What’s new in UK electricity reform: controversial nodal marginal pricing

In 2021, the UK launched the Net Zero Market Reform Program (NZMRP), which aims to conduct a comprehensive review of the UK’s existing electricity market design and to propose a reform plan with a view to achieving net zero emissions by 2025.

On July 4, 2023, the UK’s National Grid (ESO) published the conclusions of the Net Zero Market Reform Program on energy investment policy. The energy regulator, the UK Office of Gas and Electricity (Ofgem), said it is considering applying a nodal marginal pricing mechanism to deliver its 2035 grid decarbonization plan.

However, the proposed reforms to nodal marginal pricing have caused controversy in the UK energy industry. Energy investors have argued that the fairness of the new pricing approach and the validity of the pricing model are in doubt.

Nodal tariffs as a “cure” for frequent blockages and high balancing costs

In order to improve the efficiency of the grid, the UK is considering dividing the electricity market into seven price zones or hundreds of different nodes. Each node of the price of electricity will be based on its proximity to the location of the power generation changes, the price of different nodes may vary greatly.

Currently, the UK is a unified wholesale electricity market model. Generators and users can trade medium- to long-term and day-ahead electricity through bilateral contracts and power exchanges, which account for about 95% of all electricity consumption. Market participants (generators, intermediaries, large consumers, etc.) receive the same wholesale price signal regardless of their location.

Normally, generators schedule their own production without regard to grid blockage, but blockage occurs when generation at a particular location exceeds the amount of power allowed to be transmitted by the grid for safe operation. Once blockage occurs, the grid operator procures power and electricity services in the balancing market to ensure real-time balancing of the electricity system.

The balancing market is operated by the UK National Grid and resolves deviations between contracted power and actual operation through market-based means. Currently, the electricity traded in the balancing market accounts for 2%-5% of all electricity consumption in the UK. If the grid fails to deliver electricity, the grid operator will ask the power producer to reduce its output and give it some compensation, the cost of which is borne by the end-user.

However, in recent years, the balancing costs of the UK grid have been rising. information published by Ofgem shows that since 2018, the balancing costs of the UK grid have increased by 284%. in 2022, the UK’s National Grid spent £1.9bn on “blocking costs”, including compensation for renewable energy abandonment. Ofgem Ofgem said that without reforms to the electricity market, balancing costs will “grow at breakneck speed” and that consumers will ultimately pay for these costs.

The dramatic increase in balancing costs comes against the backdrop of a significant increase in the proportion of renewable energy in the UK over the past decade, which has led to greater system volatility and an increase in short-term energy shortages. At the same time, the distance between where new energy generation is located and where load is concentrated has increased. Most of the UK’s new energy units are located in the Scottish region, while loads are concentrated in England, with blockages occurring from time to time due to the limited transmission capacity of the grid.

As a result, to address rising balancing costs, National Grid is proposing to shift its tariff model to Zonal Marginal Pricing (ZMP) to reduce the system’s balancing costs.New research commissioned by Ofgem and carried out by energy consultancy, FTI Consulting (FTI), has found that switching to ZMP could result in cumulative cost savings of £48.8bn for the electricity system by 2040.The research, which was carried out by FTI Consulting, found that the system would be able to reduce its balancing costs significantly even with Zonal Pricing.

The study also found that even with a zonal pricing model (Zonal Pricing), grid costs could not be significantly reduced. According to National Grid, Zonal Pricing can only “solve part of the problem in the short term”. Nodal tariffs, on the other hand, are different and, according to the model, average annual wholesale tariffs will vary significantly from region to region.

According to the study, the northern regions of the UK, such as Scotland, northern England and northern Wales, will have the “lowest prices in Europe”, while the southern regions of the UK will be responsible for the highest prices in the UK.FTI’s model suggests that by 2040, the average annual wholesale price of electricity in the different regions of the UK will be between £37 and £58.7/MMBtu. -£58.7/MWh.

Nodal tariffs stir up controversy, and the economic accounts of different groups

Regarding the nodal tariff mechanism, the attitude of various market players in the UK is not uniform. The northern part of the UK is energy-rich and hopes to use this to reduce electricity prices. Ben Houchen, mayor of Tees Valley in the northeast of Britain, said that from the cost of living and industrialization point of view, low energy costs may bring opportunities for the city, which is expected to get better development.

Other proponents argue that nodal marginal pricing would have a significant impact on UK industry, both by encouraging generators to commission more wind turbines in the south of the UK, and by promoting new green industries such as hydrogen electrolysis, and superbattery factories in renewable energy-rich Scotland.

However, customers in the south of England, who would be exposed to the highest electricity prices in the UK if nodal marginal pricing is introduced, are not in favor of this reform. Sadiq Khan, Mayor of London, called on government agencies to consider all reform options and fully justify and study the impact of the electricity market reform program on London residents.

Practitioners in the UK’s heavy industry sector have also voiced their concerns. Arjan Geveke, head of the Energy Intensive Industry Association, pointed out that electricity prices are not the only factor affecting the layout of heavy industry companies, “the number of existing assets, ease of access to raw materials and proximity to end-users, etc., is an important factor for companies to consider when choosing the location of their plants.”

In addition, some power producers are not positive about nodal marginal pricing. Not long ago, SSE, one of the largest clean energy investors in the UK, had clearly expressed its opposition. According to the company, the implementation of nodal marginal pricing will make it more difficult for power producers to predict future revenues, thus pushing up the cost of capital of the company; secondly, after the implementation of nodal marginal pricing, power producers will no longer be compensated for the abandonment of their units as a result of grid blockage.

For ordinary residential and small commercial and industrial customers, the impact of modifying the wholesale market pricing method will not be significant.Ofgem said that electricity sellers can allow consumers to choose from different packages, such as choosing a flexible tariff package with price fluctuations or choosing a fixed tariff package.

“The benefit of variable tariffs is that electricity consumers with consumption flexibility can get appropriate discounts by, for example, changing their electricity consumption habits. For example, charging electric vehicles when electricity prices are lower or using high-power appliances to drive a change in electricity consumption behavior on the user side.”

In the face of the views of different groups, the British government has not yet made a decision. Ofgem said that there is no other effective blockage management program, nodal marginal pricing is only an option in the reform program. The UK government is working with relevant organizations to further study and refine the reform plan, and strive for a fair deal for electricity users.

Reform Vision: Three Stages of Electricity Market Design

Whether or not to implement nodal marginal pricing, the interests of the main body is still in the game, but to solve the high proportion of renewable energy caused by the blockage problem is imminent.

Clan McLeavey-Revill, head of market development at National Grid, said how to design an efficiently functioning wholesale market is one of the key challenges in transitioning the UK energy market to a net-zero structure. Currently, there has been a significant increase in the use of redispatch operations by power system operators to alleviate blockages.

McLeavey-Reville pointed out that the current harmonized market model lacks real-time and accurate wholesale tariffs, the market does not have a clear view of the true supply and demand for electricity in each region, and the balancing market can only “opaquely and inaccurately” convey real-time supply and demand in each region. In contrast, nodal marginal pricing will show the true real-time value of electricity in each region, leading to more efficient grid operations and the incorporation of more renewable energy.

“First, nodal marginal pricing can guide the construction of new zero-emission resources and storage resources to the right locations and incentivize existing fossil-fueled units to choose whether to continue to operate, retire, or upgrade based on their location, generating capacity, and economics.”

Second, market clearing prices under the nodal margin pricing model will provide effective price signals for energy storage and price responsive resources that are consistent with market conditions. With a high percentage of renewable energy development, a more diverse mix of resources in the power system, including distributed resources, energy storage, and demand-side response, will participate in the market. Dynamic, real-time and granular price signals will enable these resources to respond rather than just receive dispatch instructions.

In its long-term vision, National Grid outlines three key implementation phases for the design of the UK electricity market.

The first phase (2023-2027) is to rapidly enhance the system’s ability to dispatch flexibly, including operational arrangements for the half-hourly market, retail market reforms, expanding access to balancing markets, and strengthening grid contact lines.

The second phase focuses on adjusting investment policies and reforming the Contract for Difference (CfD) and capacity markets to achieve a three-fold increase in the total amount of CfDs in 2025-2030 compared to the current level.

In the final phase (post-2030), the UK will redesign the entire electricity market to allow demand-side resources, energy storage and grid interconnection to play a major role and improve grid flexibility.

National Grid UK expects the final Net Zero Market Reform report to be published in the fall of 2023.

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