Locational power pricing would make market liquidity ‘even worse’

Dividing the UK’s power market into a series of smaller zonal or nodal markets would make the existing problem of poor liquidity “even worse,” an industry figure has warned.

Mark Owen-Lloyd, director of the Botley West solar project, urged policymakers not to head down the “rabbit hole” of locational pricing and instead focus on measures that can bring to an end to the continued market dominance of large legacy generators.

Although he is now focused on delivering the 840MW Botley West solar farm being developed by Photovolt Development Partners in Oxfordshire, Owen-Lloyd has spent much of career working in energy trading, including heading up Eon’s power trading team between 2006 and 2010.

“When I was at Eon, I was our representative at the UK Power Trading Forum and we spent years working with Ofgem to try and improve the liquidity and the stability of the UK wholesale power market, which is a serious problem,” he recalled.

Owen-Lloyd said Britain’s European neighbours – France, Germany and the Nordic and Low Countries – all have “highly liquid” forward markets but: “The UK has none of that. It’s a physical market. It’s dominated by the large generators.”

“At the moment, if you want to trade UK power, you have to have the ability to deliver it physically and you have to deposit cash with at least one of the big traders like Eon,” he explained. He said many of the banks that were once trading energy left the market following the 2008 financial crash, meaning “it’s still dominated by the Eons and SSEs of this world.”

He said the UK’s “opaque” forward market, characterised by bilateral over-the-counter trades, is significantly less efficient than the more exchange-based markets on the continent.

As part of its ongoing Review of Electricity Market Arrangements, the government is considering the introduction of locational power pricing, whereby wholesale prices would vary across a series of geographical zones or a larger number of nodes on the power grid. These prices would reflect the balance of supply and demand in each location, meaning customers in areas with surplus renewable generation could take advantage of cheap electricity when the wind is blowing and the sun is shining.

Supporters claim locational pricing could save tens of billions of pounds in constraint payments and network reinforcement costs by improving the efficiency the electricity system and incentivising the co-location of generation and demand. Critics argue that these benefits are overstated and that introduction of locational pricing would bring massive disruption and uncertainty for investors.

Utility Week understands that the government officials have taken nodal pricing “off the table” but is still considering zonal pricing as well as other, less radical, market reforms.

Owen-Lloyd said locational pricing, whether nodal or zonal, would exacerbate the existing problem of poor liquidity in Great Britain’s national wholesale market: “If you then chop up the liquidity into zones and put in lots of new products, you’re going to make it even worse.

“It’s great in theory, it looks superb in a presentation, but in reality, it will make the wholesale market harder to trade.”

Instead of going down this “rabbit hole,” Owen-Lloyd said the government should instead focus on flooding the market with new renewable generation that is not controlled by the large, legacy energy firms: “When I was at Eon, we had a really dominant position in the market. I could turn Ratcliffe on and off and it caused significant effects to the market and Ofgem and the FCA allowed me to do that as long as I told people half an hour after I did it.”

“I think fragmenting the power market into lots of renewable assets will help because that reduces their dominance,” he added.

Owen-Lloyd said one of the reasons for greater liquidity in European market is the higher degree of interconnection, something which the UK could do with more of: “In the last 10 years we’ve built a lot of interconnectors capacity but l we still need to do to do more and really reform of the wholesale markets and make it easier for people to gain access to it.”

“I think the answer is more interconnectors, more actively traded, increased liquidity and a financial market,” he concluded. “And I think renewables will help.”

Octopus Energy, one of the most visible proponents of locational pricing, has argued that national pricing can often result in interconnectors exacerbating network constraints, for example, by incentivising exports to France when there is already insufficient generation in the south of England.

For this reason, Ofgem recently declined to provide ‘cap and floor’ support for six interconnector projects with a combined capacity of 7.5GW.