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The British Energy Market Reform: Carbon Prices, Retail Tariffs, and Cost Pass-through

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Guo, Bowei 


The United Kingdom’s (UK’s) Climate Change Act 2008 sets a “net zero” target on greenhouse gas emissions by 2050. The Act has triggered the Electricity Market Reform (EMR) started in 2013, which aims at decarbonising electricity supply, ensuring the security of supply, and minimising the cost of energy to consumers. This thesis focus on policies and instruments that support the EMR. Chapter 1 provides a review of the UK’s Climate Change Act, with a focus on the energy sector. Chapters 2 and 3 focus on the British decarbonisation policy levied on the electricity sector. Chapter 4 studies competition in the wholesale electricity market, to investigate the existence of market power. Chapter 5 examines the impact of dynamic retail tariffs and demand response, which are possible instruments to secure electricity supply. Chapter 6 concludes.

Decarbonisation requires increasing the capacity of renewable energy to phase out carbon insensitive fossil plants, and the British Carbon Price Support (CPS, a carbon tax) gives adequate, credible and sufficiently durable carbon price signals for low-carbon investments. Chapter 2 studies the impact of the CPS on the CO2 emission reduction of wind in the Great Britain’s (GB’s) electricity market. We show how to measure the Marginal Displacement Factor (MDF, tonnes CO2/MWh) of wind. The short-run (SR) MDF is estimated econometrically while the long-run (LR) MDF is calculated from a unit commitment model of the GB system in 2015. We examine counter-factual fuel and carbon price scenarios. The CPS lowered the SR-MDF by 7% in 2015 but raised the LR-MDF (for a 25% increase in wind capacity) by 18%. We discuss reasons for the modest differences in the SR- and LR-MDFs.

Being a unilateral carbon tax, the CPS can distort electricity trade with external markets. Chapter 3 shows how to estimate the deadweight cost of the distortion and possible external global benefits from reduced emissions, and investigate econometrically the impact of the CPS on GB’s cross-border electricity trade with France and The Netherlands. Over 2015-2018 the CPS raised GB day-ahead electricity price by about €11/MWh, after allowing for replacement by cheaper imports. It raised French wholesale prices by 3.5% and Dutch wholesale prices by 2.8%. The CPS increased GB imports by 12 TWh/yr, thereby reducing carbon tax revenue by €100 m/yr. Congestion income increased by €150 m/yr, half transferred to foreign interconnector owners. The unilateral CPS created €80 m/yr deadweight loss, about 32% of the initial social value created by the interconnector, or 4% of the global emissions benefit of the CPS at €2 bn/yr. About 0.9% of the CO2 emission reduction is undone by France and The Netherlands, the monetary loss of which is about €18 m/yr.

Cost pass-through rates give a useful perspective of market competition, which determines whether consumers are overwhelmed by the market power. Chapter 4 studies how generation costs are passed through to electricity wholesale prices in GB between 2015 and 2018. Our empirical results fail to reject 100% pass-through rates for gas prices, carbon prices, and exchange rates, indicating a competitive GB wholesale electricity market. We observe higher pass-through rates in peak compared to off-peak periods, because generators bidding at a lower rate during off-peak periods to supply at minimum load to avoid the cost of shutting down and starting up. We extend the argument by assessing generators’ bidding behaviour. The study also considers how two key events occurred during the examined period – the drastic decline in the GBP/EUR exchange rate since the Brexit referendum, and major reformation of the EU Emissions Trading System – have affected the electricity bill to a typical domestic household, showing that they have increased the average annual bills by €49(£41)/year/household, or a 7% rise.

Finally, one possible solution to the security of electricity supply is demand response, which is usually achieved through dynamic tariffs by offering consumers financial incentives to shift or reduce peak load to off-peak periods. In Chapter 5, we construct an agent-based model in which the retailer sets dynamic tariffs to maximize profit, and consumers respond to the prices. The model suggests that in the baseline scenario, the dynamic tariff would generate for the retailer an additional €7.35 of annual profit from the average household. For a firm equal in size to British Gas in 2017, this is equivalent to €40 million of total benefit. With market regulations, the dynamic tariff will benefit consumers and retailers alike, resulting in a win–win condition. We also find that the interaction between demand-side management stimuli and market regulation can further reduce consumer-level electricity demand, increase retail profit, and lower consumers’ electricity bills.





Weeks, Melvyn


energy market reform, carbon tax, cross-border trade, cost pass-through, dynamic electricity tariff, demand response


Doctor of Philosophy (PhD)

Awarding Institution

University of Cambridge