The UK has launched a second consultation on its review of electricity market arrangements (Rema), in which it continues to consider a shift to zonal pricing, while committing to retaining a contracts-for-difference (CfD) scheme, which it aims to future proof, it announced today.
The consultation proposes changes to the Great Britain (GB) power market to safeguard energy security and affordability as the country decarbonises, the Department of Energy Security and Net Zero (DESNZ) said.
Locational pricing
Zonal pricing would divide the wholesale market into up to 12 regions.
This could cut electricity system running costs by £5bn-15bn (€5.9bn-17.6bn) over 2030-50, and save consumers £25bn-60bn, by sending more efficient investment signals, DESNZ said.
But there are risks. Zonal pricing would transfer responsibility for managing the risk of local supply and demand mismatches from consumers to generators and could erode wholesale liquidity because of fragmentation, although there is also evidence it could have some positive effects, DESNZ said.
Other options for effective operation of a renewables-based system include optimising the use of cross-border interconnectors and introducing a locational element to CfDs.
The government will no longer consider nodal pricing because of the impact on investor confidence, and because it could jeopardise 2035 decarbonisation targets. It will also no longer consider implementing ‘local markets', which aimed to reconfigure the wholesale market into a distribution-level system.
CfD reform
The government wants to retain a "CfD-type scheme" as the key mechanism for driving investment in renewables. It estimates that the UK will need 140-174GW of renewable capacity in 2035 to meet decarbonisation targets, up from 56GW in 2023.
But it has not put forward a preferred version of the CfD scheme yet, because this "will depend on decisions made elsewhere in Rema, especially wholesale market reform decisions, such as locational pricing".
The government is still considering two reform options — capacity-based CfDs and partial CfD payments. In capacity-based CfDs, an operational asset would be paid a regular, fixed amount based on installed renewable capacity (£/MW), independent of the asset's market activity. This would be compatible with locational pricing, DESNZ said. With partial CfDs, only a percentage of an asset's capacity would be covered, leaving the remaining generation to operate on a merchant basis.
The idea of CfDs with a strike price range and revenue cap and floors has been ditched. Fluctuating CfD prices would expose assets to market signals within that boundary, DESNZ said, while a cap and floor could distort market behaviour.
The government aims to complete a narrower, deeper assessment of the remaining options by mid-2025.
Marginal pricing
The government proposes keeping the wholesale market based on marginal pricing and has ruled out a move to a split market for renewables or a green power pool, where operators would have the option to sell into a pool solely for renewable generation.
Neither option would be expected to accelerate renewable deployment, DESNZ said.
And government is considering the role corporate power purchase agreements would have, seeking input on barriers to their development and the market's growth potential.
Capacity market
The government intends to retain the capacity market as the primary means of ensuring capacity adequacy, after it found alternative options likely to be less effective.
It will continue to implement shorter-term reforms and wants minimum targets to ensure auctions procure the optimal technology mix to support a decarbonised system.
The government expects a "limited amount of new-build gas capacity" will be required to ensure flexibility and supply security. It will also work on policy to support long-duration storage and hydrogen-to-power technology.
Industry reaction
The rejection of nodal pricing was widely welcomed by industry, while some questioned the efficacy of zonal pricing and the impact of reforms on investor confidence.
UK utility SSE said "clear, consistent and predictable policy is key ... and that's why it is important we build on the current GB system. We are glad to see nodal pricing being taken off the table and look forward to the objective assessment of the benefits of the evolution of the national market".
And industry association RenewableUK's executive director for policy and engagement, Ana Musat, said nodal pricing "would have been lengthy and expensive to implement and would have provided a disincentive to investment in renewable generation".
But she noted that "given stronger locational constraints faced by projects — such as planning hurdles, including a de-facto ban on onshore wind in England or grid connections — the influence of zonal pricing on location choices will likely be limited".
RenewableUK also warned that disruption caused by implementing zonal pricing could create investor uncertainty, increasing financing costs.
Stakeholders have until 7 May to respond to the consultation.
