A new report published by management consultancy AFRY on Friday (15 September), has urged for an “evolutionary rather than a revolutionary” approach to the redesign of the UK energy market.
In Phase 2 of the study into the impact of a UK locational energy market, AFRY used detailed modelling of proposed electricity market arrangements and the input of market participants to assess the best road forward in creating a net zero ready energy market in the UK.
“The continuation of a national energy market should be accompanied by efforts to improve operational efficiency, especially for interconnectors and plants behind constraints,” said Stephen Woodhouse, director at AFRY Management Consulting. “We reaffirm our recommendation of evolutionary rather than revolutionary market design to maintain the pace of investment.”
The report was initiated by the Review of Electricity Market Arrangements (REMA), which was launched by the then Department for Business, Energy & Industrial Strategy.
Some of the arrangements under review in the first REMA consultation summary, published in March 2023, include locational market structures such as nodal or zonal.
A nodal pricing structure determines market energy prices by location on the transmission grid, called nodes, whereas a zonal market framework forms its pricing system at a much more macro level within a defined zone or region.
A number of industry players including Energy Systems Catapult and the National Grid ESO cited locational pricing markets as an attractive option and an effective way to reduce consumer costs; however, other members of the energy sector have urged caution for fear of locational pricing inducing a ‘postcode lottery’ and the potential loss of revenue for generators.
Following the results of AFRY’s investigation, Woodhouse concluded that a move to locational pricing in the UK’s electricity market would “be high risk for little reward.”
Limited economic welfare benefit
Modelling locational markets against two of the decarbonisation scenarios presented within National Grid ESO’s Future Energy Scenarios, the AFRY report found that implementing a locational energy market would only deliver a small economic welfare benefit.
Under both scenarios a zonal market could achieve an overall economic benefit of £4.2 million, between 2028 and 2050, whilst a nodal market could attain a further benefit of £200-300 million.
Overall, if these benefits were achieved they would translate to a 1% saving against consumer bills over the same period, the report continued, noting that the total economic welfare benefit of zonal and nodal markets against the business as usual case would be £4.5 billion net present value to 2050.
These benefits, however would be overshadowed by “the scale of wealth transfers between parties and the myriad of other uncertainties between now and 2035,” warned the report.
Moreover, the report found that all welfare benefits brought on by both nodal and zonal pricing frameworks would be eliminated if the cost of capital for new renewable generation increased by over 52 Basis Points (bps) in the consumer transformation scenarios and +56 bps in System Transformation.
Risks to investor confidence
One of the most pressing concerns over a locational market framework is its affect on investment in the UK’s renewable market.
An independent review based on research conducted by the University of Strathclyde warned that a locational pricing system could harm investor confidence in new generation energy capacity potentially making reliable supplies of low-carbon power harder to come by.
Echoing these concerns, the AFRY report concluded that a locational market could present large risks to unhedged generators and be reliant ton project location.
Running a sensitivity test which assumed an unanticipated delay to grid build, the report showed that, under a zonal market, the impact of such a grid delays would be “severely negative” for generators who could held behind an export constraint for an extended period of time, whilst also potentially being penalised for having a project in the wrong place in relation to the grid and risking going out of business.
“Overall, any move to a locational market design would need to be accompanied by mechanisms that limit the risks faced by individual connectees,” the report noted.
“This is a weakness in locational market designs generally, whether nodal or zonal in nature.”
Simple changes to current framework could replicate some benefits of locational markets
In order to avoid both the cost of drastic energy market changes and concerns over investor confidence, the report explored ways to enhance the locational incentives already present in Britain’s energy market.
According to the report, a tariff reform would hold a lower risk to investment and be easier, as well as cheaper, to implement than locational markets.
Creating a ‘National Enhanced’ scenario, AFRY replicated the locational signals of a zonal energy market framework within the current national energy market structure.
“By defining locational grid tariffs to mimic the locational variations in gross margin by plant type from the zonal case, we were able to achieve close matches between the National Enhanced and zonal cases on overall locational signal strength for renewable and gas carbon capture and storage plants, and obtain similar patterns of generation build by location,” stated the report.
“This approach was less successful for hydrogen-linked technologies, given the other drivers related to hydrogen infrastructure that influence those technologies.”
Time-of-use tariffs and reformed network charged for interconnectors could also add operational efficiency benefits within the current national market, added the report.
The report also warned that the window of opportunity to begin building a concrete and effective net zero energy market is closing. According to AFRY’s analysis the earliest a locational market could be implemented in time to achieve a decarbonised power system by 2035 is 2028. This leaves a window of only seven years or less.