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Zonal pricing on trial
The debate over zonal power pricing has been raging on within the energy industry for several years now. Until now the conversation has largely been conducted between the entrenched positions of industry experts. But how do these arguments land with people outside the sector? To find out, Utility Week invited a supporter and an opponent to put their cases to a ‘jury’ made up of people from trade bodies, local authorities, charities and campaign groups.
By Tom Grimwood, insights editor
Zonal pricing on trial
The debate over zonal power pricing has been raging on within the energy industry for several years now. Until now the conversation has largely been conducted between the entrenched positions of industry experts. But how do these arguments land with people outside the sector? To find out, Utility Week invited a supporter and an opponent to put their cases to a ‘jury’ made up of people from trade bodies, local authorities, charities and campaign groups.
By Tom Grimwood, insights editor
The defence
Presented by: Sarah Honan, head of policy, Association for Decentralised Energy (ADE)
Honan set her arguments in the context of rising constraint costs, noting they are expected to reach £3 billion per year by 2030. She said already this year the National Energy System Operator (NESO) has spent £400 million “turning down wind in the north and turning up gas in the south.”
She told the jury that zonal pricing would send better operational signals to generators and consumers to produce and use energy efficiently, reducing constraint costs.
The defence
Presented by: Sarah Honan, head of policy, Association for Decentralised Energy (ADE)
Honan set her arguments in the context of rising constraint costs, noting they are expected to reach £3 billion per year by 2030. She said already this year the National Energy System Operator (NESO) has spent £400 million “turning down wind in the north and turning up gas in the south.”
She told the jury that zonal pricing would send better operational signals to generators and consumers to produce and use energy efficiently, reducing constraint costs.
“It's the best thing to put power back in the hands of consumers through innovative offerings, the ability to be flexible and the ability to have some control over those things that are now fixed costs on their bill.”
Making their case to the public, opponents have framed zonal pricing as a “postcode lottery” - an argument which Honan raised herself and then tackled head on. She said households already face regional disparities of up to £130 on their annual bill as a result of network charges “and customers have no way of controlling that for themselves".
She added: “What zonal aims to do is bring down the entire country's electricity bill so even though there are differentials between zones - at least by Ofgem’s estimation in 2022 - all, if not most, consumers would be better off in a zonal market. And their estimation said that the differences between zones would be on average about £10 per year so this isn't a radical shift.”
Honan also challenged the argument that the introduction of zonal pricing would deter investment in renewables: “We haven’t seen this in other global markets that have started to move to zonal pricing. Lots of countries around the world already have this.
“Australia’s had it for well over 20 years. Most American states have had it for well over 20 years. Denmark, Norway, Sweden – all the countries that have made the best inroads to homegrown electricity have this. And they’ve not seen a landslide in investment.
“And that’s not even taking into account that we do have some of the most attractive packages of government support for renewables anywhere in the world.”
Lastly, Honan said that zonal pricing would ensure that the UK avoids “gold plating the grid and building more wires than we need to."
“Make sure the system we have works better for consumers and for demand up and down the country, rather than putting up more overhead power lines, which we all know is not politically sound,” she urged.
“(Zonal pricing) is the best thing to put power back in the hands of consumers.”
The prosecution
Presented by: Graham Pannell, head of grid and electricity regulation, BayWa renewable energy
Pannell began his case to the jury by emphasising his company’s global footprint, developing and operating renewables in 30 markets around the world, both with and without zonal pricing.
He said their experiences suggest zonal pricing will not reduce prices, noting the example of Italy, which has zonal pricing but also some of the highest electricity price in Europe. He added: “That's not to say those two things are necessarily linked, but it's clearly not true that zonal pricing in Italy has magically reduced bills.”
The prosecution
Presented by: Graham Pannell, head of grid and electricity regulation, BayWa renewable energy
Pannell began his case to the jury by emphasising his company’s global footprint, developing and operating renewables in 30 markets around the world, both with and without zonal pricing.
He said their experiences suggest zonal pricing will not reduce prices, noting the example of Italy, which has zonal pricing but also some of the highest electricity price in Europe. He added: “That's not to say those two things are necessarily linked, but it's clearly not true that zonal pricing in Italy has magically reduced bills.”
Pannell said zonal pricing has also proved politically contentious, pointing to the example of Norway, where the recent installation of new interconnectors with Denmark and Great Britain has pushed up prices its southern zone: “It’s become political with the people of Norway. It certainly became a feature of the recent election. People found it unfair and the Norwegian government felt compelled to effectively offer the option of a national fixed priced to recover that unfairness.”
He insisted that cutting up the national market into a series of smaller zones will also reduce competition and liquidity, giving individual players more market power within each zone and increasing volatility and uncertainty.
Pannell equated zonal pricing with using “sledgehammer” to resolve the problems with Britain’s electricity system, when a “scalpel” – more targeted interventions – would “get the best value this decade.”
He warned the long implementation timescales for zonal pricing would mean any benefits it did bring would not start to be realised until the 2030s: “It will involve a definite cost this decade of more expensive generation for contested possible jam tomorrow.”
The main underlying problem that needs to be resolved for Pannell is the lack of sufficient grid capacity, particularly to transport power from north to south. He said there is currently around 16GW of wind generation in Scotland whereas NESO considers a manageable grid capacity out of Scotland into England being around 11GW to 12Gw.
“The current boundary flow capacity is six, which is an embarrassment, and in fact under windy conditions, the system operator tends to throttle that back to five and half. What we have is half the amount of economically rational wires to carry cheap clean energy to where people need it.”
He went on: “Roughly for every pound you spend on wires at that border you save £10 in constraints. And if you get the constraint down to a sensible small figure, we’re probably not even having a conversation about zonal pricing.”
“It will involve a definite cost this decade of more expensive generation for contested possible jam tomorrow.”
Cross examination
In the second part of the session, the jury was invited to pose questions to our experts. One of the first questions concerned how the boundaries of zones would be drawn and whether this would support local electricity generation. Anna Railton, deputy leader of Oxford City Council, asked whether there was any possibility that her constituents might end up in different zones.
Honan explained that the zones would reflect where the transmission constraints are today and what they’re projected to develop into in the future. “The more abundant generation you have in a zone, the cheaper prices will be because you won’t have to import from other zones.”
Pannell confirmed that they will be “largely aligned with transmission networks so major cross-GB limitations in getting cheaper power to where people need it.” Alluding to their size, he said south Oxfordshire, London and Swansea might all be put in the same zone.
Colin Chick, director of economy, environment and infrastructure at Gloucestershire County Council, said the arguments they presented suggested that there needs to be greater alignment between the build out of the electricity and long-term strategic energy plans. Both speakers agreed and outlined the development of a Strategic Spatial Energy Plan and Regional Energy Strategic Plans.
Will zonal save customers money?
One of the main issues raised by the jurors was how zonal pricing would affect different types of customers, particularly those that are vulnerable. Siobhan O’Loughlin, head of impact at the Fuel Bank Foundation, asked whether those who are unable to invest in home energy upgrades to respond to price signals would be left at a disadvantage. Giving the financial pressures currently being faced by many households. She also asked whether they would be better off under zonal or national pricing in the short term.
Pannell claimed the only winners under zonal pricing would be customers in Scotland and that the benefits of reforms to the national market could be delivered much sooner.
In response, Honan acknowledged that zonal pricing would not provide immediate benefits to customers but said the wait would be worthwhile: “The conversation we’re having here is about creating the energy system for the future.
“The one we have now was a built around a handful of fossil fuel generators at the turn of the century. It never envisioned a world of millions of assets, millions of homes and businesses, all participating in keeping our system stable so why should we expect it to work for them?”
She also questioned whether reforms to the national market can really be delivered sooner. She noted that reforms to network charges – one of the proposed alternatives - “have been going on for the last decade and it’s got us to a place where actually everyone is angry with Ofgem’s decisions; not just generators; not just suppliers; everyone.”
She said having faith in the ability of the industry to reform the national market “when that is essentially what we’ve been trying to do for the last decade to 15 years is, I think, optimistic”.
Whether in a zonal or national market, they both agreed that there should be price signals that rewards customers from providing flexibility, and that vulnerable should be given support to respond to, or protect them from, these signals.
However, Panell said these should come in the form of “more granular time-of-use signals.”
“Demand flexibility is an absolute slam dunk,” he added. “It blows out of the water most of the stuff we’re talking about. Enabling small users to be aggregated... to have virtual power plant aggregation, that gives you the most efficient system overall, and simply my argument is that can be done through the Balancing Mechanism... You don’t need to rip up the wholesale market.”
Honan countered: “The system and the rules were not written with consumers in mind. They were written around generators and changing them one rule at a time has been exhausting and gotten us not very far.”
She said she “wholeheartedly agrees” that time-of-use signals are important but “what a zonal market would do is heighten those signals.” She said if time-of-use signals are national, the responses from consumers in some parts of the country may actually be detrimental for the grid due to constraints: “It’s about combining those two signals so that they are clear, or as good for the overall system, as possible.”
Honan also suggested that some vulnerable customers may actually be well placed to respond to price signals because in many cases they have set routines and needs so their usage can be more accurately predicted.
Will zonal save businesses money?
There were also similar questions about the impact on businesses and to what extent they may be willing or able to locate in areas with lower prices.
Honan made clear that she did not expect companies to move already established operations across the country. But she said new and growing business may be willing to set up in zones with low electricity prices, giving the in-vogue example of data centres.
She acknowledged that zonal pricing is “exceptionally controversial” within the business and industrial community, including among their own members, but said the ADE believes it will lower bills across the country and not just in the cheapest zones.
However, Pannell claimed zonal pricing will increase costs in areas where British industry is concentrated, making it less competitive internationally and putting thousands of jobs at risk. He pointed out that zonal pricing is opposed by numerous trade bodies such as UK Steel and unions such as Unite and Unison.
He acknowledged that the government has proposed various schemes to ensure households, businesses and generators are not adversely affected by high prices in some zones, but these will end up costing more than any of the supposed gains.
Pannell also expressed scepticism that data centres would locate in the cheapest zones, saying they instead “have a tendency to go to where they have the best possible data connections”.
He said “the shortest latency” is generally the main driver for siting decisions as evidenced by the locations of data centres in Texas, another place with locational pricing.
The verdict
Having heard the cases from Honan and Pannell, the jurors gave their verdicts on the issue.
The strongest conviction expressed in either direction came from Ben Martin, policy manager at the British Chamber of Commerce, who said they had concerns about unintended consequences from zonal pricing: “We understand the theoretical case for zonal pricing and we know that there are a number of challenges with the electricity market and it is badly in need of reform. But we're not sure if zonal pricing is the way forward.”
Martin said they were very doubtful that many of their members would be willing or able to move to zones with lower prices: “The workforce is already in a certain place. They've got existing commitments to their premises. They're close to their consumers and customers. Displacement of businesses could then interrupt local supply chains and have an impact there. So we think many, if not most, businesses would be unable to move.
“And if they did, it would have significant impacts on investment and jobs in local communities where some businesses have been established for years or decades.”
Martin said they also have concerns about the uncertainty zonal pricing would create and the impact it would have on investment given the zonal pricing is not expected to be introduced until the early 2030s: “We've got businesses making investment decisions for the 2030s now and anecdotally I’m being told there are some already reconsidering investment as a result of fear and price volatility caused by zonal prices.”
He additionally expressed frustration over the lack of neutral, independent analysis from either the government or Ofgem on the potential impacts of zonal pricing for businesses.
Although a little more cautious, Rosie Pearson, co-founder of the Community Planning Alliance, expressed a clear preference in favour of zonal pricing: “I’m worried about the zones themselves and how they seem a bit peculiar from the consumers’ perspective, but I am very much in favour any efficiency of the transmission grid and what that means for the cost for consumers in the long term. If zonal pricing does reduce constraint payments, that’s also a massive benefit.”
However, most of the jurors struggled to come down definitively on either side. David Sheen, director of public affairs for UK Hospitality, said “I feel like I now know more, but I am probably equally confused as to what the right answer is.”
“At the moment, I think the main issue is reducing cost from energy… Does this reduce my energy bills as a business? But for some of the more progressive businesses, does this lead to maybe being able to buy more renewable energy?
“I’ve got to say, I don’t have an answer either way.”
In theory, Sheen said he liked the idea of zonal market that it is more responsive to local conditions and may encourage local energy supply, but he could also understand the concerns of opponents.
He said there is a degree of short-termism among their members right now “so the argument that this could be good in 2030/2035 is a bit of a difficult one to make to businesses at the moment.
“I think businesses are just sat there going: ‘We just need something in the next year, the next two years, that bring down energy costs. But then we also do need more substantial change in how the energy market works because it’s broken clearly.”
“So, I am giving you a draw,” he concluded.
Dorothee Wollard, energy and climate officer for the London Borough of Hammersmith and Fulham, likewise said “I remain on the fence on zonal pricing,” adding: “It’s a very complex situation.”
And Anna Railton from Oxford City Council said she too was “in a slightly fence sitting position.”
“We all agree that the status quo is totally broken,” she remarked. “Something must be done. It doesn’t feel like a silver bullet. I think we do still need vast amounts of grid upgrades. I don’t want this to be an excuse to not just put in a shed load of investment which we need to do.”
Railton said she has concerns over the size price differential between zones: “I don’t have a huge amount of clarity on that.”
She said if the differentials amounted to “a few tens of pounds either way,” then this would be acceptable, but if people in some zones are paying substantially more than others then “I think it would end up being a large political problem.
All things considered, Railton said her position was “a very weak yes” or “maybe”.
Given the clear difficulty that the government has had in coming to a decision, it’s probably no surprise that our trial delivered a hung jury.
“We’ve got businesses making investment decisions for the 2030s now and anecdotally I’m being told there are some already reconsidering investment as a result of fear and price volatility caused by zonal prices.”
Ben Martin, policy manager, British Chamber of Commerce
