The Electricity Market

Your guide to how electricity is generated, imported, traded, transmitted, distributed, stored and regulated in the UK.

The Electricity Market: An Introduction

Much like water and gas, electricity began as a monopolised utility controlled by the few for the many. Until the official introduction of privatisation in the 1990s, the largest electricity suppliers had a share of more than 90% of the market.

Today, electricity is produced by large-scale traditional and sustainable generators of all sizes and sold on to suppliers through the Electricity Market, Capacity Market, and Balancing Services Market. Sources include fossil fuels, nuclear energy, carbon capture technology, and renewables (e.g. hydropower, wind, natural gas, biomass, and solar photovoltaics). Generators transmit electricity across the country through high-voltage transmission lines to substations at which the voltage is decreased so it can be safely distributed by Distribution Network Operators (DNOs) along smaller, localised power cables to homes and businesses.

Privatisation and Electricity Market Reform (EMR) policies have enabled diverse wholesalers and suppliers to offer more competitively priced services, thereby stabilising volatility and incentivising investment in renewable resources to meet our decarbonisation targets. By 2024, our electricity interconnectors will import enough energy to power 8 million homes. And by 2030, 90% of electricity imported by interconnectors will be produced by carbon neutral sources.

Speak to one of our energy specialists today for more information or read on.

Our grid is comprised of more than 1,000,000km of electricity cables – enough to circle the globe 25 times. This includes at least:

  • 4,481 miles (7,212km) of overhead electricity lines.
  • 1,391 miles (2,239km) of underground electricity cables.
  • 4,740 miles (7,630km) of high-pressure gas pipes.
  • 8 GW capacity of interconnectors in operation or under construction.

Why is electricity so different from gas and water?

Unlike water and gas, electricity can’t be stored at scale and must be manufactured at time of demand. Generators and suppliers trade through a competitive real-time wholesale electricity market that operates on a half-hourly basis. Trading takes place bilaterally or on exchanges, and contracts can span from on-the-day trading to several years ahead. Electricity can also be imported or exported from the continent or Ireland by interconnectors. 

Voltage must also be kept within a certain range to protect the safety of personnel and equipment. If voltage drops, Distribution Network Operators (DNOs) must act swiftly to correct it. To maintain the active (watts), apparent (kVA), and reactive (var) power of an Alternating Current (AC), DNOs perform Power Factor Correction (PFC) measures to prevent the loss of voltage and enhance the flow of electricity.

Key roles and responsibilities:

The Electricity System Operator (SO):

  • The National Grid is the ESO - the National Grid Electricity System Operator (NGESO).
  • Responsible for balancing supply and demand at the transmission level through the Balancing Mechanism (BM). Read on to learn more about the BM.

The Balancing and Settlement Code (BSC):

  • The BSC is managed by Elexon and governs electricity balancing and settlement prices, allowing suppliers to buy and sell in real time.
  • Elexon monitors the actual positions of generators, suppliers, and interconnectors against their contracted positions and settling imbalances when actual delivery or offtake does not match contractual positions.

Generators:

  • Own and operate power stations and sell electricity onto wholesale market to suppliers.

Suppliers:

  • Buy electricity from either the wholesale market or directly from generators and then sell this to firms and households in the retail

Transmission Network Owners (TNOs):

  • Own the high-voltage electricity transmission network of wires used to move electricity long distances across the country.
  • Large power stations are connected to the transmission network, and electricity substations connect the transmission network to the distribution network.

Distribution Network Owners (DNOs):

  • Own the lower-voltage electricity distribution network used to deliver electricity to consumers.
  • Responsible for connecting new sources of demand to networks and maintenance but do not manage supply and demand.
  • Connect new loads and perform maintenance, while TSOs manage the real-time flow of electricity.

Aggregators:

  • Aggregate demand or production from different sources to act as one entity to increase purchasing power and can negotiate with suppliers or network operators on behalf of consumers.
  • Can be independent or affiliated with a licensed supplier.

How is the electricity market regulated?

The electricity market is primarily regulated by the Office of Gas and Electricity Markets (Ofgem), The Department for Business, Energy, & Industrial Strategy (BEIS), the Department of Energy and Climate Change (DECC), and the National Grid (ESO). They are responsible for implementing policies, reviewing efficiency, incentivising investment in sustainability, and generally producing quality energy. The Balancing and Settlement Code (BSC) determines how energy companies operate, charge for services, and calculate how settlements are made to protect consumers.

Ofgem’s latest Electricity Market Reform (EMR) introduced a variety of new measures, such as the Capacity Market, the Capacity Mechanism (CM), the Operational Costs Levy (OCL), Demand Side Response (DSR) services, the Carbon Price Floor (CPF), Contracts for Difference (CfD), and Emissions Performance Standards (EPS).

Read on to learn more about these policies.

So, how does the electricity market actually work?

As “residual balancer” of the electricity system, the ESO must ensure supply matches demand on second-by-second basis. As electricity can't be stored at scale, the BM maintains frequency through bids and offers made by suppliers and generators on a half-hourly basis. An offer is a proposal to increase generation or reduce demand, while a bid is a proposal to reduce generation or increase demand.

Balancing Mechanism Units (BMUs) are used as units of trade within the Balancing Mechanism. If a provider consumes more power or generates less than the volume stipulated by their contract, they must cash-out to make up for the difference.

Elexon manages the BSC by monitoring the actual positions of generators, suppliers, and interconnectors against their contracted positions and settles imbalances when actual delivery or offtake doesn’t match contractual obligations. The imbalance price reflects the wholesale electricity price during any half-hour. The costs accrued by imbalances incentivise participants to be as accurate as possible when forecasting production and consumption.

Liquidity, or “churn”, is one of Ofgem’s key performance indicators. Churn refers to the amount of times electricity is produced and traded in any given period of time. Greater liquidity enables independent providers to compete with larger, vertically integrated companies. Long-term hedging products and robust reference prices play crucial roles in improving liquidity.

The Electricity Market, the Capacity Market, and the Balancing Services Market

These markets operate symbiotically to prevent grid imbalances, network disruptions, and stabilise the price of electricity.

The Energy Market (EM):

  • Where generators primarily sell their electricity (£/MWh) to suppliers so both can hedge their price risk. The EM determines which providers are dispatched at any one time and the direction of flow over interconnectors.
  • Generators and suppliers contract with each other every half hour of every day, and sometimes years in advance. Trading can continue up to one hour before each half-hour (settlement) delivery period.
  • Any discrepancies in production are reconciled and settled through Elexon.

The Capacity Market (CM):

  • Allows the ESO to buy capacity (£/kW/yr) from diverse providers ahead of delivery to maintain grid stability.
  • CM initiatives provide suppliers with a relatively reliable and fixed income to cover some of the investment costs not recoverable through the energy market alone.

The Balancing Services Market:

  • An “ancillary" market that provides reactive, short-term measures to prevent frequency discrepancies (e.g. power outages) through frequency response, reserve, and restoration services.
  • These include Demand Side Response (DSR) load shifting, Obligatory Reactive Power Services (ORPS), and Dynamic Containment (DC) services, Short-Term Operating Reserve (STOR), Static Firm Frequency Response (SFFR) or Dynamic Firm Frequency Response (DFFR), Triad avoidance, Super SEL, and Black Start.

Why are grid-balancing services important?

The Association for Decentralised Energy (ADE) estimates that 16% of the UK’s peak electricity requirement (approximately 10GW) could be provided by DSR providers, saving consumers approximately £600 million by 2020 and £2.3bn by 2035. Since 2010, 23GW of thermal capacity has been closed or mothballed, and a further 24GW of coal and nuclear capacity plants are expected to close between now and 2025.

How can I participate?

Generation contracts are awarded either bilaterally or through a competitive tender process. The amount paid for balancing services varies depending on the scheme, and contracts can range in length from monthly to annually. Certain money-saving schemes, such as Triad avoidance, often don’t require such formal contracts, and many suppliers offer pass-through contracts as part of their retail tariff so you can benefit from both peak transmission and distribution reduction strategies. For those that export electricity from generators, a Power Purchase Agreement (PPA) must be negotiated to receive payment.

What are CFPs and CfDs?

The Carbon Floor Price (CFP):

As of 2021, the UK has set its CFP for auctions at £15/tonne, but the fast-paced nature of Brexit negotiations will change this. Many economists agree that implementing CFPs are one of the single most effective ways for countries to reduce their carbon dioxide (CO2) emissions.

Contracts for Difference (CfDs):

A CfD is a long-term contract between a generator and Low Carbon Contracts Company (LCCC) that enable generators to stabilise revenues at a pre-agreed level. The charge is designed to support investment in low-carbon generation using a technology-dependent fixed price known as the "strike price" (wholesale price + top-up subsidy). CfD costs will vary annually due to wholesale price fluctuations and amount of CfD generation produced in each year.

CfD costs are met by a levy applied to energy suppliers, which are then passed on to consumers.

The Capacity Mechanism (CM)

The CM operates as an annual auction to procure the majority of the UK’s required energy capacity four years in advance. There is a top-up auction one year ahead of delivery to enable Demand Side Response (DSR) to participate. The cost of running the CM is passed through to consumers.

The Operational Costs Levy (OCL) supports the scheme. This is a fixed unit rate per kWh for each 12-month period. The full CM levy costs were introduced in 2016, when DSR participation began. For half-hourly (HH) sites, CM can be charged as a pass-through cost or consolidated in the overall supply rate. For non-half hourly (NHH) sites, CM can only be consolidated in the overall supply rate.

Why choose Nationwide Utilities?

As climate change levies, (CCL), CfDs, OCL, TNUoS, DSUoS, ESOS, and SECR rates continue to rise, it’s more important than ever to start exploring and understanding the electricity market. You may find that your business can generate substantial additional revenue through existing assets and wish to capitalise on them and reduce emissions.

The Levelised Costs of Electricity Generation (LCOE) of low-carbon generation technologies continues to drop each year, and the price difference compared to traditional generation is no longer just negligible – it’s almost non-existent. Due to the UK’s geographical location and weather conditions, wind generation and solar photovoltaics have proven to be the most cost-effective alternatives to traditional forms of generation.

Get in touch with our team of energy consultants today to learn more about eligibility and how much your business can save by engaging with the electricity and capacity markets.

What else does the future hold?

In 2019, Parliament accelerated the decarbonisation process by committing to the Net Zero by 2050 target. While our nation’s carbon emissions have fallen more than in any other advanced economy since the 1990s, there’s still much to be done. Only 5% of the energy used to heat homes is generated by renewables, and the use of electric cars must increase from 250,000 to roughly 40 million by 2050 to effectively offset our carbon emissions. Fortunately, the number of public electrical vehicle charging (EV) points has increased by 402% since 2015 alone.

Despite initial concerns, low-carbon generation is cost-effective.

In 2020, renewable electricity generation increased by almost 10%, causing the wholesale price of electricity to plummet. According to the IEA’s wholesale electricity price index, prices dropped by 28% in 2020, compared to just 19% in 2019.

Our efforts to secure a more sustainable future have already cut emissions by 850,000 tonnes of carbon in the past two years alone. Since 2015, power cuts have fallen almost 20%, and duration by at least 10%. Over a quarter of our electricity is now produced and distributed by smaller, greener providers, and the cost of transporting electricity has dropped by roughly 18% since the 1990s. Within the coming years, customers will save more than £8bn on energy bills and at least 400,000 new jobs will be created to meet our Net Zero obligations.

Bilateral Trading
  • Bilateral trading is performed through contracts held between generators and suppliers.
  • In the electricity market, master contract frameworks stipulate the terms and conditions for trading during a given period.
  • Separate trading contracts within the framework then determine the price and amount of electricity to be traded.
  • The ESO is informed of the volumes to be traded to ensure demand meets supply.
Short-Term Trading
  • Short-term electricity trading is primarily matched on two exchanges - known as APX and N2EX - and occurs through auctions at the day-ahead stage.
  • GB power contracts are also listed on the Nasdaq OMX and ICE exchanges.
  • These same-day, or day-ahead, trades occur on the spot market. An auction process matches offers from generators with bids from suppliers and larger consumers on a £/MWh basis.
  • Intraday power trading refers to the continuous buying and selling of power at a power exchange that takes place on the same day as the power delivery.
  • The ESO must be made aware of traded volumes to maintain grid capacity.
  • Renewable power producers are usually too small – in terms of installed power and trading expertise – to directly trade their produced power on energy markets. These trades are usually conducted using an aggregator, such as a Virtual Power Plant or a utility company.
  • Subsidy schemes are used to integrate renewable resources into the market, such as the Feed-In Premiums (FIP) scheme.
  • A FIP is a subsidy that is paid when power is sold on power exchanges either by the asset owners directly or by a third-party aggregator. Payment is based on a premium offered above the market price for electricity.
Long-term Trading
  • Long-term trading prices are determined according to forecasted market developments.
  • Due to the volatile nature of the electricity market, 
  • Long-term trading is mainly carried out by electricity brokers using energy market intelligence that can take into account a variety of factors that affect supply and demand. 
  • Long-term trades are often compared to Power Purchase Agreements (PPAs), as they're similarly considered private bilateral transactions between counterparties.

 

Fossil Fuels

The burning of fossil fuels still accounts for a significant proportion of the UK’s electricity generation. This power is mainly produced through combustion of natural gas in thermal generators (32.3% in 2018). However, coal and oil still play a diminishing part in production (4.3% combined in 2018).

Nuclear

Nuclear electricity generation is achieved by splitting uranium atoms to produce heat in a process called fission. This heat is then used to produce steam which drives turbines in generators.

In 2018, 14.8% of our electricity came from nuclear reactors. This proportion is expected decrease over the next few years, with all but one nuclear power station expected to close by 2025. However, there are plans to build a new generation of reactor which could be operational by this time.

Renewable Electricity

Renewable energy technologies use free, natural resources to produce electricity sustainably. Sources include wind, solar, wave, marine, hydro and biomass. In 2018, the combined electricity production from these sources was 26.6%. This comprised of wind and solar 17.6%, Biomass 7.6%, combined hydro sources 1.4%. The proportion of the UK’s renewable energy is set to increase as we aim to meet the EU target of 30% by 2020.

Electricity Imports

The UK relied on electricity imports for 4.78% of its power in 2018. This was carried by undersea cables called interconnectors, which transmit high-voltage power from Europe.

Currently there are four interconnectors to the UK. One from France and 1 from Belgium, with another two connecting mainland Britain with Ireland and Northern Ireland.

There are plans for an additional six electricity interconnectors to Norway, Denmark, Germany, France and Ireland. With three more already contracted to Norway, Belgium and France.

With these extra interconnectors online, it will increase our security of electricity supply and is likely to drive wholesale prices down, leading to cheaper energy bills for consumers.