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Jeremy Wilcox is managing director of the Energy Partnership, an independent Thailand-based energy and environment consulting firm 8/27 Sukhumvit Soi 8, Klongtoey, Bangkok 10110, Thailand | T: +66 2 653 1263 | Mobile: +66 860993375 | S: energypartnership
Zonal pricing will not deliver government objectives
One of the pledges made by the UK’s incoming Labour government was to lower energy bills, yet in its first nine months in office the bills have increased. The government has utilised the higher prices as justification for its commitment to an accelerated net-zero, but in a nod to the previous Conservative government it is also considering its proposed zonal pricing as a possible route to cheaper energy costs. Britain’s wholesale power prices are comparatively high owing to the reliance on gas. In March, British prices out-turned (that is, as distinct from the expected price) at GBP 88.3/ MWh (€105.7/MWh) compared with €93.9/ MWh in Germany. While 55.6% of power in Germany was from fossil fuels only 9.1% was from gas, with the share of gas-fired supply in Britain averaging 35.2%. The relative closeness of the out-turns given the sharply lower gas supply reliance is attributed to Germany’s lignite and hard coal plant raising CO2
emissions that
averaged 291% higher than in Britain. At face value this presents the net-zero argument that removing reliance on gas will lower power prices. But energy costs only made up 46.6% of the average industrial tariff in 2024 with network costs accounting for 17.1% and other costs (mostly renewable support related) accounting for 36.3%. Compare with Germany where network costs accounted for 28.7% and mainly renewable support items accounted for 22.8%.
Moving forward on a business-as-usual case, energy costs will come down as gas prices fall (lower demand, falling LNG prices, and increased displacement by biomethane and hydrogen), but network costs and renewable support costs will increase to support new renewable capacity. And herein is the anti-net-zero argument. Given that the current system must change to reflect changing market dynamics, is this best achieved via zonal pricing?
One of the strong arguments in favour of zonal pricing is the matching of demand with generation to reduce network costs by minimising the need for long-distance power transmission. Italy has a zonal market comprising seven bidding zones and its network costs are comparatively low at just 7.8% of the total 2024 average tariff. But Britain’s network costs already compare favourably, and reducing from 17% to below 10% of the tariff would not have a significant impact on the overall tariff. What would make a difference is reduced
reliance on gas and lower renewable support costs.
Proponents of zonal pricing argue that it encourages renewable generation, reasoning that regions with abundant renewable resources can generate power efficiently and economically, and can incentivise investments in local renewable energy projects. Yet in a mature renewable market such as Britain this investment is already ongoing which is why there is an abundance of renewable capacity in Scotland, which has a comparatively low demand base, while the high demand base of London has attracted significantly lower renewables investment.
But following wind, or the tides, is not straightforward. Britain has an abundance of tidal potential in the Severn Estuary yet plans to develop this potential were halted by environmentalists that argued it would adversely impact the local wildlife. Ironically, the very environmentalists that actively campaign against fossil fuels in favour of a carbon free utopia are also the main objectors to renewable projects that could disturb the local ecosystem. By far the most relevant potential benefit of zonal pricing in Britain is the provision of enhanced market signals, with zonal pricing providing clearer investment signals regarding where new generation capacity should be built by reflecting the actual cost of delivering power to different zones. The intention is that investors can make more informed decisions about where to develop new energy projects, leading to a more balanced and efficient energy market. But if the market signals point to an area that lacks renewable resources how does zonal pricing assist the government’s primary objective to decarbonise?
The main arguments against zonal pricing are that it could create regional disparities and lead to a fragmented market, which in turn would produce pricing signal uncertainties. Again, referring to Italy, the Northern and Central Northern zones tend to have zonal prices close
to the Prezio Unico Nationale (PUN, national average) due to the weighting of zonal prices with the north having 65% of national demand, while the lower demand and higher renewable penetration zones in the south will flow electricity to the higher priced importing zones in the north. In March the PUN was €120.2/ MWh with the Northern zone at €121.2/MWh and Central Northern at €121.3/MWh, while the Southern and Central Southern prices were €118.5/MWh and €119.36/MWh, with Calabria and Sardinia at €118.1/MWh and €116.5/MWh. There is no market fragmentation in Italy, and no significant price disparity with an average zonal price variation to the PUN of 1.4% in March. Similarly, there is no suggestion that zonal pricing would create regionally separate markets in Britain. There is already supply- demand disparity in the north and south and if anything, this could be reduced by zonal pricing. While zonal pricing could potentially provide some benefits in Britain by assisting with levelling up the north and south, it is difficult to see how it would reduce costs at a faster rate than under the current system. Also, with the government set on its end-decade renewable power target, the time taken to implement zonal pricing and the uncertain impact on investor appetite from switching to a new model, could be an unnecessary decarbonisation distraction. Of more benefit would be to address non- commodity costs and how they are recovered. While a reduction in renewable support costs could be achieved by scaling back the net-zero timetable this will not be adopted by this government, although it is supported by the Conservatives and Reform. The other option is changing the recovery mechanism, such as moving these costs behind the meter, i.e. transferring from a tariff cost to general taxation.
Britain’s power market needs reform, but zonal pricing will unfortunately not deliver the affordability and sustainability promised at the election.
Britain’s power market needs reform, but zonal pricing … will not deliver the affordability and sustainability promised
10 | April 2025 |
www.modernpowersystems.com
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