What the investors really think about zonal pricing
Zonal pricing is, we know, a dangerous distraction from real efforts to make energy more affordable, secure and clean.
The GB energy system needs £40 billion of investment every year to 2030 if we’re to stand any chance of meeting the UK Government’s Clean Power 2030 Action Plan. This investment will also be key to delivering the economic growth which is so crucial to the UK’s future prosperity.
When the world is touting for green energy investment, it’s vital that the UK remains attractive as a place to build the renewable energy projects we desperately need to secure our energy supplies and keep bills affordable in the long term.
So what of plans to rip up the electricity market rule book and move to a zonal model?
At Scottish Renewables we’ve already set out our position: ultimately, any theoretical benefits of zonal pricing will be outweighed by the increases to the cost of financing renewable energy projects as a result of the risks inherent to a zonal market and the uncertainty associated with radical market reform – all at precisely the time when massive private investment is needed to achieve net-zero.
Any increase in the cost of building the renewables we need would ultimately be borne by consumers; if a project’s costs increase, either the project must charge more for its power or it simply won’t get built. This is the reason why zonal pricing would be a bad thing for the country as a whole, not just renewable energy developers.
To illustrate the scale of the potential cost, analysis prepared for the UK Government found that a one percentage point increase in the cost of capital results in a move to zonal pricing having a net cost of £2-12 billion, with estimates suggesting the impact of locational pricing on the cost of capital could be as high as a two to three percentage point increase.
But what do investors actually think?
We asked three Scottish Renewables members for their views – and all agreed zonal pricing presented an existential threat to Scotland’s renewable energy sector and the UK’s wider net-zero ambitions.
Andrew Smith, a director of Greenbackers, highlighted the danger of stalled investments, saying:
“It is our view that zonal pricing would bring an unnecessary complexity and uncertainty to a market where investor appetites remain patchy and fragile.
“There is every prospect that any such market change would trigger a hiatus in investment of at least two years until the new market dynamics settled down and the way those markets operate in practice became clear. Such a hiatus inevitably results in available capital finding other sectors and geographies in which to operate. Restoring appetites and capital to markets they have deserted is notoriously challenging.
“We would observe that there are high levels of scepticism among investors that regulators would maintain policy direction in the face of any emerging opposition. That would be factored into investment thesis.”
Emma Tinker, Chief Investment Officer at Asper Investment Management, takes an even wider view of the issues posed by a moved to zonal pricing, saying that the model “fundamentally misrepresents the challenges facing our industry”.
She continues:
“Societal preferences and regulations have made it exceedingly difficult, if not impossible, to secure the necessary planning permissions to build generation assets in areas that are deemed optimal by grid planners. Instead, power generation facilities are built where the energy resources are most available. Designing a system like LMP, which fails to incorporate these societal, regulatory and practical realities, results in economic inefficiency.
“We think this approach will increase the risks and costs of developing and operating energy projects, burdening developers and consumers unnecessarily. The more granular locational proposals drive even greater uncertainty for investors, creating an uneven playing field for projects and developers.
“A more rational design would recognise that these societal challenges should be absorbed and distributed across the entire grid system, reducing barriers to development and meeting clean power targets. From an investment perspective, an electricity market design that accounts for such systemic realities reduces market volatility and creates a more stable environment for capital deployment, ensuring that infrastructure investments align with both economic and societal objectives.”
SSE’s Net Zero Acceleration Programme is a five-year, fully-funded, ~£20 billion investment plan to 2027. As an investor in, and developer and operator of, renewable energy projects, the company’s view on zonal pricing is also clear, with Group Head of Policy and Advocacy Alistair McGirr writing:
“Simply, the purported benefits of zonal pricing will be outweighed by the increased cost of borrowing caused by the greater volatility that zonal pricing would bring to infrastructure investment.”
He continues:
“It’s akin to focusing entirely on the sale price of a house but ignoring the cost of the mortgage. And you just have to look at UK Government borrowing rates over the years to see how global investors can react to public policy decisions.
“This is before you get into the period of disruption going for zonal pricing would bring. The earliest that zonal pricing could be introduced is 2032 – but worse than that is the actual zones themselves won’t even be confirmed until 2030. A tricky investment climate to say the least.”
But is a shift to zonal worth it in the long run? Could consumers – and importantly Scottish consumers – get free electricity if this all works out, as some have suggested?
Andrew Smith of Greenbackers writes:
“Perceived pluses from zonal pricing may not appear; the track record of attempts to adjust market behaviour is not encouraging.
“At a minimum we would anticipate increases in the cost of capital for projects in a market where the supply of available capital would become constrained due to some providers adopting a ‘wait and see’ attitude.”
And SSE’s Alistair McGirr agrees, saying:
“All of this may be worth it if there was a prize at the other end – but there just isn’t.
“Promises of the lowest wholesale energy prices in Europe deliberately only present half the picture. They are based on outdated information and ignore the reality that costs will just appear elsewhere on the bill – and these costs will get picked up by those least able to flex their demand, including those in Scotland.
“[Increased cost of capital] will not only cost consumers more, but will hinder Scotland’s ability to lead the global clean energy race and capture the supply chain investments that could come with it.
“This is not to say there are not improvements to make to the energy market in Great Britain, but there needs to be a focus on practical measures that can be delivered more quickly and without the disruption to investment. Specific improvements to network charges and system balancing processes can bring significant benefits to consumers, and importantly be delivered in the coming years.
“With zonal we will be waiting for years for the final shape of the market to be confirmed – all while planned upgrades make the grid constraints of today a thing of the past.”
Ends