Report into the potential and pitfalls of zonal pricing
New analysis conducted by LCP Delta examines the potential benefits of adopting a zonal locational pricing model, also known as LMP, in the electricity market compared to the current national pricing model.
This follows an announcement this week by energy secretary Claire Coutinho who said a zonal pricing system could be introduced in Britain, as part of a review of electricity market arrangements (REMA).
According to the study, implementing locational pricing could result in system benefits ranging from £5 to £15 billion. This is attributed to the more efficient locational signals that such a pricing model provides, which can inform the siting of projects and determine the price of energy based on access to the transmission network.
However, the study acknowledges that these benefits are subject to various factors, with the cost of capital for building new power plants being a key consideration. The impact of locational pricing on the cost of capital remains uncertain, but the analysis suggests that even modest increases of 0.3 to 0.9 percentage points could potentially negate the achieved system benefits.
The findings from LCP Delta’s study are part of the government’s second Review of Electricity Markets Arrangements (REMA) consultation, which presents zonal pricing as an option alongside a reformed national pricing market. The consultation recognises the need to strengthen locational signals in the market but highlights that alternative options should also be considered.
The study demonstrates that moving to locational pricing can lead to investment and operational efficiencies. It allows electricity generators to receive prices that reflect the marginal cost of electricity at specific locations, resulting in advantages such as developing plants in more beneficial areas and operational cost savings through changes in market operations.
However, the analysis also identifies several risks and uncertainties that could offset the system benefits of adopting locational pricing. Factors such as the cost of capital, the efficiency of redispatch under the national pricing counterfactual, and the timing of network build play crucial roles in determining the overall impact.
In response to the REMA consultation, LCP Delta suggests that while zonal pricing has the potential to benefit the electricity system and households, the associated risks and investment requirements should be carefully addressed. The study encourages the government to explore reforms to the existing national pricing model alongside the option of zonal pricing to mitigate potential risks and avoid additional costs for consumers.
Chris Matson LCP Delta comments:
“Locational pricing is a complex topic and one that has understandably generated a huge amount of interest in the sector. But in the secretary of state’s own words ‘There are no easy solutions in energy, only trade-offs.’
“Our analysis shows that a move to zonal pricing has the potential to bring benefits to the British electricity system and to households. However, these benefits may be offset by the additional risk premiums faced by investors, given the dramatic change to the way generators would be paid and the sheer scale of investment needed to reach net zero.”
“It is essential that the government explores ways to reduce any investment risk associated with proposed reforms, to avoid unnecessary additional costs being passed onto households. We would encourage the government to continue to explore whether any benefits can be achieved by reforms to our existing national pricing model alongside the option of zonal pricing.”
To see the full results from LCP Delta’s study and details on the methodological approach, please see the full report – System benefits from efficient locational signals (publishing.service.gov.uk)
