Reshaping the electricity market was one of the hot topics of debate at the recent International Energy Week 2024 conference, held by the Energy Institute. Marzia Zafar, Director for Strategy and Innovation at Ofgem, said the problems facing the UK electricity retail market run particularly deep. ‘The digitalisation of the energy system, away from the present analogue system, needs to happen and happen fast. Everyone needs access to smart meters that can provide the necessary granular data,’ she told the ‘Shaping the future of electricity’ panel.

Ofgem is making attempts to reform the energy market and clean up the sector. But these initiatives are plagued by spiralling energy bills and soaring household debt, as well as geopolitical uncertainty when it comes to the issue of energy security.

Some of the problems now facing the UK national grid could have been avoided, said Kathryn Porter of the independent energy consultancy Watt Logic. ‘They were created by outsourcing generation to other countries, via interconnectors. But many of these countries share the same problems as us and this has left the UK vulnerable. For example, Norway has now passed legislation to restrict exports because of falling water levels for their hydropower,’ she remarked.

Marzia Zafar, Director for Strategy and Innovation, Ofgem, speaking virtually at the ‘Shaping the future of electricity’ panel at International Energy Week 2024
Photo: Oliver Dixon Photography/Energy Institute

Market reform   
In July 2022, the UK government launched its Review of Electricity Market Arrangements in Great Britain (REMA). The review was put out for a consultation that concluded in October 2022. On the basis of the results, the UK government’s conclusion is that the ‘current market arrangements are not fit for purpose’ and will not deliver the change necessary to achieve decarbonisation by 2035.

In a second consultation launched in March (for which it is accepting responses until 7 May), the government said: ‘It is clear from the responses to our first REMA consultation in 2022, and our engagement with stakeholders since then, that a range of underlying market failures and limitations of existing interventions mean the current electricity market framework will not deliver the secure, clean, low-cost electricity system we need in the future.’

‘Delivering this transition will require a significant acceleration in low-carbon capacity, including the deployment of new low-carbon flexible technologies; clearer decarbonisation pathways for our remaining fossil-fuelled generation and some limited investment in the short-term in newbuild gas generation to maintain security of supply as existing capacity expires; stable, long-term investment signals; and a stronger focus on the efficient and safe operation of the electricity system. REMA therefore aims to establish the enduring market arrangements needed to enable the transition to, and operation of, our future renewables-dominated electricity system.’

As Omer Ahmad, Policy & Commercial Development Manager, Low Carbon Contracts Company (LCCC), told International Energy Week delegates, the REMA strategy is ‘still evolving’. Still to be ironed out are the means by which individual reviews and reforms, such as reviews of contract for differences (CfDs) and transmission network use of system (TNUoS), can be fed into the market reforms.

Across Europe, reforms to the market have had mixed results so far. It is now uncertain, for example, how effective the provisional agreement, reached only last December by the European Parliament and Council on the reform of the European Union (EU) electricity market design, will be. The agreement is designed to help the EU build a renewables-based energy system as well as ensure better protection for consumers from price spikes. It will also empower them to benefit from the transition and ensure a sustainable and independent energy supply, in line with the European Green Deal and the REPowerEU Plan.

PPAs and CfDs remain key  
Generally, EU consumers look set to get a wider choice of contracts and clearer information before signing contracts. The deal reduces the risk of supplier failure. Suppliers will be required to manage their price risks in order to be less exposed to price spikes and market volatility. Consumer protection is further strengthened by member states having to establish suppliers of last resort so that no consumer ends up without electricity.

Vulnerable consumers and the energy poor will also be protected from disconnection. Finally, the Agency for the Cooperation of Energy Regulators (ACER) and national regulators will have enhanced ability to monitor energy market integrity and transparency. In particular, ACER will be able to investigate potential market abuse cases cross border and those where the conduct affects at least two member states.

The reform will facilitate the deployment of more stable long-term contracts such as power purchase agreements (PPAs). The reform will also boost liquidity of the markets for long-term contracts that lock in future prices, so-called ‘forward contracts’. Under the terms of the deal, all public support for investment in new production capacity in infra-marginal and must-run renewable and low-carbon electricity generation will have to be in the form of two-way CfDs or equivalent schemes, with the same effects.

Kadri Simson, European Commissioner for Energy, said in a statement: ‘This agreement is great news for our consumers. A future-proof electricity market design is a key asset in triggering investments in clean power production and flexibility, supporting our efforts to reach a climate-neutral energy system while ensuring prosperity.’

Maroš Šefčovič, Executive Vice-President for European Green Deal, Interinstitutional Relations and Foresight, added: ‘The reform of the electricity market will facilitate the much-needed integration of renewables into our energy system. It will allow our industries to benefit from more stable and predictable energy prices.’

EU plan criticised   
But the EU agreement has attracted criticism. The Brussels-based think tank, Centre for European Policy Studies (CEPS), argues in a recent report that the EU’s market design reform could end up sabotaging ‘the very internal energy market it is supposed to uphold’.

The CEPS report is most concerned about two aspects of the internal energy market reforms: amendments to ‘Article (66a)’ concerning future electricity price crises, and the resort to infra-marginal revenue caps. The Article is the mechanism by which the European Commission (EC) may declare regional or EU-wide electricity ‘price crises’. This would include periods of very high prices in wholesale and retail electricity prices. During the crisis period member states are allowed to revert to regulated prices for small and medium sized enterprises (SMEs). However, CEPS argues that the conditions are ‘vague and difficult to assess’ and rely partially on the EC’s own discretion.

The report explains that the inframarginal revenue cap is a measure introduced by Council Regulation (EU) 2022/1854 at the peak of the 2022 energy price crisis. Its aim is to limit the revenues that renewable and nuclear power plants earn compared with their costs. The cap was set at €180/MWh, although member states were able to decide on their own cap above or below this benchmark and allow for exemptions if necessary. The authors echo criticism of a 2023 EC report that the cap has created ’significant regulatory uncertainty, thereby posing a risk for the development of new investment, particularly in renewable sources’.

‘The reform of the electricity market will facilitate the much-needed integration of renewables into our energy system. It will allow our industries to benefit from more stable and predictable energy prices.’ – Maroš Šefčovič, Executive Vice-President for European Green Deal, Inter-institutional Relations and Foresight

Competition concerns  
Ever since it was established in the early 1990s, the energy retail market in Europe has remained largely unchanged. Energy suppliers take responsibility for purchasing wholesale electricity and gas and then manage customer billing, meter reading, revenue collection and the roll-out of smart meters. The system remains focused on competition on price driven by a focus on switching and facilitated by price comparison websites.

But concerns about the functioning of energy retail markets have been growing over the past decade. This has been driven by evidence of mis-selling and low levels of switching. There have also been concerns around the limited nature of competition despite the emergence of major new players such as Ovo and Octopus Energy and, until recently, Shell.

The problem, said Jean-Michel Glachant, Professor at the Florence School of Regulation (European University Institute), is that market design changes alone ‘won’t cut Europe’s dependence on fossil fuels, solve nuclear reactor issues or prevent droughts hitting hydropower generation’. He maintains that: ‘A reform of electricity markets can only help if the root causes of the crisis are also addressed and if the objectives for such reform are made clear upfront.’

Indeed, it was concerns about the European market that persuaded Shell Petroleum to sell off its UK and German home energy businesses to Octopus Energy last December. The businesses have now been rebranded as Octopus Energy, which has become the UK’s second-largest household energy supplier. That same month, Octopus Energy raised $800mn to boost its valuation close to $8bn. As well as its retail arm, it has a growing portfolio of renewable energy projects and licenses its Kraken software, which helps energy retailers manage their accounts.

Greg Jackson, Octopus Energy CEO, told an International Energy Week panel that the retail market is crucial. ‘That is where attention should be focused, rather than on the rolling out of new technologies. At the moment, customers are not being given the opportunity to benefit from new renewable infrastructure and are not yet seeing the upside to the building of new wind farms etc, as levies rather than discounts are being placed on their bills.’

Meanwhile Ovo Energy, already a major supplier of solar panels to the UK market, is looking to push the growth of heat pumps with a pledge to lower operating costs by up to £500/y compared to a natural gas boiler. Last October it entered into a partnership with training specialist Heat Geek, with the aim to install low-carbon systems at scale as part of its Heat Pump Plus service.

The UK government is committed to encouraging the wider electrification of heat. But in order for this to happen it first needs to address the comparative price of electricity compared to gas. This involves rebalancing electricity costs and tariffs. A plan on how to introduce change is expected to be detailed later in 2024.

This year could be a crucial one for the electricity retail market in the UK and right across Europe. If plans by the various regulators are put in place – and are successful – it could be a boon for consumers and suppliers alike. However, fears that the proposed changes are unlikely to solve the deep-seated crisis in the sector could yet prove to be well founded.

One area of concern is the UK government’s plan for regional energy pricing. This would increase electricity prices in parts of the country where demand is greatest, such as London, and reduce prices were there is ample supply but demand is lowest, such as Scotland. But critics say it risks heightening uncertainty and pushing up financing costs for renewable power projects.

Similar concerns exist for the EU’s plans, where critics argue market design change alone is not a ‘silver bullet’ for the crises in Europe’s electricity retail sector and won’t cut its dependence on fossil fuels or solve the other power generation issues. Clearly, there is still much to play for if the UK and Europe’s hard-pressed consumers are to benefit from proposed changes to the electricity retail market.

• Further reading: ‘The green gold rush’. How the availability of finance is making clean energy projects a reality, particularly in Europe.
• Find out how power purchase agreements (PPAs) are driving Europe’s energy transition.