The real story of REMA

The UK Government has launched it's second Review of the Electricity Market Arrangement (REMA). Whilst there has recently been a lot of talk about the UK falling behind its counterparts in green investment. It is true the UK’s fiscal firepower is unable to compete with the US Inflation Reduction Act and the EU’s Green Industrial Deal, it still has the ability to punch above its weight in certain areas. Perhaps the strongest example is the UK’s current renewable energy investment scheme that has been the envy of the world over the last decade – the Contracts for Difference (CfD) mechanism.  

Over recent years, it has proven itself as a method for reducing risk in renewable investment and helping to drive down the cost of what was originally a nascent set of technologies, including offshore wind. We’ve seen this demonstrated by the substantial growth in the UK’s offshore wind capacity, with projects now competing on price with gas generators. While the most recent CfD auction was less of a success – as inflationary pressures pushed up the cost of projects and the system failed to respond effectively – the mechanism itself is still seen as crucial to achieving the target of fully decarbonising the power system by 2035, if not earlier.

But, inspired by learning the lessons of the recent energy crisis, government has launched a major Review of Electricity Market Arrangement (REMA) that has fired the starting gun on potentially major changes to the current CfD scheme. Changes that could have significant implications for developers and investors alike.

Is the CfD a victim of its own success?

The CfD has worked better than many ever hoped as a mechanism for deploying large volumes of cheap, green power. Despite this success, it has recently come under increased scrutiny because its fixed-price model removes the vast majority of price signals for generators to respond to. This means that in nearly all circumstances (beyond the most extreme period of negative prices) generators are incentivised to export power regardless of whether it is actually needed to meet demand. Government is concerned by the increasing evidence that this lack of price exposure risks making grid constraint issues worse – which Ofgem forecasts will already hit £3bn in 2028 – increasing costs for consumers.

Through the REMA process, government is therefore looking at whether the current risk protection offered by the CfD is justified, and whether it still helps to minimise the overall system cost of UK electricity supplies. It is aware that any changes to the risk protection offered to projects is likely to increase strike prices, but believes this could be offset by savings elsewhere (mainly through lower constraint costs).

What would reform mean in practice?

Making the case for reforming the CfD is one thing; how you do it is another thing all together. As government is keen to stress throughout the recent REMA consultation, it is aware that any reforms that go too far – exposing naturally intermittent clean power projects to price risks that they can’t effectively manage – could simply increase the cost of capital for projects. There is also a question as to how any changes to the CfD framework would complement (or clash) with other reforms, such as the introduction of zonal pricing.

It is therefore looking at a range of options, from a gradual evolution of the scheme to something more radical. The most recent consultation expands the set of options on the table, but they can be broadly split into two camps (the table at the end of this blog sets our more detail on each).

  • Gradual evolution: where, as has been the case with the CfD to date, limited and incremental changes at future auctions are introduced to deal with the most significant risks created by the current scheme. New features could include:
    • Introduction of sustainable industry rewards (SIR): where initially, projects are considered on merits other than strike price, e.g. supply chain capabilities, environmental benefits and the growth the project could bring to a local area [this is already being introduced for some projects from Auction Round 7].
    • New hybrid metering arrangements: this change would uncouple the CfD from the Balancing and Settlement Code at certain points to improve flexibility and grid operability.
    • Partial CfD payments: where only a percentage of the asset’s total capacity would be covered by a CfD, with a developer unable to bid to cover all its capacity.
    • Reference price reform: the CfD as it is, but with a reformed reference price that is exposes to wider market prices rather than just a static value. 
  • More radical reforms: options that, if implemented, would represent a significant change to the commercial outlook for new CfD projects, including:
    • Deemed CfD payments: generators are paid on their potential output in a particular period (based on weather conditions), rather than their actual output, meaning that generators are not required to export in order to receive payment.
    • Capacity-based CfD: a new proposal in the most recent consultation, where generators are paid a regular, fixed amount on their available renewable capacity, rather than the output.

Government is giving mixed messages on just how far it is willing to go. While all these changes are only ‘potentials’ for now, the fact it has included even more radical options in the most recent consultation is evidence that the debate is still very live. Government is aware that given the need to mitigate any risks to investor confidence, this may be the last opportunity for major reform ahead of 2035, so government believes it is worth looking at every option in detail now.

Zone out of zonal, zone into the CfD

The REMA process is now entering a new phase. Government has narrowed down the set of reform options, but final policy decisions remain to be made. These will largely affect new projects, but government is also thinking carefully about how it treats existing assets that could be impacted by reforms to wholesale and balancing markets.

The investor voice has been largely absent from the debate about REMA to date. The debate has focused been on the relative pros and cons of zonal pricing, and predominantly between developers and other external energy policy wonks and commentators.

There is a risk that this distracts from the more important debate needed on the right approach to the UK’s most successful clean energy export – the CfD scheme. Now will be the time to engage, as the decisions due in the coming months could define the success of the sector over the next decade and beyond.

This blog was written by Partner Josh Buckland and Manager Alex Goodwin. Josh leads Flint’s work on energy, sustainability and environmental issues. Prior to joining Flint, Josh was Energy Adviser to the Secretary of State for Business, Energy and Industrial Strategy. Alex works on issues relating to infrastructure and sustainability. Alex was previously at the National Infrastructure Commission as a policy adviser, working on long term net zero and climate resilient infrastructure. If you are interested in the full details regarding UK energy market reform and energy investment opportunities, please get in touch.

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