Decarbonisation and Institutional Energy Reform

Image - Zara Farrar

The US/Israeli strikes on Iran and the subsequent rise in the price of oil to a 4-year high has once again swung the spotlight onto Britain’s precarious energy composition and the ease with which geopolitical crises abroad destabilise domestic economic activity. Spelled out in Labour’s 2024 manifesto was the pledge to reduce foreign energy reliance by accelerating the transition to domestic renewables; while a step in the right direction, complete upheaval of the current framework is needed if the government truly wishes to regain energy sovereignty.

Britain’s energy system operates through a Marginal Pricing Mechanism (MPM), which ties the wholesale price of electricity onto the cost of the last and most expensive generator in the mix- typically gas. For homogenous goods like electricity, the logic goes, the cost of the most expensive generator is also the market equilibrium point, which gives gas a unique price-setting function. In practice, this means while gas produces only around a quarter of our energy, it dictates price 85% of the time, invariably tying cheaper renewables to its volatile price in a process termed inframarginal rent, raising domestic energy bills across the board.

Gas, as a global commodity traded on the international market, is heavily susceptible to fluctuations in price caused by contingencies like the closing of the Strait of Hormuz, forcing up the price of energy even if renewables run into surplus; and since 2021, has cost the UK economy an extra £90bn by disproportionately translating minimal reliance into soaring household bills.

Government strategy thus far, spearheaded by Ed Miliband, has been to ‘flood the grid’ with renewables in an effort to de-couple the link between gas and electricity prices and insulate the UK from deviations in the global gas market. But decarbonising the mix and pushing gas off the system, to the extent that its marginal use is sufficiently small so as it can no longer dictate energy prices, is a decades-long process whilst operating within the current paradigm. Instead, Miliband must go a step further.

To prevent price volatility and significantly lower bills, gas must be removed altogether from the wholesale energy market and moved into ‘strategic reserve’, ensuring its prices are stabilised and regulated, whilst still allowing for its mobilisation if renewable generation fluctuates. By completely de-coupling gas’s price from that of the wider electricity mix, removing its price-setting function and eliminating its ability to extract scarcity rent, bills would be cut by £5.1bn annually, including £65 for the average household. The government should then move legacy renewables to a monopsony model, with NESO, the National Energy Systems Operator, as the sole buyer; this would allow electricity prices to be properly regulated and eliminate windfall profits on non-gas generators. Not only would this strengthen British Industry, it would also support vulnerable families and accelerate the green transition.

The emboldening of many on the Right to speak against progressive climate policies has in part been enabled by a fraying ‘green social contract’- households have not seen the corresponding lowering of energy bills that was promised alongside the rise of renewables. A reform of the MPM system is an opportunity to rebate the claims that green energy is ineffectual and costly, whilst reinforcing energy sovereignty to ensure Britain is not liable to the caprices of states like Russia and Iran.

‍