Launched in 2022, the UK’s Review of Electricity Market Arrangements (REMA) is a government-led initiative to reform the country’s electricity market. This review aims to redesign how the UK's electricity system functions in order to support and accelerate the transition to low-carbon electricity generation across the country.

At its core, REMA has three goals: deliver a net-zero future by decarbonising electricity, ensure energy security, and increase cost effectiveness. This requires making changes to the system to accommodate growing renewable generation, offering flexible technologies like storage and demand response, while supporting reliable security of supply as the UK phases out traditional fossil fuels.

The government is consulting with various stakeholders on these changes, with the intention of finalising a plan by this summer.

‍What’s been proposed to date

As of the most recent consultation, the government is considering proposals in four areas:

1. Wholesale Market Reform: how does the structure of the wholesale power market need to change to deliver enough renewables, at the lowest cost, in the right parts of the country? (We’ll dive into the options in detail below.)

2. Reforming the Contracts for Difference (CfD) Scheme: how should we change the CfD scheme? Current options include capacity-based CfDs (payments based on capacity rather than output) and Deemed CfDs (payments based on a pre-specified level of output).

3. Legacy and Transitional Arrangements: how should existing CfD agreements be handled to ensure a smooth transition?

4. Transitioning from Unabated Gas to Low Carbon Flexibility: how will we shift to a decarbonised system?

Together, these changes would have an impact on how prices are set, how different types of power sources compete, and how to ensure a reliable energy supply.

The proposals for wholesale market reform will likely have the greatest impact, changing not just how the market sets prices, but also creating knock-on effects influencing the entire system, including energy generators and consumers. 

To understand why, let’s dig into the great debate on locational pricing.

‍Wholesale market reform: the debate on locational pricing

The UK currently operates under a single national pricing system. Regardless of location, all electricity generators across the country get paid the same wholesale price. This system doesn’t take into account regional differences in supply and demand. 

Every half hour, the UK runs a nationwide auction to set the price of electricity. This process sets a single price for that 30-minute window, which applies across the entire country. Whether you're generating electricity in northern Scotland or in London, you'll receive exactly the same payment per unit of electricity during that time period. 

But this system ignores the reality that electricity produced in different locations actually has different values to the system, depending on local supply, demand, and network constraints. Electricity generated off-shore in Scotland has a long way to travel to population centres in the south east of the country.

Locational pricing, on the other hand, would divide the UK into different zones, each with their own prices based on local network constraints and the cost of producing and supplying electricity. The intention is to better reflect the real-time physical constraints of moving electricity around the country, creating price signals that more accurately represent the true cost of delivering power to different locations. Countries like Italy, Sweden, and Denmark operate under a zonal (or locational) pricing system.

What are local network constraints and why do they matter?

Different parts of the UK have different infrastructure, capacity, supply, and demand. Network constraints arise when part of an electrical grid can’t meet the demands placed on it. Every part of the grid is designed to handle a certain amount of current. But this capacity may not always be sufficient to transport or handle the flow. If capacity is lacking, the energy goes nowhere. Rather than overload the equipment it's discarded, which is known as curtailment.

For example, it may be easier to build a new wind farm in a less densely populated area, such as Scotland. But under the current system, the increase of wind supply in Scotland will outpace what the grid can handle. These constraints mean that during particularly windy periods, turbines in Scotland are turned off (but the generators continue to get paid for electricity they’ve produced), while people who still have unmet electricity needs are supplied from non-renewable sources. This increases costs and carbon across the board, and it's widespread - you can check today's totals here.

Locational pricing: the upsides‍

‍Locational pricing should make the energy market more efficient — which will bring down bills.

The primary advantage of locational pricing is that it will bring down the cost of consumer bills, particularly in places where supply is abundant, like Scotland. By breaking up the grid into zones it is easier to manage network constraints and increase efficiency. 

There are several reasons why proponents believe locational pricing will bring down costs.

Under locational pricing, price signals could improve, as they will reflect local supply and demand realities. More local prices provide a “truer” signal to a consumer (or producer) in a specific location, as opposed to the washout effect at a national level. It could also reduce constraint costs on the system. 

The market is currently structured based on expectations that have not proven true. The grid operator (NESO) increasingly needs to step in at the last moment to deal with misalignments between the market and the physical realities of the grid. This operates like an emergency service, meaning it is highly costly. The increased frequency with which this service is needed is increasing costs across the board, which could be avoided or at least reduced under locational pricing.

Redesigning the market in this way also encourages power plants and renewable energy projects to be built in places where they’ll have the most value to the grid. Locational pricing creates a clear financial reason to consider the impact of a location, nudging new projects to areas where electricity can be easily used or transported. This could make the whole system more efficient, reducing the need for expensive grid upgrades and ensuring that renewable energy gets to where it’s needed most.

Proponents of locational pricing include energy regulator Ofgem, energy system operator NESO, and Octopus Energy.

Locational pricing: the downsides

Locational pricing could destabilise the investment case for new projects — which could create uncertainty for the market.

Shifting to locational pricing would also materially impact existing business models. It would change the economics of both new and existing energy generation, in a way that could be hard to predict. Changes to the physical network will also impact prices, which could create further uncertainty for new generation projects. Investors may price in this uncertainty with more expensive financing, or be less likely to finance new projects entirely. This uncertainty could discourage investment in low-carbon energy — which would undermine REMA’s entire net-zero goal.

Opponents of locational pricing include Renewable UK, Solar Energy UK, Scottish Renewables, and a coalition of organisations called Fairer Energy Future.

The critical question is whether the improved price signal and increased efficiency of locational pricing outweighs the increased uncertainty it brings. Because this touches so much of the energy system — consumers, producers, network planning, investment, regulatory structures, you name it — the impact isn’t easily understood. Are we happy to endure a tumultuous few years of market uncertainty in pursuit of a more efficient system, or is the next decade too critical for decarbonization to risk rolling the dice?‍

What's next?

The government plans to make a call on the locational pricing debate this summer. But making the decision is just step one in what will be a long process. Implementation could take several years, meaning that these changes — good or bad — may continue to be front-of-mind for years to come.

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