Electricity Market Reform – Taking stock

England and Wales

The Energy Act 2013 (the “Act”), whose stated aim was to deliver secure, affordable and low carbon energy to UK consumers, requires five-yearly reviews (the “Review”) of the provisions of the Act (and their implementation). The first Review was completed in 2019, covering the 2013-2018 period, delayed by the UK’s withdrawal from the European Union and the Covid-19 pandemic, was only published in May 2022.

By way of reminder, Electricity Market Reform (“EMR”) was designed to facilitate the development of a clean, diverse and competitive mix of electricity generation, to meet UK targets on decarbonisation and security of supply, while keeping bills as low as possible for current and future consumers. EMR was to tackle these challenges via two major policy interventions:

  1. Capacity Market (CM): Effectively an availability payment guaranteed to generators that would ensure security of electricity supply during system shortages. In its simplest form, it represents a commitment by committed generators to making their capacity available when needed, in return for guaranteed payments lasting between a year to 15 years. CM was introduced to ensure security of electricity supply and guarantee that the most efficient level of capacity was secured at minimum cost to consumers. This is achieved by way of annual auctions both four years and one year ahead of the relevant Delivery Year. It was subject to an independent five year review in 2019 and a ten year review is now in progress.

  2. Contracts for Difference (CfD): These were intended provide long-term revenue stabilisation for new low carbon electricity generation in Great Britain by offering projects a fixed strike price for 15 years from the CfD Start Date, paid out by a government owned Low Carbon Contracts Company. CfDs were introduced to protect low carbon generation, in light of their high upfront costs and long lifetimes, from volatile wholesale prices. Whilst only three Allocation Rounds have concluded to date, AR4 is currently ongoing and annual Allocation Rounds have been announced going forward.

The Act was also instrumental in introducing the UK’s Emissions Performance Standard (EPS), to limit carbon dioxide emissions from new fossil fuel power stations, and a Carbon Price Floor from April 2013. The latter has been revised (upwards) annually, increasing over 70% (in real terms) from 2018 to 2021.

What has happened in the energy market since the introduction of EMR?

The Revision and Expansion of CfD Schemes:

The CfD policy has been revised and extended since the Act. As anticipated, the strike price offered has fallen in each Allocation Round, to reflect reductions in the levelled cost of energy in such technologies. The policy has also been tailored to specific methods of generation: for example, floating offshore wind is now subject to more generous subsidies than bottom-fixed offshore wind, reflecting the additional costs of development of the former. Government have also tightened the Non-Delivery Disincentive, a policy intended to minimise the risk that those who enter into a CFD fail to deliver the project, preventing inefficient allocation of budget by deterring speculative applications. The CfD contract’s Force Majeure provisions have also been revised from the original drafting: compensation can now longer be claimed where the FM event results from pre-existing factors which the generator was aware of, where that event directly causes the failure of the project to meet a contractual milestone. The policy continues to be amended, for example, government is currently planning to require Supply Chain Plans from all floating offshore wind projects and to shorten the validity period of a Supply Chain Plan approval from 12 months to 9 months.

CfDs have also been applied beyond pure renewables, namely the CfD signed in 2016  for Hinkley Point C nuclear plant. The scheme is now being extended to facilitate carbon capture, usage and storage (CCUS) CfDs. Government is designing a Dispatchable Power Agreement (DPA) for power CCS – this is based on the standard terms used in CfD allocation rounds for renewables. Similarly, the UK’s Hydrogen Strategy is premised on a CfD support mechanism whereby contracts will be awarded via a competitive auction. However, unlike the generic CfD, Government does not intend to act as an offtaker of last resort for hydrogen production. Instead, there will be a sliding scale of support provided indirectly through price variation, with generators recovering higher unit prices where offtake volumes are low, and payments declining as offtake volumes increase.

Role of and Changes to CM:

Under CM, Auctions are held four years in advance, with the first delivering in 2018/19 at a cost of about £1billion. Auction clearing prices have changed year on year: the T-4 Capacity Market auction, held in February, for the 2025/26 period cleared at a record high of £30.59 /kW/year, some £8 /kW/year higher than the previous record. In contrast the T-4 clearing price for 2022/23 was just 6.44 /kW/year, largely a result of the volume participating in the auction being far greater than the capacity National Grid sought to procure.

Since 2018, onshore wind and other renewable technologies an also participate in the CM. However, as CM is focused on reliable supply, solar or offshore wind (which only provide intermittent supply) are de-rated when competing against a gas power station that can generate at almost any time. CM has, therefore, successfully expanded grid capacity but the policy has, in focusing on supply, been criticised for failing to account for the carbon intensity of the technologies it offered contracts to. In response, Government announced in 2020 that all contracted projects are now subject to reporting and verification mechanisms that place a carbon emissions limit. This limit will apply to all projects contracted before July 2019. Simultaneously, Government lowered the minimum capacity threshold for bidding technologies from 2MW to 1MW, with the aim of capturing more local-scale renewable projects.

A notable recent change has been the extension of contracts to interconnectors and battery storage facilities. In the 2025/26 period, for example, 8.3GW of battery projects bid and 1GW were awarded contracts, whilst the figure for interconnectors was nearly 7GW. In this sense, CM is starting to deliver on holistic EM objectives relating to the development of low-carbon, low-cost generation technologies.

CM was initially intended (and expected) to incentivise investment in new, large Combined Cycle Gas Turbines (CCGTs). However, despite amendments to CM to encourage uptake, the number of projects brought forward remains below Government expectations.

Deregulation of the Energy Market:

In keeping with EMR’s aims of a low cost, highly competitive energy industry, the UK has (over several decades) transitioned towards a deregulated energy market. With losses mounting, wholesale prices increasing and Ofgem’s price cap in place, 25 energy suppliers went insolvent between August 2021 and February 2022. EMR has, therefore, coincided with a period of significant change in the energy market more broadly.

Government Concerns over UK Grid Capacity:

Running concurrent to EMR have been growing concerns over domestic energy production, availability and demand, and these have spurred the accelerated adoption and rollout of interconnectors. By 2020 the UK was operating three interconnectors, connecting the UK with France, Netherlands and Belgium, with three more under construction – a second with France, plus one each with Norway and Denmark and many more planned. It is similar concerns over domestic energy security that have informed recent government pledges to increase offshore wind capacity from the present 10GW to 50GW by 2030 and nuclear from the current 9GW to 24GW by 2050.

UK as Pioneer - The Export of Policy Worldwide:

The UK’s success in increasing renewable generation through EMR has resulted in CfD-style schemes being adopted elsewhere. In Germany, for example, carbon-intense sectors such as steel and cement can apply for state subsidies, to bridge the upfront cost of lower emissions manufacturing methods, in the form of 10-year opex contracts. More recently, the European Commission has proposed contracts for difference to support the uptake of green hydrogen as a key constituent of its REPowerEU initiative. Meanwhile, the IEA recommend their deployment more widely, describing them as providing the revenue certainty requisite for renewable development at scale.

Legacy - Has EMR been a Success?

The Review concludes that CfDs have incentivised the development of low cost, low carbon projects, to the extent that the strike price for future offshore wind halved between Allocation Rounds 1 and 2. Unlike their demand-led predecessor, Renewables Obligations Certificates, CfDs have secured both stable revenues for generators, by reducing their exposure to variations in wholesale prices, and consumer protection when wholesale electricity prices are high. Across the Review period, the Act has facilitated low carbon, low cost, secure electricity generation - as originally envisaged.

The Act championed consumer protection and the Review notes that EMR has successfully addressed this. The dual functions of National Grid as system operator and EMR Delivery Body have been ringfenced, by restricting EMR information leaving the system operator and creating a designated data handling facility. The importance of this ringfencing was highlighted by the announcement in April 2022 for a Future System Operator (FSO), a new public body intended to oversee the energy network, and support new technology and build security of supply. EMR has also established an Offtaker of Last Resort (OLR) which, for the CfD duration, ensures eligible renewable generators have a backstop power purchase agreement in place. In theory the OLR guarantees renewable generators a route to market, making their projects more attractive to lenders and investors, and lowered the risk of them going insolvent. However, as the OLR has not yet been used the success of this policy cannot be assessed.

No Capacity Market Stress Event (a system stress event that has occurred at least four hours after a Capacity Market Notice has been issued) was recorded during the Review period. The resilience of CM cannot, therefore, be fully assessed as yet. Moreover, there is concern within industry that, with current wholesale prices so high, the strike price agreed under CfDs represent poor value for money. Although inherent to signing a contract guaranteeing fixed revenues (to protect against price volatility and to encourage external investment), there is discontent that generators are currently reimbursing the Low Carbon Contracts Company. As a result, there are discussions ongoing between industry and government over potential delays to CfD start dates, increasing scope for merchant revenue generation.

What next for the UK’s energy sector?

The Act imposes an obligation for a Review of EMR at five-year intervals. Given this first Review was due to be published in 2019 (and incorporates data from 2013 to 2018), the data collection and review for the next (2024) review is well underway. Contemporaneous to this review should come a second Capacity Market review, also featuring policy analysis and recommendations. At this 10-year interval it may be possible to give a more comprehensive assessment of EMR, particularly if it includes analysis of how the UK’s energy market copes with present high wholesale prices and Government ambitions to increase offshore wind capacity five-fold by 2030. In the interim, the rollout of CfDs (and of EMR) is expected to continue apace. A 5th Allocation Round has been promised by Government whilst the first CfDs under the Low Carbon Hydrogen Business Model are expected to be awarded in 2023.