Why alternatives to regional pricing won’t work

GB’s electricity market is struggling with high constraint costs - costs associated with paying wind generators to turn off and other actions the Electricity System Operator (ESO) takes to manage bottlenecks in the transmission network; costs that ultimately end up on consumer bills. These costs have skyrocketed from £170m in 2010 to over £1.3bn in 2022, and could exceed £4bn per year by the end of the decade. Without effective action, these costs will become a national scandal and lead to significant public backlash against the renewable industry.

Splitting the nation’s wholesale electricity market into zonal markets is the best way to solve this. This would mean network congestion is captured in wholesale prices, giving a price which more accurately reflects the cost of using electricity in a particular location. Zonal prices would incentivise generators, battery operators, interconnectors and consumers themselves to take actions ahead of time to resolve these constraints, rather than leaving everything to the ESO, reducing the cost to the system and making it easier to balance.

However, others are proposing to keep the single wholesale market and instead introduce changes to:

• Give the Electricity System Operator (ESO) more control: Allowing the ESO to intervene earlier and reduce the role of the market to self-balance, including through new Constraint Management Markets (CMMs) or extending the current Gate Closure.
• Amend Grid Access or Use of System Charges: Allowing the ESO to limit some assets without compensation (e.g. ‘non-firm access’), or designing network Use of System Charges to send operational locational signals.
• Redesign the Balancing Mechanism (BM): Changing pricing or rules in the BM.

However, compared to holistic reform to introduce locational pricing, these changes would be less effective and come with significant downsides for investors as well as consumers.

Options that would give more central control to the ESO would be a significant shift from today where producers and buyers in the market can manage their own portfolios, with the ESO only stepping in to take the “residual” actions needed to keep the system in balance.

Retaining the role for the market to drive dispatch outcomes - rather than a central, regulated body - is especially important as the system becomes more decentralised. The market is better placed to balance the system than the ESO because it knows its own portfolios. We know our customers and work hard to design offerings that will encourage their engagement and flexibility - including products like our wholesale pricing tracker tariff Agile, and our Free Electricity Sessions. Limiting our ability to engage with our customers in this way would be detrimental for our customers and the system.

Other options try to implement locational pricing ‘through the back door’ - for example, implementing non-firm access or locational network charges. These attempt to reflect local costs in a less efficient and more complicated way - network charges are notoriously opaque. They would also create risks that market participants cannot easily manage - wholesale price risk can be hedged using contracts in a way that network charging or network access cannot

And others - like reform to BM pricing - could allow the system to be balanced in a slightly more cost efficient manner, but they will not fundamentally change the amount of constraint actions that it needs to take. So we’ll still be wasting massive amounts of mostly renewable energy.

Most changes proposed would rely on existing industry governance mechanisms, requiring yet more years of internal industry debate and analysis before decisions can be made by Ofgem. There are countless examples of how ineffective piecemeal reform has been, including:

• The case for locational transmissions losses being made by as early as 2001, but not introduced until 2018
• Similarly, new access arrangements were signalled before go live of NETA in 2001, but the Access Significant Code Review did not conclude until 2022
• Domestic market-wide half hourly settlement was signalled by Ofgem in 2014, but is not due to be introduced until December 2026 at the earliest

And as is often the case with industry-led change, where there are winners and losers, reform programmes have been fraught with legal challenges. In the past twenty years, debate about market arrangements and network charging reforms, means these transmission bottlenecks have still not been resolved - in fact they’ve gotten worse. Continuing this approach, which has had a dismal track record, isn't the solution.

As bottlenecks in the transmission system are the root cause of the issue, some might ask why not just build more grid, and not worry about wholesale market reforms. The simple answer is - faster network build is necessary but not sufficient. We're already years behind the necessary transmission build and there’s insufficient time ahead of 2030 to bridge the gap - FTI estimate we would need to build grid at 8 times the rate we have done for the last 8 years. Moreover, building grids is expensive and politically tricky (imagine trying to do ten HS2s at once!) so using the network capacity we have better and finding other ways to resolve constraints, must be part of the solution. Zonal markets would encourage market participants to make best use of the limited transmission network. And by reducing the need for the ESO to step in and manage constraints, reduce costs to consumers.

We recognise that these proposals are trying to deliver benefits, and some of these options could provide a temporary fix—for example, National Grid’s Thermal Constraint Collaboration project is considering new types of constraint markets. We support interventions that could help before more enduring arrangements are introduced.

However, they won’t go far enough. Locational pricing is the only solution that will fundamentally bring down constraint volumes and costs, send efficient price signals, and guide market players to make decisions that reduce system costs and maximise benefits to consumers.