Zonal pricing will take at least five years to implement

Implementing zonal pricing would take at least five years, the government has said.

The Department for Energy Security and Net Zero (DESNZ) has committed to explore locational pricing plans further, however it has warned that implementation “would be complex and take significant time”.

The timeframe is revealed within the second consultation exercise in the long-delayed review of electricity market arrangements (REMA) published today (12 March).

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.

As previously revealed by Utility Week, the REMA paper rules out replacing the existing national wholesale power market with a plethora of nodal prices better designed to reflect the costs of generating and distributing electricity in different localities across the UK.

The paper adds that although nodal pricing “could potentially deliver greater system benefits than zonal pricing” it would take at least a decade to implement and therefore the “risks to investor confidence and deliverability of our 2035 decarbonisation targets are too great under nodal pricing”.

Instead, the government has committed to working up the zonal version of local marginal pricing based on areas not yet geographically defined but larger than nodes.

However, the REMA consultation document states that there are several “implementation challenges” with zonal pricing which need to be overcome. These include the impact on trading arrangements, network access rights and market liquidity.

“Introducing any form of locational pricing would be complex and take significant time,” the consultation document states. “Locational pricing would have wide ranging impacts across several aspects of market design, and would require for example, reforms to trading arrangements, network access rights and the design of the [Balancing Mechanism] (including to minimise gaming opportunities).”

It adds: “There is international evidence to argue that […] zonal models can have both a positive and negative influence on liquidity in the long-term. Due to varying characteristics in global markets as a comparator, it is challenging to infer what the impacts on liquidity within GB could be.

“However, given concerns about already low liquidity in GB electricity markets, we will need to consider any impacts carefully.”

Despite these concerns, the consultation document adds that there is a “clear case for continuing to assess locational pricing, specifically in the form of zonal pricing, due to the potential system operation and consumer savings it could offer”.

It adds: “DESNZ commissioned modelling shows that locational pricing under the form of zonal pricing could reduce the cost of running the electricity system in the region of c.£5-15bn over 2030- 2050, and that consumer benefits could be in the region of c.£25-60bn over the same period.

“Assuming these savings are fully passed through, this would be an average consumer benefit of £20-45pa per household over 2030-2050.”

The government document also states that zonal pricing has the “potential to maximise whole-system flexibility and drive economic growth” through better pricing signals.

In particular, it states that “interconnectors and storage would be used more efficiently under locational pricing to help manage rather than (at times) exacerbate network constraints”.

It adds that locational pricing could also help “unlock flexibility on the demand-side”, making investment in demand side technologies more attractive by passing through the benefits of potentially significantly cheaper electricity in over-supplied parts of the country.

As revealed by Utility Week, DESNZ is seeking a ‘locational electricity markets policy design’ team leader to work up the proposals alongside Ofgem and the future system operator.

In the next phase of REMA’s work, the focus will be to “design a more detailed zonal pricing model”.

The REMA document adds: “There would be a variety of ways to implement zonal pricing in GB. Design could vary from a light touch model which shields participants from certain risks and maintains current decentralised arrangements, to a more transformative model which might prioritise flexibility through sharper price signals and be more centralised in its operation.”