Government should ‘look again at zonal pricing post 2035’

The government should delay the introduction of zonal pricing until after 2035 once the equipment needed to decarbonise the power sector has already been built, its former head of energy strategy has argued.

Adam Bell, director of policy at the consultancy Stonehaven, said this would prevent an investment hiatus as feared by many renewable developers, whilst ultimately delivering many of the benefits touted by its proponents.

Last week, the Department for Energy Security and Net Zero (DESNZ) launched a second consultation for its Review of Electricity Market Arrangements. It revealed it is still considering the introduction of zonal power pricing, which would see wholesale power prices vary across a series of regional zones bordered by major bottlenecks on the power grid.

However, the department ruled out the option of more granular nodal pricing, whereby power prices would differ across hundreds of nodes on the transmission network. DESNZ said this option would be too difficult to deliver and would create substantial risks for investors who would be more hesitant to part with their cash and would demand higher returns to reflect their heightened uncertainty over future power prices.

Supporters of locational pricing, whether zonal or nodal, claim it would save billions of pounds over the coming decades by improving the efficiency of the electricity system, cutting network and constraint costs, and allowing consumers to take advantage of cheap electricity in areas with surplus renewable generation. They say it would also solve the problem of interconnectors “flowing the wrong way”.

Commenting on the government’s position, Bell said much of the debate around locational pricing has focused on interconnector flows and rising network constraint costs. He said zonal pricing would help to resolve these problems, although to a lesser extent than nodal pricing.

Bell agreed that nodal pricing would make it more difficult to attract investment at the speed needed to meet the UK’s climate targets: “If you don’t know what the price is you’re going to get for your energy over the next ten years because the government’s reforming the market, you’re probably not going to build.”

“Zonal pricing has the exact same issue, albeit to a less extreme degree,” he added. “You’ll know there’ll be a single price in a particular zone. You’ll probably be able to guess at that price given whatever assets are there. But it’s still not as clear cut as having a track record of a good decade-and-a-half of price data you can go back to and say: ‘This is probably what’s going to happen and therefore this is what my asset is going to make.’”

Bell said zonal pricing “looks really challenging” given the need to deliver “a lot of infrastructure very quickly”. He said this impetus would be particularly strong for a Labour government, which would be aiming to achieve a net zero power sector five years earlier than the current government’s target of 2035.

He suspects the government has only kept zonal pricing on the table to prevent an immediate backlash from supporters: “I expect it therefore to slowly die a death over the next six months to a year, but we will see.”

However, Bell also suggested that the government may want “look again at zonal pricing post 2035, once you’ve got all the kit ready”.

“To me that sounds like a fair way of approaching this problem,” he explained. “It still sorts some problems quite nicely for you… but it stops you from losing out on all the investment you require in the short run.”

In the meantime, Bell said officials should focus on alternatives such as reforms to the Balancing Mechanism and network charges: “My view is that you could probably send more operational signals with network charges as you do already to a degree on the demand side.”

He said there could also be “auctions for access to the network as you do with the gas network already, which gives you a short-run signal for when you should be seeking to dispatch your power.”

Bell said Ofgem is already reviewing network charges but conceded “of course, it’s Ofgem, so we’ll see how bold they’re willing to be.”

Tom Luff, practice manager for electricity markets policy at the Energy Systems Catapult, expressed scepticism about network charging reforms, noting that “we’ve been trying to do that for decades and it keeps getting pushed into the long grass.” And he disputed Bell’s suggestion that the government is only keeping zonal pricing on the table for show.

Luff said zonal pricing would resolve multiple problems with the current market arrangements, which “everyone agrees” are “not fit for purpose”.

“We’ve got interconnectors flowing the wrong direction when we need them the most,” he told Utility Week. “We know when there’s a lot of wind in Scotland that pushes down national prices, and then that can mean that electricity, which can’t get down from the North to the South, gets sold to France or to other neighbours. And this is really a problem for the risk of outages, especially around London and the South East.”

Luff also highlighted the potential benefits of zonal pricing for energy intensive industries: “Industrial prices are around 1/3 higher than other major comparable economies over the past decade and that is a big problem.”

He said zonal pricing would mean “overall average prices for all consumers would go down and in some parts of GB we’d likely have the cheapest power in Western Europe.”