Written evidence submitted by SSE plc (ECO0047)

A UK FTSE-100 company, SSE is headquartered in Perth, Scotland and has a growing presence in international markets. SSE’s purpose is to provide the energy needed today while building a better world of energy for tomorrow. We do this by developing, building, operating and investing in world-class electricity infrastructure that is vital to the clean energy transition, including onshore and offshore wind, hydro power, electricity transmission and distribution networks, power stations, carbon capture and hydrogen storage, solar and batteries, as well as providing energy products and services for businesses and customers. At our interim results in November 2023, we announced that we have increased our programme of capital investment in clean energy infrastructure to £20.5bn by 2027 and could invest more than £40bn over the decade to 2032 assuming a supportive policy environment.

The main points in our written evidence below relate to our response to the DESNZ consultation on the next steps of the Review of Electricity Market Arrangements (REMA) which closes on on 7 May.

What should be the underlying principles of the UK energy market?

The UK is transitioning to an energy system consisting of long life assets with mainly fixed costs principally determined at the time of investment. The principles that underpin the energy market need to start with ensuring that risks associated with these investments are appropriately allocated.

These principles should help ensure that an energy system that delivers a cleaner, more secure, more affordable electricity system based on home-grown energy sources that will be the backbone of an energy-independent, low-carbon economy out to 2050 and beyond can be efficiently delivered.

Radical change, based on greater market risks falling on producers, like splitting the eletcricty market into several zones, does not align with this principle and will disrupt the ability of the UK to meet targets through the acceleration toward a cost effective reliable and low-carbon system through investment in generation, energy storage and networks.

This system, that safeguards consumers against volatile and systemically high energy prices must also insulate producers from unmitigable risks such as locational pricing.

Can Government deliver radical reform in the UK energy market?

Government could undertake radical reform, but the pros and cons need to be fully considered. In respect of the delivery of decarbonised electricity, radical change to the market should be seen as a secondary objective to radical reform of the energy system infrastructure. Significant investment in generation, networks, and energy storage are vital, and with significant upfront costs, are very sensitive to the cost of capital.

It is important to note that there is clear consensus on the need to deploy greater generation, network and storage infrastructure in pre-determined locations as set out by the Electricity System Operator (ESO) in its recent ‘Beyond 2030’ publication [1], with a smaller number of voices calling for radical reform of market arrangements. Ultimately, it is conceivable that the UK’s energy system needs can be met by adequate investment without radical market arrangements, but it is conceiveable that the UK’s energy system needs will not be delivered should the market be radically reformed as the investment requirements will not be forthcoming.

In March 2024 DESNZ published the second consultation of REMA with a narrower range of options for electricity market reform being considered than in the first consultation. The two main options are - zonal pricing - which would be a radical change to the market, and a set of reforms to the existing market structure alongside making changes to existing schemes like Contracts for Difference (CfD) and the Capacity Market (CM).

The purported net system benefits of zonal pricing in the LCP-Delta/Grant Thornton analysis for DESNZ, are as little as £5bn between 2030-50, or only £250m/year, when taking account of incremental reforms to system balancing tools address operational issues with interconnectors and storage [2].

Importantly, this £5bn benefit would be wiped out by just a 0.3 percentage point (pp) increase to the cost of capital. Should the impact of the introduction of zonal pricing on the cost of capital be greater than 0.3 pp (as is likely to be the case) the net benefit would be a net cost (borne by consumers).

In the absence of reforms to interconnector dispatch and comparing against a no-change ‘status quo’ alternative (which is not credible given that reforms that will reduce congestion costs are already underway), the purported benefit of zonal pricing of £15bn could be wiped out by a 0.9pp increase in the cost of capital.

To put the scale of this impact in perspective, when setting the Administrative Strike Prices (ASPs) fo offshore wind in the upcoming Contracts for Difference (CfD) auction round, DESNZ determined that the commercial uncertainty associated with generator transmission charging (TNUoS) was equivalent to a 1pp increase in cost of capital. We view that the commercial uncertainty asscoiated with zonal pricing is higher than that associated with TNUoS, and analysis we commisioned from Frontier Economics put the theoretical impact close to 2-3pps [3].

This is all before considering that the network build in the analysis is 2 years out of date, since the analysis commissioned by DESNZ was commissioned. In its ‘Beyond 2030’ publication, the ESO put forward £58bn of further transmission investment, which would significantly erode the purported benefits of zonal pricing further.

Ultimately, given the geographical drivers of wind resources and land availability, as well as the location of industrial sites, we’re not going to see significant changes to what goes where, and this is a view echoed by the Energy Intensive Users Group (EIUG)[4].

There are tools which can be implemented, and some of which are being used and introduced now, which would make incremental changes to the electricity market in Great Britain faster, and without the disruption of splitting the GB market. One key tool being to ensure that electricity network development keeps pace with generation and demand evolution. Introduction of a greater focus on long-term value within the GB policy and regulatory framework will help with this, and in turn this will accelerate the rate at which the development of homegrown energy provision can reduce exposure to volatility which cost taxpayers alone £50bn in 2022/23 and a further £25bn in 2023/24 [5]. Given this, we strongly welcome the development of the Centralised Strategic Network Plan (CSNP) and the Strategic Spatial Energy Plan (SSEP).

Is the Review of Electricity Market Arrangements likely to deliver the necessary changes to the energy sector?

REMA has the potential to build on the UK’s past successes to deliver a cleaner, more secure and more affordable electricity system that will be the backbone of an energy-independent, low carbon economy out to 2050 and beyond. In order to deliver the necessary changes and to retain investment in UK plc, REMA should focus on incremental reforms to the GB electricity market arrangements.

The continued consideration of zonal pricing is a significant concern and risks undermining the UK’s attractiveness for investment as well as pushing up the cost of the investments that do take place.

What are the major benefits that the UK should be seeking to deliver from energy market reform?

Given the scale of the capital invetsment required (£275-375bn in low carbon generation alone [6]), ensuring investment in low carbon homegrown energy happens at pace and at as low a cost of capital as is practicable should be paramount to REMA.

SSE and the majority of industry are supportive of a combination of incremental reforms under a Reformed National Market (RNM) could deliver the purpoted benefits of zonal without the disruption, and would include reforms to the CfD, network charging and system balancing, alongside a focus on strategic energy infrastructure deployment.

More widely, an overfocus on piece-by-piece competition has caused a fragmention of the UK energy sector, which has undermined the ability to secure domestic supply chain investment as well as investment in skills development. Taking a more strategic approach to energy infrastructure deployment will enable early, and at scale engagement with the supply chain will best enable firm, contracted orders to trigger new supply chain capacity to locate in the UK.

What are the chief barriers to reform of the energy market and is the Government serious about addressing those?

At the moment the options under consideration are too broad and adding uncertainty to investment. To deliver accelearated decarbonised electricity, the focus should be fewer, targeted reforms that minimise disruption.

More widely, the UK’s current relationship with the EU is creating a challenge in ensuring efficient operation of interconnectors, carbon market stability and coordinated infrastructure across borders. SSE would support the EU and the UK developing a closer energy and climate relationship under the auspices of security and defence cooperation, to maxmise the energy resources available to Europe to best support energy security and industrial competitiveness.

Is it possible to ensure that consumers are insulated from market failures in the energy sector?

By definition it is not possible to insulate consumers from market failure. If the market fails then both producers and consumers will be exposed. What is possible is to protect consumers from the consequence of market failures by addressing the potential causes of market failure and in doing so reduce the likelihood of market failure. If for example a market failure is that producers cannot earn enough under market arrangements to recoup the costs of renewable electricity then consumers will lose, because the investment in the stable market is lower overall than the alternative cost production will not progress. This would leave consumers worse off. If steps are taken to insulate producers from this risk, the investment goes ahead and both investors and consumers stand to benefit.

April 2024