Ofgem report on potential impacts of introducing locational wholesale pricing

Ofgem has published its report setting out the key findings from its assessment of the potential impacts of introducing locational wholesale pricing in Great Britain. 

Responding, Andrew MacNish Porter, Senior Policy Manager at Scottish Renewables, said:  

“We are well under way on our transition to net-zero and are now almost halfway through what is a critical decade for delivery if our climate targets are to be met. This is therefore not the time to be implementing radical market reform which would increase investment risk, likely cause an investment hiatus, and therefore increase the cost to consumers of achieving net-zero. 

“The results of the modelling of a move to locational marginal pricing (LMP) published this week by Ofgem are highly contingent on several strong assumptions and therefore cannot be used as a reliable evidence base upon which to proceed with implementing LMP.  

“We have significant doubts over the reliability of the analysis for several reasons. 

1. The modelling used to estimate the impact of a move to LMP on the cost of capital are incredibly optimistic, with little justification of why such major market upheaval is assumed to have only a marginal impact on the risks facing projects. Detailed analysis from Frontier Economics has estimated that introducing LMP could lead to an increase of 2-3 percentage points in the cost of capital. As the sensitivity analysis published by Ofgem shows, an increase of just 2.29 percentage points (well within this range) could wipe out the modelled benefits of LMP. 
2. The modelling assumes that a vast quantity of electricity generators will relocate in response to locational price signals. However, many other factors influence siting decisions, and this assumption is not supported by credible evidence that projects do in reality relocate following the introduction of LMP. By introducing greater uncertainty to the market, it is more likely that LMP will instead simply make building renewables in some locations unviable whilst doing little to encourage projects to locate elsewhere. Scottish generation, which will be essential for meeting our climate targets, would be bear the brunt of these negative impacts. 
3. The modelling assumes that only Accelerated Strategic Transmission Investment (ASTI) network reinforcement projects get built over the modelling period. The avoided constraint costs which form much of the modelled benefits of a move to LMP are therefore likely to be significantly overstated. As shown in the sensitivity analysis, modelled system benefits are reduced by over 40% when the Holistic Network Design (HND) investment plans are taken into account. The modelling does not consider the additional reduction in benefits which would result from the HND Follow Up Exercise. 
4. The counterfactual used in the modelling assumes that current market arrangements remain unchanged. This overlooks the significant potential for reform to existing market arrangements to deliver much of the supposed benefits of LMP whilst avoiding the associated risks.  

“We therefore appreciate that Ofgem has recognised there are significant shortcomings to findings based on a comparison to the status quo, and we welcome Ofgem’s stated intention to support the development of a more realistic counterfactual. However, given the many additional flaws in the modelling, even with a more realistic counterfactual, we do not believe the results can be used as a reliable basis for decision making. 

“We therefore urge Ofgem to go further and join with industry in calling on the UK Government to rule out a move to LMP in the GB wholesale electricity market.  

“With LMP ruled out, attention can then focus on building an evolutionary package of reform to existing market arrangements which will deliver a reliable, efficient, cost-reflective decarbonised energy system in the best interests of consumers across the entirety of the UK.” 

Notes 

• The Ofgem report ‘Assessment of locational wholesale pricing for Great Britain’ is here. 

• The blog ‘a theory of evolution for locational signals’ by our Senior Policy Manager, Andrew MacNish Porter, is here.