Hello everyone, and welcome back to our second blog post. Thanks to everyone for their kind reactions after the release of our site. In this post I want to explore the theme we hinted at in post one. Namely market reform. I should add at this point that I'm a strong believer that the time is right to update the UK power market. The aim should be to:

1. Encourage competition

2. Reduce the cost of entry

3. Encourage innovation and new ways of doing things

Naomi Klein said something like "the only thing about change you should be afraid of is not changing"... Wise words.

Anyhow this starts with a history lesson of sorts, so bear with me.

In 1999 the UK power market was reformed. This reform was to create a traded market in which companies broken off from the CEGB during privatisation could compete and drive down the price of energy.

Generators were assets that produced electricity and exported to the grid. PowerGen, National Power, Nuclear Electric, we're some of the biggest on the generation side.

Suppliers were agents of consumption who devoured the generation from the wires, selling it on to end users. While on the supply side the old regional RECs (MEB etc) were split off and allowed to compete for customers.

These companies were all new to the competitive market, with a few notable exceptions. Mostly they were used to polishing the silver spoons found in the executive canteens left from the days of the CEGB.

Mergers were performed,  American companies came and went, whilst new small supply businesses joined the market and went bust on the price cycle. Vertical integration where generators became suppliers took place on a huge scale. The market moved to electronic exchange, but the fundamental units of trade, the generator, or supplier remained...

UNINTENDED CONSEQUENCE #1: Allowing vertical integration on a huge scale allowed generators to hide margins on the supply side. Reducing competition and allowing a few players to drive policy and reform.

The next phase of the market evolution began in 2000 with the introduction of LECs, ROCs , REGOs (Management Consultants still laugh about these names) and a whole host of other legislation followed to promote in the first instance wind, and lately solar power. This was the embedded generation revolution which put generation into the suppliers portfolio on the low (or lower) voltage grid. Moving generation to lower voltages, created, and continues to create embedded benefits when demand in the suppliers portfolio is reduced, and charges levied by the local and national grid during particular peak hours (TNUoS and DUoS for example)  are avoided.

This concept of embedded generation was a powerful one, and alongside strong subsidy schemes (did those setting out subsidy fully understand the value of embedded benefits?) meant renewable generation schemes were extremely lucrative yielding 20% plus per annum returns for investors and making supply businesses rich in the process. Everyone was happy.. Except perhaps for the consumer.

UNINTENDED CONSEQUENCE #2: Unlimited subsidy schemes led to a huge increase in renewable generation, without the cost of dealing with this on the system being factored in.

The profile of new build plant on the system in the meantime has been minimal, although the decline in demand since 2007 has left much of the CCGT capacity as “stranded assets”. In recent times the lack of investment in controllable thermal plant could be explained at least in part by l the large returns for renewable investments due to subsidy.

UNINTENDED CONSEQUENCE #3: New investments in power plant were not made due to better returns from subsidised generation, although reducing demand due to economic problems and energy efficiency played their part.

A build up of inflexible embedded generation, and lack of new build flexible plant puts the system under pressure,  hence the "Express esque" headlines about capacity margins and the lights going out. These headlines come out on a regular basis, and have again surfaced with the news that Longannet and Eggborough are likely to close in April 2016. However, they are closing because the market is not delivering a profit due to the “plentiful supply” which appears with the large fleet of windfarms now on line.

In recent times the need for flexible plant on the system has lead to an increased investment in flexible assets. Including the installation of hundreds of MWs of small scale diesel generators which provide embedded generation, but also avoid the EU ETS or carbon emissions trading scheme by being too small. So by clustering 20-100 units on a single site you can avoid emissions trading,  whilst maximising emissions, and revenues.

UNINTENDED CONSEQUENCE #4: To help cope with renewable generation the economic solution is to cover the country in small inefficient diesel engines to replace ageing flexible plant post closure.

 So today though things must look very different from how they looked in 2000 mustn’t they?... Not really, the system looks in many ways similar to what we saw back then. Suppliers and generators still exist in the market place, and to trade power you still need to have a production or consumption account, with complex rules around how to settle the volumes. These days suppliers are well used to "generating" into their consumption account, be it from uncontrolled renewable sources, or flexible distributed engines. But the initial scheme of trading through generation or supply accounts remains.

Becoming a supplier or generator is an expensive process which is probably the main barrier to market entry.

There is a litany here of unintended consequences due to incremental changes in the power system, without real market change. Who is to blame? Short term government policy for one (without a proper eye on the long term consequences perhaps not surprising with the changes in government every 5 years), and secondly I would level criticism at the larger company's (big 6 if you like) for driving reform in a direction that was appropriate for them, and to those responsible for reform for giving them a disproportionate voice (weak regulation).

This history is perhaps boring, but necessary for a few reasons.

Firstly it explains why we need to define some basic principles against which the market should operate. These principles should be high level, and we should test any decisions or policy we make against these principles regularly.

My principles would be:
1) If you can meter demand or consumption then you should be able to trade it.
2) direct payments should be made to meter owners based on the cost or benefit of consumption or generation.
3) generation and demand should be defined in terms of location

Secondly the history shows us that the market operates today in the same way that it operated in 2000. During the same period we've seen an information revolution take place, which has simply passed the energy market by. How and why? Simply, the cost of market entry is too high.

Finally it shows us where we should focus our effort in terms of revolution. Solutions should be available under the current arrangements that enable innovation, rather than waiting for the industry to deliver "smartmeters" and Ofgem to deliver its 2020 strategy. Value for consumers could be available tomorrow if the industry were to let it happen.

In my view a big step would be to dissolve the old supplier, generator model. We should have a meter based model where payment occurs at meter netted back to the notional balancing point.

Anyhow, that's the intro.  In the next post my colleague Graham Schorfield explains with some numbers and pictures how a new market model might work...