As the dust settles on the second REMA (Review of Electricity Market Arrangements) consultation, this blog reviews the debate on locational signals, their importance for flexibility, and the need for a more concrete articulation of what could be improved alongside a national wholesale market.
It feels like we have been debating the options for improving locational signals in the electricity system for a long time. The current iteration of the debate kicked off properly in spring 2022 at the start of the UK Government’s Review of Electricity Market Arrangements (REMA), although by that stage National Grid ESO (as they were called at that point) and the Energy Systems Catapult had each already published work on a case for change.
The original REMA consultation laid out three potential approaches: nodal or zonal pricing in the wholesale markets, or alternative routes to provide locational signals alongside a national wholesale market.
After two years, it still doesn’t feel like we are close to agreement on the best way forward. However, some progress has been made.
In that time we’ve had an intense debate on the value of locational wholesale pricing in either nodal or zonal form. Two of the authors of this blog along with colleague Keith Bell, carried out a detailed review of Locational Marginal Pricing in 2023, considering the challenges and opportunities for implementing it within the GB system. The debate has also produced several studies presenting quantitative modelling results based on nodal and zonal approaches, some of which include large estimates of socioeconomic welfare and consumer benefit (see reports from FTI consulting, AFRY, and LCP Delta).
Others have voiced strong opposition against locational wholesale pricing, arguing that it creates significant uncertainty and risk that would be challenging to hedge and would have significant, detrimental impacts on investment in low carbon technologies.
After considering this evidence, the UK Government removed the option of full nodal wholesale pricing from the table. In the recent second REMA consultation, the debate has been reformulated around two enduring options: zonal wholesale pricing, and what the consultation calls ‘alternatives to zonal pricing’.
Barriers to decision making
It seems to us that there are two major barriers remaining before we will be in a good position to reach a decision on which option to implement.
Firstly, there remains disagreement on the overall value of locational price signals. Whilst most people agree that both in principle and in practice there could be benefits from improved locational price signals (whether delivered through zonal wholesale pricing, or an alternative route), there remains disagreement as to the magnitude of those benefits and the trade-offs against other considerations.
For example, stronger locational price signals could translate into a higher cost of capital, particularly for renewable generators developing in areas with high renewable resources, well developed project pipelines and supportive planning and consenting regimes. If, despite these signals, we still need investment in these areas to meet wider ambitions, particularly the goal of decarbonising the electricity system by the mid-2030s, the impact of increased cost of capital has the potential to wipe out benefits arising from more efficient wholesale market operation. An even worse outcome is that the increased uncertainty slows investment and, ultimately, our progress towards overarching goals.
The second major barrier to good decision making is that we lack a full articulation of what either of the two retained approaches might actually look like in practice.
Zonal wholesale pricing could span everything from a framework based around two decentralised markets linked by cross-zonal interconnection (much like the way bidding zones in the European Single Electricity Market are linked) to a model based on full central dispatch with up to a dozen smaller zones (similar to the design of the Scandinavian zonal market).
The alternatives to zonal are even less well defined. In its consultation, the UK Government articulated four main high-level mechanisms: network charging, network access, improved constraint management and improved cross-border interconnector dispatch. There was, however, little concrete detail on their design, the principles which would underpin them, or how they might be combined into a coherent package.
The lack of detail on locational signals, particularly how to deliver them alongside a national wholesale market, is a significant gap this far into the REMA process. If we do not have clearly defined options for reform, how can we properly assess them and make good decisions?
The particular importance of location and flexibility
Flexibility can be described as the ability of assets to adjust their power output or consumption in accordance with variations in conditions either due to forecasts (in which case an action is scheduled) or unexpected events (in which case the flexibility has to be reactive).
Historically, the provision of flexibility has tended to be bundled with power generation, particularly from fossil fuel power stations. These stations had various inherent capabilities to run flexibly and support system operability in their normal operation. Revenue streams specific to the provision of flexibility could somewhat be treated as an afterthought. Many providers built their business case primarily on the bulk sale of electrical energy. Revenues from ancillary services markets, the Capacity Market, and actions through the Balancing Mechanism, were additional ‘nice to haves’. This, combined with the fact that during the first decade and a half of this century network constraints were relatively limited, has led to the situation today where there are few locational signals for flexibility.
This is critical for three reasons. First, to minimise the use of unabated fossil fuels, we need to replace the flexibility of fossil fired generators with low carbon options and ensure these are located where they are effective for the system. This includes the need to ensure a set of arrangements that can support technologies like energy storage which, unlike power stations, are ‘flexibility only’ assets and need to build their business cases entirely on flexibility revenue streams.
Second, we see an increasing demand for flexibility to reflect the variability of renewable resources. This sets much of the context for defining the characteristics which our flexibility fleet needs to exhibit including ‘schedulability’, the persistence of certain actions, overall scale, and location.
Third, whilst the debate around locational flexibility is often framed as a trade-off with network capacity (more flexibility can reduce the need for network) the interaction between investment in flexibility and networks is more nuanced and needs careful consideration. The network also plays an important role in allowing the system to access flexibility. The fast and controllable response of a pumped storage station in Scotland or Wales to the sudden trip of, say, an interconnector in south East England would be of no use without sufficient transmission capacity between the two regions.
Defining the alternative: locational signals alongside a national wholesale market
Defining the alternatives to zonal is important because we need well articulated concrete proposals for both options if we are to make good decisions through the REMA process.