So as a follow up @blueinsa I found this article from the Supplier, Good Energy.
I guess the main points I took from it are. There is only one wholesale market and the pricing is based on the 'marginal generator model.
To decouple pricing would mean a pretty fundamental shake up of energy trading but certainly not impossible.
The suppliers must make significant profits in periods where the marginal generator is far higher priced than say renewables. Its like going to Tesco, putting a loaf of Hovis,£1 a pack of apples £2.25 and bottle of malt £45 in your basket and paying £135 instead of £48.25.
I didnt get the analogy of the penalty taker at all.
All the move into renewables will mean diddly squat for consumers until they are able to match our total energy needs if the pricing model stays unchanged.
In the UK, there is one wholesale market for electricity, where generators (renewable and non-renewable) sell electricity to suppliers for particular periods of time. Like any commodity, there must be enough supply to meet demand at any one moment in time.
This means that there are negotiations throughout every single day between generators and suppliers to secure power. The price tends to fluctuate in every half hour period in response to factors such as availability and the time of day traded.
With renewables now supplying up to 40% of the UK electricity demand, big fossil fuel generating plants have had a diminishing role in the market. Whilst the greater volume of renewable generation is also altering how we decide which generation type is chosen when they are all available to meet demand.
The crucial reason for why the price of gas is so influential, comes from something called the ‘merit order’.
What is the merit order?
Think of it like ranking an order of preference. When every generation type is available to meet demand, the system has to decide which technology is brought ‘online’ first.
The good news is that renewables are always chosen first when they are available because they are the cheapest to run. This is great for reducing emissions but it is also logical to meet demand with the cheapest generators available at the time. Unlike fossil fuel generation, which has a high marginal cost to run because they are burning something, the marginal cost for renewables is practically zero.
So, how is gas setting the price?
This is because the electricity price in every half hour period is set by the marginal cost of the last generating unit to be turned off to meet demand – which is invariably a gas power plant with high marginal costs.
To provide an analogy, think of a penalty shootout in a sporting competition. A team will select a list of individuals in order of preference, with the best individuals selected first (i.e., renewables). But it’s the individual who steps up last who has the final say, deciding the fate of the result.
The problem we have at the moment is that whilst renewable capacity has grown significantly, natural gas is still responsible for 38% of our electricity generation in the UK.
When we have periods of low winds for example, the system will often turn to gas generators to fill that demand. But that comes at a high price, and even more so recently with the record prices on the wholesale gas market.
As we move to a high renewable powered electricity system, it doesn’t make sense to have gas generators setting the price.
How can we reform the market in the long-term?
If we are to fundamentally change how the price of electricity is set, a full reform of our wholesale markets will be required.
Should the government decide to make changes, possible reform options could include decoupling renewables from the wholesale market altogether, in effect having separate power markets.
Other ideas include taking an average price, which has been suggested in some European countries or moving to a model of locational pricing (nodal), which could see prices set at a much more local level and reflective of the costs of your local generator powering your home. Ultimately, however the market is designed, we need to accelerate the building out of a diverse mix of renewable infrastructure. The quicker we do this, the quicker we end our reliance on volatile fossil fuels setting the marginal price.
Thanks for taking the time to look all that up.
It’s complicated but it’s no surprise that it’s been decided the price will be set by the highest price available and it’s clear given the current crises that it is now the time to completely change the way we are charged by changing the system.