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The zonal pricing face-off
Utility Week brought together proponents and critics of locational pricing to air their differences. Here are the main talking points.
Is the energy market really broken?
There are few topics, if any, that have been more hotly debated within Britain's energy industry in recent years than the potential introduction of some form of locational wholesale electricity pricing. The debate has only grown more intense, spilling out into the public forum, as we head towards a final yes or no decision this summer.
But, as pointed out by Guy Newey, chief executive of the Energy Systems Catapult and a long-time proponent of locational pricing, much of the back and forth has so far taken place at a distance through op-eds, news articles and social media posts. Hence Utility Week brought him and several others together for a proper head-to-head debate.
Joining him to argue in favour of zonal pricing – the version still on the table since more granular nodal pricing was ruled out in March last year – was Rachel Fletcher, director of regulation and economics at Octopus Energy. On the opposing side were Johnny Gowdy, a director at Regen, and Graham Pannell, head of grid and regulation at BayWa r.e..
A key theme throughout the discussion was the relationship between the build-out of the transmission network, or lack thereof, and the benefits case for zonal pricing.
In proposing zonal pricing as part of its Review of Electricity Market Arrangements (REMA), Gowdy said the government had “rather leapt to the conclusion that the energy market was broken” when one of the main problems – rising constraint costs – is primarily the result of the “failed” Connect and Manage approach to the deployment of renewables and a decade of underinvestment in the power grid. Gowdy said strategic planning and connections reform will hopefully allow the industry to get on top of these issues “but over the next five years we’re still catching up”.
He said: “Even with the best will in the world, zonal pricing is not going to come in for at least five years, and probably into the early 2030s, by which stage one would hope that we've managed to get our act together in terms of transmission network investment.”
Echoing Gowdy’s comments, Pannell said there is currently more than 15GW of wind generation in Scotland but just over 6GW of transmission capacity – and often less due to outages – across the B6 boundary between Scotland and England. He said the two Eastern Green Link bootstraps could by themselves cut constraint costs by several billion pounds per year.
The projects were originally proposed around a decade ago but the first only began construction earlier this year. If they had been given the green light sooner “then we would not be paying those constraint costs this year and last year,” said Pannell. “The point about constraints is to have the right level of forward planning to balance the generation with the transmission capacity.”
Some of the fiercest debate so far has been over the cost-benefit analyses that have been conducted by various consultancies, and in particular the assumptions they have chosen. “Depending on which consultancy, which report, which model you look at, you get a completely different range of numbers from a net gain to a net cost to the consumer,” said Gowdy.
“What that reveals principally is that the benefit case is entirely sensitive to the assumptions that are made, particularly the assumptions around the build-out of renewable generation and the aligned or not build-out of network capacity, including interconnectors. That's what's really driving the zonal benefits case; it's the level of constraint that we are building into our future system.”
Fletcher partly agreed, saying analysis that assumes there is a “massive transmission build out... not surprisingly comes up with... much lower benefits from zonal pricing”.
But she asked: “Do you think that we can build enough transmission so that we don’t have significant constraints in our market? And is that the right thing to do?”
“Personally, I think we shouldn’t build any more transmission than we really need. If we can find a cheaper way of managing our energy balance, that’s what we should do.”
Newey said this conversation highlights an underlying issue as to what extent the build-out of the electricity system is driven by central planning or markets. He said the Energy Systems Catapult has long been an advocate for better strategic planning at the national, regional and local levels, but: “We should plan what we have to and everything else should be in markets. And where they draw that line is where the political debate, and actually where the zonal debate, will come going forward.”
“We shouldn’t build any more transmission than we really need. If we can find a cheaper way of managing our energy balance, that’s what we should do.”
Rachel Fletcher, director of regulation and economics, Octopus Energy
The actual options
Gowdy said the decision facing ministers is one he is glad he does not have to make but opting for zonal pricing would be much easier “if there was a compelling business case, and indeed a compelling design, that everyone could get behind”.
He said the claimed benefits of zonal pricing are “not actually game changing” and must be weighed against the possibility of increased financing costs or a hiatus in investment just as the industry is trying to ramp up: “At a time when raising billions of pounds of investment is absolutely key, the one thing we could all say is that now is not the ideal time to do a radical market redesign.”
Gowdy said the argument for taking such a risk “would be much more compelling if we didn’t actually look at the zonal design that is on the table... We’ve seen very little of the design but what we have seen... doesn’t look or feel like the sort of forward, progressive design we would want. In many ways, what we’ve seen is a hark back to a predominantly day-ahead centralised market” with “network capacity allocation by the system operator".
“In fact, it feels like a design for system operation, reducing re-dispatch, rather than the consumer-centric, agile, flexible design of the future.”
“It’s not a design that I would bet the house on," he concluded.
Newey accepted that the government needs to provide much more clarity on how exactly zonal pricing would work, including the grandfathering arrangements and how the zones themselves would be determined. However, he argued, it is similarly the case that there is no agreement on what the counterfactual of a reformed national market would look like.
“I hugely admire Johnny and his team's effort to really engage with what the alternative is going forward and the vast majority of things that he proposes I'm super supportive of as well," he remarked.
But he said: “We’ve been at this for three or four years and no consensus has emerged on what the alternative to zonal will be.”
He said this “raises the suspicion” that many opponents merely want to stop zonal pricing and then “chip away at TNUoS [Transmission Network Use of System charges] in the same way that we’ve chipped away at it for the last 10 years.”
Newey expressed scepticism that more industry players would be willing to back zonal pricing if there was a more complete design. He asked why they themselves hadn’t come forward with something that would work for them.
“To be frank,” Gowdy responded, “the industry hasn’t had the opportunity to present that, and in any case, it’s really up to the government and its agencies... to come up with that design and present it to industry.”
He said the current “very sketchy design, predominantly based on the Nordic model,” is “very disappointing.”
“Now that could be worked up. It could be improved. It could be changed. But we're certainly not at a point where you could make a decision based on the current design and say, right, that's it; that's us for the next 10 or 20 years.”
There was consensus among the speakers that not enough is being done now to address network constraints and operational issues through measures such as reforms to the Balancing Mechanism and the introduction of constraint markets, intertrip services and dynamic line ratings.
“It's extremely worrying that I think we've got one transmission line in the whole country that has got a dynamic line rating,” said Fletcher. “I was in France. They were flabbergasted at the little amount that we are doing.”
Given this lack of progress, she said: “I’m afraid I feel less confident that, through a series of reforms, we’re going to get anywhere close to dealing with the constraint issue that we’ve got, and that is growing.”
She said Octopus is one of two suppliers taking part in the new local constraint market and “it’s only contracted 200MWh in the context where we’re constraining off 800,000MWh a year.”
Fletcher said that “we are kidding ourselves” to think that “the pace at which we can make these piecemeal reforms is sufficient to deal with the juggernaut effect of constraints that’s coming down at us.”
Annual constraints
The challenges of implementation
When asked about her previous comments to Utility Week that zonal pricing could be implemented in a little as two to three years, Fletcher said: "Nodal pricing, which is orders of magnitude more complex, has been introduced within four years in other jurisdictions.”
She said: “Unlike the incremental reforms that we are shockingly bad at as an industry, zonal would be a top-down, legislatively determined process that we'd all then have to get behind, a bit like we did with [Electricity Market Reform]...
“I'm not for a moment claiming it would be simple or straightforward... But actually, as an industry, we have good form in - once government has made a big decision about the direction of travel - falling into line, rolling up our sleeves, working in different, parallel work streams, and thrashing out the details”.
Although other countries have made the transition to nodal pricing in a shorter time timeframe than currently proposed by the government for zonal pricing, Gowdy said his understanding is that “most of those were going from some form of a central dispatch, pool-based market, or a zonal market, to nodal”.
He said Britain instead has a decentralised market with tens of thousands of power purchase agreements (PPAs) in place and almost 8,000 energy assets connected to distribution networks.
Pannell said “every single” one of these PPAs would need to be renegotiated: “It’s a major undertaking.”
Gowdy said an issue that would need to be thrashed out, and has received “very little” thought so far, is to what extent domestic consumers would be exposed to zonal prices.
As zonal prices would be driven by network constraints, "and those constraints will change radically as we transition, ...we could easily see a consumer backlash, which is exactly what’s happened in Norway over the last six months where the zonal pricing model has been radically interrupted and changed by two new interconnectors”.
Fletcher said her own “hunch” is that the government would retain a single electricity price for consumers: “Just because there's differential consumer prices in Norway across north and south doesn't mean that there would be in Britain.” In Italy, for example, which also has zonal wholesale pricing, “customers across the whole country face the same price”.
Despite the backlash, Fletcher said Norway has not abandoned zonal pricing: “It simply allowed customers to opt out from being exposed to zonal differences. But all market participants still face the price signal.”
In response, Pannell asked how insulating consumers from zonal pricing would affect the benefits claimed by supporters.
Fletcher said: “What's really important for the demand side is that those purchasing for consumers face the within-day price as it varies from Scotland down to the South East, because it's the within day price that provides the operational signal...
“That's the kind of locational price signal that we need, and that matters, and that drives the majority of the benefits of zonal pricing; not the fact that customers in the South East, on average across the year, might pay a bit more.”
However, Newey took a different tack, saying we should not shy away from having some price variation across the country: “We have different prices for different things across the country already, right? Housing primarily responds to supply.”
He said the politics may be difficult but this an argument that could be won: “Of course we can, because it’s happened in loads of other countries.”
