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The UK looks set to break the link between soaring gas and electricity prices.

The UK looks set to break the link between soaring gas and electricity prices.

 


As the largest state intervention in modern history to protect UK households from soaring energy prices took effect on Saturday, a sweeping reform of the energy wholesale market was focused on to prevent a repeat of the crisis.

In last month’s controversial mini-budget, Prime Minister Kwasi Kwarteng pledged to overhaul a system that charges all electricity at rates that reflect the UK’s native, inexpensive and low-carbon energy source, where gas is a source of energy for consumers. We promised to lower our rates.

The move is similar to an initiative in the European Union (EU) as Russian President Vladimir Putin continues to weaponize gas supplies to Western Europe.

Why do wholesale electricity prices track gas prices?

As on the continent, in the UK wholesale electricity market, prices are based on short-term marginal cost. All generators participate in the bidding, but the daily market price is set at a level that guarantees sufficient supply to meet demand. In other words, the price is always determined by the most expensive power plant using fossil fuels needed for the day.

In fact, this means that gas-fired power plants, which make up less than 40% of the UK’s electricity supply, set the price for electricity by more than 80%, University College London scholars said.

The system worked when the UK’s electricity system was dominated by coal, gas and nuclear power, but renewable resources such as wind and solar, which operate very cheaply once built, are rapidly gaining market share. According to government data, renewable generation, including biomass, accounted for 43% of total power generation in 2021.

As gas prices more than quadruple since early 2021, consumers and businesses are paying significantly more for electricity than the average cost of electricity generation across the market.

What we’ve seen last year is that as gas prices rise, so does electricity, so some renewable energy generators are making very big profits. Ed Birkett, head of energy and climate at think tank Onward, said it was right for politicians and customers to ask if this was the right system.

What changes have occurred?

Key options for reform include splitting the wholesale market in two to separate renewable prices, or an approach that charges customers based on the type of generation capacity in a region called regional pricing.

There are various ways to segment the market, but they generally include creating a separate pool for cheap but intermittent, renewable power that can be scaled to nuclear power, and a second pool for traditional fossil fuel power plants that can be generated when needed. .

The dual approach will reduce the price charged for low-carbon electricity by separating it from the cost of gas.

Professor Malcolm Keay, a senior research fellow at the Oxford Institute of Energy Studies and one of the architects of the segmented market approach, finds it attractive that consumers can save money by aligning their usage with the plentiful supply of renewable energy. said one.

They may install a battery or other form of storage in their home, or the provider may use central storage. In the future, people will have things like electric cars and heat pumps… and these could be designed to match the price at the time, he said.

Critics point out that the segmentation approach is largely conceptual and will be difficult to implement unless the EU market to which the UK power system is connected adopts a similar model.

Pricing by location is designed to solve another big problem in the electricity market. Traditionally, wind farms in Scotland pay hundreds of millions of pounds a year to turn them off when the local power grid is producing too much power.

This approach would require hundreds or potentially thousands of different price points across the country to reflect local demand and supply. For example, on a windy day in Scotland, prices will plummet.

Proponents argue that it will encourage investment in battery storage in areas where excess power is produced or, conversely, encourage energy-intensive industries to establish in areas that provide cheaper electricity.

A study of regional pricing by technology and innovation center Energy Systems Catapult and supplier Octopus Energy found that this approach would be proportionally larger in Scotland and northern England, but cost savings everywhere.

This approach is already in use in other countries, such as Italy, but critics argue that the system will result in a zip code lottery. domestic bill.

How fast can you reform the market?

Some energy experts warn ministers of a hasty approach, with estimates ranging from one to five years, depending on the type and extent of reform.

We need to calm our nerves to some extent… This is, by definition, a medium to long-term reform option, and the gas crisis is an immediate short-term problem. There is a risk of using the wrong tools to solve the problem, said Tom Luff, senior advisor for electricity markets and policy at Energy Systems Catapult.

What is the government doing in the meantime?

As a first step, officials are negotiating with renewable energy and nuclear power generators to accept a 15-year fixed-price contract below the current wholesale market price. Some still subsidize in addition to the usual wholesale price under existing contracts, which can generate exceptional returns.

But Ed Miliband, Labor’s shadow energy minister, warned that the government is in a weak negotiating position and could end up agreeing to a fixed price, which is lower now but will be very expensive in 15 years. .

Prime Minister Liz Truss has so far ruled it out, but some experts believe the windfall could be simpler in the short term.

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