms to EMR10) and should be further developed under ESCrsquos proposed governance recommendation ensuring balanced stakeholder engagement and informed by high quality market monitoring

Outcome-based policy mandates will drive system integration investment and contracting innovation

The replacement of the CM with a decentralised model (as detailed in section 3 and Annex 8) ideally Decentralised Reliability Options would support flexibility for two key reasons First it would remove the CMrsquos distorting influence on short-term wholesale electricity prices restoring lsquomissing moneyrsquo for flexibility Second it would more strongly motivate suppliers to use DSR and BTM assets within their own portfolio of resources to avoid high imbalance charges and to meet reliability requirements cost-effectively

Phasing out CfDs for established and competitive technologies (as detailed in section 3) would force developers and investors of these technologies to pursue various routes to market in order to beat expected returns This would include responding to price signals to support system integration and investing in storageflexibility solutions co-located with variable renewable energy generation Phase in of the decarbonisation obligation on suppliersrsquoofftakersrsquo portfolios along with carbon intensity standards applied to DSOESO procurement aligned with the carbon budget process would drive clear demand for zerolow carbon flexibility solutions and reduce demand for fossil fuelled options Replacement of CfDs with the decarbonisation obligation would also drive innovation in forward contracting and development of financial productsservices for variable renewables and complementary flexible energy resources eg innovative PPAs and contracts standardisation hedging insurance portfolio diversification (see Annex 4)

Section summaryThe reforms we propose will substantially improve the ability of markets to accurately reveal the value of flexibility by time and location and will allow all energy resources and market actors to capture this value if they are able to provide the needed zerolow carbon flexibility integration and optimisation services Higher quality market signals performance-based monopoly regulation and improved governance will also drive efficient coordination between market actors Below we set out how our six proposals will address the lsquosystem integration challengersquo 1 Make electricity markets work more accurately in time and space This will provide more accurate closer to real time and locational prices mdash fully incorporating all marginal



create a credible investable market signal for investors in portfolios of zero carbon generation and flexibility DSR assets as the decarbonisation obligation would be aligned with the carbon budget process

restore value and confidence in wholesale market price signals which is important for flexibility investment drive demand for and investment in a balanced portfolio of clean energy resources including much

greater uptake of demand-side flexibility and demand-side storage which will provide energy flexibility and least cost reliability

3 Evolve policy to support financial market development and contracting for investment This will encourage innovation in contracting and developing financial productsservices for variable renewables and

complementary flexible energy resources eg innovative PPAs and contracts standardisation hedging insurance portfolio diversification

4 Redesign innovation and early deployment support for immature technologies to avoid distorting markets This will ensure innovation support policy pays attention to the operational capabilities of capacity increase innovation support for emerging flexible and dispatchable energy technologies including storage

and demand-side resources ensure the full benefits of demand-side and zerolow carbon flexible energy resources are fully taken

into account when developing innovation support policy ensure prevention or minimisation of potential market distortions caused by the design of innovation support

schemes which will benefit flexible energy resources able to respond to sharp price signals5 Overhaul governance and role definitions for industry codes system operation data and digital interoperability

This will ensure that data availabilityaccess digitalisation and interoperability are enablers and not bottlenecks

which is crucial for rapidly increasing system flexibility accelerate the DNO to DSO and ESO to ISO transitions and proactively evolve ESODSO coordination

in anticipation of VREDER growth6 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle

This will ensure that lowzero carbon energy resources are prioritised for providing flexibility in combination with adoption of local energy planning and reforms to the DSO role provide a clearer

framework for project developers to identify where in the system flexibility investment is needed encourage vector switching in order to provide flexibility and reduce carbon emissions ensure policies used to promote new electricity demand are linked to incentives to use zerolow carbon

electricity and to provide flexibility to the system


DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V Re

siden

tial O

ff St

reet

DSR

mdash E

V D

epot

Effic

ienc

y mdash

Dom

estic

(LED

s)

Offs

hore

Win

d

Sola

r (la

rge)

Effic

ienc

y mdash

Non

Dom

estic

Nuc

lear

Ons

hore

Win

d

Biom

ass C

CS

Li-I

on B

atte

ry T

2T3

CCG

T

Gas

CCS

Li-I

on B

atte

ry T

1

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash O

ther

Dom

estic

OCG

T

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V D

epot

DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash E

V Re

siden

tial O

ff St

reet

Effic

ienc

y mdash

Dom

estic

(LED

s)

Effic

ienc

y mdash

Non

Dom

estic

Offs

hore

Win

d

Sola

r (la

rge)

Ons

hore

Win

d

CCG

T

Gas

CCS

Nuc

lear

Biom

ass C

CS

Li-I

on B

atte

ry T

1

Li-I

on B

atte

ry T

2T3

DSR

mdash O

ther

Dom

estic

OCG

T

8000

7000

6000

5000

4000

3000

2000

1000

0Cum

ulat

ive d

iscou

nt sa

vings

(poundm

) co

mpa

red

to c

urre

nt p

ositi

on

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050

DSO driven TSO coordinates Sharpened incentives Perfect information

Figure 17 Comparison of system coordination scenarios


Innovation and early deployment support for immature technologies can be designed to avoid distorting markets

Innovation support needs to be reformed in two ways to support system integration First the policies need to be designed to support system integration avoiding potentially distorting impacts on existing markets Second the identification of innovation support needs should be based on resource adequacy assessments that sufficiently assess the power systemrsquos changing integrationflexibility needs and the operational capabilities that an efficient cost-effective and decarbonised power mix will need Innovation support for technologies with the needed capabilities must be sufficient relative to future requirements Greater attention should be given to supporting innovation in non-generation technologies including on the demand side given the significant potential multiple benefits that could be unlocked

Innovation support policy for early deployment of promising technologies needs to be designed using clear evidence-based prioritisation based on value-for-money (VFM) analysis that includes the full costs and benefits as well as the implicit support and risk transfers under current policy ESCETI collaborated with Frontier Economics to devise a VFM methodology which revealed how strike prices for support policies would vary when the full costs and benefits would be accounted for (LCP and Frontier Economics 2018) This methodology has been recently updated as part of the ReCosting Energy project to include demand-side technologies (Frontier Economics 2020 Sandys amp Pownall 2021) Application of the methodology can usefully reveal the multiple benefits of DER and the demand-side


Figure 16 illustrates a comparison of two different methodologies to assess and represent costs The levelized cost of electricity (LCOE) is typically defined as the average revenue per unit of electricity generated that would be required to recover the costs of building and operating a generating plant during an assumed financial life and duty cycle The Whole Electricity System Cost (WESC) method requires adding on the additional costs and benefits attributable to a technology on the wider system WESC includes the impact on total system costs of adding a sufficient amount of a technology that will produce or avoid the requirement for 1MWh of electricity Negative values represent technologies that can reduce system costs Figure 16 is illustrative only as values for each technology will vary depending on network location and other specific conditions

Accelerate DNO-DSO and ESO-ISO transitions and evolve ESODSO coordination Drawing on the potential future worlds characterised by the ENArsquos Open Networks

project (Energy Networks Association 2020b) the ESC published a study (Poumlyry amp Energy Systems Catapult 2019) that estimates the value that DSOs can deliver to GB compared to the existing arrangements There are major benefits to be realised from driving the transformation from DNO to DSO and improving ESO-DSO coordination (as illustrated in Figure 17 mdash see Annex 11 for more detail)

Figure 16 Comparing the outcomes from a LCOE and WESC analysis including demand assets

Source (Frontier Economics 2020) ndash for the ReCosting Energy project (Sandys amp Pownall 2021) These example figures should not be interpreted as generic estimates of the whole system impact of a class of technologies Whole

system impacts are dependant on the wider electricity system and when technologies are assumed to be built Source Energy Systems Catapult 2019f

Notes Perfect information Assumes a single market for flexibility resources which can be accessed (with perfect information) by a single coordinator DSO driven Assumes a key role for the DSO in balancing and procuringactivating flexibility mdash with left over resources passed to the ESO TSO (ie ESO) coordinates Assumes ESOrsquos needs are prioritised with residual flexibility offered to the DSO Sharpened incentives Assumes TCR SCR NAFLC network charging reforms are an improvement from Current Position but still lead to a sub-optimal outcome

300

200

100

0

-100

-200

-300

Today Levelised Cost

Technology own variable costs Technologyownfixedcosts Levelised costs

Impa

ct o

n w

hole

syst

em c

osts

(poundM

Wh)

300

200

100

0

-100

-200

-300

Tomorrow Whole System Costs

Technology own variable costs Technologyownedfixedcosts Capacity adequacy costs Balancing costs

Displaced generation costs Distribution network costs Total WSC



Ofgemrsquos recent proposals (Ofgem 2021) for transitioning NG ESO to an independent system operator (ISO) create a significant opportunity to transform both the power system and power markets through a whole systems consumer-focused approach that could minimise system integration costs and unlock associated benefits Crucial to ensuring that the new ISO performs as an effective facilitator of the GB power systemrsquos transformation to Net Zero mdash for both system operation and market development mdash will be the setting of ambitious objectives and strong incentives appropriate governance arrangements and scrutiny as well as sufficient resources so that it can enhance its capabilities and effectively deliver

The DSO transition and evolving ESO-DSO coordination must anticipate the growing flexibility needs of the power system that may not be linear New innovations must become business-as-usual and procurement of system services must be neutral in treatment of transmission versus distribution supply versus demand and small versus large assets DNOs and the ESO (ISO) require stronger incentives through the RIIO price control framework and Ofgem will need to be proactive in regulating and directing industry Higher quality system monitoring and forecasting capability are also necessary

The RIIO price control methodology is being evolved to better drive innovation by strengthening incentives for network operators to be more ambitious and innovative In the short to medium term it would be key for distribution network companies to invest in new technologies and innovations that can effectively achieve or contribute to the following desired outcomes

progress on opening access to network data and data modernisation digitalisation and network monitoring implementing recommendations of the Energy Data Taskforce (Energy Systems Catapult 2019b)

facilitation of local energyflexibility markets progress on the implementation of DSO functions particularly in relation to

neutrality and enabling third party access and innovation as well as developing functions in a way that retains future institutional optionality

development of whole system outcomes including progress on utilising methodologies that enable whole system assessment and cost-benefit analysis as to maximise value for customers

facilitation of integration of distributed energy resources eg electric vehicles (DfT-Energy Systems Catapult-LowCVP 2019) heat pumps PV panels

improved coordination between ESO (ISO) and the DNOs (DSOs) and procurement of demand-side energy resources or energy efficiency measures

in order to operate and develop the system at least cost and greatest benefit for energy consumers


Regulate to ensure data availabilityaccess digitalisation and interoperability are enablers and not bottlenecks

In a short time considerable progress has been made in implementing the Energy Data Taskforcersquos recommendations (see Annex 10) This momentum needs to be maintained Ofgem has signalled its intention to make ESCrsquos data best practice guidance (Energy Systems Catapult 2020d) part of the RIIO2 price control framework Other energy actors across the rest of the sector will need incentives to implement data best practice

Data interoperability is particularly important and some standards are under development such as for the Common Information Model for Electricity network data and SMETS2 data (ie Smart Metering Equipment Technical Specifications (second generation smart meter)) Further standardisation across the rest of the sector will require regulatory encouragement Some areas will require strong regulatory measures to overcome weak or opposing interests For example in many cases market actors are incentivised to avoid standardisation if this potentially threatens their competitive position and in other cases the benefit of standardisation does not accrue to the implementing organisation but to other market actors (eg as is the case for network data) Areas that need particular focus include supplier switching data suppliergenerator trades and market data to enable carbon tracking for energy products

With respect to digitalisation Ofgem should be ensuring that the right system elements are being digitalised to enable new regulatory and market systems to be implemented For example the development of dynamic network pricing based on time or location requires the right data to illustrate the need for it Effective implementation of EMR strategy is also relevant as the right metrics must be developed and data accessed for monitoring and evaluation purposes

Use a range of policy measures to encourage the flexibility of new electricity demand

While roll out of electric vehicles (EVs) and heat pumps is in the early stages it is important to ensure that new demand that is potentially flexible is encouraged to provide flexibility In addition to poor price signals and market barriers there exist cultural and information barriers

To address such barriers in relation to smart-charging the Electric Vehicle Energy Taskforce (EVET) 32 sets out a number of proposals (OLEV Energy Systems Catapult amp LowCVP 2020) that would encourage EV owners to smart-charge their vehicles such as best practice industry standards with accreditation for information provision relating to smart charging and electric vehicle services at the point of sale public information campaign on benefits of smart charging government-funded independent tailored advice and information service on smart charging and EVs and potentially triggered by installation of a chargepoint the requirement to install a smart meter before or alongside the installation of a chargepoint (see Annex 12 for high-level summary of all proposals)

32 The Electric Vehicle Energy Taskforce (EVET) was convened by the Office for Low Emission Vehicles (OLEV) for the Government and chaired by ESC brought together the transport and electricity sectors for the first time and involved over 350 different stakeholder organisations


To encourage the flexibility of new electricity demand the design of policy measures aimed at accelerating heattransport electrification (eg tax relief subsidies) could be directly linked to incentives to ensure that these resources provide flexibility consume zero carbon electricity andor interact with Local Area Energy Planning (LAEP) Policy measures should be integrated or well coordinated to ensure that synergies can be maximised and any conflicts resolved in a way that is best for the whole system

Facilitate vector switching by aligning carbon price signals Aligning effective carbon prices 33 across the energy vectors and sectors of the economy

will facilitate switching from high-carbon vectors and technologies to zero carbon alternatives For example below (Table 6) is a comparison of the annual energy and total lifetime costs of heating a typical UK semi-detached home when using an air source heat pump (ASHP) versus a gas boiler under the current market arrangements and for the case with aligned effective carbon prices (Energy Systems Catapult 2020b) For the purposes of the illustration we have increased the effective carbon price of gas to equal electricity There is a case to be made for removing the decarbonisation policy costs from electricity retail prices and socialising these costs given that the power sector plays a central role in decarbonising the whole economy (Energy Systems Catapult 2019c)


33 Theincentiveorrewardforafirmorindividualtoreduceemissions(inpoundtCO₂e)resultingfromdirect(egexplicitcarbonpricinginstruments energy and fuel taxation etc) and indirect (eg reduced VAT on energy subsidies for low and zero carbon options etc) carbon policies

34 Notes RHI will no longer be open to new applications after March 2021 and without it even with a levelised effective carbon price the lifetime costs of an ASHP still remains higher than a gas boiler In the near-term this points to the need for capital cost reductions in technology and installation In addition with the use of time of use tariffs and home energy management systems the annual cost of running a heat pump can be further reduced Assumptions Homes are assumed to have a lsquonormalrsquo level of insulation the gas boiler (23 kWth) has a mean efficiency of 092 and the ASHP (6 kWth) has a mean seasonal performance factor of 3 We have assumed that for householdsin2020theeffectivecarbonpriceforelectricityispound48tCO₂eandgasispound1tCO₂e

Table 6 Cost comparison for heat pumps and gas boiler (Energy Systems Catapult 2020b) 34

Air Source Heat Pump Gas Boiler

pound752pound19800 or pound14047 with RHI

Annual Energy Costs (2020)Lifetime Cost (2016ndash2030)

pound712pound12414

If carbon polocies were introduced that levelise the effective carbon prices



pound979pound15601


50 Network infrastructure and investment challenge



The next phase of decarbonisation requires infrastructure investment in the order of hundreds of billions of pounds by 2050 This investment needs to be coordinated efficiently across the energy value chain particularly in networks at the distribution level and between different vectors in order to minimise costs and facilitate the modernisation and decarbonisation of the energy system

Much of the evidence suggests that

zero carbon electricity will be central to heat and transport decarbonisation but also that

there may be significant regional variation in the role of zero carbon electricity (eg to decarbonise heat) and its integration with related infrastructure investments such as in industry hydrogen and heat networks

This calls for a more strategic and whole systems approach to developing energy system infrastructure There are important synergies and trade-offs between network infrastructure investments and investments in flexibility smart control optimisation and trading at local regional and national scales The flexibility requirement for local electricity networks is likely to be very different in heat pump dependent locality compared to an area reliant on heat networks Opportunities to exploit synergies are currently being missed under current market and regulatory arrangements but can be captured with improvements to the design of the latter

Section summary Net zero will require major investment in electricity networks and complementary infrastructure

(eg heat networks EV charging etc) particularly at distribution level Much of the evidence suggests that (a) more zero carbon electricity will be central to the future energy system and

(b) there may be significant regional variation in the role of zero carbon electricity (eg to decarbonise heat) and its integration with related infrastructure investments in industry hydrogen and heat networks

There are important synergies and trade-offs between network infrastructure investments and investments in flexibilitysmart control optimisation and trading at local regional and national scales

Digitalisation opens up new opportunities to coordinate and optimise investment and control across network infrastructures different asset classes and on the demand side Effective exploitation of these opportunities is a key challenge for delivering net zero efficiently

Digitalisation presents new opportunities to coordinate and optimise investment and control across network infrastructures different asset classes and on the demand-side (Energy Systems Catapult 2021) Modernising energy data practices will help realise benefits including increasing transparency creating opportunities for innovation across a range of new low-carbon products and services and providing clarity on investment needs to alternative market solutions can be put forward

Requirements to progress in data modernisation ahead of and during the RIIO-2 price control through forthcoming licence conditions linked to digitalisation strategies and adopting Data Best Practice are important steps towards digitalisation Requirements need to be sufficiently clear and strong to drive demonstrable progress by network companies The principle of energy system data being treated as ldquopresumed openrdquo should be implemented robustly to deliver real improvement to data access for third parties unlocking non-standard solutions to network reinforcement that are efficient and lower costs to consumers Effective exploitation of these opportunities is a key challenge for delivering Net Zero efficiently


Current framework lacks mechanisms for strategic planning and coordination ESC has long highlighted the need for developing whole-system understanding of

infrastructure requirements and shown that strategic planning at the local level can unlock significant benefits (Energy Systems Catapult 2018c) Energy network companies will be at the centre of the next phase of decarbonisation and the investments they make in energy infrastructure will be key to supporting both the overall net zero transition and the delivery of locally and regionally tailored decarbonisation strategies

Section summary The current framework lacks a full set of mechanisms for strategic planning and coordination of energy

infrastructure at both national and localregional levels Current approaches to network regulation are structured in silos risking that network companies are not clearly

incentivised to think and plan strategically from a whole system perspective Risk of miscoordination of planning and investment and of network companies failing to engage fully with net zero agenda

The low granularity of market signals obscures value at local level and risks slowing the adoption of new non-network solutions This in turn risks reinforcing a bias towards investments in network enhancement over alternative options (flexibilitydemand sidealternative low carbon vectors such as heat networksstorage etc)

Taken together this means that the current framework risks unnecessary andor poorly targeted investment in network infrastructure missed opportunities for major cost savings and the network being insufficiently prepared for variable renewables and DER growth slowing decarbonisation and hampering innovation


Tocoordinateinvestmentefficientlyacrosstheenergyvaluechainparticularlyinnetworksandfordifferentvectors

50 Network infrastructure and investment challengecontinued



Deciding the optimal mix of anticipatory network reinforcement investments and procurement of non-wires alternatives requires timely high-quality analysis Requirements of the EU Clean Energy Package which include many relevant provisions have only recently been implemented by Ofgem through updates to licensing conditions 35 the RIIO framework can also provide incentives More work is needed however to develop standardised assessment methodologies and approaches adapted to reflect the multi-vector nature of decarbonisation options at local level

A combination of the low granularity of market signals (that obscures value) and potential lag in adopting new methodologies to assess non-network solutions risks reinforcing a bias towards investments in network enhancement over alternative options (flexibilitydemand sidealternative low carbon vectors such as heat networksstorage etc)

While the current framework is developing in a generally positive direction greater and swifter progress will be needed to shift network companies towards adopting more flexible and dynamic solutions to minimise the risks of unnecessary andor poorly targeted investment in network infrastructure missed opportunities for major cost savings and the network being insufficiently prepared for VREDER growth slowing decarbonisation and hampering innovation

At the national and transmission level the Offshore Wind Industry Council (OWIC) has identified several issues relating to network infrastructure development that may hamper timely and cost-effective achievement of the Offshore Wind Sector Deal target of 30GW by 2030 (Offshore Wind Industry Council 2019) OWICrsquos analysis finds that the design and development of both the onshore and offshore transmission grid is not as coordinated and efficient as it could be such that consumers miss out on considerable potential cost savings

Siloed regulation not incentivising whole system approach to investment

Consumersrsquo bills will be much higher than necessary if regulation relating to investment in energy network infrastructure remains siloed Without reform mdash and potentially stronger recognition of some lsquowhole systemrsquo functions and duties for network companies mdash the existing RIIO framework risks embedding incentives for network companies to focus on reducing risk and optimising within individual energy vectors rather than delivering optimal whole system infrastructure Equally the current framework risks constraining the development of efficient operational incentives for system operation of gas electricity and potentially in future heat networks

Poor market signals and lag in adopting new methodologies to assess non-wires solutions

Growth in demand for zero carbon electricity and the resulting need to address network constraints and capacity is likely to be a prominent dynamic in the next phases of the energy transition But the current framework of market and network regulation signals is poorly adapted to signalling the nature and most valuable location for flexibility to address network constraints

Competitive tendering by ESOTOsDNOs of non-traditional energy resources such as DER and demand-side energy resources as an alternative to grid reinforcement is progressing in the UK with National Grid and DNOs setting out their ambitions in network development plans and launching tenders But these approaches only offer a partial and not especially agile correction to the underlying lack of granular and accurate market signals relating to network capacity

There is value in continuing to incentivise network companies to procure flexibility but scrutiny is required to ensure energy resources and technologies are treated fairly in tender requirements Network companies and NGESO are in sole control of purchasing processes and innovation can be constrained due to unnecessarily restrictive eligibility criteria preferred bidders or providers and the use of set prices or fixed price long-term contracts that do not reflect actual market value There are limits on what can be achieved through procurement approaches that are controlled and operated by network companies in the absence of wider reforms to develop more granular price formation



35 httpswwwlegislationgovukuksi20201401made


Outcome-based policy mandates mdash more clarity for project investors and network developers

The arguments underpinning the need for a decentralised policy framework as part of a coherent policy governance framework which can drive market-led investment risk-mitigation and reliability with a reduced role for government are set out in section 63 The details relating to how the obligations can be designed for carbon and reliability are covered in section 33 and Annex 8

Our contention is that outcome-based obligations can be designed in ways that are more predictable over the medium term than centralised contracting style policy support This should allow a clearer more predictable medium-term project pipeline to develop in turn improving the visibility of forward demand for network capacity This can be a key input to network companiesrsquo investment planning and Ofgem price and output setting decisions

Effective regulation of TOs and DNOs to drive efficient investment

The RIIO price control methodology is being evolved to better drive innovation by strengthening incentives for network owners and operators to be more ambitious and innovative and to undertake efficient investments Particularly necessary is to ensure the network companies develop and use methodologies that enable whole system assessment and cost-benefit analysis as to maximise value for customers (See also the proposals concerning network regulation in section 43)

Incentivising network companies to provide data for efficient planning and investment

The current limited understanding of networksrsquo characteristics at lower voltage levels due to inadequate data needs to be urgently addressed While stronger incentives can be applied to DNOs through the RIIO price control framework (as set out in section 43) other areas need effective reform such as the Long Term Development Statement (LTDS) and cost-benefit analysis methodology

The LTDS review and proposals for reform to improve availability handling and quality of data for network planning and forecasting are welcome developments It is critical that publishable materials such as heat maps cover sufficient technical and cost information (eg capacity cost of connection as well as thermal constraints) to enable system value at distribution level to be revealed and captured Further action is needed to ensure the full benefits of unlocking flexibility and permanent demand reduction solutions are incorporated into cost-benefit analyses for monitoring investment at the lower network levels (eg 11kV) where the majority of low-carbon technologies like heat pumps electric vehicles and distributed energy resources will be located

For further detail on our recommendations for digitalising the power system and unlocking the benefits of data see the Energy Data Taskforce report (Energy Systems Catapult 2019b) and ESCrsquos recent report focused on local energy ldquoEnabling Smart Local Energy Systems The value of digitalisation and data best practice (Energy Systems Catapult 2021)




More accurate and granular pricing will better inform system development

Our recommendations for improving market signals are detailed in sections 33 and 43 More granular market pricing will be a key enabler to improve siting decisions for a range of system value enhancing investments in both network infrastructure and flexibility and to maximise the role of the market because

market prices will become more accurate indicators of where network capacity is becoming constrained

innovators who bring propositions that unlock flexibility in ways that accurately target relieving network constraints will be rewarded

propositions that deliver flexibility in electricity demand may provide the business case for investment in other energy vectors (eg the business case for heat networks may be strengthened where they can providesupport flexibility to the electricity system) and

persistent price disparities will provide useful information relevant to network investment planning and to network regulation output setting

Section summaryOur proposals will help unlock greater flexibility and the associated benefits at the distribution level minimising the risks of unnecessary andor poorly targeted investment in network infrastructure Below we set out how four of our six proposals will address the lsquonetwork infrastructure and investment challengersquo1 Make electricity markets work more accurately in space and time This will generate a clearer picture of the opportunities for system value enhancing combinations

of flexibility DER and network capacity investments2 Phase out centralised contracting (CfDs and CM) by mid-2020s and replace with outcome-based

policy mandates on market participants This will provide a clearer basis for project investors ndash and therefore a clearer picture of forward demand

for network capacity3 Overhaul governance and role definitions for industry codes system operation

data and digital interoperability This will strongly incentivise DNOs and TOs to make efficient investment from a whole systems perspective

and for ESO (ISO) to facilitatecoordinate more efficient network investment strongly incentivise DNOsDSOs to share data and facilitate digitalisation enabling innovators

to provide flexibility and unlock value for consumers unlock significant benefits for consumers through greater strategic planning and coordination

of major infrastructure investments including interconnection place Local Area Energy Planning (LAEP) at the centre of the network price control planning processes ensuring

planning and investment decisions for Net Zero are informed by a whole system locally calibrated strategic view ndash leading to a more balanced whole system planning process and greater benefits for consumers

4 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle This will ensure Ofgem continues to strengthen lsquowhole systemsrsquo guidance requirements and incentives in refining

regulatory frameworks for DNOs DSOs TOs and ESO (ISO) to deliver efficient networksystem investment for a Net Zero power system


LAEP can be particularly useful to help reduce uncertainty around cost-optimal decarbonisation by identifying the potential of low regret investment options for an area for instance linked to the placement of monopolistic infrastructure assets like heat networks Successful trials of LAEP in three local areas mdash Newcastle Bridgend and Bury mdash have highlighted the benefits of tailoring to local conditions (Energy Systems Catapult 2018c)

In order to scale up implementation of LAEP

BEIS and MHCLG should jointly integrate a new process of Local Area Energy Planning (LAEP) into the emerging reforms of the planning system

BEIS and devolved administrations should coordinate national roll out of LAEPs Ofgem should progress integration of LAEP into the RIIO2 framework and

promote the use of LAEP as a key source of evidence to guide the use of net zero and other reopener mechanisms designed to enable price controls to flex as the pathway to Net Zero emerges

further work is needed to consolidate evidence and establish formal decision-making frameworks funding streams and planning processes while ensuring that local actions meet regional and national priorities



Unlock benefits through strategic planning and coordination of infrastructure investments

The location of infrastructure development is important to containing the cost of transforming both the electricity system and the wider energy system Greater locational differentiation in energy prices (see section 3 and Annex 7) would encourage more efficient system development Strategic planning can helpfully complement price signals in identifying the efficient set of collective investments and choices that can underpin an efficient net zero transition tailored to local needs and priorities An independent system operator (ISO) as proposed by Ofgem (Ofgem 2021) could play a key role in strategic planning and investment coordination

OWIC (Offshore Wind Industry Council 2019) has identified significant opportunities to better coordinate development of offshore wind transmission infrastructure including connection with interconnectors Working with OWIC the Government and NG ESO (ISO) could facilitate improved coordination More strategic sitingplanning of offshore wind could help ensure greater geographical diversity of turbines around the UKrsquos coastline and this would improve security of supply mitigate price cannibalisation and enable coordination with industrial centres particularly those investing in hydrogen production and use

Strategic planning at the local level through LAEP Local Area Energy Planning (LAEP) is a method developed by ESC to provide a

data driven collaborative and spatial approach to explore a range of scenarios to decarbonise an area cost-effectively from a whole systems perspective LAEP works though a collaborative process involving local government network operators and local stakeholders and takes into account the unique characteristics of the local area (incl geography people building stock) and its existing energy system (incl gas electricity and heat networks) DNOs can be incentivised and supported to use LAEP to inform their network investment choices and Ofgem can use the RIIO price control framework to incentivise DNOs to incorporate LAEP into their business plans

Ofgem recently commissioned ESC and the Centre for Sustainable Energy (CSE) to set out the purpose value and methodology for LAEP including quality criteria that indicate if LAEP is being effectively developed and implemented (Energy Systems Catapult and Centre for Sustainable Energy 2020) A well-developed LAEP process will incorporate robust and transparent technical evidence comprehensive stakeholder engagement process clear assessment of non-technical factors impacting local plans and credible and sustained approach to governance (see Figure 18)

Figure 18 Four key elements for Local Area Energy Planning according to Local Area Energy Planning The Method Guidance

The use of robust tehnical evidence produced using analytical techniques which consider the whole energy system and make consistent use of available data

A comprehensive assessment of wider non-technical factors which need to be understood and addressed to secure change

A well designed and invovling social process which engages appropriate stakeholders effectively uses the technical evidence appropriatley and manages vested interests effectively thus ensuring the resulting plan can be seen as an informed and legitimate representation and local intent in relation to energy system decarbonisation

A crediable and sustained approach to governance and delivery



Enable Ofgem to regulate for net zero through a whole systems approach

Ofgem has recently taken action to embed whole system thinking in the price control framework via strengthened guidance introducing

whole system licence condition for electricity distribution networks mdash in particular introducing a whole system element as part of business

planning incentives whole system considerations in innovation stimuli Whole System Re-Opener (ie the Coordination Adjustment Mechanism) mdash

without an explicit driver to engage in whole system planning however the use of the whole system re-opener may remain limited

While Ofgem is starting to refine the existing RIIO framework to provide a more balanced set of incentives for network companies and to remove capex bias Ofgemrsquos room for manoeuvre is limited by the primary legislation that provides the basis of the gas and electricity network regulation regimes The extent of adaptation within vector specific regulatory regimes remains modest and relatively lsquosoft-edgedrsquo within the context of strong behavioural drivers and incentives that relate to each network companies own network assets and specific performance measures The legislation setting out Ofgemrsquos role and responsibilities may therefore need review




36 See for example Energy Systems Catapult 2020c


Net Zero requires radical overhaul of our electricity system as well as substantial and co-ordinated investments in complementary lowzero carbon energy infrastructure eg heat networks EV charging A zero (or even negative) carbon electricity system will be central to our Net Zero energy system and there will be important synergies and interactions with complementary infrastructure systems and energy vectors36 Sector coupling across industry heat electricity is therefore expected to grow stronger as we transition to Net Zero The whole system nature of the Net Zero challenge is now becoming more prominent

Current governance policy and regulatory architectures are not well-adapted for the challenges of delivering the major change and investment at pace required by Net Zero To unlock innovation will require substantial reform and improvement of governance arrangements to bridge the traditional policy siloes covering different energy vectors and sectors of the economy This is key for a zero carbon electricity

Section summary

Net zero requires radical overhaul of our electricity system ndash as well as substantial (and co-ordinated) investments in complementary lowzero carbon energy infrastructure (eg heat networks EV charging and potential hydrogen)

Sector coupling across industry heat electricity will grow stronger as we transition to net zero mdash the whole system nature of challenge is becoming more prominent

A zero (or even negative) carbon electricity system will be central to our net zero energy system and that there will be important synergies and interactions with complementary infrastructure systems and energy vectors

Our governance policy and regulatory architectures are not well-adapted for the challenges of delivering the major change and investment at pace required by net zero Governance arrangements that can support unlocking innovation across sectorspolicy siloes will be essential for a successful transition

Action will also need to be coordinated at and between local regional and national scales This will be important both within the electricity system (eg coordination of an increasingly distributed and decentralised set of resources) and between electricity and other vectors (ie the mix between electricity and other low carbon vectors is likely to vary across regions and localities)

The Net Zero ambition presents significant challenges for developing and implementing reforms to market design policies and regulations with respect to

1 Coordinating the development and timing of multiple marketpolicyregulatory reforms paying attention to the interactions between these reforms

2 Taking a holistic whole systems approach that ensures coherent strategy across different sectors and vectors

3 Developing strategy with balanced stakeholder input particularly given stakeholdersrsquo varying level of resources information and expertise and given evidence that the current arrangements fall short of providing a genuine level playing field between

different energy resourcestechnologies supplydemandstorage different sizetype of market actor incumbents new entrants SMEs

companies from other sectors and industry and consumers 4 Efficient and effective co-ordination across energy vectors and at and between

local regional and national scales


The governance of the energy sectorrsquos regulatory framework was identified by the Competition and Markets Authority (CMA) as a barrier to competition in its investigation of the sector (Competition and Markets Authority 2016) ESCrsquos own work through the ESCIET Future Power Systems Architecture Programme (FPSA) found shortfalls in the ability of current governance arrangements to deliver the additional functionality needed by a decarbonising power system in an effective and timely manner (Energy Systems Catapult and The Institution of Engineering and Technology 2017 Energy Systems Catapult and The Institution of Engineering and Technology 2018) The need for governance reform in the electricity sector has also been highlighted by a range of other studies (Helm 2017 Sandys et al 2017 Sandys et al 2018)37

Section summary

Industry governancecode processes are complex slow and risk capture by incumbents

Consumers and local communities lack agency under current governance policy and market arrangements mdash which are structured according to industry categories rather than outcomes for consumers or society This risks undermining the ability of the electricity system to meet consumer needs or to adapt to reflect local priorities

Insufficient emphasis on whole system interactions risks constraining innovation and preventing the unlocking of synergies across portfolios of assetsdifferent energy vectors

Lower market visibility and lack of clear focus on market performance risks a self-perpetuating cycle of poor market performance followed by regulatory intervention or inaction

Risk that siloed and unresponsive governance and policy-making leads to short-termist market and policy intervention with consequent low levels of innovation

37 See governance work of the Energy Policy Group of Exeter University httpgeographyexeteracukresearchgroupsenergypolicy


To substantially improve the whole system coherence of policy-making regulation market governance and system operation

60 Policy Governance Challengecontinued




Industry governancecode processes are complex slow mdash risks capture by incumbents

Existing power system change governance mechanisms are not fully fit to meet the evolving needs of GBrsquos future power system The existing governance mechanisms result in slow decision making and implementation of change they do not engage effectively with the parties who operate on the customer side of the meter and they present barriers to new entrants restricting competition (Energy Systems Catapult and The Institution of Engineering and Technology 2018)

More than thirty organisations are actively involved in administration of the regulated energy industry alone costing over pound600m per annum directly (Howard 2015) with further associated indirect costs The change processes are only suited to incremental changes which themselves can take years to implement and fail to involve all the relevant parties The example of developing changes to the Loss of Mains (LoM) protection Rate of Change of Frequency (RoCoF) and Vector Shift protections illustrates many of these issues and is described in the text box below (Energy Systems Catapult and The Institution of Engineering and Technology 2018)

If governance arrangements are not adapted the non-delivery or late delivery of required changes to power system functionality and structure will risk

compromising decarbonisation outcomes and increasing costs frustrating customer expectations and reducing the reliability and security of supply as the system develops

in an uncoordinated way (Energy Systems Catapult and The Institution of Engineering and Technology 2018)

The barriers to delivery and consequences of non-delivery of improved functionality are described in more detail in the published FPSA2 Synthesis Report (Energy Systems Catapult and The Institution of Engineering and Technology 2017)


Consumers and local communities lack agency mdash risks undermining consumersrsquo needs

Consumers have relatively limited agency under current arrangements mdash partly due to regulatory complexity and partly due to the relatively limited differentiation of consumer offerings Ofgem has attempted to strengthen consumer agency through for example introducing Consumer Challenge Groups into the RIIO2 network price control process However these kinds of approaches remain structured according to industry needs and categories (in this case the price control process) rather than according to the outcome (eg reliable service) that consumers may wish to achieve

Similarly local authorities have relatively limited formal roles in relation to the planning and delivery of energy infrastructure and services in the context of the privatised energy networks and associated Gas and Electricity Act regimes The delivery of Net Zero will demand different solutions in different localities and creates a need for co-ordinating action by electricity network providers with other actors including planning and transport authorities and players in the built environment

The lack of agency for consumers under current market and policy arrangements risks creating a disconnect between the needs of consumers and the solutions that electricity infrastructure and service providers implement This risks creating a consumer pushback that slows the uptake of low carbon choices by consumers

The lack of a clear locus for local communities and local authorities to guide and engage with Net Zero choices creates a substantial risk of uncoordinated action and a failure to clarify the role of zero carbon electricity in wider decarbonisation of buildings transport and industry Addressing these risks will be crucial for successful coordination of investment and creating the conditions for a smart responsive electricity system

Source Energy Systems Catapult and The Institution of Engineering and Technology 2018 (updated) wwwnationalgridcomsitesdefaultfilesdocuments01_BSUoS20Update_Jul18_OpsForum_0pdf

Illustration of poor GB change governance arrangements the case of Loss of Mains (LoM) protection RoCoF and Vector Shift protections

As an example of how difficult the existing change process is the current project to change protection settings on small generation is revealing The project started in 2012 and has progressively introduced new Loss of Mains (LoM) protection Rate of Change of Frequency (RoCoF) and Vector Shift protections for different sizes and classes of small generation Eight years on (at the time of writing) it is still less clear when and how to apply the changes to existing small generators even though all stakeholders agree they promote security of supply and for which there is an overwhelmingly positive business case The project needs changes to the Distribution Code the Balancing and Settlement Code and possibly to the Grid Code and National Gridrsquos transmission licence There is no party with overall responsibility for assessing the strategic approach and driving it through the various governance regimes which is made harder still because they all have independent objectives and success criteria While the RoCoF problem remains

unresolved the costs to customers through ancillary services mitigating actions totalled some pound40m per year (2018 data) Furthermore the loss of distributed generation was a contributing factor to 9th of August 2019 event The cumulative infeed loss would have been reduced with full LoM rollout According to ESO approximately 2 GW of small generators are connected to the distribution networks via relays which disconnect the generators if the RoCoF is greater than 0125Hzs It is quite important to review and update the LoM protection settings to avoid high cumulative infeed loss and as a result less inertia will be required in the future for a given loss Having an iterative interoperable and agile governance arrangements would enable us to react quickly to changing opportunities and risks and also would enhance ESO-DSO interactions in order to bring more effective change management mechanisms for required codes and standards modifications The development of an inertia market would also be helpful



Insufficient emphasis on whole system interactions mdash risks constraining innovationsynergies

Developing strategy to transform the power system as part of a wider energy system transformation strategy is a highly complex and risky task The risks of getting it wrong are much higher in the absence of taking a whole systems perspective The policy and regulatory change landscape is constantly evolving for the power sector and the energy system more broadly involving multiple departments and teams within Governmentrsquos administration and the regulator Ofgem There exist examples of related policies or regulations being reformed with weak coordination

For example one of the most important learning points of the network charging reform process identified by ESC through its work with innovators of the PFER (UKRI 2020) projects is the need to better coordinate reforms that affect sources of value for business models that aim to achieve policy goals The Targeted Charging Review (TCR) process and the Network Access and Forward-Looking Charges (NAFLC) process are separate processes focused on different parts of network charges The TCR relates to the residual component of network charges while the NAFLC relates to the forward-looking and potentially dynamic component The TCR decision has already been taken reducing some sources of value that had been supporting flexibility business models (eg Triads embedded benefits) This value might be replaced by NAFLC or other mechanisms but this is currently unknown Commitment to coordinating policy development and implementation of decisions would significantly reduce policy and regulatory risk for innovators

Undertaking analyses to compare the impact of policy design on different vectors or sectors will be increasingly necessary For example a study commissioned by ESC compared the impact that network charging and policy reforms could have on gas tariffs compared to electricity tariffs if reforms would be based on cost-reflective and fairness principles (Energy Systems Catapult 2019c) The comparison illustrated how such reforms could significantly improve the economics for heat pumps compared to gas boilers (see Table 7)


Lack of market visibility and focus on market performance mdash risks self-perpetuating cycle of poor market performance

Significant policy change is underway but each mechanism is being reviewed and reformed on an individual basis The evolution of the market and policyregulatory framework of the electricity sector is not being monitored and evaluated as a whole The EMR interventions are interacting with each other and with the power markets as described extensively in chapter 3 and Annex 2 There is a growing tension between the EMR interventions and development of efficient market signals but current processes appear to favour further interventions rather than addressing the root causes of market failure

The EMR interventions must be reviewed every 5 years in accordance with the Energy Act (UK Energy Act 2013) but this time frame is too long and the review arrangements promote a compartmentalised style of analysis These arrangements risk creating interests that favour (a) perpetuation of current arrangements at the expense of wider whole system objectives and (b) a dynamic that requires perpetual intervention

Unresponsive industry governance and siloed policy mdash risks short-termist intervention constraining innovation

The issues and evidence discussed above point to the risk that unresponsive governance for example the onerous code modification processes will stifle adaptation and change in market arrangements and lock out or slow the potential for innovation as the technology mix changes An example here would be the length of time taken to implement the changes required for half hourly settlement

The siloed policy making processes and governance structures increase the likelihood that future policy development will be driven by short-termist dynamics and partial analysis that fails to capture and reflect whole system challenges and needs The risk is further fragmentation of an already complex electricity policy landscape market and proliferation of policy interventions

Source Energy Systems Catapult 2019c Costs that are more appropriately recovered from general taxation rather than network charges

(eg carbon reduction policy costs such as CfD costs)

Fixed cost (poundyear)

Cost per kWh (poundkWh)

Peak surcharge (poundkWh)

Transfer to taxation

Gas

Typical (2016) 8638 0038 mdash mdash

Cost reflective 27702 0024 1138

Electricity


Cost reflective 19800 0063 01029 9016

Table 7 Comparison of hypothetical network charge reforms for electricity and gas




Consumer-focused reforms to industry governance and codes

Reforms to industry governance are urgently needed alongside codes simplification and expedition of key codes that could immediately unlock competition and innovation (eg P415)

Ofgemrsquos recent proposals (Ofgem 2021) for transitioning NG ESO to an independent system operator (ISO) create a significant opportunity to transform both the power system and power markets through a whole systems consumer-focused approach that could drive innovation and unlock huge benefits for UK plc and consumers Establishing an ISO as well as an independent power market monitor (explained in more detail below) would make a substantial contribution to improving the sectorrsquos governance arrangements Crucial to ensuring that the new ISO performs as an effective facilitator of the GB power systemrsquos transformation to Net Zero mdash for both system operation and market development mdash will be the setting of ambitious objectives and strong incentives appropriate governance arrangements and scrutiny as well as sufficient resources so that it can enhance its capabilities and effectively deliver

The Government should confirm its proposals to reform the governance of the energy industry codes and ensure they are in place well ahead of the mid-2020s A systems engineering approach as recommended by the ESCIET FPSA programme (see Annex 13) can provide the tools and process capable of designing consumer-focused reforms


An updated sector strategy providing clarity on required system outcomes

BEIS and CCC recognise the case for reviewing electricity sector strategy in recent publications although there remain substantial areas of debate about the governance reforms that can best enable integration of the flexible and decentralised resources on which full decarbonisation of the electricity system is likely to be based The 6th Carbon Budget has clarified the scale of the challenge and the pace required from the electricity sector to deliver Net Zero

Our contention is that the Carbon Budget process provides a robust and evidence-based mechanism for defining the outcomes required from the electricity system This in turn can provide the foundation of a revised electricity sector strategy with policy and market design being framed explicitly around requiring markets collectively to deliver those outcomes

The key market outcomes that the GB electricity markets must deliver relate to reliability and decarbonisation At present the Government regulates by defining the inputs of the policy interventions CfDs and the CM The details of a decentralised market-led approach for achieving power system reliability whereby retailers are expected to achieve acceptable reliability outcomes are set out in section Annex 8 The same approach can also be taken with carbon reduction by requiring retailers and offtakers to ensure their energy resource portfolios comply with a decarbonisation outcome (see section 33) and by requiring building owners to achieve carbon performance standards for the buildings they own (Energy Systems Catapult 2020b)

Clearer outcome-based approach for competitive innovative market-driven investment

If market design and complementary policyregulatory reforms are orientated around outcomes as opposed to mechanisms that define inputs they are more likely to

simplify and reduce regulation unleash the innovation that can deliver whole systems decarbonised solutions that

consumers need and want drive down costs for consumers force incumbents to compete and adapt guarantee achievement of these outcomes

Introducing an outcome-based approach to policy and regulation could enable substantial streamlining of electricity sector policy mechanisms while providing market participants with a less prescriptive and more predictable overall policy environment An outcome-based approach can improve the technology-neutrality of market arrangements enabling competition and innovation to drive discovery of the best combination of zero carbon generation resources storage flexibility and demand side measures

Section summary

The reforms we propose will substantially improve governance arrangements so they can enable a consumer-focused transformation of the power sector to net zero Below we set out how two of our six proposals will address the lsquopolicy governancersquo challenge

1 Overhaul governance and role definitions for industry codes system operation data and digital interoperability This will

help rebalance stakeholder engagement and help design markets policies and regulations so they achieve better outcomes that meet consumersrsquo and usersrsquo needs and wants

2 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycle This will

underpin a much clearer definition of required system outcomes providing greater clarity and certainty for all market participants and stakeholders

substantially strengthen the foundations for competitive and innovative market-driven investment in zero carbon electricity over the next decade

enable more agile decision-making (based on whole system analysis amp evidence) to improve and course-correct the market and policy framework performance while strengthening investorsrsquo and stakeholdersrsquo trust in power markets

through LAEP provide a key part of a multi-layered whole system policy and governance framework mdash providing the strategic context for competitive market-driven investment



Removing reliance on prescriptive forms of policy support should enable more agility in contracting and financing arrangements and reduce the impact of unpredictable policy risk on longer term investments in supply chains and the project development pipeline

The development of enhanced and more granular market signals will help to ensure that the pricing framework is more clearly and accurately rooted in the underlying physics of the emerging zero carbon electricity system This too will help to ensure that competition innovation and project development and design choices are driven by system needs rather than the design of policy support mechanisms

Ofgem recognises that the complex regulatory landscape would benefit from simplification and clarification for example in steps to streamline the supply licence and move towards principles-based regulation (Ofgem 2020c) But these steps are only the start A move to an outcome-based approach to policy formulation and regulation will empower and liberate a wider range of innovation to deliver the required changes in system outcomes

Overhauled evaluationmonitoring for agile decision-making better market performance and stakeholder confidence in power markets

The GB electricity system will form the centrepiece of the wider Net Zero energy system An independent process for monitoring and evaluating sector strategy would enable objective analysis of the electricity system transformation and the performance of electricity markets This will be vital given its role in enabling economy-wide decarbonisation

Timely course correction of sector strategy and policy design will be vital given the complexity of the system and the challenges of effectively integrating a range of new technologies alongside potentially radical change in retail offerings to customers The Government published its White Paper on Regulation for the Fourth Industrial Revolution in June 2019 (BEIS 2019b) setting out a commitment and vision for a more agile approach to regulation intended to enable innovation in a time of rapid technological change

A new sector strategy monitoring and evaluation framework can be designed to integrate across interventions and markets and assess performance against a hierarchy of well-defined outcomes key performance indicators and metrics It should also incorporate fast feedback loops and a learning function to support more agile regulation and corrective action Implementing this function transparently can also play a role in reducing policyregulatory risk for investors and market participants


Our proposals to substantially improve independent monitoring of wholesale and retail electricity markets will also be crucial for establishing confidence in the markets and ensuring timely correction of any market failures or abuse A strong well-resourced market monitoring function can reassure stakeholders mdash particularly consumers media and politicians mdash that markets are functioning well and free of market abuse Timely communications will also be key to reduce the risk of arbitrary intervention into markets which could reintroduce policy risk

Market monitoring has two dimensions a) surveillance of the behaviour of market participants to ensure fair play38 and b) assessment of the performance of markets in delivering the outcomes they were designed to deliver These two aspects are inter-related as good market design can prevent market manipulation Effective market monitoring involves a continuous cycle of monitoring effects in markets (due to policy interventions participant behaviour market rules) data analysis provision of explanation or advice to decision-makers and resultant actions by those decision-makers (see Figure 19)39

38 This is covered by REMIT an EU regulation on energy market integrity and transparency (EU 12272011) httpswwwofgemgovukgaswholesale-marketeuropean-marketremit

39 For best practices see httpswwwraponlineorgknowledge-centercan-we-trust-in-electricity-prices-the-case-for-improving-the-quality-of-europes-market-monitoring

Figure 19 Market monitoring as part of a continuous evaluation process

Government EISO and DSOs Ofgem CMA

Consumers Market participants

Politicians Media Investors

Independent monitoring experts

Actions Effects

Info Data analysis


Power market monitoring should ideally be carried out by a body that is independent of the various authorities that have the power to address the recommendations Evidence in other jurisdictions suggests that additional costs of independent market monitoring can be considerably outweighed by the benefits (RAP 2016)

Ofgemrsquos data portal for wholesale and retail electricity markets does not yet cover participation of demand-side response and storage in markets As part of developing the SSFP Ofgem and BEIS have taken the positive step of consulting stakeholders on developing market monitoring for flexibility This could draw from best practice in other jurisdictions including the US PJM market for which an independent market monitor issues quarterly market monitoring reports with a chapter dedicated to demand-side response40 While it could be an option to move the market monitoring capability to NG ISO (eg as for the CAISO market USA)41 we recommend that market monitoring be independent of all actors that have a role in developing and implementing market design (eg as in PJM ErcotTexas MISO NY-ISO ISO-NE markets USA)42

Decision-makers (ie BEIS Ofgem ISO DSOs investors market participants) can make higher quality and faster decisions if they have access to the right information at the right time Higher quality of monitoring of the GB power markets and of the power sector more broadly will support the Governmentrsquos ambition to enact more agile decision-making and to ensure confidence in the GB power market

LAEP as strategic context for competitive market-driven investment in a decentralised system

Markets can play a key role in relation of the resource mix required to deliver a Net Zero electricity system But key elements of the transition will require co-ordinated collective choices and investments mdash most obviously in energy network infrastructure mdash which will need to be tailored to local needs and resources (see section 5 for more information on LAEP)

The role of local authorities can be strengthened so they can play a more active role in shaping electricity system development to meet local Net Zero transition needs and to drive network companies and DSOs to understand and engage with local strategies accommodate local energy resource development and enable efficient interaction and interface with complementary energy infrastructures and resources (eg EV charging infrastructure heat networks etc)


40 See demand response section of latest quarterly report by Monitoring Analytics41 httpwwwcaisocommarketPagesMarketMonitoringDefaultaspx 42 See httpswwwpotomaceconomicscom and httpswwwmonitoringanalyticscomhomeindexshtml


70 Summary of ESCrsquos proposals for EMR20

This paper argues that five key challenges need to be addressed for electricity markets to be able to drive the innovation needed for an efficient and effective transition to Net Zero Risks with the current market and policyregulatory arrangements will potentially worsen unless the system is reformed to match further growth in variable renewables and DER ESC believes these risks can be mitigated but it requires a new wave of electricity market reforms informed by a comprehensive whole system strategy

The broad choice is between two models One a more centralised framework requires more and more decisions to be made by central Government or institutions acting on behalf of central Government This is the current direction of travel

The second is a more decentralised outcome-based market framework where policy mandates require outcomes from the retail market but leave more decisions to market actors Under this approach decisions about investments technology choices business models and innovation are made by market actors based on market signals that reflect the physics of the power system and the need to decarbonise This paper argues that this more decentralised outcome-based framework will encourage greater innovation reducing overall costs increasing the chances of meeting carbon targets and unlocking clean growth for companies that can develop products and services that deliver consumer and societal benefits

To achieve this will require orientating future market design and policy frameworks around consumers and the retailers or service providers who can act on their behalf to commission combinations of energy resources Such an approach has the potential to unleash new business models that can deliver attractive decarbonised integrated and optimised products and services for consumers

Achieving this requires that prices are costsystem-reflective and granular by time and location and that all energy resources

are exposed to these price signals and can access the markets and capture the value if they can provide the needed

products and services

A well-designed decentralised downstream policy framework would not distort the short-term wholesale markets It would drive consumer-focused decentralised contracting including forward contracting and use of risk mitigation products and services provided by the financial markets

Under this policy approach the Government should be able to take a reduced role setting the boundaries of what needs to be delivered and by whom letting consumers and retailers decide how best to deliver

70 Summary of ESCrsquos proposals for EMR20 continued

Figure 20 ESCrsquos proposals for consumer-focused market design


energy services

Policy drives retail innovation that delivers attractive consumer-focused propositions Service Value Automation Optimisation Financing Project management Decentralised contracting Driving supply chains Revenue stacking Hedging


energy services












1 Make electricity markets work more accurately in time and spaceIntroduce more efficient dynamic and granular market signals in short-term wholesale markets to more accurately reflect system status by time and location expose all wholesale market actors to these price signals and progress locational pricing reforms and closer to real time settlement

Rationale for reformCloser to real-time and locational pricing reforms will better internalise the value of flexibility and sharpen incentives for investment in capacity flexibility and system integration resources of most value to the wider energy system and demand decarbonisation

bull A more granular market pricing framework will also generate a clearer picture for DNOsDSOs of the opportunities for system value enhancing network investments and investments

bull Market participants will benefit from improved clarity on how locational value in GB power system will be more efficiently and fully revealed in future and how price signals will be improved over time

bull A shorter time between gate closure and delivery will allow market participants more time to adjust their positions and it will also help reduce reserves required

Proposed actionsbull BEIS and Ofgem to undertake a comprehensive assessment of the costs

benefits and trade-offs of the potential options for efficiently revealing locational value in energy prices (eg nodal pricing zonal reconfiguration andor local energy trading models)

bull BEIS and Ofgem to require NG ESO (ISO) to develop consult on and initiate implementation of a strategy and roadmap for improving the granularity and accuracy (with respect to systemcost reflectivity) of short-term wholesale price formation with an objective to restore value to and confidence in the short-term markets It should also be an objective to maximise the role of the market and minimise the role of the system operator in balancing the system in order to deliver greater competition innovation and consumer benefits

bull This strategy and roadmap should be based on an independent holistic assessment of the functioning and performance of GBrsquos short-term wholesale electricity markets (day ahead intraday) including interactions with reserves capacity market balancing mechanism policies The roadmap should include for example

mdash actions to develop lsquofaster marketsrsquo able to more efficiently integrate variable renewables evolving in anticipation of power system change For example shortening market time units scheduling time intervals the financial settlement period and the time period between gate closure and real-time delivery

mdash coherent coordinated reforms to mechanisms (eg nodalzonal energy pricing network access charges use of network charges local flexibility markets) to more efficiently price and signal locational value in operational timescales moving to real-time

mdash provisions for subsequent timely review and evolution of the strategy and roadmap over time with input from the independent market monitor (see recommendation 6)

Timescale Next 12 months

StrategyRoadmap by 2023 1st phase implementation by 2025

2 Phase out centralised contracting (CfDs amp CM) by mid 2020s and replace with outcome-based policy mandates on market participantsMove from the current centralised approach of EMR10 to a decentralised framework of policy mandatesobligations placed on market participants to drive retail innovation and achieve decarbonisation and reliability outcomes without distorting short-term electricity market signals

Rationale for reformbull Moving from the centralisedupstream contracting approach adopted under EMR10 to a framework based on outcome-

based policy mandates applied in a more decentraliseddownstream approach will force structural change in supply chains to deliver required market outcomes as efficiently and competitively as possible This will place consumers via retailers and service providers at the centre stage in driving market changes and new service propositions

bull An outcome-based policy approach will open more freedom for innovators in technology contracting new business models and service propositions It provides the necessary foundation for competitive and innovative market driven investment in zero carbon electricity with the potential to deliver significantly greater social welfare than would otherwise be the case When combined with more accurate granular and dynamic market signals this should reveal a clearer evidence base about the pattern of forward demand for network capacity facilitating more efficient investment

bull Immediate reforms of the current CfD scheme can begin the process of change towards an outcome-based policy framework bull A clear outcome-based decarbonisation obligation applied to all entities purchasing electricity can create a credible

investable market signal for investors in portfolios of zero carbon resources used for energy balancing and adequacy removing the need for CfDs for mature technologies It can combine with (or potentially replace) the UK ETS to drive complete electricity sector decarbonisation according to a highly visible emissions reduction trajectory

bull Shifting responsibility for reliability to suppliers will drive supply of longer-term contracts for a balanced portfolio of clean energy resources for flexibility and reliability Phase out of the capacity mechanism can restore confidence in short-term wholesale market price signals improve expected returns for DSR and make more demand-side projects NPV positive

Proposed actionsbull Reform CfDs immediately for mature technologies to reduce market

distortions and increase exposure of investors and developers to market signals (eg through adapting the CfD scheme)

bull Assess the design options for an explicit decarbonisation outcome obligation on major electricity purchasers (linked to or nested within the UK ETS cap) as a technology-neutral instrument to drive full decarbonisation of electricity generation Also consider how the decarbonisation obligationmandate approach should be applied to system operatorsrsquo procurement of products and services (eg balancing ancillary and congestion services)

bull Develop a plan for phase out of the capacity mechanism and replacement with a model that will be truly technologyresource-neutral and compatible with development of the power and financial markets restoring confidence and value to wholesale market signals Models to be assessed should include a Decentralised Reliability Obligation Decentralised Reliability Options and Strategic Reserves It should be possible to adapt and refine the design of the reliability mechanism over time as markets develop and confidence in them grows

bull Consider the detailed design of linked outcome-based mandates for other sources of new zero carbon electricity demand (eg for building decarbonisation)

bull Continuously enhance and update consumer protection arrangements to address issues that may arise with greater retail innovation and service-based contracting in a more dynamic retail sector Ofgem can draw from the consumer services experience of other sectors to address minimum service levels consumer rights quality assurance and retail market surveillance

Timescale Implement within 12 months with phase out by 2025

Initiate in next 12 months phase in by 2025


Next 24 months

Ongoing




3 Evolve policy to support financial market development and contracting for investmentEvolve the policy framework (point 2) alongside industry-led initiatives to develop financial markets risk management and forward contracting through the private sector to enable investment in a balanced mix of zero carbon electricity resources

Rationale for reformDeveloping deep and liquid financial markets and a range of contracting arrangements will enable industry adapt to the withdrawal of government-led long-term contracts enable new routes to market to emerge and attract new types of investor

Proposed actionsbull The Government could set up a Zero Carbon Electricity Financing and Contracting

Task Force (this could be set up as a sub-group of the wider Green Finance Taskforce) involving representatives of the power and finance sectors the Low Carbon Contracts Company (LCCC) and relevant trading platforms The task force could identify mechanisms or measures to develop the forwardfuturesretail markets through contracting innovation and might include offtaker of last resort for zero carbon merchant generation (Sandys amp Pownall 2021) offtaker-generator matching facilitation service credit-worthiness standards insurance productsservices standardisation knowledge exchange and raising awareness guidance sector analysesstudies The task force should draw from learning and experience in other countries and sectors

bull Implement industry-led initiatives and collaboration with wider green financing initiatives potentially with a transitional market making function

bull Ensure that the impact on development of financial markets is assessed for all new proposed policy or regulatory interventions

TimescaleTo begin work in 2022

From 20234

Immediate

4 Redesign innovation and early deployment support for immature technologies to minimise or avoid distorting markets Support innovation and early deployment of promising technologies using clear evidence-based prioritisation and wherever possible through mechanisms that limit distortion of energy markets (eg innovation grant support regulated assets partial risk transfers etc)

Rationale for reformThere will be an ongoing need to support innovation and early deployment of a range of technologies but it is important that this does not distort the development of a broader zero carbon electricity market structure and supporting financial and contracting arrangements

The 10 Point Plan for a Green Industrial Revolution identifies the need for innovation and pre-commercial deployment support to commercialise new zero carbon technologies (including hydrogen and nuclear power and carbon capture and storage) reduce their costs and enable scale-up Such policy support can be designed in a way that minimises distortive impacts on electricity markets This can be achieved by ensuring that

bull avoidance or minimisation of market distortion is a design criterion for policy support measuresbull innovation policy support targets immature zero carbon resources with attention to their operational

capabilities and inclusive of storage demand aggregated resources as well as generationbull support should be prioritised taking account of value-for-money analysis that includes the full

costsbenefits as well as implicit support and risk transfers andbull a credible outcome-based policy driver replaces CfDs to drive investment in competitive zerolow carbon

energy resources at needed pace (see point 2 above)

Proposed actionsbull Implement a credible outcome-based policy driver to replace CfD support

for mature technologies (see recommendation 2)bull Apply the value-for-money methodology developed by the ETI (LCP and Frontier

Economics 2018) (Frontier Economics 2020) to design innovation policyschemesbull Ensure the design of innovation support policies for immature technologies

minimises or avoids distorting energy markets (eg innovation grant support regulated assets partial risk transfers etc)

bull Ensure early deployment policy (eg subsidies) aimed at driving new electricity demand (eg heat transport) encourages these resources to offer flexibility consume zero carbon electricity andor to align with Local Area Energy Plans

TimescaleBefore 2025

Immediate

Immediate

Immediate




5 Overhaul governance arrangements and role definitions for industry codes system operation data and digital interoperabilityAdopt a systems engineering to drive a lsquowhole systemrsquo overhaul of sector governance platforms and standards ensure balanced stakeholder engagement accelerate DNODSO and ESOISO transitions and evolution of ESO-DSO coordination and implement EDTF recommendations

Rationale for reformThe need to reform industry governance and simplify industry codes is pressing given their potential to stifle innovation

A systems engineering approach as recommended by the ESCIET FPSA programme (see Annex 13) can provide the tools and process to redesign marketpolicy arrangements with consumer focus and rebalance stakeholder engagement

Development of a stronger more independent ESO (or ISO) function a clearer DSO function and stronger ESO-DSO coordination will enable efficient power system operation and development with a high share of variable renewables and DER that is compatible with greater competition and innovation unlocking major benefits for consumers

Continued progress on data openness and digital interoperability will also be crucial to enabling efficient market functioning and maximising innovation

Proposed actionsbull Government to consult again on governance arrangements for the energy sector in

2021 (as committed in Energy White Paper) The scope should be sufficiently broad Adopt a systems engineering approach as recommended by the ESCIET FPSA programme (see Annex 13) to achieve more balanced stakeholder engagement and greater consumer focus in guiding the design development and implementation of new industry governance arrangements The process timeframe should aim for accelerated implementation within two years

bull Set ambitious objectives and strong incentives for ESO (or new ISO) to enable its effective facilitation of the GB power systemrsquos transformation to Net Zero for both system operation and market development based on a whole systems and consumer-focused approach Clearly define its ambitious role and responsibilities establish robust governance arrangements provide strong incentives through price control

bull Accelerate the development of DSO functions and ESO-DSO coordination through the RIIO price control framework

bull Maintain momentum in implementing the Energy Data Taskforcersquos Recommendations with particular attention tomdash the RIIO framework ensuring it delivers implementation of best

practice from the DNOsmdash further improving data availabilityaccess in relation to supplier switching

data suppliergenerator trades market data to enable carbon tracking for energy products and market monitoring data

mdash ensuring that the right system elements are being digitalised to enable new regulatory and market systems to be implemented and

mdash establishing a broad and systematic regulatory approach to interoperability involving consideration of multiple forms of interoperability simultaneously and including the provision of test and trial environments

TimescaleImplementation within the next 24 months

Next 24 months

In 2021 RIIO-ED2

6 Align electricity sector strategy regulation and outcome-based policy mandates with the carbon budget cycleAlign sector strategy formulation and set decarbonisation (and other) policy mandates in line with requirements emerging from carbon budget process empower Ofgem and local authorities to drive needed actions at required pace set up independent process for sector strategy evaluation and create and resource an independent power market monitor

Rationale for reformLinking electricity sector strategy more explicitly to the carbon budget process can enhance investor confidence in policy stability Outcome-based policy mandates that explicitly align to the required pace of change identified through carbon budgets can form the centrepiece of an innovation-friendly sector market framework

The government should provide strategic direction and guidance to enable lsquowhole systemrsquo network planning and investment at national and local levels Ofgem and local authorities should be enabled to drive the needed actions at the required pace in alignment with net zero Local authority-led Local Area Energy Planning can play a key role in identifying the best mix of measures and collective investments (including energy network investments) to deliver net zero at local level within national and regional policyplanning frameworks This can provide a key part of a multi-layered whole system policy and governance framework ndash providing the strategic context for competitive market-driven investment tailored to local needs and circumstances

Establishing independent arrangements for both sector strategy monitoring and evaluation and electricity market monitoring and surveillance can help to build and retain stakeholdersrsquo trust in market integrity and performance mdash assuring investors and helping them to manage policyregulatory risk while providing clear objective feedback to policy makers and regulators Evidence from other jurisdictions suggests a favourable costbenefit case for establishing and maintaining such independent arrangements andor institutions

Proposed actionsbull Follow up the publication of the Energy White Paper and the Call for Evidence

on ldquoEnabling a high renewable net zero electricity systemrdquo with a comprehensive and integrated review of GB market design and power sector policies for net zero Future development of the BEISOfgem joint Smart Systems and Flexibility Plan (SSFP) following its update due to be published in Spring 2021 should be under the new governance arrangements enabling balanced stakeholder engagement and its scope should be broadened to include reforms to EMR10

bull Design and implement arrangements for an independent and continuous monitoring and evaluation framework for electricity sector strategy and policy with integration across interventions and markets fast feedback loops a learning function and a hierarchy of well-defined outcomes key performance indicators and metrics This should be designed to support the agile decision-making needed to evolve market design and the policyregulatory overlay in a timely manner replacing uncoordinated reviews of individual policy mechanisms

bull Establish an independent expert and well-resourced electricity market monitoring function to undertake surveillance of the wholesale and retail markets and to monitor the performance of market design and identify required corrective actions by BEIS Ofgem CMA the ESO (ISO) DSOs and feed into the sector strategy evaluation framework

bull BEIS and MHCLG to jointly integrate a new process of Local Area Energy Planning (LAEP) into the emerging reforms of the planning system

bull BEIS and devolved administrations to co-ordinate national roll out of LAEPs bull Ofgem to progress integration of LAEP into the RIIO2 framework and promote

the use of LAEP as a key source of evidence to guide the use of net zero and other reopener mechanisms designed to enable price controls to flex as the pathway to net zero emerges

TimescaleNext 24 months

Next 18 months

Implement by 2023

2022

2020s2021ndash25




ESCrsquos recommendations are based on a whole systems approach to addressing the five challenges with each proposal targeting multiple challenges as illustrated in Figure 21

The holistic review of GBrsquos market design for a Net Zero future should start without delay Net Zero requires an integrated and coordinated assessment with full consideration of interactions between policies and markets and their combined impact on market actors resourcestechnologies and consumers The phased implementation can begin immediately with reform of CfDs for established technologies while the new legislative framework is developed for implementation in the mid-2020s Proposed phasing of the reforms is set out in Figure 22

Figure 21 Mapping of ESCrsquos EMR20 proposals to the 5 key challenges


System integration

Consumer focus

Network investment

Policy governance







Figure 22 Phasing and coordination of ESCrsquos EMR20 proposals






Levelise carbon prices in economy + sectoral carbon performance standards on actors that drive markets (eg on building owners) to drive optimisation

Enabling conditions










Financing Task Force

2021 2025 2030 2035


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Baker P 2017 Unleashing demand response with effective supplier compensation Available at httpswwwraponlineorgwp-contentuploads201706rap-baker-unleashing-demand-response-effective-supplier-compensation-2017-junepdf

Baker P amp Gottstein M 2013 Capacity markets and European market coupling mdash can they co-exist Available at httpswwwraponlineorgwp-contentuploads201605rap-final-draft-marketcouplingcapacitymarkets-march-12-2013pdf

BEIS 2019a Capacity Market Five-year Review (2014ndash2019) Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile819760cm-five-year-review-reportpdf

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BEIS 2020b Contracts for Difference for Low Electricity Generation Consutlation on proposed amendments to the scheme Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile885248cfd-ar4-proposed-amendments-consultationpdf

BEIS 2020c GB Implementation Plan Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile910153gb-electricity-market-implementation-planpdf

BEIS 2020d Carbon in Flexibility Markets Workshop (14th October 2020)

BEIS amp Ofgem 2017 Upgrading our Energy System Smart Systems and Flexibility Plan Available at httpswwwofgemgovuksystemfilesdocs201707upgrading_our_energy_system_-_smart_systems_and_flexibility_planpdf

BEIS amp Ofgem 2018 Upgrading Our Energy System - Smart Systems and Flexibility Plan Progress Update Available at httpswwwofgemgovuksystemfilesdocs201810smart_systems_and_flexibility_plan_progress_updatepdf

BEIS amp Ofgem 2019a Future energy retail market review Available at httpswwwgovukgovernmentpublicationsfuture-energy-retail-market-review

BEIS amp Ofgem 2019b Flexible and Responsive Energy Retail Markets mdash Putting consumers at the centre of a smart low carbon energy system Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile819624flexible-responsive-energy-retail-markets-consultationpdf

Billinoria F amp Poudineh R 2019 Market design for resource adequacy A reliability insurance overlay on energy-only electricity markets Utilities Policy Volume 60

BNEF Chatham House amp FS-UNEP 2016 Finance Guide for Policy-Makers Renewable Energy Green Infrastructure Available at httpswwwbbhubiobnefsites4201608Finance-Guide-for-Policymakers-RE-GreenInfra-August-2016pdf

Brown T Reichenberg L 2020 Decreasing market value of variable renewables is a result of policy not variability Available at httpsarxivorgabs200205209 arXiv200205209 [q-finGN]

Buchan D amp Keay M 2015 Europersquos Long Energy Journey Towards an Energy Union Oxford OUP-OIES

Climate Change Committee 2020a Policies for the Sixth Carbon Budget and Net Zero Available at httpswwwthecccorgukwp-contentuploads202012Policies-for-the-Sixth-Carbon-Budget-and-Net-Zeropdf

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Competition and Markets Authority 2016 Energy market investigation Available at httpswwwgovukcma-casesenergy-market-investigationhistory

Cornwall Insight 2018a The case for a floor price CfD Available at httpswwwcornwall-insightcomnewsroomall-newsthe-case-for-a-floor-price-cfd

Cornwall Insight 2018b Wholesale Power Price Cannibalisation mdash Energy Spectrum Analysis Available at httpswwwcornwall-insightcominsight-paperswholesale-power-price-cannibalisation

Cornwall Insight 2019 ldquoConstrained development Scottish wind and the issues of network chargingrdquoAvailable at httpswwwcornwall-insightcomnewsroomall-newsconstrained-development-scottish-wind-and-the-issues-of-network-charging

Cornwall Insights 2020 The net zero paradox Challenges of designing markets to bring forward low marginal cost resources Available at httpswwwcornwall-insightcominsight-papersthe-net-zero-paradox-challenges-of-designing-markets-to-bring-forward-low-marginal-cost-resources

Cramton P 2017 Electricity Market Design Oxford Review of Economic Policy 33(4) p589ndash612

DECC 2012 Electricity Market Reform policy overview Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile656347090-electricity-market-reform-policy-overview-pdf

DECC 2014 Implementing Electricity Market Reform (EMR) mdash Finalised policy positions for implementation of EMR Available at httpswwwgovukgovernmentuploadssystemuploadsattachment_datafile324176Implementing_Electricity_Market_Reformpdf

DLA PIPER amp Inspiratia 2019 Europersquos Subsidy-free Transition mdash the road to grid parity Available at httpswwwdlapipercom~mediafilesinsightspublications2019122019-330-enr-subsidy-free-report-digital-spreadspdf

EEX 2020 Renewable Energy Price Risk Management at the Energy Exchange Available at httpresource-platformeuwp-contentuploadsfilesknowledgereportsEEX-renewable-energy-price-risk-mitigationpdf

Energy Networks Association 2020a DSO Implementation Plan Available at httpswwwenergynetworksorgelectricityfuturesopen-networks-projectdso-implementation-planhtml

Energy Networks Association 2020b Open Networks Project Available at httpswwwenergynetworksorgelectricityfuturesopen-networks-project

Energy Security Board 2018 National Energy Guarantee mdash final detailed design Available at httpwwwcoagenergycouncilgovaupublicationsenergy-security-board-E28093-final-detailed-design-national-energy-guarantee

Energy Systems Catapult amp Centre for Sustainable Energy 2020 Local Area Energy Planning The Method Available at httpsescatapultorgukreportslocal-area-energy-planning-the-method

Energy Systems Catapult and The Institution of Engineering and Technology 2017 FPSA2 mdash Future Power System Architecture mdash Synthesis Report Available at httpsescatapultorgukreportsfpsa2-synthesis-report

Energy Systems Catapult and The Institution of Engineering and Technology 2018 FPSA3 mdash Fast Track to Britainrsquos Future Power System Available at httpsescatapultorgukreportsfast-track-to-britains-future-power-system-2

Energy Systems Catapult 2017 Energy Systems Architecture Methodology Enabling multi-vector market design Available at httpsescatapultorgukwp-contentuploads201712SSH3-Energy-Systems-Architecture-Methodology-Multivector-Market-Designpdf

80 Bibliographycontinued



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Energy Systems Catapult 2018b An introduction to interoperability in the energy sector Available at httpsescatapultorgukbrochuresan-introduction-to-interoperability-in-the-energy-sector

Energy Systems Catapult 2018c Local Area Energy Planning key to minimising decarbonisation costs Available at httpsescatapultorguknewslocal-area-energy-planning-key-to-minimising-decarbonisation-costs

Energy Systems Catapult 2019a Broad model for a capacity remuneration mechanism in an Energy Service Provider-led market Available at httpsescatapultorgukreportsbroad-model-for-a-capacity-remuneration-mechanism

Energy Systems Catapult 2019b A strategy for a Modern Digitalised Energy System mdash Energy Data Taskforce Report Available at httpsescatapultorgukwp-contentuploads201906Catapult-Energy-Data-Taskforce-Report-A4-v4AW-Digitalpdf

Energy Systems Catapult 2019c Cost Reflective Pricing Available at httpsescatapultorgukcase-studiescost-reflective-pricing

Energy Systems Catapult 2019d Future market signals mdash value sources in electricity markets and mapping for GB A working paper to Energy Systems Catapult

Energy Systems Catapult 2019e Towards a new framework for electricity markets Available at httpsescatapultorgukreportstowards-a-new-framework-for-electricity-markets

Energy Systems Catapult 2019f Assessing the potential value from DSOs Available at httpsescatapultorgukreportsassessing-the-potential-value-from-dsos

Energy Systems Catapult 2020a Living Lab Available at httpsescatapultorgukcapabilitiesdigital-and-dataliving-lab

Energy Systems Catapult 2020b Accelerating to Net Zero A sector led approach to an economy-wide carbon policy framework Available at httpsescatapultorgukreportsaccelerating-to-net-zero-a-sector-led-approach-to-an-economy-wide-carbon-policy-framework

Energy Systems Catapult 2020c Innovating to Net Zero Available at httpsescatapultorgukreportsinnovating-to-net-zero

Energy Systems Catapult 2020d Data Best Practice Guidance Available at httpsescatapultorgukbrochuresenergy-data-best-practice-guidance

Energy Systems Catapult 2020e Storage and Flexibility Modelling Available at httpsescatapultorgukcapabilitiesinfrastructure-and-engineeringnetworks-and-energy-storagestorage-and-flexibility-modelling

Energy Systems Catapult 2021 Enabling Smart Local Energy Systems The value of digitalisation and data best practice Available at httpsescatapultorgukreportsenabling-smart-local-energy-systems-the-value-of-digitalisation-and-data-best-practice

Energy Technologies Institute 2019 CVEI Market Design and System Integration Report Available at httpswwweticoukprogrammestransport-ldvconsumers-vehicles-and-energy-integration-cvei


EnergyRev 2020 Early insights into system impacts of Smart Local Energy Systems Available at httpswwwenergyrevorgukmedia1420energyrev-newwave_earlyinsightsreport_final_202006pdf

Frontier Economics 2020 Modelling Whole System Costs of Demand-Side Technologies Analysis carried out for the ReCosting Energy Project Available at httpwwwchallenging-ideascomwp-contentuploads202101ReCosting-Energy-Powering-for-the-Futurepdf

Graf C Quaglia F amp Wolak F A 2020 Simplified electricity market models with signficant intermittent renewable energy evidence from Italy Available at httpsngistanfordedusitesgfilessbiybj14406fGrafQuagliaWolak_SimplifiedElectricityMarketMod-elsRenewables28129pdf

Gramlich R amp Hogan M 2019 Wholsale electricity market design for rapid decarbonisation a decentralised markets approach Available at httpsenergyinnovationorgwp-contentuploads201906Wholesale-Electricity-Market-Design-For-Rapid-Decarbonization-A-Decentralized-Markets-Approachpdf

Gramlich R amp Lacey F 2020 Whorsquos the Buyer How better state assignment of procurement roles can improve retail and wholesale markets Available at httpswwwutilitydivecomnewswhos-the-buyer-how-better-state-assignment-of-procure-ment-roles-can-impro574413

Green R 2007 Nodal pricing of electricity How much does it cost to get it wrong Journal of Regulatory Economics 21(1) p67ndash87

Grubb M amp Newbery D 2018 UK Electricity Market Reform and the Energy Transition Emerging Lessons EPRG working paper 1817 Cambridge working paper in economics 1834 Available at httpswwweprggroupcamacukwp-contentuploads2018061817-Textpdf

Helm D 2017 Cost of Energy Review Available at httpsassetspublishingservicegovukgovern-mentuploadssystemuploadsattachment_datafile654902Cost_of_Energy_Reviewpdf

HM Government 2020 The Ten Point Plan for a Green Industrial Revolution Available at httpsas-setspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile93656710_POINT_PLAN_BOOKLETpdf

Hogan M 2016 Hitting the Mark on Missing Money How to ensure reliability at least cost to consumers Available at httpswwwraponlineorgwp-contentuploads201609rap-hogan-hitting-mark-missing-money-2016-septemberpdf

Howard R 2015 Governing Power Improving the administration of the energy industry in Great Britain Available at httpspolicyexchangeorgukwp-contentuploads201609governing-powerpdf Policy Exchange

Imperial Business Partners 2020 Electricity markets with a high share of variable renewables A review of issues and design options Available at httpsimperialcollegelondonappboxcoms028irer6xb67qodf7ll991ul1wfbcshp

Imperial College London 2019 Electricity markets incentives and zero subsidy renewables Do Britainrsquos power markets and policies need to change Available at httpsimperialcollegelondonappboxcomswrjcxtxa11a1yd6p06xhlrjxn27dox4a



Katzen M amp Leslie G 2020 Revisiting optimal pricing in electrical networks over space and time mispricing in Australias zonal market Available at httpspapersssrncomsol3paperscfmabstract_id=3501336

Keay amp Robinson 2017 The Decarbonised Electricity System of the Future The Two Market Approach Available at httpswwwoxfordenergyorgwpcmswp-contentuploads201706The-Decarbonised-Electricity-Sysytem-of-the-Future-The-Two-Market-Approach-OIES-Energy-Insightpdf

LCCC 201920 Annual Report and Accounts for Low Carbon Contracts Company Ltd Available at httpswwwlowcarboncontractsuksitesdefaultfiles2020-09LCCC20Annual20Report202019-20pdf

LCP and Frontier Economics 2018 A framework for assessing the value for money of electricity technologies A report for the Energy Technolo-gies Institute Available at httpswwweticouksearchsize=10ampfrom=0amp_type=allamppublicOnly=-falseampquery=a+framework+for+assessing+the+val-ue+for+money+of+electricity+technologies

Leslie G Stern D Shanker A amp Hogan M 2020 Designing Electricity Markets for High Penetration of Zero or Low Marginal Cost Intermittent Energy Sources CCEP Working Paper mdash Crawford School of Public Policy Australian National University Available at httpsccepcrawfordanueduausitesdefaultfilespublicationccep_crawford_anu_edu_au2020-05wp_2002pdf

Liebreich M 2017 Six Design Principles for the Power Markets of the Future Available at https assetsbbhubioprofessionalsites24201705 Liebreich-Six-Design-Principles-for-the-Power- Markets-of-the-Futurepdf

Liu Y 2016 Demand response and energy efficiency in the capacity resource procurement Case studies of forward capacity markets in ISO New England PJM and Great Britain Energy Policy Volume 100 p271ndash282

Lockwood M Mitchell C amp Hoggett R 2019 Unpacking lsquoregime resistancersquo in low-carbon transitions The case of the British Capacity Market Energy Research amp Social Science Volume 58

London Economics 2013 The Value of Lost Load (VoLL) for Electricity in Great Britain Final report for Ofgem and DECC Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile224028value_lost_load_electricty_gbpdf

National Grid ESO 2020a FES 2020 documents Available at httpswwwnationalgridesocomfuture-energyfuture-energy-scenariosfes-2020-documents

National Grid ESO 2020b Electricity Capacity Report Available at httpswwwemrdeliverybodycomCapacity20Markets20Document20LibraryElectricity20Capacity20Report202020pdfsearch=de2Drating202020

National Grid ESO 2020c Power Responsive Demand side flexibility annual report 2019 Available at httppowerresponsivecomwp-contentuploads202004Power-Responsive-Annual-Report-2019pdfutm_source=Energystamputm_medium=Energystamputm_campaign=Annual20Report202019

Natural Resources Defence Council Sustainable FERC Project Sierra Club amp Vote Solar 2020 Submission to the State of New York Public Service Commission - Case 19-E-0530 Comments relating to Proceeding on Motion of the Commission to Consider Resource Adequacy Matters Available at httpdocumentsdpsnygovpublicCommonViewDocaspxDocRefId=7BDEAFE823-9481-4437-B48D-973ACBD434857D

Newbery D 2016 Missing Money and Missing Markets Reliability Capacity Auctions and Intercon-nectors Energy Policy Volume 94 p401ndash410

Octopus Energy 2020 Introdcing Agile Octopus Available at httpsoctopusenergyagilegclid=Cj0KCQjwhIP6BRCMARIsALu9LfmV52VfkDt45X074g2RPz7DVSbV2XI-wkvsN6FI4DoVQUUCOBhRB1oaAoKxEALw_wcB [Accessed 2020]

Official Journal of the European Union 2018 Directive EU 20182001 on the promotion of the use of energy from renewable sources (recast) Available at httpseur-lexeuropaeulegal-contentenTXTuri=CELEX32018L2001


Offshore Wind Industry Council 2019 Enabling efficient development of transission networks for offshore wind targets Available at httpswwwofgemgovukofgem-publications161477

Ofgem 2016 Energy market investigation Appendix 52 Locational pricing in the electricity market in Great Britain Available at httpsassetspublishingservicegovukmedia576bcac940f0b652dd0000a8appendix-5-2-locational-pricing-frpdf

Ofgem 2018 Future supply market arrangements ndash response to our call for evidence Available at httpswwwofgemgovuksystemfilesdocs201807future_supply_market_arrangements_-_response_to_our_call_for_evidence_0pdf

Ofgem 2019 Targeted charging review decision and impact Available at httpswwwofgemgovuksystemfilesdocs201912full_decision_doc_updatedpdf

Ofgem 2020a Data Portal mdash Wholesale Market Indicators Available at httpswwwofgemgovukdata-portalelectricity-generation-mix-quar-ter-and-fuel-source-gb

Ofgem 2020b Electricity Settlement Reform Available at httpswwwofgemgovukelectricityretail-marketmarket-review-and-reformsmarter-markets-programmeelectricity-settlement-reform

Ofgem 2020c Future of retail market regulation Available at httpswwwofgemgovukgasretail-marketmarket-review-and-reformfuture-retail-market-regulation

Ofgem 2020d Electricity network access and forward-looking charging review Open letter on our shortlisted policy options Available at httpswwwofgemgovuksystemfilesdocs202003access_scr_open_letter_march_2020_0pdf

Ofgem 2021 Review of GB energy system operation Available at httpswwwofgemgovuksystemfilesdocs202101ofgem_-_review_of_gb_energy_system_operation_0pdf

OLEV Energy Systems Catapult amp LowCVP 2020 Report of the Electric Vehicle Energy Taskforce - Energising Our Electric Vehicle Transition Available at httpswwwlowcvporgukassetsreportsEV_Energy_Taskforce_Report_Jan2020pdf

OVO Energy and Imperial College London 2018 Blueprint for a post-carbon society How residential flexibility is key to decarbonising power heat and transport Available at httpswwwovoenergycombinariescontentassetsdocumentspdfsnewsroomblueprint-for-a-post-carbon-society-how-residential-flexibility-is-key-to-decarbonising-power-heat-and-transportblueprintforapostcarbonsocietypdf-compressedpdf

Policy Exchange 2020 Powering Net Zero Why local electricity pricing holds the key to a Net Zero energy system Available at httpspolicyexchangeorgukpublicationpowering-net-zero

Potomac Economics 2019 2018 State of the Market Report for the ERCOT Electricity Markets Available at httpswwwpotomaceconomicscomwp-contentuploads2019062018-State-of-the-Market-Reportpdf

Poumlyry amp Energy Systems Catapult 2019 Assessing the potential value from DSOs Available at httpsescatapultorgukreportsassessing-the-potential-value-from-dsos

Poumlyry 2013 From ambition to reality Decarboni-sation of the European electricity sector Available at httpswwwpoyrycomsitesdefaultfilesmediarelated_material0013_pov_from_ambition_to_reali-ty_-_decarbonisation_final1111_web2pdf

Poumlyry 2015 ldquoIndependent evaluation of the Electricity Market Reform - Final Report to the Department of Energy and Climate Changerdquo Available at httpsassetspublishingservicegovukgovernmentuploadssystemuploadsattachment_datafile468257Independent_evaluation_of_Electricity_Market_Reform_-_Final_report_-_14_pdf

RAP 2015 Carbon Caps and Efficiency Resources Launching a ldquoVirtuous Circlerdquo for Europe Available at httpwwwraponlineorgwp-contentuploads201605rap-carboncapsefficiencylaunchingvirtuouscircle-2015-janpdf

RAP 2016 Can We Trust Electricity Prices Available at httpswwwraponlineorgwp-contentuploads201607rap-keaybright-eu-market-monitoring-2016-july-1pdf

REA 2019 Energy Transition Readiness Index Available at httpswwwr-e-anetwp-contentuploads201911Energy-Transition-Readiness-Index-2019pdf



Renewable Energy Foundation 2019 A decade of constraint payments Available at httpswwwreforgukref-blog354-a-decade-of-constraint-payments

Renewable Energy Foundation 2020 Escalating UK grid management costs Consumers fell the chill of sub-zero electricity prices Available at httpswwwreforgukref-blog361-escalating-uk-grid-management-costs-consumers-feel-the-chill-of-sub-zero-electricity-prices

RE-Source 2020 Risk mitigation for corporate renewable PPAs Available at httpresource-platformeufilestoolkitRE-Source-risk-mitigation-for-corporate-sourcingpdf

Sandys L Hardy J amp Green R 2017 ReSHAPING REGULATION Powering from the future Available at httpwwwchallenging-ideascompubsreshaping-regulation-power-from-the-future~text=This20report20aims20to20welcomeenergy2C20technology20and20primarily20consumers

Sandys L Hardy J Green R amp Rhodes A 2018 ReDESIGNING REGULATION Powering from the future Available at httpwwwchallenging-ideascomredesigning-regulation-powering-from-the-future

Sandys L amp Pownall T 2021 ReCosting Energy Powering for the Future Available at httpwwwchallenging-ideascomwp-contentuploads202101ReCosting-Energy-Powering-for-the-Futurepdf

Simhauser P 2018 On intermittent renewable generation and the stability of Australias National Electricity Market Energy Economics Volume 72 p1ndash19

The Brattle Group 2018 Market Power Screens and Mitigation Options for AESO Energy and Ancillary Services Markets - Prepared for AESO Available at httpsbrattlefilesblobcorewindowsnetfiles13751_market_power_screens_and_mitigation_options_for_aeso_energy_and_ancillary_service_marketspdf

The Energyst 2019 Demand Side Response Shifting Value Available at httpstheenergystcomdsr

UK Energy Act 2013 Available at httpswwwlegislationgovukukpga201332contentsenacted

UKRI 2020 Prospering from the Energy Revolution (PFER) Available at httpswwwukriorginnova-tionindustrial-strategy-challenge-fundprosper-ing-from-the-energy-revolution

UKRN 2020 Moving Forward Together Performance Scorecards Available at httpswwwukrnorgukpublicationsperformance-scorecards

Watson Farley amp Williams 2019 The Future of Renewable Energy Renewable power generation merchant risk and the growth of corporate PPAs Available at httpswwwacuriscomassetsWatson20Farley20Williams_Renewables_ReportpdfokTiRHexDVjXoa3yRoXNUXDiJwG9TwPD

Wind Solar Alliance 2020 Whos the Buyer Retail electric market structure reforms in support of resource adequacy and clean energy deployment Available at httpsgridprogressfileswordpresscom202003whos-the-buyerpdf

Wolak F A 2011 Measuring the benefits of greater spatial granularity in short-term pricing in wholesale electricity markets American Economic Review 101(3) p247ndash252

Wolak F A 2019 The role of efficient pricing in enabling a low carbon electricity sector Economics of Energy and Environmental Policy 8(2) p29ndash52

Zarnikau J Woo C K amp Baldick R 2014 Did the introduction of a nodal market structure impact wholesale electricity prices in the Texas (ERCOT) market Journal of Regulatory Economics 45(2) p194ndash208

Annex 1 ESC modelling evidence

ESC has several in-house models that analyse different elements of the energy sector on different scales and different levels of granularity We use the insights from this modelling to inform our thought leadership Below are two key sets of analysis that have provided supporting evidence for this report

Innovating to Net Zero mdash Clockwork and PatchworkIn March 2020 ESC published a report lsquoInnovating to Net Zerorsquo (Energy Systems Catapult 2020c) exploring how the UK could transition to Net Zero and its wider implications This report included analysis conducted by ESCrsquos Energy System Modelling Environment (ESME) an optimisation model widely used by Government Industry and academia ESME is a whole-system optimisation model which finds the least-cost combination of energy resources and technologies to 2050 with assumptions about future UK demand and behaviours The model includes constraints on resources technology deployment rates and operation factors as well emissions budgets for the economy (which includes transport electricity industry and buildings) Two main scenarios Clockwork and Patchwork were detailed both of which are consistent with the UK reaching Net Zero in 2050

The results from this analysis of the evolving composition of the power sector are shown in Figure 23 and Figure 24


Power Generation Capacity and Electricty Supplied

Geothermal Plant (EGS) Electricty and Heat

Tidal Stream Hydro Power Solar PV (Domestic) Solar PV (Farm) Offshore Wind (Floating) Offshore Wind (Fixed) Onshore Wind H2 Turbine Anaerobic Digestion CHP Plant Incineration of Waste IGCC Biomass with CCS Biomass Macro CHP Converted Biomass Plant (Drax) Biomass Fired Generation Nuclear (SMR Elec only) Nuclear (SMR CHP SW) Nuclear (SMR CHP NW) Nuclear (SMR CHP NE) Nuclear (Gen IV) Nuclear (Gen III) Nuclear (Legacy) WasteGasificationwithCCS WasteGasification CCGT with CCS CCGT IGCC Coal with CCS PC Coal OCGT Gas Macro CHP Oil Fired Generation Innterconnector Nordel (Electricity) Innterconnector Ireland (Electricity) Innterconnector France (Electricity) Innterconnector Benelux-Germany (Electricity) H2 Micro CHP ndash Space Heat

Electric Consumption

Electrolysis Rail MGV HGV LGV Car Bus DACCS Heat offtake for DHN Air Conditioning Large Scale Heat Pump GSHP ASHP Electric Resistive Heating Lighting Public and Commercial

Buildings Cooking Appliances Industry


Tidal Stream Hydro Power Solar PV (Domestic) Solar PV (Farm) Offshore Wind (Floating) Offshore Wind (Fixed) Onshore Wind H2 Turbine Anaerobic Digestion CHP Plant Incineration of Waste Converted Biomass Plant (Drax) Biomass Fired Generation Nuclear (SMR CHP) Nuclear (Gen III) Nuclear (Legacy) WasteGasificationwithCCS WasteGasification CCGT with CCS ndash 99pct CCR CCGT with CCS CCGT IGCC Coal with CCS ndash 99pct CCR PC Coal OCGT Gas Macro CHP Oil Fired Generation Innterconnector Nordel (Electricity) Innterconnector Ireland (Electricity) Innterconnector France (Electricity) Innterconnector Benelux-Germany

(Electricity)




Figure 24 Patchwork mdash Power generation capacity (top) electricity supplied (below left) electricity consumption (below right)

Annex 1 ESC modelling evidencecontinued

Figure 23 Clockwork mdash Power generation capacity (top) electricity supplied (below left) electricity consumption (below right)

2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh

Electricty Consumption

2010

2015

2020

2025

2030

2035

2040

2045

2050

300

250

200

150

100

50

0GW

Power Generation Capacity

2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

180

160

140

120

100

80

60

40

20

0GW






A significant difference between the two scenarios Clockwork and Patchwork is the role of nuclear More advanced nuclear technologies can offer some flexibility to the power system mdash such as Generation IV coupled with hydrogen production Small Modular Reactors (SMR) deployed with district heating mdash but the extent of their role for Net Zero will depend on cost reductions that can be achieved

This analysis conducted for the lsquoInnovating to Net Zerorsquo report showed that increasing the ambition of the greenhouse gas emissions reduction target from 80 to Net Zero significantly reduces the solution space for 2050 The lack of allowable lsquoresidual emissionsrsquo means more action needs to be taken and certain technologies become essential for a cost-optimal transition

Notably raising the target from 80 to Net Zero has significantly increased the necessary ambition for renewable technologies It also has increased the overall demand for electricity with more of the economy being electrified than former scenarios The demand assumptions for electrification of heat and transport under both Clockwork and Patchwork scenarios can be seen in Figure 25 and Figure 26

In both scenarios nearly all cars are electric by 2050 and electric heating (mainly heat pumps) account for well over half of space heat production

There is also an increasingly important role for hydrogen The total demand for it and generation type will affect the electricity demand on the system Importantly a large proportion of the UK heat supply could be provided by electricity or hydrogen leading to uncertainty on the total demand and the profile of electricity demand There is still considerable uncertainty as to whether it will be cost effective for this hydrogen to be widely produced by electrolysis An increased prevalence of this process will considerably increase the demand on the electricity sector and the capacity of renewables compared to other scenarios

The emissions reduction achieved in other sectors of the economy will also affect the cost optimal balance of the electricity sector as this will affect the total electricity demand and the acceptable carbon intensity of the electricity system

For further discussion of these results see lsquoInnovating to Net Zerorsquo httpsescatapultorgukreportsinnovating-to-net-zero

It should be noted that the cost-optimising modelling does not consider the real world practicalities of financing and does not necessarily capture the potential for innovation to drive down costs develop new technologies or empower consumers Efficient market design supported by a well-designed policy framework are crucial for minimising the systemrsquos total costs

Baringa deep dive on the electricity systemThe ESC commissioned Baringa to model an array of Net Zero pathways to 2050 for the GB power sector

These modelling runs looked for the lsquocost optimalrsquo transition pathway with different assumptions about future technology costs and behaviour

One further modelling run is included which estimates future capacity build looking at likely decisions by investors in a scenario with a continuation and strengthening of current policy This is based on Baringarsquos lsquohigh commodities and decarbonisationrsquo market scenario from the end of 2019 which achieves a carbon intensity of circa 40gCO2 kWh rather than net-zero

These scenarios were commissioned to explore the potential lsquoresult spacersquo for a cost optimal transition to Net Zero and to explore the importance of specific factors

The underlying assumptions for the analysis were aligned to the ESME modelling completed for the recent ESC report lsquoInnovating to Net Zerorsquo outlined above The demand growth proportion of demand supplied by electricity and decarbonisation trajectory were broadly aligned with the outputs and inputs from this whole system analysis The technology cost projections were a combination of ESCrsquos and Baringarsquos own assumptions

Figure 25 Deployment of cars in Clockwork (left) and Patchwork (right)

2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles

Hydrogen FCV Battery EV PHEV Hybrid ICE

2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles

Figure 26 Space heat production in Clockwork (left) and Patchwork (right)

2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh

Heat Pump Electric Heating Biomass Boiler H2 Boiler Gas Boiler Oil Boiler District Heating Solid Fuel Boiler

2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh




Base Case ScenarioThe Base Case sees a high capacity of renewables and flexibility technologies in the energy system by 2050 Nuclear capacity plays a smaller roller in these scenarios than ESCrsquos ESME analysis The core renewables technologies by 2050 are offshore wind and solar with onshore wind and tidal also providing a reasonable capacity There is considerable capacity of flexible plant in the system including interconnectors long duration storage DSR hydrogen and CCGTs By 2050 renewable capacity reaches 127 GW (60 of the total generation mix) whereas gas with CCS and nuclear represent 11 and 5 of the mix respectively Storage constitutes 24GW (or 11 of the mix) hydrogen 14GW and BECCS 2GW (the maximum capacity permitted to be built in the model)

In the Base Case offshore wind tidal and nuclear play a considerable role (including small modular reactors) as illustrated in Figure 27

The load factors from the model show that technology roles evolve over the pathway to net-zero (see Figure 28) CCGTs (without CCS) operate in a broadly mid-merit manner through the 2030s at load factors of between 35-45 These drop more rapidly beyond this point to almost zero in 2050 Gas with CCS plants (both the default 95 and 99 capture variants) operate firmly as a mid-merit plant from their initial introduction in the late 2030s onwards mdash operating at circa 40-50 load factor and providing flexibility for the wider system Hydrogen turbines also provide significant volumes of flexibility to the system Their introduction in the early 2040s starts off as a mid-merit role but moves quickly to more of a low carbon peaking role with load factors of less than 20 by 2050

These low load factors for a considerable capacity of the energy system shows that market arrangements must be evolved to enable investment in flexibility and accurately reward it for its system value The way capacity operates will inevitably change over time with growth in variable renewables and DER While new capacity is added to the system some capacity will inevitably need to exit the system Market arrangements should support retention of capacity with needed capabilities (eg zero carbon flexible) and efficient exit of capacity that is no longer needed (eg carbon intensive inflexible)

Figure 27 Baringa Net Zero Base Case to 2050 for capacity (left) and energy (right)

Note that total electricity demand is assumed to be consistent with the ESME Patchwork scenario excluding large scale production of hydrogen from electrolysis (which is assumed to be produced at scale from CCS-based routes)

100

90

80

70

60

50

40

30

20

10

0Gen

erat

ion

load

fact

or (

)20

19

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

Nuclear (SMR)

CCGT

CCGT with CCS

CCGT with CCS (99 CCR)

OCGT

BECCS

Hydrogen

Short duration storage

Long duration storage

Figure 28 Technology roles expected to evolve with time impacting load factors

Interconnector Long duration storage


DSR Solar Offshore Wind Onshore Wind

Tidal Hydro Hydrogen BECCS Biomass and Waste

Oil OCGT

OCGT with CSS (99 CCR)

OCGT with CSS CCGT

Nuclear (SMR) Nuclear (Gen III) Coal

Carbon Intensity Peak Load

Net Imports Long duration storage



Tidal Hydro Hydrogen BECCS Biomass and Waste Oil OCGT


OCGT with CSS CCGT


Carbon Intensity Load

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

250

200

150

100

50

0Capa

city

(GW

)

600

500

400

300

200

100

0Gen

erat

ion

(TW

h)

Carb

on In

tens

ity (g

KW

h)

Carb

on In

tens

ity (g

KW

h)


Base

Cas

e

Inve

st P

olic

y

Stre

ss R

ES

Fav

Nuc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

ss R

ES

200

150

100

50

0

Capacity Mix 2030

GW



Exploratory ScenariosBaringa developed the following scenarios to explore different sensitivities in comparison with the Base Case

Cross-scenario capacity comparisonThe capacity mix in 2030 is relatively consistent across the different scenarios explored The notable exception is the constrained renewables scenario which was assessed to see whether CCS and nuclear would become more attractive than renewables in a highly stressed system This scenario shows an increase in generation capacity but renewables remain the main technologies The capacity mix of the compared scenarios for 2030 and 2050 are shown in Figure 29

Figure 29 Modelling results for different scenarios for 2030 (top) and 2050 (bottom)

ID scenario name Description and rationale

Base_CaseBase Case

This takes the near term market view of capacity evolution to 2025 and optimised to net-zero within a maximum of 100gCO2 kWh by 2030 and 20gCO2kWh by 2050 (given the potential for up to 2 GW of BECCS within the power sector) Near-term and longer-term technology costs are based on central views from a mix of published Baringa or ESME model data with adjustments to reflect the transition from FOAK to NOAK technology costs for nuclear and CCS depending on where they start to be deployed in the pathway

Stress_RES (S1)Stressed Renewables

Sensitivity 1 explores whether more challenging conditions for renewable integration would shift the emphasis to other forms of low carbon electricity such as CCS and nuclear This scenario assumes conditions where system flexibility (DSR batteries and interconnectors) is limitedmore expensive combined with higher operational reserve requirements (ca 4 times greater compared to the Base Case) as a result of prolonged periods of low wind availability lasting several days

Fav_Nuc (S2)Favourable Nuclear

Sensitivity 2 explores the impact of lower nuclear costs on long-term capacity build under the Net Zero 2050 target focusing on the extent to which nuclear might replace more renewables as the bulk low carbon electricity source More optimistic long-term assumptions for nuclear are used compared to the base case

CCS_Demo (S3)Early Gas CCS Demo

Sensitivity 3 further explores the role of gas CCS technology in meeting the 2050 Net Zero target Material gas CCS technology demonstration schemes are assumed to be deployed earlier in the pathway 08 GW in 2026 reaching 32GW by 2030 This helps to reduce future technology costs more rapidly compared to the base case

Fast_Decarb (S4)Fast Decarbonisation

Sensitivity 4 explores the implications of a faster decarbonisation profile by fixing the 2030 emission target at 50 gCO2kWh compared to 100 gCO2kWh in the Base Case This explores the impact on system costs and whether a faster decarbonisation target changes the end-state of the system seen in the base case in 2050 or whether it simply accelerates the transition to this original end-state

Constr_Stress_RES (S5)Constrained Stressed Renewables

This scenario further constrains Sensitivity (Stressed Renewables) by limiting the availability of nuclear and gas CCS build in the future This sensitivity investigates the additional cost implications of meeting Net Zero with a low carbon electricity system which is overwhelmingly reliant on RES and where integration and balancing is inherently more expensive

Invest_PolicyInvestorCurrent Policy

The ldquoInvestorCurrent Policyrdquo scenario is not a cost-optimised scenario but one which uses information to assume investor behaviour in the future to estimate how the capacity mix may grow under different assumptions This case assumes a gradual evolution of current policies This scenario achieves 40 gCO2kWh emissions intensity in 2050 since it is framed by a wider energy system that meets the original 80 by 2050 emissions target The main purpose is to contrast this scenario to the Base in order to understand the key differences in the technology mix and system costs between an lsquooptimal net-zero systemrsquo and the one likely to emerge without a more radical change in policy ES

ME

Patc

ESM

E C

loc

Base

Cas

e

Barin

ga D

Stre

ss R

ES

Hig

h N

uc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

s

300

250

200

150

100

50

0

Capacity Mix 2050

Interconnector Long-term storage Short-term storage DSR Solar Offshore Wind

(Floating) Offshore Wind

(Fixed) Onshore WInd Tidal Hydro H2 Turbine

WasteGasificationwith CCS

Biomass and Waste Oil OCGT CCGT with CCS mdash

99pct CCR CCGT with CCS CCGT Nuclear (SMR) Nuclear (Gen III) Coal

GW

Coal Nuclear (Gen III) Nuclear (SMR) CCGT CCGT with CCS CCGT with CSS

(99 CCR) OCGT Oil Biomass and Waste BECCS Hydrogen

Hydro Tidal Onshore Wind Offshore Wind Solar DSR Short Duration

Storage Long duration

Storage Interconnector




Cross-scenario system cost comparisonUndiscounted system costs to 2050 show a significant rise in absolute terms to 2050 but a gradual decline on a poundMWh basis as shown in Figure 29

The annualised system costs represented here cover the total sum of capital fixed operation variable operating fuel and net import costs for the electricity system In addition proxies are included for the underlying transmission and distribution network costs from the ETIrsquos Consumers Vehicles and Energy Integration project The latter are ~pound4bny of costs in a world with very high uptake of electric vehicles and heating (ie broadly consistent with a net-zero scenario) but are not assumed to change across scenarios The costs reflect the underlying lsquosocietal resource costsrsquo for electricity but do not represent a full retail cost stack as eg they do not include policy cost recovery for efficiency or smart metering schemes or taxes

Meeting the net-zero target whilst significantly expanding electricity supply leads to a substantial increase in absolute costs by 2050 However the poundMWh costs gradually decline This is driven primarily by a rapid decline in key technology costs such as wind solar and batteries

The stressed renewables case with fewer and more expensive balancing options raises costs by ~pound5MWh over the pathway This rises to closer to pound10MWh in the constrained stressed case due primarily to the lack of CCS which is providing both low carbon electricity and flexibility to the system The faster decarbonisation case does raise costs in the medium term as expected (by ~pound3MWh) but broadly equalise again with the base case by 2050 Interestingly from the 2030s the Baringa decarbonisation market case is more expensive than all of the optimised cases (bar the constrained stressed renewables case) This is largely a result of imperfect policy mechanisms accelerating build of technologies such as wind solar batteries and nuclear slightly ahead of their optimal deployment timing However the broader insight is that incremental costs moving from a highly decarbonised to a net-zero power mix could be limited under a well-designed system

Figure 30 Cross-scenario system costs for Net Zero by 2050 (pound total cost left and poundMWh right)

2020 2030 2040 2050

45

40

35

30

25pound bi

llion

2020 2030 2040 2050

90

85

80

75

70

65

60poundM

Wh

Base Case Baringa Decarb Stress RES High Nuc CCS Demo Fast Decarb Cons Stress RES




Modelling of high offshore wind scenario using ESCrsquos Storage and Flexibility ModelESCrsquos Storage and Flexibility Model (SFM) (Energy Systems Catapult 2020e) is a cost-optimising energy systems model that provides the most comprehensive view to date on how storage and flexibility technologies could help the UK decarbonise at least cost ESC built the SFM in response to the increasingly complex challenge of balancing supply and demand in the energy system Without a deeper understanding of how storage and flexibility technologies could help in balancing energy networks we will at best end up with a system that costs more than it needs to and at worst one that fails to manage supply and demand

The SFM has the capability to represent multiple vectors network levels geographic regions and timeframes including sub-hourly system services It also has the ability to represent long term strategic and short-term operational uncertainties

SFM has been used to explore the potential impact of high volumes of offshore wind (OSW) on the energy system For a cost-optimised scenario of 70GW of OSW

Just over 30 of wind is curtailed Significant back-up capacity is required to manage rare low-renewable weeks Although

this back-up capacity is part of a least-cost system its infrequent use leads to difficulties in presenting a viable commercial business case when considering existing markets

The requirement for reserve replacement increases substantially under both scenarios up to a maximum of 28GW Demand for reserve replacement corresponds to high levels of wind dispatch (Reserve replacement is the injection of power for longer durations to balance forecast errors and power outages Minimum response time is several minutes with a minimum duration of several hours)

Electrical storage is high by 2050 at 78GW333GWh Electrical storage is used to balance supply and demand predominantly over the course of a day with battery storage by far the most preferred technology

Figure 31 System requirements for the 70GW OSW scenario

Source Energy Systems Catapult 2020e Notes The calculation of system services is based on current marketpolicyregulatory arrangements which

may change as processes improve andor the energy system develops for example improved forecasting Future modelling analysis should account for these developments

Frequency Containment Headroom

Frequency Replacement Headroom

Reserve Replacement Headroom

35

30

25

20

15

10

5

0GW

Peak Winter Summer Peak Winter Summer

2030 2050


Annex 2 ESC modelling evidencecontinuedAnnex 2

Economics of market design and price cannibalisation

Some generators and investors in variable renewables are concerned that they will not recover their fixed costs due to the price cannibalisation effect and because they believe the energy-only wholesaleretail market is not well suited to deliver large volumes of zero carbon capacity at minimum cost to consumers The latter is based on the reasoning that in the long run with a large share of variable renewables in the power mix the price in the wholesale power market will often be set by variable renewables with low short run marginal cost (SRMC) and plant with high sunk costs and therefore low SRMC will be under-compensated

Across the globe economists debate this issue A recent paper by Cornwall Insight (Cornwall Insights 2020) introduces several proposals for interventions to address the revenue shortfall of variable renewables and a paper commissioned by Scottish and Southern Electricity (SSE) (Imperial Business Partners 2020) examines the pros and cons of some market design reform proposals with the conclusion that deeper analysis is needed The options examined in the SSE paper are as follows

The ESCrsquos proposals most closely align with option 2 the pure energy market but we propose a policy overlay that would secure investment in zero carbon energy resources at the needed pace to align with Net Zero while ensuring efficient system integration and least cost reliability with activation of the demand-side through consumer engagement Our proposed policy overlay would help develop the wholesale and retail markets in the right direction working in support of efficient price formation (unlike EMR which is currently working against this) As the power system decarbonises and efficient market signals are established this policy overlay can be evolved and eventually phased out

The frequently cited shortfalls of the energy only option are that the model is likely to under-deliver the energy investment needed as price will not meet cost at target delivery volume In addition it is argued that lsquospikyrsquo revenues mean the risk profile is not well suited to the expectation of steady predictable returns that low-cost debt providers would normally expect from a high CAPEX type investments (eg grid-scale storage interconnectors H2 turbines CCS+gas large-scale wind etc) While it might be accepted that the presence of subsidies significantly contributes to the price cannibalisation issue it is argued that their removal would not solve the problem because

generation outputs correlate and are largely independent of demand marginal costs of variable renewables are zero and short run marginal

costs set wholesale prices

ESC takes the view that the current energy-only market design model is highly desirable from an innovation perspective because it is technology neutral dynamic and if allowed to function as intended can produce very efficient price signals and with the right policy overlay and well-developed and sufficiently deep forward and futures markets can ensure full cost recovery for energy resources needed by the system

Efficient market signals are necessary as is full exposure of all wholesale market participants to those signals (extended to retail participants in ways and on a timeline that is useful and appropriate) Pricing the whole-of-system impact of participant actions and exposing market participants to those prices will ensure participants internalize their impact on social welfare and will encourage short and long-run efficient behaviour and investment Participants should face prices that reflect the whole-of-system impact of their actions on the margin Greater penetration of variable renewables in the system increases the importance for adequately pricing scarcity and all network constraints and services Such pricing is required to deliver the right investment incentives for the right technologies with the right capabilities to locate at the right locations to efficiently maintain a stable and reliable electrical network

The discussion on market design for systems based on a high share of variable renewables must focus on how to address the inefficiencies that exist in the current market design and policy framework These inefficiencies are distorting market signals at times of both peaks and troughs causing inefficient operation and making investment riskier and more costly to consumers

Option 1 Changes to current market design mdash price floors (Cornwall Insight 2018a) and value stacking (Aurora 2018)

Variable renewables generators have access to the capacity balancing ancillary services markets along with zero-subsidy CfD

Option 2 The lsquopurersquo energy market (EU Clean Energy Package and single energy market legislation)

For the option studied this involves removal of the GB capacity market

Option 3 lsquoSegmentedrsquo energy market mdash lsquoon demandrsquo market and lsquoas-availablersquo market (Keay amp Robinson 2017)

This option divides both wholesale and retail energy markets into two separate electricity markets an lsquoon-demandrsquo market for controllable and flexible generation and an lsquoas-availablersquo market for variable renewable generation

Option 4 Direct lsquoflexibilityrsquo mechanism

Interventions to support flexibility (like CfDs CM) providing long-term contracts eg auction approach could be combined with instituting a lsquobuyer-of-last-resortrsquo as part of the committed (eg by the system operator) which would effectively guarantee a floor price

Option 5 Indirect flexibility mechanism mdash equivalent firm power (Helm 2017)

Simplifies the market structure by replacing CfDs and capacity mechanism with an all-in-one mechanism

Option 6 Centralised procurement

The system operator procures tranches of different types of generation plant that best suits its assessment of meeting demand whilst balancing multiple system needs and constraints reliability sufficiency emissions constraints and managing transmission constraints Could use for example RAB-based models allow large-scale portfolio players to solve for optimal investment



In relation to this discussion on the compatibility of the energy-only market with a power mix based on a very high share of variable renewables ESC emphasises the following points

1 Energy-only market design principles are technology invariant Market design has three components (Leslie et al 2020) an allocation rule a pricing rule and an exclusion rule Market design is not designed to be support particular cost structures of investments it is designed to deliver efficient market outcomes and maximise social welfare (ie the sum of the benefit provided to all consumers and all producer profits) Market design determines property ownership where the property is allocated to the highest bidder mdash the allocation rule mdash among the registered bidders mdash the exclusion rule mdash and the price set by that bid mdash the pricing rule (Leslie et al 2020)

2 Growth in variable renewables can lead to more volatile prices but does not necessarily lead to lower average prices accumulation of capacity through CfDs and CM is causing price suppression (Simhauser 2018) argues that the focus on short-run ldquomerit order effectsrdquo with respect to variable renewables penetration is not a complete analysis Low SRMC resources are pushed to the margin when variable renewables production is high while high SRMC resources are pulled to the margin when variable renewables production is low mdash or would be if the supply of capacity would be allowed to equilibrate at the level that is needed to ensure cost effective resource adequacy (the out-of-market compensation of the CM distorts this) The ldquomerit order effectrdquo in its more structural sense can therefore lead to more volatile prices (ignoring the impact price responsive demand can have) but does not necessarily lead to lower average wholesale prices mdash that depends on what else is in the resource mix to balance supply and demand at all times and the extent to which the market is supplied or indeed over-supplied The current suppression of average wholesale prices is the result of an accumulation of capacity and CfDsrsquo shielding of generators much less the result of the production cost structure of variable renewables (ie high capex low opex) Adding any supply suppresses prices in the short-run but any subsequent removal of supply raises prices Short-run merit order effects from variable renewables penetration will be accompanied by long-run price rises as some other market participants respond by exiting the market

A recent study by Brown amp Reichenberg (2020) shows how market incentives interact with prices revenue and costs for renewable electricity systems The study illustrates how the policy of subsidy is the primary factor driving lower market values and this decline happens even for dispatchable low-emission technologies The variability of wind and solar is found to be a secondary factor that accelerates the decline if they are subsidised The authors show that if instead the driving policy is a carbon dioxide cap or tax wind and solar shares can rise without cannibalising their own market revenue even at penetrations of wind and solar above 80 (see Figure 32) ndash market values remain stable event at VRE penetration approaching 100 as long as sufficient flexibility is available in the system


Note lsquoSystem costrsquo is the average system generation cost including all capital and marginal costs but excluding subsidies and the CO2 price lsquoMarket valuersquo is defined as the revenue averaged over each unit of energy sold Source Brown amp Reichenberg 2020

ESC does not foresee removing CfDs and relying on extremely high and potentially volatile carbon prices to drive investment (see Annex 5) but rather envisages replacement of CfDs by a decarbonisation obligation (eg carbon intensity standard involving no subsidy) applied to offtakersrsquoretailersrsquo portfolios of energy resources to complement the carbon price The obligation will enable the market to pull zero carbon investment at needed pace avoiding depression of market prices VRE price cannibalisation and insufficient cost recovery for VRE

3 Marginal costs are not zero and prices are not necessarily set by the SRMC of the last generator dispatched in the merit order Prices in the wholesale market are meant to be set by the marginal cost of balancing supply of and demand for both energy and security reserves not by the short-term operating cost (ie fuel cost) of the highest cost generator in the merit order At many times these are roughly equivalent but in many other periods especially periods of large shortages or surpluses of supply they can be quite different Prices in a healthy market should not rise above or fall below marginal cost but marginal cost mdash and thus prices mdash can very often rise above or fall below ldquofuel costrdquo If prices actually do reflect the true marginal cost they will rarely be zero even during periods when a high share of energy infeed is from variable renewables In many instances they could even be quite high due to the physical impact of variable renewables on the power system at times of high output Market design therefore needs to ensure that the full marginal cost of meeting the combined demand for energy and reserves is reflected as much as possible in the short-term prices of the day ahead and intraday markets The design of the GB market model is based on lsquosecurity-constrained economic dispatchrsquo it is not or should not be based simply on lsquoeconomic dispatchrsquo with neglect of marginal costs of complying with the demand for reliability

Figure 32 Electricity price (left) and market value for VRE (right) for increasing VRE penetration under different policy scenarios

140

120

100

80

60

40

20

0

Mar

ket V

alue

(SM

Wh)

0 20 40 60 80 100

Wind+Solar Penetration ()

140

120

100

80

60

40

20

0

Elec

tricit

y Pr

ices (

SM

Wh)

0 10 20 30 40 50 60 70


VRE support system cost VRE support market cost CO2 system cost CO2 market price

VRE support VREsupportwithflex CO2 policy CO2policywithflex




47 Sources and notes for upper figure as presented in (Hogan 2016) (The Brattle Group 2012) mdash weekly average prices from Ventyx (2012) weekly average prices for Australia from AEMO (2012) historical prices shown for ERCOT are at the North Hub Australia prices are at New South Wales PJM prices are at the Eastern Hub and ISO-NE prices are at the System Hub

48 Source Hogan 2016

Figure 33 Comparison of US markets with and without capacity markets

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0

Weekly average energy price (2012) in markets without CRM 47

ERCOT Alberta Australia

Wee

kly A

vera

ge P

rice

(SM

Wh)

Network constraints a significant marginal cost are poorly accounted for in GB power market Markets can provide opportunities for private gain without social benefit if the market mechanisms that determine prices and allocations do not match the physical constraints of the system (Cramton 2017 Wolak 2019) This is currently happening in the GB power market with extremely high payments being made to onshore wind generators in Scotland for curtailment (Renewable Energy Foundation 2020) combined with storagedemand not receiving efficient market signals and facing market barriers and socialisation of costs

If all physical network constraints would be incorporated in energy prices the market design would be more robust to technological change For the GB power system wholesale energy prices are flat across the country and do not vary by location EU legislation sets out provisions for zonal energy pricing and market splitting involving calculation of imbalance prices for different zones46 Experience in other jurisdictions such as Australia informs that zones need to be sufficiently granular in order to realise the benefits (Katzen amp Leslie 2020)

4 The existence of CM contracts tends to dampen the scarcity pricing effect in the short-term wholesale electricity markets Without scarcity pricing the market nor system can be efficient If generators do not pass on capacity payments in reduced wholesale prices they gain windfall profits If however generators do pass on the capacity payments then the lower wholesale price at times of system peakstress

drives up the capacity payments and CfD payments required reduces the value that could be captured by flexibility providers through

energy arbitrage does not help variable renewables to improve its average capture prices

in the wholesale energy market and does not mean end-useretail prices will be lower

See Figure 33 below which illustrates the impact that centralised capacity markets can have on average energy prices and energy price volatility compared with energy-only markets

46 The EU Capacity Allocation and Congestion Management (CACM) Network Code sets out requirements and methodology for establishing price zones

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0

Weekly average energy price (2012) in markets with CRM 47

PJM East ISOndashNE Ontario

Wee

kly A

vera

ge P

rice

(SM

Wh)

Average annual wholesale prices (2015) in five US ISORTO markets 48

Energy Capacity

$60

$50

$40

$30

$20

$10

$0Price

s (S

MW

h)

CAISO MISO ISONE PJM ERCOT

Note multiple factors impact WM prices and volatility including share of renewables and support policies mdash however these price patterns align with the theory of impact of CM on prices and is for illustrative purposes only



Scarcity pricing plays an important role indicating to all market participants when where and in what way the system is running short of critical services rather than through out of market mechanisms like CRMs prejudging and communicating a need for additional resources only to a limited range of possible solutions and without reflecting the relative value of different resource capabilities49 At times of resource scarcity plant will more likely bid based on opportunity costs This is also the case for energy resources with very lowzero marginal costs and high capex (eg hydropower) For example the generatorsrsquo bids are based on the opportunity cost of releasing water now versus in the future In the future it can be foreseen that other high capex resources with very low marginal costs such as large batteries would provide peaking and balancing services and the prices they would set would be based on opportunity costs

In future it can be expected that prices in peak hours will increase significantly for firm dispatchable capacity able to flex around variable renewables due to reduced operating hours because of growth in variable renewables covering more but not all demand peaks Market design must allow free price formation including scarcity (and surplus) prices and it must also allow plant to exit the system if such demand-driven market compensation fails to recover their costs In a market with free price formation hedging volume and price risk through forward contracting will be increasingly necessary as is common in other commodity markets High quality market monitoring is also key to ensuring stakeholdersrsquo acceptance of scarcity prices

The prospects for price volatility and scarcity pricing are crucial for the business case of time-shifting demand and storage that can respond to prices and make profit through energy price arbitrage Storage will not be incentivised to take advantage of low energy prices if it has no opportunity to sell back when the system is tight Price distribution (ie lsquoprice duration curvesrsquo) should be expected to stabilise at a sustainable level of volatility if variable renewable generation is combined with sufficient elastic demand and storage (though some curtailment will be optimal)

5 CfD design distorts bidding behaviour Under the CfD scheme generators and investors are not motivated to increase their price capture rates Analysis by Cornwall Insight shows that the cannibalisation effect from growing levels of CfD generation will be greatest on the day-ahead index as the generators bid into the day ahead market motivated by the fact that the subsidies close the gap between the reference price which is based on the day-ahead price and the strike price By contrast generation supported by the RO scheme (CfD predecessor) was incentivised to exploit several routes to market and to beat market expectations (see Annex 9 for more information on the RO and CfD schemes and how they incentivise generatorsinvestors) (Note as an innovation support scheme the RO suffered shortfalls compared to the CfDs in driving down costs and securing financing but the comparison serves to illustrate how scheme design strongly influences market participantsrsquo behaviours)

The design of the CfD scheme incentivises variable renewables to produce (up to a maximum of 6 hours) so long as the sum of the negative market reference price and strike price is positive The Renewable Obligation (RO) also incentivises negative bidding behaviour but to a lesser extent This has been addressed through recently adopted EU law (Official Journal of the European Union 2018) and the UK is proposing to cease CfD payments when prices are negative (BEIS 2020b) (Note this is not to suggest there is anything wrong with negative prices it is the fact that renewable support schemes inefficiently shield variable renewable generators from exposure to market prices)

6 Prices will rarely be zero if variable renewables are combined with sufficient elastic demand and storage (though some curtailment will be economically optimal) A significant issue is the combination of variable renewables with inflexible demand If demand (including storage) could be more price responsive this could help address price cannibalisation for variable renewables We should not assume continued inelasticity of energy demand and use this as an argument in favour of developing a new market design demand-side response is crucial to cost-effective integration of both DER and variable renewables Instead the current market design can be evolved to enable price responsiveness of demand by removing or minimising the distorting impacts of policymarket mechanisms particularly the CM If market signals are efficient and demand can respond prices will rarely be zero or negative compared to the historical expected frequency of such occurrences At the same time the market should indicate when supply is sufficient and not encourage overbuild Some curtailment will occur in a cost-optimal system

The consequences of developing a power system with a high share of variable renewables combined with inelastic energy demand and insufficient action to remove barriers to storageDSR and the cause of price distortions mentioned above are a) higher cost to consumers with variable renewables integration that is much more expensive than it needs to be b) higher risk of reliability issues or blackouts that would be politically unpopular c) continued dependency of variable renewables on Government financial support and d) riskier investment

7 While short-term market signals can influence investment decisions they do not on their own bring forward investment mdash the forward and futures markets are a crucial integral component of the energy-only market design model In the GB power market investment is mainly driven through the forward markets over different timeframes up to several years ahead (ie more than 95 of trading is through bilateral contracting in forward markets) While forward bilateral contracts might link to prices in the short-term markets the terms of the contract are negotiated such that generators cover their costs and risks are allocated between the contracting parties and priced accordingly Market participants use the short-term markets to fine tune their position having previously negotiated bilateral contracts in the forward markets to buy and sell energy resources along with risk mitigation products and services Market participants are starting to adapt the nature of these contracts to better reflect the risk profiles of the new technologies


49 Scarcity pricing is the principle of pricing electricity at a value above the marginal cost of the marginal unit during conditions of high system stress according to the incremental value that flexible capacity offers to the system in terms of keeping the loss of load probability in check


Figure 34 Explicit DR has greater impact on price formation than implicit DR

P

P dr

0

Price

(poundM

Wh)

Quality (MW)

Demand Curve (with explicit demand response)

Demand Curve (assuming only implicit

demand response)

Marginal Cost Supply Curve

Explicit Demand Response


As the design of the CfD scheme has transferred considerable risk from industry to Government (consumers) which is a form of subsidy the demand of the renewables industry for risk mitigation products and services from the private sector is much lower than it would otherwise be This gives rise to missing futures and insurance markets (Newbery 2016) At present there exists a mismatch between the tenor of debt contracts and the short duration of hedging and insurance products available as well as the shorter length of energy contract that retailers are willing to sign up to Greater exposure of market participants to efficient price signals along with a highly visible and credible investment driver in the form of a decarbonisation obligation on suppliers would force the markets and market participants to adapt Improved market surveillance and monitoring to ensure well-functioning markets would be necessary

8 Cross-border trading helps address price cannibalisation Given GBrsquos interconnection investment interests EU policy will likely remain important for GB and the costsbenefits of policy alignment for GB consumers must be carefully considered The price cannibalisation issue is directly addressed through greater interconnection and balancing over very large geographic areas Britain currently has 54GW of interconnector capacity Roughly an additional 36GW of interconnection is currently under construction and a further 56GW awaits consents50 While the UK is exiting the EU it has substantial interconnection to several EU counties Assuming GB will continue to trade with its neighbours the GB market design and policy framework should not be reformed in isolation from the EU given potential significant impacts on GB consumers The EU Clean Energy Package which includes the recently reformed Electricity Directive and Electricity Regulation sets out a clear path towards establishing a well-functioning energy-only market complemented by well-designed policies

Illustration of market design reform impacts on price formation and explicitimplicit DSRExplicit and implicit DSRThe valuation of DSR can be explicit or implicit explicit DSR is sold as a product on a market (it appears explicitly on the market) and therefore requires a specific control (ex-ante andor ex-post check based on baseline etc) implicit DSR on the other hand does not need such a process since it is not sold to anyone and remains only for the benefit of the final consumer and the corresponding retailer or the Balancing Responsible Party an optimisation respectively of its sourcing costs or imbalances

Explicit demand response has a much greater impact on price formation in the wholesale energy market (both upward when prices are low and downward when prices are high) compared with implicit demand response where consumers directly respond to prices such as time-of-use (TOU) tariffs perhaps with the help of a controllertimer on the load Explicit DSR typically involves a third party or aggregator acting on behalf of the consumer to optimally control their load(s) aggregated with other energy resources in order to maximise revenues from multiple sourcesopportunities

The comparison between explicit DSR and implicit DSR and their impact on price formation is illustrated in Figure 34 below (with stylized demand curves) explicit DSR applies greater downward pressure on price formation compared with implicit DSR lowering clearing prices for the benefit of all consumers The resulting benefits which may be from multiple sources of value will be passed on to the consumer through simple energy bill discounts or payments potentially as part of an attractive energylifestyle service proposition (with override options)


50 See httpswwwnationalgridcomgroupabout-uswhat-we-donational-grid-venturesinterconnectors-connecting-cleaner-future and httpswwwofgemgovukelectricitytransmission-networkselectricity-interconnectors Source Baker 2017


Figure 35 Clearing price impacts in peak periods for three scenarios

Quantity (MW)

20000

10000

1500

P1 = 80Price

(euroM

Wh)

Average VoLL

Price cap

A Legacy practices demand for reserves ignored price caps and socialization of marginal balancing costs

Capped supply curve

Energy-only demand curve

˜

˜

Quantity (MW)

20000

10000

P2 = 2000

0Price

(euroM

Wh)

Average VoLL

B Prices reflect full marginal costs to meet demand for Energy and Reserves (Historical Demand)


Energy plus reserves demand (1)

Marginal cost supply curve

˜

˜

Quantity (MW)

20000

10000

P3 = 800

0Price

(euroM

Wh)

Average VoLL

C Scenario B with consequent increase in responsiveness of demand



˜

˜

National Gridrsquos Wider Access Balancing Mechanism reforms ndash driven to a considerable extent by the EU Clean Energy Package - are reducing barriers to flexibility in the Balancing Mechanism The reforms include introduction of the concept of Virtual Lead Parties (VLP) which enables independent aggregators to access the Balancing Mechanism independent of a supplier To enable access of VLPs to the wholesale energy market Enel X UK Ltd has proposed BSC P415 51 this has the potential to significantly increase explicit DSR via independent aggregators driving competition between suppliers and independent aggregators

Illustrative examples of market design and impact on DSR and price formationFigure 35 illustrates how the clearing price will be impacted under three different scenarios when the system is tight in a hypothetical system scenario a) the demand for balancing services is not reflected in clearing prices with marginal costs of emergency resources available to the SO socialized or ignored scenario b) marginal costs of all balancing actions reflected in the supply curve the price cap is lifted to the average value of lost load and demand curve now reflects full demand for both energy and reserves scenario c) illustrates the moderating impact of investments in greater demand responsiveness when prices are allowed to reflect the full cost of keeping the lights on

Of the three scenarios the GB power market is nearest to reflecting scenario b) having introduced the cash out reforms52 At present however prices rarely reach high levels due to price distortions and issues outlined in this paper Implementing our proposals would restore value to the prices in the short-term wholesale markets with greater occurrence of higher prices and more volatility but greater price response would result and move the GB power market towards scenario c) ultimately reducing average wholesale prices and total system costs for consumers


51 httpswwwelexoncoukmod-proposalp41552 httpswwwofgemgovukelectricitywholesale-marketmarket-efficiency-review-and-reformcash-out-arrangements Source Hogan 2016

Annex 3 ESC system architecture for consumer engagement and energy services

In 2017 ESC published Energy Systems Architecture Methodology Enabling multi-vector market design that presented a series of conceptual tools and analyses developed from systems engineering tools applied to the future UK energy system (Energy Systems Catapult 2017) The study assessed twelve candidate system of system architectures for the future GB energy system with comparison across four dimensions

level of value chain bundling how interfaces between upstream and downstream actors are formed level of sophistication in the retail proposition and means of internalising carbon cost

The evaluation criteria were based on the following five principles

consumer-centric ensuring the whole energy system is focused on meeting consumer needs

societal objectives ensuring the system evolves affordably equitably securely and sustainably

physically constrained ensuring constraints are reconciled in strategic and operational timeframes

commercially aligned ensuring actors optimise the whole value chain across all energy vectors

security and resilience ensuring the system is resilient to systemic failure modes

The consumer-centric principle supposes that a future energy system must address the consumerrsquos needs of energy and therefore have an insight into why consumers use the commodity and what is important to them such as comfort and convenience At the same time it must also provide freedom of supplier choice This principle also recognises that consumers have differing needs and wants At present the regulatory framework struggles with defining consumer needs beyond cost and vulnerability most consumers however purchase on value not cost Aesthetics responsiveness hassle and personalisation are example factors of importance to consumers

The system architecture that emerged from the above-mentioned study showing greatest promise against the evaluation criteria was the lsquofully unbundled retail of experience-based servicesrsquo model This model requires policy to define market outcomes and involves decentralised contracting and establishing resource service level agreements between retailers and consumers

See Appendix D of Energy Systems Architecture Methodology Enabling multi-vector market design (Energy Systems Catapult 2017) for detailed description of the market actors and their rolesresponsibilities as applicable to the lsquofully unbundled retail of experience-based servicesrsquo model (ie system architecture candidate 10)


53 This product was introduced by EEX in 2015 it was suspended however in 2020 due to splitting of the GermanAustria bidding zone

54 The Renewables Infrastructure Group (TRIG) provides an example of a company providing a diversified exposure to renewable energy assets

Source Watson Farley amp Williams 2019

A wide range of PPA structures with utilities corporates public sector organisations or other institutions as offtakers Among them are baseload PPAs combining offshore wind and storage sought by buyers looking for baseload output with a low risk profile (DLA PIPER amp Inspiratia 2019) In a baseload PPA variable renewables generation is turned into a baseload block and the balancing responsibility risk is allocated to the producer who receives a premium for this The profitability of PPAs with storage depends on arbitrage potential and so the investment in storage should be less than what the buyer would have spent in sleeving fees (ie fees to the utility) Examples of these PPAs include EDF Renewables North America signed a PPA with local utility NV Energy for its 200MW solar PV plus 75MW five-hour storage system in June 2019 Portuguese IPP EDPR signed a 20-year PPA with California-based utility East Bay Community Energy for its 100MW solar PV plus 30MW storage project (DLA PIPER amp Inspiratia 2019)

Volume Firming Agreements (VFAs) can be used to help mitigate volume profile and cannibalisation risks the VFA transfers the financial risks of a renewable power plantrsquos overndash or underndash production from the corporate buyer to an insurer who can diversify that risk across a portfolio of weather-linked exposures (RE-Source 2020)

Hedging products can be used to mitigate price risk ndash either stand alone or to cover risk not covered by PPAs mdash and power exchanges are moving in the direction of offering hedging products of longer duration (RE-Source 2020) For example the European Energy Exchange (EEX) has introduced standardised exchange traded renewables derivatives mdash such as Wind Power Futures 53 mdash to enable the dedicated hedging of risk of variable renewable generation EEX is in the process of listing further calendar futures with much longer expiries up to 9 or 10 years ahead (EEX 2020)

Portfolio diversification by investing in different energy sector assets (eg windsolarstorage) and across different countries is an approach to hedging against both long-term risks affecting returns and short-term cash-flow volatility affecting debt repayments (Aurora 2019)54

Annex 4 Innovation in forward and futures marketscontinuedAnnex 4

Innovation in forward and futures marketsA recent survey (Q1 2019) of 150 senior level investors financiers developers and independent power producers and utilities based across Europe identified a range of barriers holding back the deployment of offshore wind without Government support (see Figure 36 Figure 37 and Figure 38 below) (Watson Farley amp Williams 2019) Among the top three barriers identified were bankability concerns and that banks and financial institutions are not ready to move away from requiring projects to have long-term contracted revenues at the start of construction The survey shows there is clearly room for improvement in the market policy and regulatory framework particularly as the majority of respondents do not think investordeveloper or financing markets are adapting sufficiently quickly There is marked difference between the responses of financiers compared to generatorsindependent power producersutilities with financiers being more critical of lack of progress

While progress could be accelerated change and innovation are happening in the investment landscape with a proliferation of new business models investment vehicles and risk mitigation approaches emerging for the power sector which can mobilise different investors and finance all stages of an assetrsquos life Examples include

Figure 36 Question mdash Which of the following do you see as the biggest obstacles holding back the development of subsidysupport-free projects for the OSW


Bankfinancial institutions ldquoarenrsquot readyrdquo to move away from long-term contracted revenues at the start of construction

Levelised cost of electricity in the relevant jurisdiction is still too high

Bankability concerns

Restrictiveunsupportivecomplexpolicies and regulation

Low demand from potential electricty buyersandor underdeveloped CPPA market

Increase technology risks

Risk of cannibalisation

6371

6354

5251

4374

3121

2611

2218

The market is not adapting hardly adapting at all

The market is adapting slowly

The market is adapting quickly but not quickly enough

The market is adapting sufficiently quickly

22

6

0

2535

31

26

5830

46

46

1533

17

28

Europe South East Asia

Developers Financiers Independent power

producersgenerators and utilities

Investors

Figure 37 Question mdash How well do you think the financing market is adapting to a greater degree of merchant

Figure 38 Question mdash How well do you think the developerinvestor market is adapting to a greater degree of merchant risk





52

0

6

2035

23

26

6045

60

48

1518

17

20

Developers Financiers Independent power producers

generators and utilities Investors


By the time this divergence point is reached it could be socio-economically optimal to introduce carbon intensity performance standards obligations or targets (that could be tradable) applied to the retailerrsquos portfolio of energy resourcessales (Energy Systems Catapult 2020b Buchan amp Keay 2015)56 This approach would align well with the concept of driving decarbonisation of supply chains through retailers on behalf of consumers (see Figure 4) particularly if retailers are also responsible for reliability Carbon intensity performance standards or obligations have the potential to create much greater investor certainty compared to volatile carbon prices if linked to a clear decarbonisation trajectory for the power sector which fits transparently with carbon budget legislation and analysis of what is required from the various sectors

A carbon intensity standard for the sector for 2030 was previously promoted by the Climate Change Committee (CCC) in 2012 before adoption of the EMR (Committee on Climate Change 2012) The GB power sector does not currently have a carbon intensity target or decarbonisation trajectory that it is expected to achieve but Part I of the Energy Act 2013 gives the Government the power to set a decarbonisation target or trajectory for the power sector

56 See also Laura Sandys Challenging Ideas ldquoReCosting Energyrdquo which proposes application of a decarbonisation obligation on suppliers httpwwwchallenging-ideascomprojects

Annex 5 Changing roles of CfDs and carbon pricing to decarbonise powercontinuedAnnex 5

Changing roles of CfDs and carbon pricing to decarbonise power

55 Source Poumlyry 2013

As the scope of the UKETS extends beyond the power sector a specific decarbonisation trajectory for the power sector is not guaranteed This may be necessary however given the importance of the power sector in enabling Net Zero to be achieved for the whole economy by 2050 If the decarbonisation trajectory needs to be steeper for the power sector compared to other sectors then carbon intensity targets may be necessary to keep the sector on an ambitious and guaranteed trajectory

Analysis by Poumlyry (Poumlyry 2013) (now AFRY) has identified a potential lsquodivergence pointrsquo around 2030 linked to diminishing returns from incremental carbon price increases as the carbon intensity of the power mix declines which may eventually impair the effectiveness of carbon pricing (see Figure 39) Essentially the carbon price may have increasingly limited influence on the merit order as the power mix decarbonises A broad range of potential carbon price trajectories may be possible depending on the power mix and its level of demand flexibility with potentially very high carbon prices if technologies such as CCS dominate at the margin and if demand flexibility is low

The consumer perspective on higher carbon prices should be considered as the inframarginal rent paid by consumers through their electricity bills per tonne of carbon reduced can be many multiples higher than the carbon price paid by generators per tonne CO2 reduced (RAP 2015)

600

550

500

450

400

350

300

250

200

150

100

50

0Carb

on p

rice

(eurot

CO2)

2012

2015

2020

2025

2030

2035

2040

2045

2050

Higher nuclear and CSS capex

Lower flexibility

Core AM case

Higher flexibility

CO2 price cap

Figure 39 Post 2030 mdash potential of high and volatile carbon prices and diminishing impact on merit order 55

AM AM(flexibilityhigh) AM(flexibilitylow) AM (GG reliance) DS

7 9 1640

100

190

300

430

600

370

210

130

250

130

220180

130

250

310

bull Narrow range of potential carbon prices up to 2030

bull Broad range of potential carbon prices beyond 2030


Three key dimensions ndash temporal spatial and technological - influence the ability of resources connected to the system to deliver system value GBrsquos market design and policyregulatory framework needs to better incorporate these three dimensions in order that they can facilitate in-depth characterisation and appraisal of the factors that drive value creation and influence value realisation by different providers

Annex 6 The 5C framework mdash analysis of sources of valuecontinuedAnnex 6

The 5C framework mdash analysis of sources of value

ESCrsquos work with Poumlyry (now AFRY) (Energy Systems Catapult 2019e) employed a 5C framework for analysis of value in the power system as described in Figure 40

The five categories highlight the diversity of value sources that exist within the electricity sector and the multiple dimensions that need to be reflected or considered in efforts to create appropriate market signals They also hint at the complexity of market design in seeking to ensure that price signals reflect the different sources of system value and to enable resource providers to capture that value

The sources of value in the GBrsquos current electricity market policy and regulatory framework are spread across numerous mechanisms as illustrated in Figure 41 The value is highly fragmented across many mechanisms and attention needs to be given to addressing the inefficiencies of this and to the negative interactions between mechanisms and markets as illustrated in Table 8

Source Energy Systems Catapult 2019e

Driver

Commodity Capacity Capability Carbon Congestion

Commodity Presence of explicit capacity revenue streams reduces requirement for scarcity pricing in wholesale marketCapacity market distorts wholesale price formation

Capacity held for balancing services typically cannot participate in other markets potentially affecting signalsBalancing Mechanism is commonly the vehicle for utilising balancing services Potential for more balancing to take place in wholesale market

EU ETS and CPS feed into variable costs for carbon emitting generators and wholesale price whenever carbon emitting plant is at the marginCfDFiT difference payments are made with reference to market reference price which encourages supported generators to capture the reference price from trading and so reduces incentives to respond to market signals

Network cost avoidance incentives affect dispatch decisionsBalancing Mechanism is commonly the vehicle for resolving transmission constraints as no locational differentiation in energy prices

Capacity Access to wholesale revenue streams will influence required bid prices into capacity auction

Access to capability revenue streams will influence required bid price into capacity auction

Smaller scale thermal units not covered by EU ETS which is likely to affect capacity market bid prices

Access to network cost revenue streams will influence required bid price into capacity auction

Capability Access to capacity market revenue stream alters the resource mix participating in balancing services Capacity market design is based on least cost resource adequacy neglecting operational stabilitysecurity

EU ETS price and CPS feed into variable costs for carbon emitting generators

Carbon Ability for low carbon generators to benefit from EU ETS price and CPS relies on carbon emitting plant being at the margin and setting price

Access to capacity market revenue streams may facilitate carbon emitting resources

Access to balancing service revenue streams may facilitate carbon emitting resources

Access to network cost avoidance revenue streams may facilitate carbon emitting resources

Congestion No locational dimension to wholesale energy prices Supported generators bid into the day-ahead and intraday wholesale markets at negative price based on opportunity cost of lost support revenue affecting costs on congestion management

No locational dimension to capacity market so impact on congestion not considered

Supported generators bid into the Balancing Mechanism at negative price based on opportunity cost of lost support revenue affecting costs on congestion management

Im

pact

Table 8 Selection of interactions between value components (not exhaustive)

Source Energy Systems Catapult 2019d

Figure 40 5Cs framework for value


Value of MWh energy delivered to the system

Value of Reliability of availability in support of security supply

Value of supporting system operability in operational timescales

Value of avoided carbon emissions

Value of easing network congestion or offsetting network build

Commodditybull Imbalance settlementbull Balancing mechanismbull Spot marketsbull Limited forwardfutures

insurance marketsbull Losses arrangements

Capacitybull Capacity market

Capabilitybull Firm frequency responsebull Reserves (eg STOR)bull Reactive power black

start inertia and other non-frequency ancillary services provided as by-products of thermal plant

Carbonbull EU ETSbull Carbon Price Supportbull Renewables Obligation

Certificatesbull Contract for Differencebull Feed-in Tariffsbull Small-scale Feed-in-Tariffsbull Smart export guarantee

Congestionbull Demand TNUoS

chargesbull RedAmberGreen

creditsbull Super Red Creditsbull Constraint payments

(Balancing Mechanism

Figure 41 The 5C sources of value for todayrsquos market arrangements


Annex 6 The 5C framework mdash analysis of sources of valuecontinued

In 2019 ESC worked with Poumlyry to map value across the 5C sources of value with attention to temporal spatial and technological dimensions as shown in Table 9 (source (Energy Systems Catapult 2019d)

Note Reforms to balancing services are currently underway see National Grid ESO httpssubscribersnationalgridcouktd-DA559715AA355CC82540EF23F30FEDED


Table 9 Value mapping of the 5 Cs

Commodity

Mechanism

ValuePrice formation

Dimensions of valueprice signal Technologies

Temporal Spatial Technological

Imbalance settlement

Single marginal cashout

Dynamic Non-locational Non-technology specific

All

Balancing mechanism

Pay-as-bid Dynamic Partially locational Technology specific

Forward and spot markets

Forward Pay-as-bidSpot Pay-as-clear


Distribution losses

Output scaling Dynamic Locational Non-technology specific

Transmission losses


Capacity

Mechanism




Capacity market

Capacity aution Static (Tndash4 Tndash1 years ahead)

Non-locational Technology specific

Partial

Supported low carbon excluded

De-ratings influence ability to participate

Capability

Mechanism




Firm frequency response

Pay-as-bid Varying (1ndash24 month contracts)


Battery engine pumped storage OCGT CCGT and DSRFast reserve

Short-term operating reserve

Enhanced reactive power service

Static (min 12 months with 6 month increments)

Locational Transmission connected generation battery

Carbon

Mechanism




EU-ETS EUA price linked to emission cap vs supply of allowances

Dynamic Non-locational Technology specific

Any technology with lower carbon content that the marginal generator

Carbon price support

Set by Gov as a top up tax on fossil fuel

Static (2 years ahead)

ROCs ROC price linked to buy-out price and recycle

Static (20 years contracts)

ca30 variants of renewble technologies

FiDeR Strike price (based on negotiation)

Static (15 year contracts)


ssFiTs Generation tariff on total productionExport tariff on deemed export volume


Technically eligible solar PV wind CHP Hydro or AD

CfD FiTs Strike price auction (bilateral negotiation for early nuclear)


Gov decision ahead of each allocation round



Table notes Network charges are currently under reform TCR and NAFLC The Targeted Charging Review (TCR) mdash Ofgem has adopted a decision and implementation details are being finalised

impacting transmission connected TGR distribution connected BSUoS Behind-the-Meter TNUoS and Demand TNUoS (Triads) See httpswwwofgemgovukelectricitytransmission-networkschargingtargeted-charging-review-significant-code-review

The Network Access and Forward-Looking Charges (NAFLC) mdash this review is underway and includes wide review of DUoS and focused review of TNUoS charges as well as transmission and distribution access rights See httpswwwofgemgovukelectricitytransmission-networkschargingreform-network-access-and-forward-looking-charges


Mechanism




Generator TNUoS

Determined by transmission network charging methodology

Semi-static Locational Technology specific

All transmission connected

Demand TNUoS (Triads)


Dynamic Locational Non-technology specific

Behind-the-meter (generally enginesmall CHPstorage

Embedded export tariff



Distribution connected OCGTEngines solar PV (unlikely to capture wind CHP hydro DSR storage

RedAmberGreen credits

CDCM (common distribution charging methodology)

Dynamic Locational Technology specific

LVHV distribution connected OCGTEngines solar PV (unlikely to capture wind CHP hydro DSR storage

Super-red credits

EDCM (EHV distribution charging methodology)


EV distribution connected OCGTEngines solar PV (unlikely to capture wind CHP hydro DSR storage

Local flexibility markets

Pay-as-bid if competitive tendersAdministratively set if low liquidilty (region dependant)


Distribution connected OCGTEngines CHP DSR Storage

Constraints payment

Pay-as-bid Dynamic Locational Non-technology specific

All (size dependant)

Co

nges

tion

Congestion Current value across the 5CsActual value currently revealed in the 5C categories is set out in Figure 42 for 2018 for illustrative purposes only as the values depend on assumptions used and there are overlaps between the 5C sources of value and mechanisms Also the current policy landscape is fast changing with for example network charging reforms underway This Figure however is helpful in thinking about how value could shift over time under different market design arrangements

Figure 42 illustrates that the current capacity market value is significant at 5 With an alternative CRM model that would unlike the current model not impact price formation in wholesale electricity markets much of the value could move from lsquocapacityrsquo to lsquocommodityrsquo and the value for lsquocommodityrsquo would rise If the new reliabilitymarket arrangements would be well-designed such that lsquomissing moneyrsquo is restored in the wholesale market the rise would be less than 5 given that the CM over-procures capacity

The value of ancillary services under lsquocapabilityrsquo is increasing with variable renewables growth reflecting changing system needs and associated costs which are expected to increase in future The current market design does not yet fully reveal the value of capability in ancillary services though NGESO is implementing reforms While system integration needs and costs are expected to increase efficient market design can help minimise the increase in these costs The value for lsquocongestionrsquo which is not yet fully revealed through current market design can also be expected to increase in future with growth in variable renewables and DER and it could be more efficient for congestion value to be revealed in energy prices rather than through network charges and the Balancing Mechanism

25

20

15

10

5

0


poundbn

72 5 318 2

Commodity Wholesale market revenue for FYE 2018 is calculated by monthly demand and day-ahead baseload pricesCapacity Total capacity payments made to generators in FYE 2018Capability Annual cost of ancillary services between June 2017 mdash May 2018Carbon Total climate change levy received and the government spending for RO ssFiT CfD in FYE 2018Congestion Annual cost of constraints (as a component of BSUoS) between June 2017 mdash May 2018

Figure 42 Annual monetary value attached to each 5C source of value using 2018 data





The value of carbon represented is significant at 18 and this includes the Climate Change Levy and renewable support payments but not the value of emissions allowances under the EU ETS The value of carbon can be expected to grow in future but perhaps it will not be efficient or politically possible beyond a certain level (see Annex 5) Ultimately carbon may have no value in a fully decarbonised system

Based on this analysis ESC concludes that an increased role for market players in delivering consumer requirements across the 5C sources of value depends on price signals becoming more efficient as well as dynamic and granular by space and time We conclude that attention be focused on streamlining the sources of value Market design should ensure that that all marginal costs and externalities are accounted for and prices should accurately reflect the status of the power system (ie system value) by time and location The sources of value need to be easily accessible by any energy resources and market players able to deliver the required products and services

Current Future

Dynamic Commodity More dynamic

Static Capacity Dynamic

Varying Capability Dynamic

Varying Congestion Dynamic

Dynamic (CO2 pricing) Carbon Dynamic

(CO2 pricing)

Potential for increased dynamism through closer to real-time market operation and shorter settlement periods

Ensure the scarcity value is reflected in wholesale pricing avoiding dampening effect of capacity market Potential for enhanced dynamism in capacity value

Potential for increased dynamism though closer to real-time contracting and shorter commitment periods

Potential for locational differentiation in wholesale pricing to increase dynamism of congestion value

Figure 43 Stronger role for the wholesale market in future ndash temporal dimension

Current Future

Non-location specific Commodity Non-location

specific

Non-location specific Capacity Non-location

specific

Varying Capability Varying

Location specific Congestion Dynamic

Non-location specific Carbon Non-location

specific

Potential for wholesale pricing to combine commodity and congestion values through a move to nodalmore granular zonal pricing and for reduced emphasis on network charging for congestion related value and signals

Location specific commodity value likely to have effects on capacity value in different locations

Figure 44 Stronger role for the wholesale market in future mdash spatial dimension

Future value across the 5CsWe envisage a much stronger role for the short-term wholesale electricity markets in future with wholesale electricity prices incorporating full marginal costs to deliver power to consumers (see Figure 43 and Figure 44 below) The shorter-term wholesale markets have potential to be much more dynamic in future through closer to real-time market operation and shorter settlement periods Removing the current capacity market model or replacing it with a more market-friendly alternative would eventually restore scarcity value in dynamic wholesale prices

Locational differentiation in wholesale pricing would increase the dynamism of congestion value enabling flexible energy resources to efficiently reduce congestion in operational timescales reducing dependency on network charges for pricing signals which have limited potential For ancillary services closer to real-time contracting and shorter commitment periods would support more efficient integration of variable renewable generation reducing costs



How are proposals would impact the 5C sources of value is illustrated in Figure 45 below

Commoditybull Highly granular

fast spot markets with distortion-free price formation (scarcity pricing)

bull Deep forwardfutures insurance markets

bull Locational energy pricesbull Imbalance settlementbull Balancing Mechanismbull Losses arrangements

Capacitybull Scarcity pricing in

spot marketsbull CM replaced by Decentralised Reliability

Options or Decentralised Obligation (with retailers forward contracting for energy and resource adequacy + self-balancing using own portfolio of resources)

bull reduced role for ESODSOs as lsquobackstoprsquo reserve function using Strategic Reserves if market fails to clear (for lsquoout-of-marketrsquo andor commercially unviable reserves)

Capabilitybull Dynamic containmentbull Dynamic moderationbull Dynamic regulationbull Competitive transparent

procurementmarkets for fully costed emergency stability and other non-frequency services needed by high-VRE system

Carbonbull Aligned effective carbon

prices across economy including UK ETS

bull Innovation support and CfDs for emerging zero carbon technologies

bull Carbon standardsobligations (with trading) potentially applied to retailersrsquo net portfolio of energy resources to replace CFDs and to complement UK ETS in order to drive investment aligned with decarbonisation trajectory specific to power sector

Congestionbull Dynamic elements

to network access and forward-looking network charges

bull Flexibility platformsmarkets

Figure 45 ESC proposalsrsquo impact on future 5C sources of value

Value traded in (Local) Flexibility PlatformsMarkets could potentially include Commodity Capacity Capability Carbon Adoption of locational energy prices would reduce value in or need for flexibility platformsmarkets ESO TOs and DSO among other flexibility users can procure from flexibility platforms ESODSOs must coordinate to ensure seamless national regional and local markets Ideally trading of flexibility products and services is price driven

Value in losses arrangements and the Balancing Mechanism could be considerably reduced with existence of locational energy pricing Decentralised approach to reliability reduces balancing interventions by NGESO and DSOs as retailers have primary balancing responsibility (with system operator as backstop using Strategic Reserves if market fails to clear)

The role of dynamic network charges will depend on extent of locational differentiation in energy prices (double-counting should be avoided)

Annex 7 Locational differentiation in energy prices

More sophisticated options such as nodal pricing and locational marginal pricing (LMP) are successfully used in other jurisdictions Efficiency gains from transitioning to nodal markets that align the market mechanism with physical constraints can be found in (Green 2007 Graf et al 2020 Wolak 2011 Zarnikau et al 2014) These approaches allow for better locational differentiation in pricing at wholesale level and typically rely on financial tools such as long-term future products or Financial Transmission Rights (FTR) to enable risk hedging for market participants

Nodal or LMP prices are attractive solutions as energy reserve and congestion are co-optimised in prices and would reduce the need for comparatively expensive balancingcongestion services and influence capacity value in different locations However nodalLMP pricing tends to require centralised algorithms and coordination as well as being accompanied by centralised dispatch and trading From the perspective of developing retail innovation to support consumer engagement and given the need to efficiently integrate many millions of potentially controllable distributed energy assets in future GBrsquos current decentralised self-dispatch model is more desirable compared with centralised dispatch That said nodal pricing can be implemented with decentralised self-dispatch

The different approaches to locational pricing require the consideration of multiple trade-offs as set out in Table 10 Ofgem has considered and rejected options for locational pricing in the past (Ofgem 2016) With much higher ambition and fast growth in variable renewables and DER however the need for locational value to be revealed for the purposes of achieving efficient and cost-effective system integration and network development is becoming increasingly pressing and ESC recommends thoroughly reviewing the options

Nodal market design is often criticised due to its potential to allow for the abuse of local market power However ex-ante local market power mitigation mechanisms and ex-post detection mechanisms have effectively been developed and provide arguments for why local market power issues in nodal markets would continue to exist (and may be exacerbated) under a zonal market design (see for example (Potomac Economics 2019 The Brattle Group 2018)) Administrative scarcity pricing mechanisms can be used which have the benefit of ensuring scarcity pricing while giving system operators and regulators reassurance that the scarcity pricing reflects legitimate scarcity and not the abuse of market power


Annex 7 Locational differentiation in energy pricescontinued

57 This relates to potential for the requirements for re-dispatch actions to be influenced by market participants andor the available range of bidsoffers for re-dispatch purposes to be limited in instances of market power

Annex 8Comparison of CRMs and compatibility with energy services

ESC has worked with AFRY (previously Poumlyry) to develop a CRM model that is compatible with the vision of consumer-focused market design and the likely characteristics and needs of the future electricity system which will be dominated by variable renewables and DER (Energy Systems Catapult 2019a) This model creates the potential for energy service providers and the market more broadly to deliver security of electricity supplies via decentralised contracting solutions rather than relying on centralised interventions for delivering resource adequacy as through the current CM model The premise is that a decentralised market-led solution will allow retailers to take decisions based on detailed understanding of their consumersrsquo needs regarding the route by which to deliver required reliability Compared to the centralised approach of the current CM the hypothesis is that a decentralised market-led solution is expected to both incentivise and accommodate

a more flexible approach to delivering security of supply with market participants taking decisions based on their own positions in respect of

mdash the nature and blend of resource needed to deliver reliability to meet their consumersrsquo needs

mdash the quantity of resource needed taking into account the reliability requirements of consumers and within the Energy Service Providerrsquos (ESP) portfolio sources of reliability



Within this model which assumes retailerssuppliers would have primary balancing responsibility the role of NGESO (and DSOs) would be limited to oversight and backstop provision Their reduced role as lsquoreserve operatorrsquo would be to implement arrangements to ensure that supply and demand are continuously matched such as

stabiliser mechanisms eg to avoid sharp control changes in aggregate supply and demand and

contingency overrides eg to manage response to cyber-security attacks that exploit supply andor demand controls

Table 10 Commonly cited arguments relating to locational pricing approach

Feature National Zonal Nodal

Efficient use of existing grid

Moderate if re-dispatch process is effective

Moderate if re-dispatch process is effective and zone definition is sensible

Good if well implemented

Incentives for efficient resource dispatch

No incentives linked to location within zone

Mixed depending on number of zones

Strong locational incentives but could constrain innovation in context of complex bidding

Re-dispatch volume (ie extent of ESOTSO revision to market positions)

High if network expansion delayed

Lower than national No re-dispatch

Risk of market power abuse on pricing

Lower risk because of broad price setting geography

In between High in absence of regulation because of local scarcity potential

Market power abuse on re-dispatch 57

Potentially high in absence of regulation

In between Low due to central dispatch

Incentives for locationally efficient resource investment

None from energy prices Moderate effectiveness depends on credibility and stability of zonal price signals

Stronger effectiveness depends on credibility and stability of local price signals

Credibility of prices as incentives for investment

High linked to price stability across broad geography

In between Reduced if local prices are difficult to predictunstable


Annex 8 Comparison of CRMs and compatibility with energy servicescontinued


Various CRM models were then compared to assess the extent to which they could align with these requirements The analysis revealed that a market-led decentralised approach mdash either Decentralised Reliability Options (DRO) or Decentralised Obligation (DO) mdash combined with a backstop reserve function provided by the system operator (SO) which could draw on Strategic Reserves (SR) should the market fail to clear would align most closely with the requirements Results for the CM DRO and DO are set out in Table 12 below

In developing the new CRM model ESC and AFRY identified key requirements that the new model would have to have in order to align with ESCrsquos vision of innovative consumer-centric markets These requirements are set out in Table 11 below

Table 11 Key requirements for a consumer-centric market-led CRM model

Requirement High-level assessment

Requirement 1Resource providers need appropriate risk-reward balance

bull Trade of certificates provides a value source for capacity providers based on market price helping to mitigate price and volume risk linked to wholesale market revenue in support of an investible business case for resource providers

bull ESPs can internalise value of within-portfolio resource based on avoided certificate cost

Requirement 2Overall resource requirement identified by market and ESPs

bull Minimum standards to ensure consumer protection and the overall obligation framework set by governmentregulator

bull Within this framework the market as a whole and ESPs specifically determine resource requirements needed to meet reliability standardsobligations This allows for ESPs to form an accurate assessment of the level of resource needed to deliver required reliability based on their detailed knowledge of consumer requirements and within portfolio flexibility instead of reliance on central determination

bull Reserves operator(s) will require visibility

Requirement 3 Obligation to secure resource resides with ESP

bull ESPs have the obligation to secure the resource they determine to be necessary to meet customersrsquo service requirements

bull ESPs have flexibility and choice in terms of routes for fulfilling resource requirements rather than reliance on central procurement Importantly this includes ability to use within-portfolio resource to satisfy overall reliability requirements

Requirement 4 Flexibility for ESP to choose resource blend

bull ESPs have choice over the underlying resource needed to meet consumer reliability requirements

bull As above this includes ability to use within-portfolio resource to satisfy overall reliability requirements Ability to utilise within portfolio resource allows for innovative solutions to be lsquoself-certifiedrsquo by the ESP increasing scope for such resource to be accessed

bull Scope for lsquoself-certificationrsquo of within portfolio resource reduces requirement for central coordination of certification However some central coordination is expected to be required to determine capacity contributions of resources to support certificate trading although this may become more industry-led over time as the system becomes more established

Requirement 5 Market at forefront but with backstop

bull Provides commercial incentives for ESPs to fulfil reliability obligations meaning that the market as a whole and ESPs specifically have primary responsibility for securing reliability needed to meet customer needs

Requirement 6 Minimum service standards to protect consumers

bull Government and regulator will have ability to define minimum service standards to protect consumers This will need appropriate definition of standards and then monitoring of performance to ensure that standards are being upheld

Note ESP=Energy Service Provider (ie retailers providing electricity (could be more than one) Source Energy Systems Catapult 2019a

Table 12 Assessment of compatibility of different reliability approaches with consumer-centric markets and energy service provision

Assessment criteria Decentralised obligation Decentralised reliability option Current capacity market

ESPrsquos ability to secure the level of reliability it believes is appropriate for its portfolio

Partly yes Reliability standard and each ESPrsquos required capacity ticket holdings are determined centrally But ESP has choice over level of capacity tickets to buy relative to obligation If it under-procures it could face penalties Through commodity market ESP can secure energy to provide the level of reliability it considers is needed

Yes Can determine reliability standard and procurement of reliability options and through market and options can secure energy to provide the level of reliability it considers is needed

No Reliability standard and capacity requirement to deliver are determined centrally and procurement is central Through commodity market ESP can secure energy to provide the level of reliability it considers is needed

ESP discretion to choose resource options for meeting customer needs re reliability and decarbonisation

Limited Capacity eligibility to for tickets and eligible availability determined centrally Through its bilateral trading for capacity tickets the ESP has flexibility to choose its counterparties from the full range of options But this mix will be influenced by the central capacity market

Yes Through its forward trading can choose its counterparties from full range of options

Limited Capacity providers capacity eligibility to participate and eligible availability determined centrally Through its forward trading for commodity ESP has flexibility to choose counterparties but mix influenced by the central capacity market

ESP ability to use within portfolio resource (including cross-vector) to meet its reliability requirements

Yes ESP can use within portfolio resource to support delivery of reliability across its portfolio and offsetreduce need to procure requirements from the commodity market and the capacity certificate market

Yes ESP can use within portfolio resource to support delivery of reliability across its portfolio and offsetreduce need to procure requirements from the commodity market

Yes for energyNo for capacity ESP can directly use within portfolio resource to fulfil its energy requirements and offsetreduce need to procure requirements from the commodity market But as capacity procured centrally ESP cannot directly use its within portfolio resource to meet its capacity needs

ESP ability to offer within-portfolio resource to market

Largely yes ESP can offer within portfolio resource into the commodity market and if certified into the capacity certificate market

Yes ESP can offer within portfolio resource into the commodity market

Maybe ESP can offer within portfolio resource into the commodity market and if certified into the capacity certificate market

ESP ability to capture value for flexibility of resource

Limited Capacity product does not reflect flexibility of underlying resource But within portfolio resource offsets ESPrsquos potential capacity certificate requirements and associated costs Value for flexible resource within consumer portfolio will need to be extracted via commodity or capability components But this may be hindered by nature of capacity product and its interactions with other value sources

Yes Options allow flexibility to be realised through bilateral trade with other market participants to manage wholesale price volatility and imbalance risk

Limited Capacity product does not reflect flexibility of underlying resource Must extract value for flexible resource within consumer portfolio via commodity or capability components but may be hindered by nature of capacity product and interactions with other value sources

Effects on costs of delivering reliability

Largely yes Improved investor certainty regarding investment returns due to capacity revenue stream moderates costs of delivering security of supply

Improved investor certainty moderates costs Difference payment under reliability option reduces exposure to price spikes

Improved investor moderates costs but centrally defined capacity requirement may over-procure




A key merit of a decentralised approach is that it strongly incentivises retailers to secure adequate resources for reliability purposes either from within their own resource portfolio or externally These incentives include

potential contractual penalties under service agreements with consumers if agreed standards are not met

potential penalties if government specified minimum service standards are not adhered to and

wholesale market incentives to balance commodity position to avoidreduce potential imbalance cost exposure (noting expectation outlined above that wholesale arrangements would evolve potentially to become more granular)

In addition it may make sense to create an incentive linked to the CRM itself This depends upon the perceived strength of the combined incentives outlined above If implemented this could take the form of a capacity certificate imbalance

Indeed challenges are associated with the increased emphasis on the market for delivering system balancing but these can be addressed through the design of the scheme and its implementation plan requiring

Market participants to be allowedrequired to balance their positions much closer to and potentially in real-time with corresponding reduction in system operation responsibility This will require a change in emphasis in the philosophy for system balancing and clarity on the division of obligations between ESPs and the Reserve(s) Operators This will also be linked to the development and availability of within-portfolio resource for ESPs to use for balancing and supporting arrangements for coordination of actions This may be a phased transition as more resource becomes available for use by ESPs

Sharper incentives for market participants to balance their positions in support of the increased importance of their role in balancing

Development of toolkit for market participants to access resource to balance positions and manage risks

Framework for coordinating balancing actions across market participants in real time Framework for coordinating actions of Reserve Operator(s) including national

and local dimensions Review of standards for consumer protection and framework to allow differentiation

of standards above the minimum

Table 13 below summarises and compares the key features of the GBrsquos current CM model with the alternatives of the DO DRO and Strategic Reserves

Table 13 Summary of CRM concepts and building blocks for different options

Strategic Reserves Capacity Market (auction)

Decentralised Obligation

Decentralised Reliability Option

Capacity requirement volume

Centrally determined Centrally determined Centrally determined Market participantconsumer choice

Responsibility for securing capacity

Central procurer Central procurer Retailers Retailersconsumers

Method for procuring capacity

Tendercompetitive process

Auction Bilateral trading Bilateral trading

Lead time Forward to allow for new build (year(s))

Forward to allow for new build (year(s))

Buyer and seller choice Buyer and seller choice

Capacity price setting Determined by tender competitive process

Auction clearing price Bilateral trading Bilateral trading

Product Available capacity Available capacity Available capacity Energy option and available capacity

Eligibility Limited Broad (market-wide) Broad (market-wide) Broad (market-wide)

Duration Multi-year Annual as standard multi-year for new

Annual Buyer and seller choice

Nature of obligation Physical Physical Physical Financial settlement of energy option and physical

Nature of penalty Administered penalty if not available

Administered penalty in event of shortage


Exposure to unhedged option settlement and administered penalty in event of shortage

Participation of capacity in the wholesale market (ie market fails to clear)

Ring-fenced participation in extreme circumstances only (ie market fails to clear)

Standard participation Standard participation Standard participation

Payment ESO recovered through system operation costs

Suppliers based on share of demand over a selection of trading periods

Suppliers based on bilateral trade


Pros Limited in scope and administrative burden If pricing and rules surround use are set appropriately can be a complement to an energy only market

Provides revenue stream for all successful capacity based on competitively determined price

Provides revenue stream for capacity providers based on bilaterally negotiated price More choice for buyers and sellers

Provides revenue stream for capacity providers based on bilaterally negotiated price

More choice for buyers and sellers

Cons May interfere with market-led investment decisions given real or perceived slippery slope Utilisation price may set limit on energy pricing if set too low

Reliance on centrally determined capacity requirement may over-emphasise need Over-procurement distorts short-term wholesale electricity prices Administratively heavy

Reliance on centrally determined capacity requirement may over-emphasise need Effectiveness dependent on level and nature of penalty

More financial obligation may not elicit confidence of delivery

Market participants have not felt inclined to develop such products




Decentralised reliability options (DRO) bring the advantage that they help develop the forwardfutures markets the spot markets and the retail markets They also protect consumers against scarcity prices The DRO model can be complemented by Strategic Reserves that would be used in situations when the market fails to clear covering emergencies such as lsquopeak weekpeak seasonrsquo involving energy resources rarely used and potentially commercially unviable in well-functioning markets with free price formation The model has significant but positive implications for the roles of the Government system operator(s) and retailers (energy service providers) with the Government being able to take a reduced role as the model enables the market to provide the technical solutions

If however the Government believed it necessary to retain centralised control when moving to a decentralised approach the Decentralised Obligation model could be the preferred option This model is used in France and a lighter-touch variation is used in Australia (NEM) The Government could reduce its role over time evolving the model (perhaps to a DRO model + Strategic Reserves or Strategic Reserves only) so that retailers could eventually take ownership of their reliability requirements

The process and timing for delivering the anticipated framework are dependent on wholesale market being sufficiently well-functioning enabling market participants to undertake more balancing actions closer to or potentially in real-time This is being achieved through reforms to some degree already

move to single imbalance price based from 1 November 2018 on marginal 1MWh energy balancing action

introduction of reserve scarcity pricing (RSP) function which places a value on when it is used based on system tightness at the time reserve and

pricing disconnections and voltage reductions at from 1 November 2018 pound6000MWh

In time the imbalance price cap of pound6000MWh could be raised towards the weighted average VoLL of pound16940MWh identified by London Economics (London Economics 2013) with rate of increase taking into account consumer response Ofgem and Elexon (the Balancing and Settlement company) have the authority to review this price cap (BEIS 2020c) Raising this price cap would return some of the missing money to the wholesale energy market (imbalance prices should be reflected back to day-ahead prices and thus to forward market prices) reduce dependency on the CM and incentivise flexibility including demand-side response and storage

Reducing gate closure timescales and increasing granularity of trading periods would help better align with real-time balancing needs sharpen prices and give market participants more time to adjust their positions in order to avoid imbalance charges which under these proposals could potentially be much higher

Decentralised Reliability Options mdash innovation and market friendlyA DRO scheme which is the more market friendly of the two decentralised options studied introduces a set of contracts between capacity providers including demand side management and (indirectly) consumers The mechanics of DROs are illustrated in Figure 46 Retailers are required to buy reliability options to meet their demand at critical times and to notify details of option holdings to the system operator (based on which monitoring can be conducted) Sellers of reliability options commit their availability at critical periods and forego revenue from price spikes in return for which they receive a stable revenue stream Contract duration can be determined by the parties Longer-term arrangements lock-in certainty for both sides If new capacity is required to meet a retailerrsquos requirement potential providers are likely to require a longer-term contract and the associated option fee in order to help support investment

The contracts are a hybrid between a call option (which is essentially commercial) and a physical commitment to make capacity available to the system at key times The call option introduces a financial settlement (aside from the physical commitment and penalty arrangements) whereby the seller of the option returns the difference between the reference market price and the strike price if any to the buyer Customers benefit from security of supply to an agreed standard and their exposure to scarcity pricing is reduced in return for an up-front fee


Trading Delivery Settlement

TSO

Buye

rD

eman

d sid

e re

spon

se

is im

plic

ity in

clud

ed

Selle

rIn

c w

eath

er v

aria

ble

an

d cr

oss b

orde

r

Figure 46 The mechanics of decentralised reliability options

SettlementReceives peak energy rent when reference price gt strike price

SettlementPays peak energy rent when reference price gt strike price

ShortfallSurplus settlement

Trading and re-tradingBuys reliability options to meet actual demand at times of scarcity

Trading and re-tradingSells reliability options up to the chosen level of capacity (subject to characteristics of physical availability)

ForecastingMakes (non-binding) forecasts for capacity balance from several years ahead until close to deliveryCross-border capacity creditDetermines maximum cross-border capacity contributionPublish informationPublishes aggregate level of contracted and uncontracted capacity

NotificationNotify reliability options contracts

Call options

Availability declaration




ESC modelling using the Storage amp Flexibility Model (Energy Systems Catapult 2020e) illustrates that extreme events will need to be catered for (see Annex 1 ESC modelling evidence) In ESC modelling the lsquopeak seasonrsquo is modelled assumed to roughly correspond to a one-in-ten year event and is identified as a week where demand and interconnector prices are high and wind and solar resource are low This results in considerable generation and storage assets being built across multiple vectors just to cope with this period though this would be minimised through efficient market design Some assets risk being commercially unviable if operating only once every few years and therefore may need to be subsidised and in order not to distort the market would need to be part of an lsquoout-of-marketrsquo strategic reserve

Support in other jurisdictions for approaches with reduced centralisedGovernment roleThe BEIS 5-year review of the CM (BEIS 2019a) indicates intention to explore CRMs in other jurisdictions but only with respect to improving the current model This would be erroneous given developments in other jurisdictions where the serious flaws of centralised approaches are increasingly being recognised and fiercely critiqued It is highly recommended to explore international trends in countries with well-functioning organised power markets and with high ambition to achieve a power mix based on a high share of variable renewables requiring innovation in system flexibility

Strategic Reserves are commonly used to complement energy-only markets and are the preferred option in the EU as set down in the recently adopted EU Electricity Regulation (EU 2019943) If designed correctly in accordance with Article 22 of the Regulation this CRM model is regarded to be the least distortive of CRM models on price formation in wholesale electricity markets Strategic Reserves are used in Sweden Finland Lithuania and Germany59 Several EU countries do not have any CRM in place including the Netherlands Denmark Norway Estonia Switzerland and Austria The ERCOT market in the USA is regarded to be one of the best performing competitive power markets (both wholesale and retail) in the world and also has no CRM France has adopted a Decentralised Obligation approach while Centralised Reliability Options are in place in Ireland and Italy

Given that the different approaches can impact wholesale prices careful consideration should be given to cross-border trading and how non-harmonisation of CRM design with interconnected neighbours might impact GB consumers Cross-border trading in the absence of network constraints will cause prices between interconnected countries to converge Out-of-market compensation such as through the CM can potentially be costly for consumers in the country hosting the intervention This is because the intervention can have a downward impact on short-term wholesale prices but the consumers of the host country might not benefit from this as cross-border trading could cause the prices to rise if prices are higher in neighbouring countries Consumers in neighbouring countries would benefit if their prices are higher due to no intervention (out-of-market compensation) Meanwhile consumers in the host country must pay for the intervention through levies on their retail bills

Role of System Operator would be a lsquoreserve functionrsquo in our decentralised proposalsTo provide a complementary backstop for the decentralised mechanism Strategic Reserves would be used by the SO to fulfil a lsquoreserve functionrsquo role Like a targeted tender the Strategic Reserve approach also seeks to secure a defined quantity of capacity However unlike the targeted tender route

strategic reserve is not typically intended to deliver new capacity but rather focuses on contracting existing generation capacity and

the contracted capacity is intended to be ring-fenced from the wholesale market to be held for use by the system operator in extreme circumstances so preventing the distortion of price formation in the market (ie only activated if market predicted not to clear)

It is extremely important that the strategic reserve capacity will only be used in exceptional circumstances to avert extreme security of supply issues that the market is unable to resolve Rules setting out conditions in which strategic reserve can be called upon must therefore set sufficiently high a threshold and discretion for its use must be limited as specified in the EU Electricity Regulation58 In order to avoid distorting price formation in the wholesale market strategic reserve utilisation should be priced close to or at the value of lost load and the resources should not be able to participate in the wholesale market Such design would avoid the lsquoslippery slopersquo problem often referred to by critics (Lockwood et al 2019)

The BEIS 5-year review document states ldquoA strategic reserve had several downsides compared to a CM It applies less downward pressure on wholesale priceshelliprdquo (BEIS 2019a p26) In a market with well-designed Strategic Reserves prices are free-forming and may be more volatile and have higher peak prices compared to a market with a CM which provides energy arbitrage opportunities for flexibility providers that in turn reduce price volatility until an equilibrium is reached This should drive greater system efficiency which in turn should have a downward impact on average wholesale prices This is a positive feature of the Strategic Reserves model

The resource available to the Reserves Operator(s) within a lsquoStrategic Reserversquo could include from the retailerrsquos resource portfolio

ability to trigger automatic response from appliances in the event of extreme system frequencies or

ability to exercise interruption contracts or trigger intertrips to allow for automatic disconnection for defined system users in agreed circumstances

59 See httpsfsreuieunew-publication-the-clean-energy-package-and-capacity-remuneration-mechanisms58 See Article 22 of the EU Electricity Regulation 2019943




Consumer-focused decentralised approaches are also being promoted by experts in other parts of the world For example Gramlich and Hogan (Gramlich amp Hogan 2019) argue that spot markets combined with decentralised forward procurement provides the best-performing framework for integrating variable renewablesDER reliably and at least cost when evaluated against criteria that include rapid decarbonisation short-run and long-run efficiency short-run and long-term reliability and efficient financing of investment Billimoria and Poudineh (Billinoria amp Poudineh 2019) have developed an insurer-of-last-resort model that works as a risk overlay on existing energy-only design It unbundles energy and reliability and incorporates insurance-based risk management concepts to align incentives for centralized decisions and allows revealed consumer preferences to guide new capacity deployment

In the US where centralised capacity market models similar to the model used by the UK are well established mdash for example in Pennsylvania-Jersey-Maryland (PJM) and New England Independent System Operator (ISO-NE) mdash there exists considerable criticism and evidence in support of more decentralised approaches to reliability In a submission to the state of New York Public Service Commission several organisations set out an in-depth critique of the centralised approach being pursued by the New York ISO (Natural Resources Defence Council et al 2020) The submission points to comments by numerous parties that conclude that the New York ISOrsquos current market design and approach to resource adequacy is untenable given the environmental and social objectives of the Climate Leadership and Community Protection Act with the current approach over-procuring capacity and sidelining clean and distributed energy resources The submission points to evidence in other organised power markets mdash California ISO Southwest Power Pool Midcontinent ISO mdash where more decentralised approaches have been adopted enabling more cost-effective reliability involving greater use of DER including DR and storage with ISOs taking a reduced role

Further information about the different CRM schemes mentioned above can be found in ESCrsquos ldquoBroad model for a capacity remuneration mechanismrdquo publication (Energy Systems Catapult 2019a)

Australiarsquos National Electricity Market (NEM) recently adopted a decentralised approach The NEM is a well-functioning organised power market with one of the highest bid caps intheworldat$14700MWh(asympUSD$10000)in201920ThishighbidcapplustheRetailerReliability Obligation (RRO) (adopted in July 2019) are the key elements of the resource adequacy mechanisms in Australia There is no direct lsquomarketrsquo for capacity as in the UK however the RRO has the ability to trigger both forward contract quantity requirements for retailers and ultimately the building of additional capacity when retail forward contracts are deemed insufficient to cover the market operatorrsquos reliability forecast If a reliability gap is identified by the Australian Energy Market Operator (AEMO) it will apply to the regulator to trigger the RRO by making a reliability instrument60

Where a reliability instrument is made liable entities are on notice to enter into sufficient qualifying contracts to cover their share of a one-in-two year peak demand A Market Liquidity Obligation placed on Generators will ensure there are contracts available to smaller market customers by requiring certain generators in each region to make contracts available to the market AEMO will also run a Voluntary Book Build mechanism to help liable entities secure contracts with new resources

If the market response is insufficient and the Australia Energy Regulator (AER) confirms a reliability gap one year out liable entities must report their contract positions for the reliability gap period to the AER If actual system peak demand exceeds an expected one-in-two year peak demand the AER will assess the compliance of liable entities and determine whether their share of load for the reliability gap period was covered by qualifying contracts

AEMO may commence procurement of emergency reserves at this point through the Reliability and Emergency Reserve Trader framework to address the remaining gap with costs to be recovered through the Procurer of Last Resort cost recovery mechanism

Entities whose required share of load is not covered by qualifying contracts for the specified period will be required to pay a portion of the costs for the Procurer of Last Resort up to an individual maximum of $100 million

60 See httpswwwaergovauretail-marketsretailer-reliability-obligation


Annex 9 The impact of the Renewable Obligation and Contracts for Difference schemes on bidding behaviour and marketscontinuedAnnex 9

The impact of the Renewable Obligation and Contracts for Difference schemes onbidding behaviour and markets

A significant difference between the CfD and RO schemes is the extent to which they expose the technologies to market signals Eventually the technologies need to be able to participate in markets without support

While CfDs have been more successful than the RO scheme in driving down the costs of technologies and securing investor confidence they have failed to prepare the technologies for exposure to markets The CfD scheme shields renewable generators from market prices and so fails to incentivise investments that target system integration either through design choices or complementary investments Consequently system costs have increased significantly year on year

CfD-supported generators receive subsidies so long as the sum of the negative market reference price and strike price is positive so generators are encouraged to produce even when prices are negative (up to a maximum of 6 hours) The Renewable Obligation (RO) also incentivises negative bidding behaviour though not as much compared to CfDs This issue has been addressed through recently adopted EU law (Official Journal of the European Union 2018) and the UK is proposing to cease making CfD payments when prices are negative (BEIS 2020b)

As the subsidies provided according to the CfD design top up revenues to a strike price and do not allow generators to keep the upside (in contrast to the RO scheme) generators are not encouraged to develop bidding and risk mitigation strategies to maximise revenues including response to market signals that indicate system integration needs

When incentivised as under the RO scheme generators are able to beat market

expectations and pursue multiple routes to market Under the CfD scheme generators are only incentivised to sell their output in the day-ahead market which is the basis for setting the Intermittent Market Reference Price (IMRP) generators aim to achieve a capture price as close as possible to IMRP in order that they can achieve their strike price The only risk generators face is some price risk as the capture price may differ from the IMRP Under the RO scheme the revenue was fixed at a certain level and so generators were motivated to beat this level as they could keep the resulting profit this motivated generators to pursue multiple routes to market through the forward markets of different timeframes as illustrated in Figure 47

Various renewable and low carbon technologies are now competitive and well-established and so a strategy and reforms are needed to gradually expose these technologies to the markets As an interim and immediate measure the CfD scheme could be reformed for competitivemature technologies and BEIS currently considers several options which are set out in its Call for Evidence on Enabling a High Renewable Net Zero Electricity System

moving the reference price used for intermittent generators from the day-ahead hourly market to a more forward market such as the seasonal market price used for baseload plant

moving from paying based on physical output to paying on deemed generation thus reducing the incentive to export power to the grid in order to receive payments and presenting incentive to exploit other market opportunities

capping the amount of subsidy provided at times of low prices

reducing contract length from 15 years moving to a price floor where generators

would retain the upside of high prices but be protected against low prices

These options should be assessed in relation to the costs and benefits for consumers from a whole systems perspective with scrutiny of impact on incentives for different market participants wholesale energy prices competition forward and futures markets Ideally the selected options should remove or minimise the generators incentive to dispatch below SRMC and incentivise generators to respond to market signals and pursue various

routes to market in order to maximise revenues The Government should also consider the speed with which changes can be phased in and implemented as the need to address market distortions and price cannibalisation is urgent

The Government could also consider voluntary (opt-in) renegotiation of existing contracts to achieve win-win outcomes for Governmentconsumers and industry Experience in other jurisdictions shows this can be successfully managed and achieved in a way that avoids retrospective removal of policy support compatible with contract law and investmenttrade treaties (eg Energy Charter Treaty)

Source Cornwall Insight 2018b

Ener

gy re

venu

e mdash

poundM

Wh

200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150

Power Price mdash poundMWh

200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150


Contracts for difference Renewables to obligation

Profit Loss

Power revenue CFD revenue

Profit Loss

Power revenue RO revenue

Figure 47 Comparison of RO and CfD schemes ndash revenues and routes to market

Generator Off-taker Market

CfD project reference price at IMRP index Hedge to IMRP index N2EX day-ahead auction

RO project long-term fixed price or index linked PPA

Fine tune balancing

Adjust hedge to forecast granular shaping

Uncertain output hedge to PSO

Intraday

Prompt day-ahead auction

Forward markets years seasons

Routes to market CfD RO


Annex 10 ESCrsquos Energy Data Taskforce recommendations and interoperability analysiscontinuedAnnex 10

ESCrsquos Energy Data Taskforce recommendations and interoperability analysis

Digitalisation and DataLast year the Energy Data Taskforce (EDTF) mdash commissioned by Government Ofgem and Innovate UK chaired by Laura Sandys and run by ESC mdash delivered a strategy aimed at modernising the UK energy system and driving it to a Net Zero carbon future through an integrated data and digital strategy for the sector (Energy Systems Catapult 2019b) Central to the strategy is the goal to deliver better outcomes for consumers via superior utilisation of assets greater price discovery and opportunity to attract new productive assets to the system The strategy is centred around two key principles mdash filling in the data gaps through requiring new and better-quality data and maximising its value by embedding the presumption that data is open

The strategy is based on a staged approach given the existence of interdependencies and as some actions build on others

1 Data Visibility Understanding the data that exists the data that is missing which datasets are important and making it easier to access and understand data

2 Infrastructure and Asset Visibility Revealing system assets and infrastructure where they are located and their capabilities to inform system planning and management

3 Operational Optimisation Enabling operational data to be layered across the assets to support system optimisation and facilitating multiple actors to participate at all levels across the system

4 Open Markets Achieving much better price discovery through unlocking new markets informed by time location and service value data

5 Agile Regulation (cross-cutting 1 to 4 above) Enabling regulators to adopt a much more agile and risk reflective approach to regulation of the sector by giving them access to more and better data

In addition the EDTF strategy sets out five key recommendations

Recommendation 1 Digitalisation of the Energy System mdash Government and Ofgem should direct the sector to adopt the principle of Digitalisation of the Energy System in the consumersrsquo interest using their range of existing legislative and regulatory measures as appropriate in line with the supporting principles of lsquoNew Data Needsrsquo lsquoContinuous Improvementrsquo and lsquoDigitalisation Strategiesrsquo

Recommendation 2 Maximising the Value of Data mdash Government and Ofgem should direct the sector to adopt the principle that Energy System Data should be Presumed Open using their range of existing legislative and regulatory measures as appropriate supported by requirements that data is lsquoDiscoverable Searchable Understandablersquo with common lsquoStructures Interfaces and Standardsrsquo and is lsquoSecure and Resilientrsquo

Recommendation 3 Visibility of Data ndash A Data Catalogue should be established to provide visibility through standardised metadata of Energy System Datasets across Government the regulator and industry Government and Ofgem should mandate industry participation though regulatory and policy frameworks

Recommendation 4 Coordination of Asset Registration mdash An Asset Registration Strategy should be established to coordinate registration of energy assets simplifying the experience for consumers through a user-friendly interface in order to increase registration compliance improve the reliability of data and improve the efficiency of data collection

Recommendation 5 Visibility of Infrastructure and Assets mdash A unified Digital System Map of the Energy System should be established to increase visibility of the Energy System infrastructure and assets enable optimisation of investment and inform the creation of new markets

InteroperabilityInteroperability is the ability of a product or system to cooperate with other products or systems to share resources Broad interpretation of interoperability and a good understanding of its wider implications will be essential if the energy system and consumers of energy are to benefit from the potential of digitisation

ESC has identified six areas of interoperability

1 Consumer Interoperability ensuring that provisions exist for consumers to switch between both different commercial offers and technology choices

2 Commercial Interoperability to ensure that incentives are aligned across the energy system to ensure that value can flow where it needs to driven by market forces

3 Data Interoperability to ease the sharing and portability of data between different systems 4 Device Interoperability to ensure that devices are swappable replaceable and

exchangeable as needs change and technologies develop and to allow consumers to make informed choices between open and closed eco-systems

5 Physical Interoperability to ensure that equipment and devices operate in a co-ordinated and compatible manner with other system equipment and devices

6 Vector Interoperability to ensure that energy provision across gas electricity heat transport fuels etc are compatible with one-another and that coordination occurs in a timely fashion

ESC has analysed the types of interoperability which must be considered to deliver demand-side flexibility and as part of this analysis conducted a case-study involving provision of flexibility using smart hybrid heat pumps (HHPs) (Energy Systems Catapult 2018b) The analysis provides evidence of the benefits of taking a systematic approach involving consideration of multiple forms of interoperability simultaneously The approach has also been applied to electric vehicles


Annex 11 ESODSO coordination continuedAnnex 11

ESODSO coordinationIt is well recognised that the role of Distributed System Operators (DSOs) and their coordination with NGESO will be pivotal to the efficient effective use of energy resources to support the system Drawing on the potential future worlds characterised by the ENArsquos Open Networks project the ESC published a study (Poumlyry amp Energy Systems Catapult 2019) that estimates the value that DSOs can deliver to Great Britain plc compared to the existing arrangements

A phased approach to more sophisticated architecture and coordination is desirable as there is a risk of stranded costs and programme failure if major institutional and commercial platform changes are introduced too quickly That said there is a risk of missing out on substantial cost savings if not prepared The scenarios used for the study are set out in Table 14 (including explanation of slight differences compared to the ENA lsquoFuture Worldsrsquo) The study concluded that moving immediately to the lsquoESO coordinatesrsquo framework is a no-regrets option with NGESO leading system optimisation working alongside the DSO to ensure a balanced approach towards meeting national and local requirements Many of the systems required for the DSO to take an active role in market facilitation can be developed under this framework ENA is progressing in this direction with implementation of its DSO Implementation Plan (Energy Networks Association 2020a) for eight DSO functions including DSO coordination network operation investment planning connections and connection rights system defence and market facilitation service optimisation and charging While ENA is making good progress BEIS could take a more proactive role to help accelerate progress

Moving towards the more sophisticated frameworks should depend on the speed of electrification and scale of flexibility services being offered to the market As pointed mentioned earlier the scale of flexibility on the demand-side needs to be dramatically accelerated This analysis of frameworks was based on National Gridrsquos Future Energy Scenarios (FES) two degrees scenario with significant load growth underway from 2030 and with the need for the more sophisticated options starting then Since then however FES has been updated (National Grid ESO 2020a) to reflect Net Zero and associated increased ambition it is clear that major efforts are needed to accelerate electrification of heat and transport

The cost savings for each scenario are shown in Figure 48 below Network cost savings are the same under Perfect Information and DSO-driven scenarios but the DSO-driven scenario has relatively higher costs for generation opexcapex This is due to the need for a) more generation capacity at the national peak given the prioritisation of local peak for vehicle-to-grid (V2G) and DSR as well as b) higher generation costs due to prioritisation of local balancing means flex services are almost unavailable for the national peak leading to a higher need for additional peaking plants (see Figure 48)

Our qualitative assessment of the frameworks reveals that the more sophisticated frameworks of DSO-driven and Perfect Information score much more highly for enabling innovation and driving improved efficiencies though there is a trade-off with respect to the regulatory and institutional change needed and implementation challenge which is greatest for Perfect Information

Progress in mobilising DSR has not kept pace with the growth in variable renewable energy The decarbonisation of power generation is far ahead of decarbonisation of energy demand Given the time pressure to achieve Net Zero growth in renewables should not be held back rather the decarbonisation of energy demand must be accelerated and system flexibility particularly on the demand-side needs to dramatically improve to unlock cost reductions and other benefits

Table 14 Summary of differences between ESCPoumlyry frameworks and ENA worlds

ENA world ESCPoumlyry framework Difference between ENA worlds and ESCPoumlyry frameworks

ESO coordinates World D

Current position The ENA assumes that in the short term the DSO is able to manage its network efficiently based on asset solutions but in the long term NGESO coordinates all flexibility services to LV In our Framework we assume relationships continue as now so the division of roles on the distribution and transmission network remain the same

Price-driven flexibilityWorld C

Sharpened incentives The ENA assumes price signals work optimally following the changes made as a result of the Ofgem SCR We assume the charging arrangements are an improvement from Current Position but still lead to a sub-optimal outcome

Joint procurement World B

ESO coordinates The ENA assumes the DSO needs are prioritised with residual flexibility offered to the ESO In our Framework the ESOrsquos needs are prioritised with residual flexibility offered to the DSO

DSO coordinatesWorld A

DSO driven The ENA assessment assumes the DSO does not have balancing responsibility Our Framework assume a key role for the DSO in balancing and procuring activating flexibility mdash with left over resources passed to the ESO

Flexibility coordinators World E

Perfect information We assume a single market for flexibility resources which can be accessed (with perfect information) by a single coordinator Sharpened

incentivesTSO

CoordinatesDSO

drivenPerfect

information

Energy costs Balancing costs poundm Energy costs Generation costs poundm Generation costs CapexOpex poundm Network system costs Tx poundm Network system costs Dx poundm

12

10

8

6

4

2

0

-2

-4

-62050

cum

ulat

ive d

iscou

nted

savin

gs c

ompa

red

to C

urre

nt P

ositi

on (

poundbn)

Figure 48 Cumulative discounted cost savings compared to the lsquocurrent positionrsquo framework to 2050

Source Poyry amp Energy Systems Catapult 2019


Annex 12 Electric Vehicle Energy Taskforce recommendations

Theme 1 Delivering consumer benefits through interoperability

Enabling the electric vehicle transition mdash detailed proposal timings

Innovation Implementation Impact

Theme 3 Utilising and protecting data for better consumer outcomes

Theme 4 Winning consumers trust and confidence

Theme 5 Developing and maintaining the charging infrastructure consumers need

2020 2025 2030

Proposal 11 Access data

Proposal 12 Chargepoint registration

Proposal 13 Access and privacy framework

Proposal 1 Review of international standards

Proposal 2 CPO System Security

Proposal 3 Roaming

Proposal 4 Smart charging coordination

Proposal 5 Minimun technical requirements of chargepoints

Proposal 6 Emergency charge limitation

Proposal 7 Electric vehicle supply equipment (EVSE) labelling

Proposal 14 Body of consumer facing communications

Proposal 15 Independent tailored advise service

Proposal 16 Complaint handling

Proposal 17 Market protections

Proposal 18 Point of sale information

Proposal 8 Developing accessible flexibility markets

Proposal 9 Smart meters

Proposal 10 Default smart charging

Proposal 19 Forward planning and maintenance of EV charging

Proposal 20 Effective operation amp maintenance mdash Govt support amp sharing best practice

Proposal 21 Electricity network infrastructure investment

Theme 2 Rewarding consumers for charging smartly

Annex 13 Systems Engineering and Enabling Frameworks for more balanced stakeholder engagement in a whole systems approach

What is a systems engineering approach Systems engineering is a structured multidisciplinary approach to problem-solving that transforms a set of needs into a practical plan for implementation and a solution that satisfies a range of stakeholders It is about solving the right problem in the right way

It is deployed to address complex and often technologically challenging problems It takes a lsquowhole systemrsquo approach where physical factors (infrastructure novel

technologies) are considered at the same time as economic behavioural and social issues It is a discovery process that allows participants to consider the interactions trade-offs and

synergies between different parts of the system using quantitative and qualitative tools methods and skills If implemented well it can lower costs and speed up implementation

It provides a structured process for engaging stakeholders and for capturing their expertise

Systems engineering comprises principles and processes supported by a variety of tools The processes address

How to identify capture and describe needs and requirements How to define the scope of the lsquosystem of systemsrsquo and the interactions

between the systems which comprise it How to identify and engage the right stakeholders How to understand the functions that are being performed by the systems Given an intent to make a change what are the options for doing so How to evaluate the options and understand the trade-offs between them How to establish criteria for decision-making as well as organisational

and governance arrangement How to manage delivery of systems from organisation and governance perspectives How to assess and validate the impacts of interventions made in the system How to capture learning from the system and apply it to the understanding

of needs and determining possible future changes

What are the advantages of taking a systems engineering approach to achieve Net Zero Techno-economic modelling and other analysis techniques support decision-making by building the best evidence possible from data that is available but it is largely restricted to building understanding of the ldquoknown knownsrdquo This is essential to understand what we could do However given that these decisions are taken with ldquobounded rationalityrdquo we may exclude information that is important because we are not aware that it exists that it is relevant or how it relates to the problem we are trying to solve


Source (Energy Systems Catapult and The Institution of Engineering and Technology 2017 Energy Systems Catapult and The Institution of Engineering and Technology 2018)

Systems engineering approaches add insight in to how we could address a particular problem by allowing us to gain insight into the wider considerations interactions and implications associated with that problem in this way we reduce we reduce the restrictions of ldquobounded rationalityrdquo Such approaches

Can reveal the ldquounknown unknownsrdquo arising from interactions that might not be obvious visible or well understood (the impacts of human behaviour in the context of new technologies for example)

Accommodate that a decision is in many situations more likely to be a sequence of decisions being made in multiple areas (technology policy regulation consumer matters etc) across time

Provide feedback loops to collect evidence as progress is made in an environment where change is fast paced so that corrective interventions can be taken more effectively or change accelerated with less risk

The systems approach is intended to support achievement of the following outcomes

Create a lsquoliversquo repository for institutional memory and wider stakeholder knowledge to enable an adaptive approach and allow easy sharing of information

Navigate complexity and uncertainties by creating a framework to test and learn about interactions between systems identify viable options for change reveal gaps and update knowledge

Systematically incorporate the whole system social cultural and behavioural factors as well as technology markets policy and how they influence each other

Allow the building of a credible viable and adaptive rsquoliving roadmaprsquo with clear imelines sequencing and dependencies

Help ensure parts of the system remain fully functioning during transition to a potentially significantly different world so that outcomes not only work in 2050 but across different pathways on the way to 2050

Understand key blockers and enablers to promote desired behavioural and societal changes by cross-sectoral policyregulatorytaxationinvestmentcommunications interventions

Better target the use of techno-economic modelling forecasting simulation tools tests trials demonstrations etc to help transform ldquounknown unknownsrdquo to ldquoknown unknownsrdquo to ldquoknown knownsrdquo

Provide a framework for using external expertise more usefully (including interdisciplinary expertise outside the lsquousual suspectsrsquo) The process helps identify key stakeholders and engage them in an effective way to achieve balance between inclusivity and required pace

Systems approaches do not replace existing approaches Systems engineering can enhance existing approaches by mitigating the risk that the wrong problem is identified in the first place or the risk that the root cause(s) of the problem are not fully identified or understood

Annex 13 Systems Engineering and Enabling Frameworks for more balanced stakeholder engagement in a whole systems approachcontinued


Systems engineering approach to code governance through lsquoenabling frameworksrsquoThe design of the Enabling Frameworks process illustrated in Figure 49 is based on the following concepts

ldquoEmergent architecturerdquo is an approach that is not based on traditional lsquoroadmaprsquo A to B pre-planned and fixed outcomes It allows for the continuous development implementation and integration into the overall whole system architecture thereby ensuring evolving and disruptive technology can be readily assimilated and integrated into the developing architecture without the need for redesign andor central planning

ldquoPrinciple-based governancerdquo is defined by the Financial Services Authority (FSA) as ldquoprinciples and outcome-focused rules rather than detailed rules prescribing how outcomes must be achievedrdquo it is a significant cultural shift for the regulatory industry but one gaining traction from the Better Regulation Executive (BRE) within BEIS

Enabling Frameworks offers significant benefits compared with todayrsquos change and governance approach

A Whole System approach extending into homes and businesses and including the power networks and systems

Co-ordination and engagement with the whole range of relevant stakeholders Applies agile techniques facilitated by digital tools and techniques to deliver change

solutions more quickly and support iteration to an optimised outcome Overcomes barriers including silos between power sector bodies and disconnects

between power sector standards and wider industrial and digital standards bodies and The process is supported by a dedicated Enablement Organisation

Figure 49 Enabling Frameworks for improved energy sector governance framework to 2050

Change development

Decision Implementation

3 Preparatory work

Research and data collection

Stakeholdergroup formed

Strategic inputand resource

Facilitate access for all

Collaboration support

Whole system coordination

5

Enablement organisation facilitating change

Forward-looking capabilities Knowledge continuity

2 User needs identified

1 Interested stakeholders drive the changes

4 Enabling framework


Energy Systems Catapult (ESC) Limited Licence for (Report Name)ESC is making this report available under the following conditions This is intended to make the Information contained in this report available on a similar basis as under the Open Government Licence but it is not Crown Copyright it is owned by ESC Under such licence ESC is able to make the Information available under the terms of this licence You are encouraged to Use and re-Use the Information that is available under this ESC licence freely and flexibly with only a few conditions

Using information under this ESC licenceUse by You of the Information indicates your acceptance of the terms and conditions below ESC grants You a licence to Use the Information subject to the conditions below

You are free to copy publish distribute and transmit

the Information adapt the Information exploit the Information commercially and

non-commercially for example by combining it with other information or by including it in your own product or application

You must where You do any of the above acknowledge the source of the Information

by including the following acknowledgement ldquoInformation taken from (Report Name)

by Energy Systems Catapultrdquo provide a copy of or a link to this licence state that the Information contains copyright

information licensed under this ESC Licence acquire and maintain all necessary licences from

any third party needed to Use the Information

These are important conditions of this licence and if You fail to comply with them the rights granted to you under this licence or any similar licence granted by ESC will end automatically

Exemptions This licence only covers the Information and does not cover

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Non-endorsement This licence does not grant You any right to Use the Information in a way that suggests any official status or that ESC endorses You or your Use of the Information

Non-warranty and liability The Information is made available for use without charge In downloading the Information you accept the basis on which ESC makes it available The Information is licensed lsquoas isrsquo and ESC excludes all representations warranties obligations and liabilities in relation to the Information to the maximum extent permitted by law

ESC is not liable for any errors or omissions in the Information and shall not be liable for any loss injury or damage of any kind caused by its Use This exclusion of liability includes but is not limited to any direct indirect special incidental consequential punitive or exemplary damages in each case such as loss of revenue data anticipated profits and lost business ESC does not guarantee the continued supply of the Information

Governing law This licence and any dispute or claim arising out of or in connection with it (including any noncontractual claims or disputes) shall be governed by and construed in accordance with the laws of England and Wales and the parties irrevocably submit to the non-exclusive jurisdiction of the English courts

Definitions In this licence the terms below have the following meanings lsquoInformationrsquo means information protected by copyright or by database right (for example literary and artistic works content data and source code) offered for Use under the terms of this licence lsquoESCrsquo means Energy Systems Catapult Limited a company incorporated and registered in England and Wales with company number 8705784 whose registered office is at Cannon House 7th Floor The Priory Queensway Birmingham B4 6BS lsquoUsersquo means doing any act which is restricted by copyright or database right whether in the original medium or in any other medium and includes without limitation distributing copying adapting modifying as may be technically necessary to use it in a different mode or format lsquoYoursquo means the natural or legal person or body of persons corporate or incorporate acquiring rights under this licence

LicenceDisclaimer

Rethinking Electricity Markets 198

Please get in touch with any queries atsarahkeay-brightescatapultorguk

copy 2021 Energy Systems Catapult Published March 2021

This document has been prepared by Energy Systems Catapult Limited For full copyright legal information and defined terms please refer to the ldquoLicence Disclaimerrdquo section at the back of this document

All information is given in good faith based upon the latest information available to Energy Systems Catapult Limited No warranty or representation is given concerning such information which must not be taken as establishing any contractual or other commitment binding upon the Energy Systems Catapult Limited or any of its subsidiary or associated companies

This report was written by Sarah Keay-Bright and George Day Contributions from ESC staff Guy Newey Amir Alikhanzadeh Phil Lawton Daniel Mee Eric Brown Richard Dobson Matt Lipson Vilislava Ivanova Susie Elks Tim Chapelle and Danial Sturge

We would like to thank the experts that provided feedback throughout developing this report Providing feedback does not imply endorsement and the content of the report remains solely that of Energy Systems Catapult

BEIS Ofgem LCCC Gareth Davies and Simon Bradbury AFRY Mike Hogan The Regulatory Assistance Project Phil Baker The Regulatory Assistance Project Paul Troughton ENEL X Nick Eyre University of Oxford Thomas Pownall University of Exeter Laura Sandys Challenging Ideas William Blyth Oxford Energy Kirsty Hamilton Chatham House Alifa Starlika and Joseph Underwood Energy-UK Alastair Martin Flexitricity David Sykes and Clementine Cowton Octopus Energy William Steggals SSE Marzia Zafar Kaluza Caroline Bragg ADE Simon Skillings E3G Jeff Hardy Imperial College London Tom Pakenham Ovo Energy John Twomey National Grid ESO

About Energy Systems CatapultEnergy Systems Catapult was set up to accelerate the transformation of the UKrsquos energy system and ensure UK businesses and consumers capture the opportunities of clean growth The Catapult is an independent not-for-profit centre of excellence that bridges the gap between industry government academia and research We take a whole systems view of the energy sector helping us to identify and address innovation priorities and market barriers in order to decarbonise the energy system at the lowest cost We have more than 200 staff based in Birmingham and Derby with a variety of technical commercial and policy backgrounds We work with innovators from companies of all sizes to develop test and scale their ideas We also collaborate with industry academia and government to overcome the systemic barriers of the current energy market to help unleash the potential of new products services and value chains required to achieve the UKrsquos clean growth ambitions as set out in the Industrial Strategy

Rethinking Electricity MarketsRethinking Electricity Markets is an Energy Systems Catapult initiative to develop proposals to reform electricity markets so that they best enable innovative efficient whole energy system decarbonisation

As part of the project we worked alongside AFRY to

identify and characterise key sources of value within electricity markets and how they are reflected in current GB arrangements

review approaches taken in other jurisdictions and identify the main strategic choices for GB electricity policy for improving market signals across time and space

consider how to strengthen the evidence base to inform decision-making about improving the coherence of the existing UK market framework

Building on the insights from our Rethinking Electricity Markets initiative this report also pulls together relevant evidence from across Energy Systems Catapultrsquos various teams and capabilities including modelling power systems engineering system architecture and consumer insights Using this evidence base we have developed credible policy options for the power sector that will drive socially beneficial innovation This is the latest of a number of reports that we have published available on our website

Acknowledgements

Rethinking Electricity Markets 3Rethinking Electricity Markets 2







Executive summary


















































































































energy services































Enabling conditions











2021 2025 2030 2035








2

3 4

5 6










System integration

Consumer focus

Network investment

Policy governance






















Outcomes



Outcomes





EMR10+

EMR20













































Contentscontinued





































Acronyms


Glossary



































Glossary continued




























4 Policies









125

100

75

50

25

0Tera

wat

tndashho

urs (

TWh

qua

rter

)

Q1

1998

Q4

1998

Q3

1999

Q2

200

0

Q1

2001

Q4

200

1

Q3

200

2

Q2

200

3

Q1

2004

Q4

200

4

Q3

200

5

Q2

200

6

Q1

2007

Q4

200

7

Q3

200

8

Q2

200

7

Q1

2009

Q4

201

0

Q3

201

1

Q2

201

2

Q1

2013

Q4

201

3

Q3

201

4

Q2

201

5

Q1

2016

Q4

201

6

Q3

201

7

Q2

201

8

Q1

2019

Q4

201

9

Q1

2020

Coal Oil


Gas Nuclear




Source Ofgem 2020a

































































































Section summary











90

80

70

60

50

40

30

20

10

0

-10

-20



Telecoms and Media

Water

Energy

UKCSIScore


CustomerEethos

EmotionalConnection









Section summary











62Comfort focussed




17Value focussed




21Cost focussed

















Transmission

BSUoS

HDCAAAHEDC

Distribution

RO

FiTs

CfDs

Capacity Market

CERTCESPECO

WHD

9

8

7

6

5

4

3

2

1

0pkW

h







Cons

umer

s and

ow

ners

of t

heir

asse

ts


and control





Contracting

eg Warmth


eg Mobility




























Section summary



















































Section summary




















25gCO2kWh

100gCO2kWh
























Today Future




45

40

35

30

25

201819 201920 202021 202122 202223 202324 202425 202526 202627 202728 202829 202930 3031

poundM

Wh
















Inflexible demand


not reflected


(CFDs CM)

















Tndash0 T+29 days

T+14 months

Time



OptionsSwaps

PX trades


Bespoke bilaterals

Bala

ncin

g M

echa

nism

Imba

lanc

e se

ttlem

ent

Trad

ed p

erio

d

Financial markets

Fina

ncia

l se

ttlem

ent


































































































































market


markets





reduction


backstop


RSP



reflected

EMR10 EMR20

Market signals

Market signals


Investment driver

























Future changes






















Source BEIS 2020d












Source REA 2019


1 2 3 4 5 6 7 8 9

Net

herln

ds

Finl

and

Swed

en

Den

mar

k

Irela

nd

Nor

way

Ger

man

y

Gre

at B

ritia

n

Fran

ce


















significant ways






































1000+ price nodes















259 pricing nodes

Italy 6 price zones






























energy system

2Maximising the

value of data

3Visibility of data

Data catalogue

4Coordination


5Visibility of


Digital system map

Principles

Building blocks














































DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V Re

siden

tial O

ff St

reet

DSR

mdash E

V D

epot

Effic

ienc

y mdash

Dom

estic

(LED

s)

Offs

hore

Win

d

Sola

r (la

rge)

Effic

ienc

y mdash

Non

Dom

estic

Nuc

lear

Ons

hore

Win

d

Biom

ass C

CS

Li-I

on B

atte

ry T

2T3

CCG

T

Gas

CCS

Li-I

on B

atte

ry T

1

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash O

ther

Dom

estic

OCG

T

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V D

epot

DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash E

V Re

siden

tial O

ff St

reet

Effic

ienc

y mdash

Dom

estic

(LED

s)

Effic

ienc

y mdash

Non

Dom

estic

Offs

hore

Win

d

Sola

r (la

rge)

Ons

hore

Win

d

CCG

T

Gas

CCS

Nuc

lear

Biom

ass C

CS

Li-I

on B

atte

ry T

1

Li-I

on B

atte

ry T

2T3

DSR

mdash O

ther

Dom

estic

OCG

T

8000

7000

6000

5000

4000

3000

2000

1000

0Cum

ulat

ive d

iscou

nt sa

vings

(poundm

) co

mpa

red

to c

urre

nt p

ositi

on

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050















300

200

100

0

-100

-200

-300



Impa

ct o

n w

hole

syst

em c

osts

(poundM

Wh)

300

200

100

0

-100

-200

-300




































pound712pound12414




pound979pound15601












































































































Section summary















Section summary

















































Gas



Electricity


Cost reflective 19800 0063 01029 9016



















Section summary




























Actions Effects

Info Data analysis
























energy services



energy services










































Next 24 months

Ongoing











From 20234

Immediate














Immediate

Immediate

Immediate



















Next 24 months

In 2021 RIIO-ED2













Next 18 months

Implement by 2023

2022

2020s2021ndash25








System integration

Consumer focus

Network investment

Policy governance














Enabling conditions











2021 2025 2030 2035





















80 Bibliography



























































































































(Electricity)







2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

300

250

200

150

100

50

0GW


2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

180

160

140

120

100

80

60

40

20

0GW




















2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh










100

90

80

70

60

50

40

30

20

10

0Gen

erat

ion

load

fact

or (

)20

19

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

Nuclear (SMR)

CCGT

CCGT with CCS


OCGT

BECCS

Hydrogen








Oil OCGT


OCGT with CSS CCGT








OCGT with CSS CCGT



2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

250

200

150

100

50

0Capa

city

(GW

)

600

500

400

300

200

100

0Gen

erat

ion

(TW

h)

Carb

on In

tens

ity (g

KW

h)

Carb

on In

tens

ity (g

KW

h)


Base

Cas

e

Inve

st P

olic

y

Stre

ss R

ES

Fav

Nuc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

ss R

ES

200

150

100

50

0

Capacity Mix 2030

GW







Base_CaseBase Case














ME

Patc

ESM

E C

loc

Base

Cas

e

Barin

ga D

Stre

ss R

ES

Hig

h N

uc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

s

300

250

200

150

100

50

0

Capacity Mix 2050







GW














2020 2030 2040 2050

45

40

35

30

25pound bi

llion

2020 2030 2040 2050

90

85

80

75

70

65

60poundM

Wh


















35

30

25

20

15

10

5

0GW


2030 2050




































140

120

100

80

60

40

20

0

Mar

ket V

alue

(SM

Wh)

0 20 40 60 80 100


140

120

100

80

60

40

20

0

Elec

tricit

y Pr

ices (

SM

Wh)

0 10 20 30 40 50 60 70










2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)









2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)


Energy Capacity

$60

$50

$40

$30

$20

$10

$0Price

s (S

MW

h)

















P

P dr

0

Price

(poundM

Wh)

Quality (MW)



demand response)













Quantity (MW)

20000

10000

1500

P1 = 80Price

(euroM

Wh)

Average VoLL

Price cap


Capped supply curve


˜

˜

Quantity (MW)

20000

10000

P2 = 2000

0Price

(euroM

Wh)

Average VoLL





˜

˜

Quantity (MW)

20000

10000

P3 = 800

0Price

(euroM

Wh)

Average VoLL




˜

˜






































6371

6354

5251

4374

3121

2611

2218





22

6

0

2535

31

26

5830

46

46

1533

17

28




Investors







52

0

6

2035

23

26

6045

60

48

1518

17

20













600

550

500

450

400

350

300

250

200

150

100

50

0Carb

on p

rice

(eurot

CO2)

2012

2015

2020

2025

2030

2035

2040

2045

2050


Lower flexibility

Core AM case

Higher flexibility

CO2 price cap



7 9 1640

100

190

300

430

600

370

210

130

250

130

220180

130

250

310











Driver



















Im

pact




























Commodity

Mechanism







All

Balancing mechanism





Distribution losses


Transmission losses


Capacity

Mechanism




Capacity market



Partial



Capability

Mechanism












Carbon

Mechanism




























Mechanism




Generator TNUoS
















Super-red credits








Constraints payment



Co

nges

tion




25

20

15

10

5

0


poundbn

72 5 318 2









Current Future






(CO2 pricing)






Current Future


specific


specific




specific






































































































































































































TSO

Buye

rD

eman

d sid

e re

spon

se

is im

plic

ity in

clud

ed

Selle

rIn

c w

eath

er v

aria

ble

an

d cr

oss b

orde

r









Call options

















































Ener

gy re

venu

e mdash

poundM

Wh

200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150


200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150



Profit Loss


Profit Loss






Fine tune balancing



Intraday

















































incentivesTSO

CoordinatesDSO

drivenPerfect

information


12

10

8

6

4

2

0

-2

-4

-62050

cum

ulat

ive d

iscou

nted

savin

gs c

ompa

red

to C

urre

nt P

ositi

on (

poundbn)











2020 2025 2030






Proposal 3 Roaming
























































Change development


3 Preparatory work







5


























LicenceDisclaimer












Executive summary


















































































































energy services































Enabling conditions











2021 2025 2030 2035








2

3 4

5 6










System integration

Consumer focus

Network investment

Policy governance






















Outcomes



Outcomes





EMR10+

EMR20













































Contentscontinued





































Acronyms


Glossary



































Glossary continued




























4 Policies









125

100

75

50

25

0Tera

wat

tndashho

urs (

TWh

qua

rter

)

Q1

1998

Q4

1998

Q3

1999

Q2

200

0

Q1

2001

Q4

200

1

Q3

200

2

Q2

200

3

Q1

2004

Q4

200

4

Q3

200

5

Q2

200

6

Q1

2007

Q4

200

7

Q3

200

8

Q2

200

7

Q1

2009

Q4

201

0

Q3

201

1

Q2

201

2

Q1

2013

Q4

201

3

Q3

201

4

Q2

201

5

Q1

2016

Q4

201

6

Q3

201

7

Q2

201

8

Q1

2019

Q4

201

9

Q1

2020

Coal Oil


Gas Nuclear




Source Ofgem 2020a

































































































Section summary











90

80

70

60

50

40

30

20

10

0

-10

-20



Telecoms and Media

Water

Energy

UKCSIScore


CustomerEethos

EmotionalConnection









Section summary











62Comfort focussed




17Value focussed




21Cost focussed

















Transmission

BSUoS

HDCAAAHEDC

Distribution

RO

FiTs

CfDs

Capacity Market

CERTCESPECO

WHD

9

8

7

6

5

4

3

2

1

0pkW

h







Cons

umer

s and

ow

ners

of t

heir

asse

ts


and control





Contracting

eg Warmth


eg Mobility




























Section summary



















































Section summary




















25gCO2kWh

100gCO2kWh
























Today Future




45

40

35

30

25

201819 201920 202021 202122 202223 202324 202425 202526 202627 202728 202829 202930 3031

poundM

Wh
















Inflexible demand


not reflected


(CFDs CM)

















Tndash0 T+29 days

T+14 months

Time



OptionsSwaps

PX trades


Bespoke bilaterals

Bala

ncin

g M

echa

nism

Imba

lanc

e se

ttlem

ent

Trad

ed p

erio

d

Financial markets

Fina

ncia

l se

ttlem

ent


































































































































market


markets





reduction


backstop


RSP



reflected

EMR10 EMR20

Market signals

Market signals


Investment driver

























Future changes






















Source BEIS 2020d












Source REA 2019


1 2 3 4 5 6 7 8 9

Net

herln

ds

Finl

and

Swed

en

Den

mar

k

Irela

nd

Nor

way

Ger

man

y

Gre

at B

ritia

n

Fran

ce


















significant ways






































1000+ price nodes















259 pricing nodes

Italy 6 price zones






























energy system

2Maximising the

value of data

3Visibility of data

Data catalogue

4Coordination


5Visibility of


Digital system map

Principles

Building blocks














































DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V Re

siden

tial O

ff St

reet

DSR

mdash E

V D

epot

Effic

ienc

y mdash

Dom

estic

(LED

s)

Offs

hore

Win

d

Sola

r (la

rge)

Effic

ienc

y mdash

Non

Dom

estic

Nuc

lear

Ons

hore

Win

d

Biom

ass C

CS

Li-I

on B

atte

ry T

2T3

CCG

T

Gas

CCS

Li-I

on B

atte

ry T

1

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash O

ther

Dom

estic

OCG

T

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V D

epot

DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash E

V Re

siden

tial O

ff St

reet

Effic

ienc

y mdash

Dom

estic

(LED

s)

Effic

ienc

y mdash

Non

Dom

estic

Offs

hore

Win

d

Sola

r (la

rge)

Ons

hore

Win

d

CCG

T

Gas

CCS

Nuc

lear

Biom

ass C

CS

Li-I

on B

atte

ry T

1

Li-I

on B

atte

ry T

2T3

DSR

mdash O

ther

Dom

estic

OCG

T

8000

7000

6000

5000

4000

3000

2000

1000

0Cum

ulat

ive d

iscou

nt sa

vings

(poundm

) co

mpa

red

to c

urre

nt p

ositi

on

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050















300

200

100

0

-100

-200

-300



Impa

ct o

n w

hole

syst

em c

osts

(poundM

Wh)

300

200

100

0

-100

-200

-300




































pound712pound12414




pound979pound15601












































































































Section summary















Section summary

















































Gas



Electricity


Cost reflective 19800 0063 01029 9016



















Section summary




























Actions Effects

Info Data analysis
























energy services



energy services










































Next 24 months

Ongoing











From 20234

Immediate














Immediate

Immediate

Immediate



















Next 24 months

In 2021 RIIO-ED2













Next 18 months

Implement by 2023

2022

2020s2021ndash25








System integration

Consumer focus

Network investment

Policy governance














Enabling conditions











2021 2025 2030 2035





















80 Bibliography



























































































































(Electricity)







2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

300

250

200

150

100

50

0GW


2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

180

160

140

120

100

80

60

40

20

0GW




















2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh










100

90

80

70

60

50

40

30

20

10

0Gen

erat

ion

load

fact

or (

)20

19

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

Nuclear (SMR)

CCGT

CCGT with CCS


OCGT

BECCS

Hydrogen








Oil OCGT


OCGT with CSS CCGT








OCGT with CSS CCGT



2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

250

200

150

100

50

0Capa

city

(GW

)

600

500

400

300

200

100

0Gen

erat

ion

(TW

h)

Carb

on In

tens

ity (g

KW

h)

Carb

on In

tens

ity (g

KW

h)


Base

Cas

e

Inve

st P

olic

y

Stre

ss R

ES

Fav

Nuc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

ss R

ES

200

150

100

50

0

Capacity Mix 2030

GW







Base_CaseBase Case














ME

Patc

ESM

E C

loc

Base

Cas

e

Barin

ga D

Stre

ss R

ES

Hig

h N

uc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

s

300

250

200

150

100

50

0

Capacity Mix 2050







GW














2020 2030 2040 2050

45

40

35

30

25pound bi

llion

2020 2030 2040 2050

90

85

80

75

70

65

60poundM

Wh


















35

30

25

20

15

10

5

0GW


2030 2050




































140

120

100

80

60

40

20

0

Mar

ket V

alue

(SM

Wh)

0 20 40 60 80 100


140

120

100

80

60

40

20

0

Elec

tricit

y Pr

ices (

SM

Wh)

0 10 20 30 40 50 60 70










2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)









2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)


Energy Capacity

$60

$50

$40

$30

$20

$10

$0Price

s (S

MW

h)

















P

P dr

0

Price

(poundM

Wh)

Quality (MW)



demand response)













Quantity (MW)

20000

10000

1500

P1 = 80Price

(euroM

Wh)

Average VoLL

Price cap


Capped supply curve


˜

˜

Quantity (MW)

20000

10000

P2 = 2000

0Price

(euroM

Wh)

Average VoLL





˜

˜

Quantity (MW)

20000

10000

P3 = 800

0Price

(euroM

Wh)

Average VoLL




˜

˜






































6371

6354

5251

4374

3121

2611

2218





22

6

0

2535

31

26

5830

46

46

1533

17

28




Investors







52

0

6

2035

23

26

6045

60

48

1518

17

20













600

550

500

450

400

350

300

250

200

150

100

50

0Carb

on p

rice

(eurot

CO2)

2012

2015

2020

2025

2030

2035

2040

2045

2050


Lower flexibility

Core AM case

Higher flexibility

CO2 price cap



7 9 1640

100

190

300

430

600

370

210

130

250

130

220180

130

250

310











Driver



















Im

pact




























Commodity

Mechanism







All

Balancing mechanism





Distribution losses


Transmission losses


Capacity

Mechanism




Capacity market



Partial



Capability

Mechanism












Carbon

Mechanism




























Mechanism




Generator TNUoS
















Super-red credits








Constraints payment



Co

nges

tion




25

20

15

10

5

0


poundbn

72 5 318 2









Current Future






(CO2 pricing)






Current Future


specific


specific




specific






































































































































































































TSO

Buye

rD

eman

d sid

e re

spon

se

is im

plic

ity in

clud

ed

Selle

rIn

c w

eath

er v

aria

ble

an

d cr

oss b

orde

r









Call options

















































Ener

gy re

venu

e mdash

poundM

Wh

200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150


200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150



Profit Loss


Profit Loss






Fine tune balancing



Intraday

















































incentivesTSO

CoordinatesDSO

drivenPerfect

information


12

10

8

6

4

2

0

-2

-4

-62050

cum

ulat

ive d

iscou

nted

savin

gs c

ompa

red

to C

urre

nt P

ositi

on (

poundbn)











2020 2025 2030






Proposal 3 Roaming
























































Change development


3 Preparatory work







5


























LicenceDisclaimer
























































































energy services































Enabling conditions











2021 2025 2030 2035








2

3 4

5 6










System integration

Consumer focus

Network investment

Policy governance






















Outcomes



Outcomes





EMR10+

EMR20













































Contentscontinued





































Acronyms


Glossary



































Glossary continued




























4 Policies









125

100

75

50

25

0Tera

wat

tndashho

urs (

TWh

qua

rter

)

Q1

1998

Q4

1998

Q3

1999

Q2

200

0

Q1

2001

Q4

200

1

Q3

200

2

Q2

200

3

Q1

2004

Q4

200

4

Q3

200

5

Q2

200

6

Q1

2007

Q4

200

7

Q3

200

8

Q2

200

7

Q1

2009

Q4

201

0

Q3

201

1

Q2

201

2

Q1

2013

Q4

201

3

Q3

201

4

Q2

201

5

Q1

2016

Q4

201

6

Q3

201

7

Q2

201

8

Q1

2019

Q4

201

9

Q1

2020

Coal Oil


Gas Nuclear




Source Ofgem 2020a

































































































Section summary











90

80

70

60

50

40

30

20

10

0

-10

-20



Telecoms and Media

Water

Energy

UKCSIScore


CustomerEethos

EmotionalConnection









Section summary











62Comfort focussed




17Value focussed




21Cost focussed

















Transmission

BSUoS

HDCAAAHEDC

Distribution

RO

FiTs

CfDs

Capacity Market

CERTCESPECO

WHD

9

8

7

6

5

4

3

2

1

0pkW

h







Cons

umer

s and

ow

ners

of t

heir

asse

ts


and control





Contracting

eg Warmth


eg Mobility




























Section summary



















































Section summary




















25gCO2kWh

100gCO2kWh
























Today Future




45

40

35

30

25

201819 201920 202021 202122 202223 202324 202425 202526 202627 202728 202829 202930 3031

poundM

Wh
















Inflexible demand


not reflected


(CFDs CM)

















Tndash0 T+29 days

T+14 months

Time



OptionsSwaps

PX trades


Bespoke bilaterals

Bala

ncin

g M

echa

nism

Imba

lanc

e se

ttlem

ent

Trad

ed p

erio

d

Financial markets

Fina

ncia

l se

ttlem

ent


































































































































market


markets





reduction


backstop


RSP



reflected

EMR10 EMR20

Market signals

Market signals


Investment driver

























Future changes






















Source BEIS 2020d












Source REA 2019


1 2 3 4 5 6 7 8 9

Net

herln

ds

Finl

and

Swed

en

Den

mar

k

Irela

nd

Nor

way

Ger

man

y

Gre

at B

ritia

n

Fran

ce


















significant ways






































1000+ price nodes















259 pricing nodes

Italy 6 price zones






























energy system

2Maximising the

value of data

3Visibility of data

Data catalogue

4Coordination


5Visibility of


Digital system map

Principles

Building blocks














































DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V Re

siden

tial O

ff St

reet

DSR

mdash E

V D

epot

Effic

ienc

y mdash

Dom

estic

(LED

s)

Offs

hore

Win

d

Sola

r (la

rge)

Effic

ienc

y mdash

Non

Dom

estic

Nuc

lear

Ons

hore

Win

d

Biom

ass C

CS

Li-I

on B

atte

ry T

2T3

CCG

T

Gas

CCS

Li-I

on B

atte

ry T

1

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash O

ther

Dom

estic

OCG

T

DSR

mdash H

P D

omes

tic

DSR

mdash H

P N

on D

omes

tic

DSR

mdash E

V D

epot

DSR

mdash E

V Re

siden

tial O

n St

reet

DSR

mdash O

ther

Non

Dom

estic

DSR

mdash E

V Re

siden

tial O

ff St

reet

Effic

ienc

y mdash

Dom

estic

(LED

s)

Effic

ienc

y mdash

Non

Dom

estic

Offs

hore

Win

d

Sola

r (la

rge)

Ons

hore

Win

d

CCG

T

Gas

CCS

Nuc

lear

Biom

ass C

CS

Li-I

on B

atte

ry T

1

Li-I

on B

atte

ry T

2T3

DSR

mdash O

ther

Dom

estic

OCG

T

8000

7000

6000

5000

4000

3000

2000

1000

0Cum

ulat

ive d

iscou

nt sa

vings

(poundm

) co

mpa

red

to c

urre

nt p

ositi

on

2018

2020

2022

2024

2026

2028

2030

2032

2034

2036

2038

2040

2042

2044

2046

2048

2050















300

200

100

0

-100

-200

-300



Impa

ct o

n w

hole

syst

em c

osts

(poundM

Wh)

300

200

100

0

-100

-200

-300




































pound712pound12414




pound979pound15601












































































































Section summary















Section summary

















































Gas



Electricity


Cost reflective 19800 0063 01029 9016



















Section summary




























Actions Effects

Info Data analysis
























energy services



energy services










































Next 24 months

Ongoing











From 20234

Immediate














Immediate

Immediate

Immediate



















Next 24 months

In 2021 RIIO-ED2













Next 18 months

Implement by 2023

2022

2020s2021ndash25








System integration

Consumer focus

Network investment

Policy governance














Enabling conditions











2021 2025 2030 2035





















80 Bibliography



























































































































(Electricity)







2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

700

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

300

250

200

150

100

50

0GW


2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh

Electricty Supplied

2010

2015

2020

2025

2030

2035

2040

2045

2050

600

500

400

300

200

100

0TWh


2010

2015

2020

2025

2030

2035

2040

2045

2050

180

160

140

120

100

80

60

40

20

0GW




















2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

50

40

30

20

10

0

Million vehicles


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh


2020

2025

2030

2035

2040

2045

2050

400

350

300

250

200

150

100

50

0

TWh










100

90

80

70

60

50

40

30

20

10

0Gen

erat

ion

load

fact

or (

)20

19

2022

2025

2028

2031

2034

2037

2040

2043

2046

2049

Nuclear (SMR)

CCGT

CCGT with CCS


OCGT

BECCS

Hydrogen








Oil OCGT


OCGT with CSS CCGT








OCGT with CSS CCGT



2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

2019

2021

2023

2025

2027

2029

2031

2033

2035

2037

2039

2041

2043

2045

2047

2049

250

200

150

100

50

0Capa

city

(GW

)

600

500

400

300

200

100

0Gen

erat

ion

(TW

h)

Carb

on In

tens

ity (g

KW

h)

Carb

on In

tens

ity (g

KW

h)


Base

Cas

e

Inve

st P

olic

y

Stre

ss R

ES

Fav

Nuc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

ss R

ES

200

150

100

50

0

Capacity Mix 2030

GW







Base_CaseBase Case














ME

Patc

ESM

E C

loc

Base

Cas

e

Barin

ga D

Stre

ss R

ES

Hig

h N

uc

CCS

Dem

o

Fast

Dec

arb

Cons

Stre

s

300

250

200

150

100

50

0

Capacity Mix 2050







GW














2020 2030 2040 2050

45

40

35

30

25pound bi

llion

2020 2030 2040 2050

90

85

80

75

70

65

60poundM

Wh


















35

30

25

20

15

10

5

0GW


2030 2050




































140

120

100

80

60

40

20

0

Mar

ket V

alue

(SM

Wh)

0 20 40 60 80 100


140

120

100

80

60

40

20

0

Elec

tricit

y Pr

ices (

SM

Wh)

0 10 20 30 40 50 60 70










2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)









2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

$500

$450

$400

$350

$300

$250

$200

$150

$100

$50

$0



Wee

kly A

vera

ge P

rice

(SM

Wh)


Energy Capacity

$60

$50

$40

$30

$20

$10

$0Price

s (S

MW

h)

















P

P dr

0

Price

(poundM

Wh)

Quality (MW)



demand response)













Quantity (MW)

20000

10000

1500

P1 = 80Price

(euroM

Wh)

Average VoLL

Price cap


Capped supply curve


˜

˜

Quantity (MW)

20000

10000

P2 = 2000

0Price

(euroM

Wh)

Average VoLL





˜

˜

Quantity (MW)

20000

10000

P3 = 800

0Price

(euroM

Wh)

Average VoLL




˜

˜






































6371

6354

5251

4374

3121

2611

2218





22

6

0

2535

31

26

5830

46

46

1533

17

28




Investors







52

0

6

2035

23

26

6045

60

48

1518

17

20













600

550

500

450

400

350

300

250

200

150

100

50

0Carb

on p

rice

(eurot

CO2)

2012

2015

2020

2025

2030

2035

2040

2045

2050


Lower flexibility

Core AM case

Higher flexibility

CO2 price cap



7 9 1640

100

190

300

430

600

370

210

130

250

130

220180

130

250

310











Driver



















Im

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Commodity

Mechanism







All

Balancing mechanism





Distribution losses


Transmission losses


Capacity

Mechanism




Capacity market



Partial



Capability

Mechanism












Carbon

Mechanism




























Mechanism




Generator TNUoS
















Super-red credits








Constraints payment



Co

nges

tion




25

20

15

10

5

0


poundbn

72 5 318 2









Current Future






(CO2 pricing)






Current Future


specific


specific




specific






































































































































































































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Ener

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venu

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poundM

Wh

200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150


200

150

100

50

0

-50

-100

-150

-200

-150 -100 -50 50 100 150



Profit Loss


Profit Loss






Fine tune balancing



Intraday

















































incentivesTSO

CoordinatesDSO

drivenPerfect

information


12

10

8

6

4

2

0

-2

-4

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cum

ulat

ive d

iscou

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savin

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ompa

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urre

nt P

ositi

on (

poundbn)











2020 2025 2030






Proposal 3 Roaming
























































Change development


3 Preparatory work







5


























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