Power pricing: dual-market model would serve customers better

Opening an electricity bill these days is enough to turn anyone into a proponent of radical market reform. Renewable electricity is getting cheaper and accounts for an ever-larger slice of the UK mix — some 60 per cent. Yet the cost for retail customers has risen by almost two-thirds over the past year. Cue proposals to bring down costs in the UK and Europe.

These focus on marginal pricing. In this current system, electricity is priced at the cost of the most expensive plant required to kick in to satisfy demand. Often that is gas-fired generation. This has proved very expensive as a result of the Ukraine War.

Some cheaper solar and wind plants exposed to the wholesale market have pocketed windfall profits. Others have handed them over to the government under long-term price agreements.

One solution is to split the two markets. Renewables generators would then compete with each other for long-term contracts. Pricing would reflect the cost of investments — maybe €50-€80/MWh for new plants. Flexible suppliers would compete on a spot market, presumably at much higher prices. This would include generators using fossil fuels and hydrogen plants, and perhaps battery arrays.

That would enable canny distributors to buy much of their electricity on long-term contracts at low prices, lowering its cost in time for the next gas crisis. It would also be good prepping for when renewables make up most of the power market. As things stand, delinked renewable power prices would be too low for plants to recoup their investments, because running costs tend towards zero.

The split-market proposal has plenty of advocates, including David Robinson and Malcom Keay at the Oxford Institute of Energy Studies. It also has plenty of snags. The main one reflects committed thinking: the market we have today is not ideal but it does distribute electricity.

That is true. But renewables work in fundamentally different ways from the old power plants. This means a different set of rules is needed.

The Lex team is interested in hearing more from readers. Please tell us what you think of split electricity pricing in the comments section below