The EIUG recognises the need for reform of electricity market arrangements to address increasing constraint and network costs, as a result of moving towards a more renewables-based system. However, whether introducing zonal pricing is the best option is not clear and might increase electricity prices for energy intensive industries, depending on the zone and assumptions about cost of capital.
The FTI Consulting & Energy Systems Catapult assessment for Ofgem and LDPDelta & Grant Thornton study for DESNZ about locational wholesale electricity market design options rule out of scope applying zonal pricing to (large) demand uses because there is too little information to make any assessment. Thus, currently there is no economic analysis or good understanding about how zonal pricing might directly impact energy intensive industries. A short EIUG poll of its members, submitted as part of its response to the 2nd REMA consultation, shows that there are other variables, such as access to raw resources, electricity network connection and good transport infrastructure, that determine the location of investments as well instead of only electricity prices.
Nevertheless, both studies estimate that consumers could benefit from applying location pricing to generators. Yet, the LCPDelta & Grant Thornton study estimates in its high scenario that wholesale prices in southern GB zones could go up relative to the national wholesale price and it concludes that, “on average, demand weighted wholesale prices are slightly higher in the locational pricing factual than the national counterfactual. Prices in high demand zones show price increases compared to a national pricing counterfactual”. Though the report estimates a positive economic impact, it also states that “system cost benefits could be outweighed by increases in cost of capital. Increases in cost of capital of 0.3 to 0.9 percentage points result in a move to locational pricing becoming a net cost to the system”. The risk of higher cost of capital, wholesale price volatility and market liquidity in the zones need to be properly assessed and understood before making a policy decision.
The electricity market arrangement used to have an incentive in the form of TRIADS encouraging large demand users to reduce electricity consumption at peak times to avoid inefficient investments in transmission network capacity, precisely the objective that REMA aims to address. However, Ofgem has nearly regulated this incentive away.
The EIUG urges DESNZ not to introduce zonal pricing to energy intensive industries without a proper evidence base and impact assessment to justify it. The EIUG also encourages DESNZ to improve engagement with large demand uses and to continue assessing the alternatives to locational pricing as set out in the second REMA consultation. This includes fully reinstating TRIADs and the reformed national market program.