Friday, 15 September 2023 10:15

AFRY study finds a move to locational pricing in UK electricity market would be high risk for little reward

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AFRY Management Consulting has published a report summarising the second phase of its study on reform of electricity market arrangements in Great Britain.

Over the past 15 months, AFRY has completed a review of electricity market arrangements in Great Britain, in response to a government consultation. Using its power modelling expertise, AFRY assessed proposals to switch to locational electricity markets. Changing to a zonal or nodal market could dent investor confidence and comes with little modelled benefit. Investor confidence is particularly important considering the recent offshore wind auction that received no bids, in the context of the target to decarbonise the power system by 2035 and the limited window to do so. Due to the risks associated with changing the market design radically, a more evolutionary approach to improving to market arrangements is recommended.

On locational energy pricing, AFRY Management Consulting concludes:  

  • the potential economic welfare benefit of moving to locational markets is only around 1% and would be overshadowed by wealth transfers between parties;
  • these potential economic welfare benefits disappear, and costs outweigh benefits, if investment risk in generation increases due to the change;
  • the distribution of benefits between consumers and producers is very dependent on the nature of any specific mitigation measures such as grandfathering of rights for existing parties; and
  • the increased complexity of locational markets may create barriers to entry, and at least some of the benefits of locational markets can be replicated in a national market framework with less risk to investment. 

Overall given the trade-off between additional benefit and additional complexity, AFRY recommends that: 

  • nodal pricing, the most granular form of locational market, should not be progressed;
  • any further exploration of a zonal market design should be accompanied by a programme of work to explore ways in which the risks – and wealth transfers – could be mitigated; and
  • if the existing national market is retained, action should be taken to improve incentives and achieve some of the benefits of locational markets.

2023 09 15 101530“We aim to decarbonise the GB power system by 2035, and investor confidence is essential. We do not recommend a move to a nodal market, which would be a severe departure from today's arrangements. We have found rather small potential benefits of a move to a zonal energy market, but this would come with risks which could outweigh the benefits which must be mitigated if zonal markets are to be considered further. Alternatively, the continuation of a national energy market should be accompanied by efforts to improve operational efficiency, especially for interconnectors and plants behind constraints. We reaffirm our recommendation of evolutionary rather than revolutionary market design to maintain the pace of investment” says Stephen Woodhouse, Director at AFRY Management Consulting and market design expert.

Sign up for the study webinar on 26 September 2023 at 11am BST here

Read the Key Messages and Recommendations here

Read the Executive Summary here

Background

The study was initiated in response to the electricity transmission operator National Grid’s programme for net zero reform, and the Review of Electricity market Arrangements (REMA) process, which was launched by the Department for Business, Energy & Industrial Strategy, now the Department for Energy Security and Net Zero (DESNZ) in July 2022. One of the most divisive topics in the REMA consultation is whether the current national wholesale energy market should be subdivided into zones or nodes, in which energy wholesale prices would vary by location. This change would result in a locational energy market.

Since the Phase 1 report in October 2022, AFRY has quantitatively addressed the issue of locational energy pricing. The Phase 2 report, which has been informed by a wide range of market participants, and detailed modelling of proposed electricity market arrangements. Phase 2 of the study confirms that evolutionary change is advisable to maintain the investment momentum which is required to deliver a decarbonised power sector by 2035. 

AFRY Management Consulting works globally on market design and provides commercial analysis, strategic and operational advice for private investors and operators. With experience of a wide range of global electricity markets, AFRY Management Consulting experts possess a deep insight into the merits of alternative electricity market designs. 

AFRY provides engineering, design, digital and advisory services to accelerate the transition towards a sustainable society.   

We are 19,000 devoted experts in industry, energy and infrastructure sectors, creating impact for generations to come. AFRY has Nordic roots with a global reach, net sales of 24 BSEK and is listed on Nasdaq Stockholm.  

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