Local electricity pricing ‘would cut £2.1bn a year from system costs’

Wholesale electricity prices should be set locally instead of nationally, an influential right-of-centre thinktank has urged.

In a new report, entitled Powering Net Zero, the Policy Exchange also calls for reforms of both the Contracts for Difference (CfD) and Capacity Market regimes.

The report recommends the introduction of local pricing in the electricity market, following the examples of US states like California and Texas.

This would result in electricity prices varying across Great Britain, depending on local supply and demand for electricity.

Lower electricity prices in parts of the country which are close to abundant renewable power resources, like Teesside, would also encourage energy intensive industries to build factories and data centres there, the report claims.

Initially, it says residential and small business customers should be charged a regional electricity price unless they opt into local pricing. Over time, the government should aim to extend local pricing to all customers.

Regional differences in electricity prices could be offset by government using fixed credits and charges on residential and small business customers’ bills.

Modelling by Aurora Energy Research, commissioned by Policy Exchange, estimates that localised pricing would mean reduce system costs by £2.1 billion per year, saving the average household £37 every year,

“By showing customers and energy suppliers the true cost of electricity, the government will give customers and suppliers the motive and the means to react, lowering costs for everyone,” says the report.

It recommends kicking off local pricing in April 2026.

The report also backs a reform to the CfD subsidies so that developers would be offered a guaranteed annual minimum payment rather than a long-term fixed price.

By increasing the exposure of owners of wind and solar farms to market signals, they would be encouraged to build projects in places closer to concentrations of demand, therefore reducing transmission costs.

To speed up deployment, the government should run CfD auctions annually and at the same time as those for the Capacity Market auctions so that it is easier to combine the two regimes in the future.

Existing renewable energy generators should be allowed to compete for one-year CfDs once their existing support contracts end to ensure they are not decommissioned prematurely.

The government should “radically simplify” the CfD scheme by scrapping delivery years and price caps for established technologies and allow project developers to nominate their own “load factor”.

The planned 2021 CfD auction should be the last one held under the current rules, according to the report.

The third main plank of the report’s recommendations is a reform of the Capacity Market to include a quota for new low-carbon resources, such as gas plants fitted with CCS, low-carbon hydrogen, geothermal and “ultra-long” duration energy storage technologies.

The Capacity Market should also be amended to include regional capacity pricing, such as that operating in New York State’s market.

The first Capacity Market and CfD auctions under the new rules should be held in late 2023.

Longer term, market competition should play a bigger role in the electricity system, reducing the role of the government and Ofgem, says the report: “The recommendations in this report will put the government on a path to less intervention in the electricity sector without risking much-needed investment in the UK’s renewables sector.”

Ed Birkett, senior research fellow at Policy Exchange and author of the paper, said: “Local electricity pricing would fundamentally change the way that power stations, wind farms, batteries and large customers interact with the electricity market. It would encourage power stations to switch on when there’s a shortage in their area, and it would encourage large customers like data centres to use more electricity when their area is oversupplied.

“Energy costs are a big concern for UK manufacturers. With local pricing, companies along the UK’s coastline could benefit from really cheap electricity from offshore wind farms when it’s windy. This could provide a huge boost to green manufacturing in the UK, helping to level up places like Humberside, Teesside, South Wales, and Grangemouth.

“With local pricing, it needs to be designed so that it works for residential customers. We’ve proposed a gradual introduction and a system that would mean that each region of Britain will have the same average electricity bill.”