Local grid pricing risks net zero transition, warns EUK

Moving from the existing one-size-fits all wholesale electricity market to more locally specific pricing arrangements could pose a “considerable risk” to the transition to net zero, Energy UK (EUK) has warned.

The trade association has sounded the alarm ahead of the government’s upcoming second consultation into its Review of Electricity Arrangements, which has been promised before Christmas.

Under locational marginal pricing (LMP), the wholesale market would be broken down into a plethora of nodes or zones, with the aim that prices will better reflect the varying costs of producing and transporting electricity in different areas.

The EUK paper says that before overhauling the wholesale electricity market, there should be a thorough analysis of the alternative options.

It warns that a “fundamental change” to the wholesale market’s design could lead to an investment hiatus, which could increase the costs of projects or reduce the number that come forward.

It adds that LMP will increase uncertainty by making it harder to forecast prices and returns in small zones or nodes. Consequently, EUK warns this could increase cost of capital by up to three percentage points, making it more expensive to finance projects.

These increases could, according to one study cited in the paper, increase the cost of the consumer of LMP by £28 billion.

In addition, the potential for lower expected returns could undermine the economics of projects, leading to fewer assets being built, says the paper.

It adds: “If LMP leads to a significant fall in investment, this will jeopardise our ability to build the generation capacity and infrastructure needed to decarbonise the power system and wider economy, putting the Net Zero transition and the UK’s climate leadership at risk.

“Introducing LMP would represent a fundamental shift to existing arrangements, bringing with it the potential for considerable risk, including for the transition to net zero. Such radical change requires a high evidence threshold and a robust case.”

Given these “substantial risks”, any study making the case for the introduction of LMP should be able to provide “irrefutable evidence” that investment would not be damaged as a result, EUK says.

It says that other mechanisms should be explored, such as improving the system’s balancing mechanism, which already dispatches assets based on their location relative to where constraints exist.

And it says any move to implement LMP will require some, if not most, existing generating assets, having their current market arrangements preserved or ‘grandfathered’.

The EUK paper also says that if transmission infrastructure is developed ahead of need, as the government is pressing for, network constraints are “likely to be less of an issue”, which will have a knock-on impact on the overall value of implementing LMP.

The Energy UK paper follows the publication of a report last week by the Scottish Future Trust, which warned that moving towards LMP could stunt investment in major new wind projects in Scotland.

The warnings against LMP comes just weeks after Ofgem threw its weight behind the proposal. In its own evaluation, the regulator concluded that “all or most” consumers would be better off from full exposure to locational pricing when compared to the status quo of national wholesale power pricing.