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Should energy suppliers charge customers based on where they live?

18 April 2024

Locational pricing aims to support renewable energy in the UK, but it might not be the answer, writes Peter Kydd.

Should energy suppliers charge customers based on where they live?
Under this system, consumers would pay different amounts for the same electricity depending on where they used it. Image credit: Shutterstock

The UK is committed to deliver a low-carbon electricity system by 2035.

Doing this in a secure and reliable way is the job of the Department of Energy Security and Net Zero, who last month launched its second Review of Electricity Market Arrangements (REMA) consultation.

Announcing the consultation, the government emphasised the need for more gas-fired power stations as a backup for when the sun doesn’t shine and the wind doesn’t blow.

And it’s true that gas-fired power stations will be part of the journey to net zero. But not everyone agrees that new stations are necessary.

Indeed, some say this ambition sends the wrong signals about the UK’s carbon commitments.

But what does the consultation paper itself say? Let’s take a look.

Introducing locational pricing

There isn’t much on gas-fired power stations. Instead, one of the main options is the introduction of locational pricing.

Under this system, wholesale electricity prices would reflect the marginal cost of generating electricity at different points on the network.

This would account for the availability of energy, losses during transmission, and imbalances in local supply and demand.

Simply put, consumers would pay different amounts for the same electricity depending on where they used it.

In regions with abundant renewable energy, where generation costs would be lower, so too would consumer prices.

What’s the government trying to achieve?

The proposed changes aim to encourage the energy market to deliver a net zero electricity system by 2035.

This means a huge amount of investment: £275-375 billion just to provide the new generation capacity needed by 2035.

How will locational pricing help? Good question!

Locational pricing could send clear signals about where investment in new electricity generation is most needed.

It could increase competition among renewable generators in specific locations.

On one end of the scale, a change in pricing could have a huge influence on future investment. But on the other, it could mean a disruptive change.

There will be winners and losers

The consultation doesn’t make clear how beneficial the change from a national pricing system to a locational one will be.

It will be disruptive. And a big question is whether the disruption costs will outweigh the benefits.

Inevitably, there will be winners and losers – and some of those losers may be the energy intensive industries and the people they employ.

Is the government taking a whole-systems approach and considering these consequences?

Questions still need answering

Matters to consider include:

  • Will the UK and Europe need grid interconnectors – particularly if the EU introduces its own form of locational pricing?
  • Could there be an inherent conflict relating to where the optimal energy resource exists, and the cost associated with it?
  • Is this being considered from the perspective of different sectors or just within an electricity bubble?
  • As the decarbonising heat and transport sectors come to rely more on electricity, and grid demand increases, will pricing need to adapt?
  • Could locational pricing change the emphasis from conventional strategic planning (optimising delivery on a supply and demand basis) to an investor-led model that rewards shorter-term financial returns?

There are hopes that the response to the second consultation will examine these, and other potential negative effects, in more detail.

Has locational pricing been tried elsewhere?

In a 2023 report, Ofgem described locational pricing as “a well-established market design” used across North America, Europe, and New Zealand.

It was also considered in Australia but rejected after seven years of development due to investor concerns.

Interestingly, Ofgem concluded that there would be challenges in implementing locational pricing in the UK because of the fundamental changes that would be necessary.

This could in turn risk the flow of investment into the sector as existing business models changed.

It’s our future

So, should our energy system evolve based on locational pricing principles?

Or should we use a more strategic, whole-systems approach? One that provides a framework in which the market can compete to deliver the appropriate infrastructure the UK needs?

What do you think?

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