How would you prefer your electricity prices to be set – nationally or locally? There is little middle ground in the bitter lobbying battle over zonal pricing, the proposal that Great Britain’s electricity market should be split into regions with prices set by local supply and demand. The energy secretary, Ed Miliband, must decide in the next few months, in time for this summer’s auction for new wind and solar projects.
One camp – led by Greg Jackson, the politically plugged-in founder of Octopus Energy, the UK’s biggest retail energy supplier – argues that customers’ bills will “skyrocket” unless zonal pricing is adopted. It points to the wasted money spent paying windfarms to shut down when, for example, it is blowing a gale in Shetland and the local grid is overloaded with more power than can be transported south.
Constraint costs were about £1bn last year, according to figures from the National Energy System Operator (Neso). The figure covers payments to windfarms to stop generating plus the cost of requiring other generators to fire up on the other side on a bottleneck. The cost all ends up on bills – indeed, constraint payments equated to 2.4% of consumers’ total electricity bills last year.
Flexible zonal pricing would fix the problem – or prevent it getting worse, advocates argue. More generating capacity would be built nearer to where it is needed. Demand would move nearer to supply. Overall costs would fall because price signals would force the system to run more efficiently. Fewer pylons might be required. They paint a happy picture of windy Scotland as a place of low bills and a background purr of AI datacentres running on cheap energy.
The bulk of the rest of the industry – to judge by the 55 signatories of a letter to the government last month – thinks the zonal vision is dreamy nonsense. It would “do nothing” to reduce bills, is “completely at odds with the government’s clean power mission” and should be ruled out “at the earliest opportunity”, wrote those developers, generators and investors.
Windfarms need to be where it is windy, and London is not awash with open spaces for large solar installations, runs this line of thinking. There would be a “postcode lottery” for consumers on bills. And latency issues in telecoms connections may mean Scotland never becomes an AI paradise.
Then there is the objectors’ argument about pure money: if zonal pricing is seen as a riskier proposition, any imagined savings could evaporate via higher financing costs. The sprint to clean power by 2030, as Miliband characterises it, involves a £200bn investment programme from the private sector over five years.
“You would be asking people to invest £40bn a year into a market that they no longer understand how it works,” says Keith Anderson, the chief executive of ScottishPower. “You are at risk of slowing down investment or people pricing that risk into the [renewables] auction.”
The quarrel is accompanied by a war of big numbers and long reports by consultants. Octopus quotes savings for consumers of at least £55bn on the way to 2050, citing a report it commissioned from FTI Consulting. In the other direction, Alistair Phillips-Davies, the chief executive of SSE, points to LCP Delta’s conclusion that adding a single percentage point to the cost of capital would increase the cost of the energy transition by about £50bn.
Who will win this scrap? At the moment, the outcome looks to be genuinely up in the air. There is “civil war” among officials at the Department for Energy Security and Net Zero on the issue, says one insider. One can make a few observations, however.
First, the current market structure will not last. “The amount you have to pay windfarms to get constrained off – the amount that we end up with a system that is inefficient – if we do absolutely nothing, I think means it is not economically credible for British consumers to leave it as it is,” said Jonathan Brearley, the chief executive of Ofgem, the energy regulator, on the Montel News podcast last month.
The choice, then, is between zonal pricing or a rejig of the current national market to try to make it more efficient, probably by forcing changes to internal transmission charges and established balancing mechanisms.
Either way, the goal will be to avoid the danger of shambolic events – for example, bill payers paying UK windfarms to turn off their turbines while power is simultaneously imported via an interconnector from Norway.
Second, Ofgem has made up its mind. “We’ve had a robust debate within Ofgem … and we have come to the view that zonal pricing is the best way forward,” Brearley said. If Miliband were to reject that view, he would be refusing the advice of the independent regulator – albeit Brearley revealed that Ofgem’s board was not unanimous in its thinking.
Third, if he backs zonal pricing, Miliband should worry about the backlash. The companies may not be bluffing about higher financing costs and reduced risk appetites.
Last year’s renewables auction resulted in contracts for difference, or CfDs (essentially a guaranteed price for output), of roughly £59 per megawatt hour (expressed in 2012 prices under the government’s weird accounting system) for new offshore wind projects. Energy analysts’ guess had been £62-£64 per MWh this year.
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A £70-plus outcome if developers are genuinely in “too much uncertainty” mode would be politically embarrassing. Miliband would be sanctioning a roughly 20% year-on-year increase at a moment when he is trying to hold the line that more renewables will mean cheaper bills by 2030.
Fourth, to soothe developers’ fears, the government could spell out exactly what it meant when it said last autumn that existing windfarms with CfDs, and those bidding into AR7, would be “insulated from zonal price risk” if a zonal system is adopted.
Owners of windfarms say the wording is too vague. It would be hard for the government to justify across-the-board compensation. Some windfarms – including a portion with old-style renewables obligations certificates, the pre-CfD subsidy scheme – have enjoyed lucrative returns. But clarity might help.
Fifth, there’s always the option of kicking the can down the road. After all, the £70bn upgrade to the transmission network, part of the overall £200bn clean power programme, is partly designed to ensure constraint costs don’t spiral upwards.
Anderson of ScottishPower says he is not against zonal pricing in principle but the debate should happen once the new network infrastructure is built and constraint bottlenecks can be reassessed. “Why do it when we are in the largest investment programme we have tried to do in the UK?,” he argues. “Don’t do it in one fat lump that scares the bejesus out of everybody.”
The counterargument is: if you truly believe the flexibility of zonal pricing is essential to make a renewables-heavy intermittent system function efficiently, you should do it as soon as possible, especially if advocates are correct in saying reform would limit constraint costs if transmission upgrades do not arrive on time. Remember that even Neso says the government’s 2030 target for clean power will push the limits of what is feasibly deliverable.
There are, then, no easy, risk-free options. The dry-sounding “review of electricity market arrangements” started three years ago under the previous government and sounded at the time like a subject only for energy boffins.
Instead, as constraint costs have risen with the renewables rollout, the idea of zonal pricing has become a critical policy decision. It affects not only the UK’s electricity system and consumers’ bills but also industrial policy. Miliband is entering a minefield.
