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The implementation of locational pricing brings benefits to the GB energy system but benefits could be offset by associated risks

Summary

- New LCP Delta and Grant Thornton data study outlines economic benefits of moving to a locational pricing model.
- The report shows system benefits of £5bn to £15bn from moving to locational pricing compared to our current national pricing model.
- However, benefits could be offset by increases the cost of capital for building new technologies because of the increased complexity locational pricing brings.
- Outcome of Government’s REMA consultation keeps both zonal pricing and reforms to national pricing as options for reform.

12th March 2024 – New analysis from LCP Delta shows that moving to a zonal locational pricing model (otherwise known as LMP) could deliver system benefits compared to our national pricing model of £5-15bn. This is a result of the more efficient locational signals that locational pricing provides compared to current market signals which inform the siting of projects and price of energy based on access to the transmission network.

However, these benefits are dependent on a number of factors, in particular the impacts of locational pricing on the cost of capital for building new power plants. It is uncertain to the extent that moving to locational pricing would have on cost of capital, but the study finds that increases to cost of capital for new plants of 0.3 to 0.9 percentage points could potentially wipe out any achieved system benefits.

These findings from LCP Delta’s study, ‘System Benefits from Efficient Locational Signals’, produced in collaboration with Grant Thornton, form part of the Government’s second Review of Electricity Markets Arrangements (REMA) consultation, published today – Review of electricity market arrangements (REMA): second consultation – GOV.UK (www.gov.uk).

The outcome of the REMA consultation discounts a move to full nodal pricing but keeps zonal pricing as an option on the table alongside a reformed national pricing market. The consultation highlights that strengthening locational signals in the market needs to be considered but this could take the form of zonal pricing or a set of alternative options.

Moving to locational pricing leads to investment and operational efficiencies

Locational pricing is based on the fundamental principle that the price received by electricity generators reflect the marginal cost of electricity at that specific location. This compares to our current national pricing model where wholesale electric energy prices reflect the value of electric energy across the whole of GB, accounting for the patterns of load, generation, and the physical limits of the transmission system.

LCP Delta’s study demonstrates that a zonal locational pricing model leads to some economic benefits, primarily driven by investment and operational efficiencies. This includes developing plants in areas more beneficial to the system, as well as cost savings by making changes to the way in which the market operates.

The impact of moving to locational pricing is subject to several risks and uncertainties

Within the analysis, there are a number of key uncertainties that impact the results, some of which could offset the system benefits of moving to locational pricing:

  • Cost of capital – Our analysis finds that system cost benefits could be outweighed by modest increases in the cost of capital. Uniform increases of 0.3 to 0.9 percentage points in cost of capital for all technologies (excluding Nuclear) results in a move to locational pricing becoming a net cost to the system.
  • Efficiency of redispatch in the national pricing counterfactual – What is assumed on locational redispatch in the national pricing counterfactual, particularly on how interconnectors flow with the respect to constraints, make a key difference to the results. System benefits are reduced from £15bn to £5bn if a more efficient redispatch is assumed under national pricing.
  • Network build – A delayed build in transmission networks can increase the benefits of moving to locational pricing as more efficient location drives higher benefits in a more constrained network. The analysis shows that a 3-year delay in network build can increase system benefits of moving to locational pricing by 10%.

 

Commenting on the Government’s publication of the REMA consultation, Chris Matson LCP Delta, said:

“Locational pricing is a complex topic and one that has understandably generated a huge amount of interest in the sector. But in the secretary of state’s own words “There are no easy solutions in energy, only trade-offs.”

“Our analysis shows that a move to zonal pricing has the potential to bring benefits to the British electricity system and to households. However, these benefits may be offset by the additional risk premiums faced by investors, given the dramatic change to the way generators would be paid and the sheer scale of investment needed to reach net zero.”

“It is essential that the government explores ways to reduce any investment risk associated with proposed reforms, to avoid unnecessary additional costs being passed onto households. We would encourage the government to continue to explore whether any benefits can be achieved by reforms to our existing national pricing model alongside the option of zonal pricing.”

ENDS

 

Notes to editor

  • LCP Delta and Grant Thornton were commissioned by Government to assess the impacts of alternative locational signals within the wholesale electricity market by modelling the market under current national pricing and under a move to locational pricing.
  • For this analysis, a zonal approach where the country is split into 12 zones which capture the key transmission network boundaries was used. This approach seeks to capture the most important network constraints, without modelling at a spuriously accurate level of detail.
  • The benefits of moving to locational pricing are subject to various uncertainties around the future make-up of the power sector and how locational pricing is implemented. Many of these are reflected in the analysis undertaken.
  • To see the full results from LCP Delta’s study and details on the methodological approach, please see the full report published this morning here – System benefits from efficient locational signals (publishing.service.gov.uk)

 

About LCP Delta

LCP Delta™ is a trading name of Delta Energy & Environment Limited and Lane Clark & Peacock LLP. LCP Delta™ combines the expertise of LCP Energy and Delta-EE to provide a single partner across the whole energy value chain. We are a team of passionate people using data, primary research, insights, analysis and models embracing advanced technology and innovation to accelerate the energy transition globally. Find out more here.

Media contacts

Instinctif Partners, LCP@instinctif.com

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