Ed Miliband and the UK zonal pricing conundrum

Ed Miliband, Secretary of State for Energy Security and Net Zero in the UK administration elected in July 2024, has a lot on his hands. He has pledged to make Britain a clean energy superpower with zero-carbon electricity by 2030 while generating growth, tackling the cost-of-living crisis and relieving the country of power imports.

And then there is the issue of zonal pricing. This is the idea of splitting the UK’s wholesale electricity market into different pricing zones to more closely reflect local demand and stimulate energy infrastructure investment in areas where it has greatest value. 

As things stand today, the UK—like most other countries—has a single wholesale electricity market where the price you pay, or get, for electricity is the same at any point in time from Land's End to John o' Groats. But the value of electricity generation is not the same across the country. 

Places such as London or the industry-heavy Midlands, for instance, have a massive need for electricity and are thus willing to pay more for it. In contrast, in the Scottish Highlands or Welsh Valleys the demand for electricity, and its value, is much less.

Zonal pricing proponents believe that splitting the UK into different electricity market zones would give renewable plant developers an incentive to build projects in areas where demand is greatest, thus relieving the strain on grids that currently transport power across the country from where it is produced to where it is needed.

Zonal pricing could also contribute to the UK’s net zero goals, since grid constraints currently mean the abundant renewables produced in the north of the country do not always make it to the energy-starved Midlands and central regions of the UK—which then rely on gas-fired power instead. 

With zonal pricing, the thinking goes, energy-intensive industries might move to areas with higher levels of renewable generation and lower electricity prices, contributing to what the previous government called levelling up. 

Meanwhile, demand response schemes would be encouraged in areas with high energy costs, reducing the need for gas. In March 2024, under the previous administration, the Department of Energy Security and Net Zero launched the second of two consultations on zonal power pricing. 

Earlier, a 2023 study commissioned by the regulator Ofgem, based on National Grid’s 2022 Future Energy Scenarios and featuring seven zones, said zonal pricing could create £15 billion in socio-economic benefits from 2025 to 2040. But there could be downsides too, according to public affairs firm Brevia Consulting. 

"Bruising debate"

Zonal pricing could exacerbate the volatility of wholesale electricity rates, making it riskier to finance renewable energy projects and driving up the cost of capital. Also, vulnerable consumers in zones with high electricity prices would be even more likely to fall into energy poverty. 

But perhaps the most worrying impact would be on investor confidence. In March 2024, the National Energy System Operator’s chief strategy officer Claire Dykta told a House of Commons Energy Security and Net Zero Committee that “five years is probably a sensible time” to implement a zonal pricing scheme. 

This would mean five years of uncertainty while details get ironed out and rules are established. For energy infrastructure investors, the obvious temptation during this period would be to pass over the UK and put money into markets with greater regulatory certainty instead. 

Thus, while the introduction of zonal pricing could deliver significant benefits in the long term, during its implementation it would likely lead to an investment paralysis… precisely at a time when Miliband needs to increase clean energy spending in pursuit of his stated goals. 

This impasse has led to what The Guardian newspaper has described as a “bruising debate” over UK zonal energy pricing.

“The debate has driven deep rifts across the industry, between modernisers who believe the new price signals would give rise to a new, rational market and those who fear the changes risk unravelling Britain’s low-carbon agenda,” it said. 

Among the former is British renewables group Octopus Energy. “The single wholesale price across GB often gives the wrong price signal to low-carbon flexible assets,” it argues. “This means these assets are doing the wrong thing (worsening network constraints) for the system around 30% of the time. 

“The sooner we correct this, the sooner we can realise savings in cost and carbon from effective use of these assets.”

In contrast, says industry body RenewableUK: "The industry consensus is that the risks of overhauling the system in such a radical manner would vastly outweigh any potential benefits. 

“A move to zonal pricing would significantly increase the costs of financing projects across all technologies, due to the extreme price volatility it brings and the greater potential risk for investors as a result. … The uncertainty of such a lengthy implementation process could also lead to a hiatus of investment, further stifling development.”

Uncertainty about uncertainty

Martin Pibworth, chief commercial officer at the multinational energy company SSE, adds “It’s time to move on from the zonal pricing debate” and notes that “building out the grid while at the same time developing plans to split the market doesn’t make sense.”

At Pacific Green, we are sympathetic to both points of view. We are agnostic on whether the UK should ultimately have one single national or several zonal wholesale electricity markets. But we do have a message for Ed Miliband: if there is one thing that investors are averse to, it is uncertainty.

True, the introduction of zonal pricing could lead to doubts over the future market structure, but right now there is uncertainty about that uncertainty… because it is unclear whether the change will go ahead or not. The best thing Miliband could do right now is simply settle the debate one way or another.  

“This needn’t involve making a final decision on the matter,” says Dane Wilkins, Pacific Green’s managing director of Europe. “But investors need to know if moves towards a zonal pricing structure will kick off during this legislation. That’s still a tough decision, but just making the call may be a relief to many in the energy sector.”