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How should electricity prices be determined – on a national level or tailored locally? This critical question is at the center of a heated debate over the proposed zonal pricing model in Great Britain, which suggests dividing the electricity market into regions with prices influenced by local supply and demand. The energy secretary, Ed Miliband, faces a significant decision in the upcoming months, as final determinations need to be made ahead of this summer’s auction for new wind and solar installations.
Proponents of zonal pricing, led by Greg Jackson, founder of Octopus Energy – now the largest retail energy supplier in the UK – contend that without such an approach, consumer electricity bills will surge. They emphasize the financial waste associated with compensating wind farms for halting operations during instances of surplus energy, such as when strong winds occur in Shetland, overwhelming local grid capacity.
According to the National Energy System Operator (Neso), constraint costs reached approximately £1 billion last year. This figure encapsulates payments made to wind farms to cease production alongside the expenses incurred from activating other energy sources to compensate for bottlenecked power generation. Ultimately, these costs are passed on to consumers, with constraint payments accounting for 2.4% of total electricity bills in the previous year.
Advocates argue that flexible zonal pricing would address these inefficiencies and potentially reduce costs by encouraging new generation capacity to be situated closer to areas of high demand. They assert that this model would create economic incentives for the system to operate more effectively, possibly reducing the need for extensive transmission infrastructure. They envision a scenario where regions like windy Scotland benefit from lower energy prices, supporting the development of AI data centers powered by affordable energy.
Conversely, a sizable portion of the energy sector, as illustrated by the 55 stakeholders who signed a recent letter to the government, dismisses the zonal pricing concept as impractical. They argue it would fail to lower bills, contradict the government’s objectives for clean energy, and should be dismissed promptly. Critics point out that wind farms must be located where wind resources are plentiful, and that urban areas like London lack suitable spaces for large-scale solar installations, potentially creating a disadvantageous “postcode lottery” for electricity consumers. Additionally, concerns over lagging telecommunications infrastructure may hinder the feasibility of establishing an AI hub in Scotland.
Opponents also cite financial concerns, arguing that if zonal pricing is perceived as a risky venture, potential savings could be offset by elevated financing costs. Miliband’s push towards clean energy mandates a significant £200 billion investment from the private sector over five years.
Keith Anderson, CEO of ScottishPower, warns, “You would be asking people to invest £40 billion a year into a market they no longer understand.” He believes this uncertainty may deter investments or result in higher pricing during renewable energy auctions due to perceived risks.
The dialogue around zonal pricing is fraught with numbers and varying projections. For example, Octopus claims consumers could save over £55 billion by 2050, citing a report from FTI Consulting, while SSE’s CEO, Alistair Phillips-Davies, references a study by LCP Delta suggesting that even a minor increase in capital costs could elevate the energy transition cost by around £50 billion.
As deliberations continue, the outcome remains uncertain. One insider describes the situation within the Department for Energy Security and Net Zero as akin to “civil war.” Nonetheless, several observations can be made.
Firstly, the existing market arrangement is unlikely to persist. Jonathan Brearley, CEO of Ofgem, remarked that the costs incurred due to the need to pay wind farms to disconnect, combined with the inefficiencies of the current system, render it unsustainable. “If we do absolutely nothing, I think it is not economically credible for British consumers to leave it as it is,” he stated recently on the Montel News podcast.
This brings forth the dilemma of choosing between implementing zonal pricing or restructuring the national market to enhance efficiency, potentially involving adjustments to internal transmission charges and regulatory mechanisms.
A primary objective for either option will be to avert scenarios where consumers financially support wind farms to halt energy production while simultaneously importing power from neighboring countries like Norway.
Secondly, Ofgem appears to lean towards supporting zonal pricing. Brearley acknowledged that, following extensive deliberations, there’s a consensus within the organization favoring zonal pricing as a forward-looking solution. If Miliband decides against this, he risks dismissing the counsel of the independent regulator, even though Brearley has indicated some dissent within Ofgem’s board.
Thirdly, should he endorse zonal pricing, Miliband might need to prepare for backlash from the industry, which has expressed concerns over potential increases in financing expenses and diminished willingness to engage, creating a more precarious investment climate.
During the previous year’s renewable energy auction, contracts for difference (a pricing mechanism ensuring guaranteed pay for output) were awarded approximately £59 per megawatt hour for new offshore wind projects, which appeared to undercut energy analysts’ expectations of £62-£64 per MWh for the current auction.
An outcome exceeding £70 per megawatt hour, driven by market uncertainties, could pose a significant political challenge for Miliband, who optimistically asserts that expanding renewable energy sources will lower costs by 2030.
Fourthly, to alleviate developers’ concerns, government clarity is essential regarding previous assurances that existing wind farms with contracts for difference would be “insulated from zonal price risk” under a new pricing system. The ambiguity surrounding this commitment raises apprehensions among project stakeholders. While some wind farms benefiting from older subsidy schemes have enjoyed substantial profits, providing precise guidelines could enhance confidence in the market.
Lastly, postponing the decision is always an option. The £70 billion needed to upgrade the transmission network aims to bolster the electricity infrastructure, thereby preventing high constraint costs from spiraling further. Anderson of ScottishPower advocates for a discussion on zonal pricing post-infrastructure developments to avoid imposing abrupt, large-scale changes on the energy market at this critical investment juncture.
On the flip side, if proponents of zonal pricing believe it is necessary for an efficient operation of a renewable-dominant system, they argue action should be taken promptly. They contend that swift reform could limit constraint costs in preparation for anticipated delays in transmission upgrades. Neso’s indications suggest that meeting the government’s 2030 clean energy target will stretch feasibility limits.
The current landscape presents no straightforward, risk-free solutions. What began as a seemingly technical “review of electricity market arrangements” initiated by the prior government has evolved into a pivotal policy discussion. The implications of zonal pricing extend far beyond the electricity sector to shape economic and industrial strategies. As Miliband navigates this complex terrain, he must tread cautiously amid competing interests and the pressing urgency for actionable solutions.
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www.theguardian.com