The UK’s Review of Electricity Market Arrangements (REMA) started in July 2022 with a remit to consider a wide range of policy reforms to make the UK market more fit for purpose for a future decarbonised electricity system. Recent debate has become increasingly focused on one of those options – zonal pricing. We believe now is not the time to focus on zonal pricing, and explore the reasons for this here.

Zonal pricing is fundamentally a response to improving the efficiency of markets (and therefore consumer outcomes) in the face of structural congestion in the transmission system. Such congestion is defined as that which is ‘capable of being unambiguously defined, is predictable, is geographically stable over time, and frequently reoccurs under normal electricity system conditions’.

Some of the current congestion in the system is due to under-investment in the 2010s. This is being addressed now through other mechanisms, including adjustments to transmission charging and the way congestion imbalances are handled.

The reason that stability of the zones is important is that it is the transmission capacity between zones that both defines the zones and drives the price differentials between them. For buyers and sellers to trade efficiently in zonal pricing markets, these zones would need to be stable over time with reasonably predictable levels of transmission constraint between zones.

Not currently stable
In a recent UKERC paper we set out our analysis for why we think zones are not currently stable and predictable enough. This is due to the GB transmission system being massively upgraded to suit a future zero-carbon electricity system, with investments of £58bn planned by the system operator, as set out in the Holistic Network Design, Beyond 2030, and the Strategic Spatial Energy Plan (SSEP).

In the horse-and-cart analogy, the grid is the horse, driving the physical relationship between zones. By extension, zonal pricing is the cart, creating an efficient commercial relationship between zones.

Placing the cart of zonal pricing before the horse of grid build-out would create unstable and unpredictable commercial relationships between zones, meaning higher investor risk and ultimately higher costs for consumers. Our paper evaluates one particular aspect of these risks, namely risks to investors in wind power of not being able to sell their electricity within the boundaries of a particular zone due to delays in planned infrastructure build-out. We show a range of consumer cost impacts up to £3bn per year depending on assumptions.

A common narrative emerging in the debate around zonal pricing is that the government is ‘damned if they do, and damned if they don’t’ with regard to the decision to proceed with zonal pricing. If they do, this creates unacceptable investor risks; if they don’t, these risks just get kicked down the road, perpetuating them in the future.

However, we believe this is a false dichotomy.

Placing the cart of zonal pricing before the horse of grid build out would create unstable and unpredictable commercial relationships between zones, meaning higher investor risk and ultimately higher costs for consumers.

Policy process
While introducing zonal pricing now could lead to net costs for consumers, doing so in future could restore the cart behind the horse, resulting in a more efficient and lower cost system benefiting everyone. The policy process for doing so would have to be carefully designed to avoid creating a perception that risks were simply being perpetuated and exacerbated by delay. This could be along the following lines.

First, announce that zonal pricing is to be ruled out ahead of 2030 in favour of enhanced national pricing that would include various reforms to Transmission Network Use of System (TNUoS) charging and reforms to the balancing mechanism.

Second, instigate a robust zonal review process as an outcome of REMA to include:

• A structural congestion assessment against criteria and assumptions pre-agreed through consultation to be included as part of the SSEP update in 2031/2032, to take place every five years, and to be forward-looking at least 10 years to establish stability of zones over time.
• A robust governance process with clear roles and responsibilities, with opportunities for consultation with stakeholders and the devolved administrations.
• A cost and benefit assessment (CBA) process open to feedback, showing benefits exceed the costs by a sufficient margin.
• A detailed zonal implementation process to be defined, including transitional arrangements to protect legacy investments.

Defining this process now would avoid rushed decisions, build investor confidence in the policy, reduce costs for consumers in the short term, maximise the chances of success of a zonal policy in the long term, and strengthen the government’s negotiating hand in forthcoming CfD auctions to help re-establish momentum towards its 2030 goals.

The views and opinions expressed in this article are strictly those of the authors only and are not necessarily given or endorsed by or on behalf of the Energy Institute.

• Further reading: ‘A country divided: exploring the pros and cons of zonal electricity pricing’. A war of words has broken out in the electricity industry about whether to split Great Britain’s electricity market into smaller zones, in the hope of reducing costs and making more efficient use of renewables. Janet Wood explores the current complex situation, and how we got here.
• Following an inquiry into energy grid and grid connections, the UK Parliament’s House of Lords Industry and Regulators Committee suggests that regional zonal pricing should enable better use of existing grid capacity and lower the cost of electricity, provided that the transition and its risks are managed well. Chair of the 12-member Select Committee is Baroness Taylor of Bolton.