Fully decarbonising the electricity system to help meet Britain’s Net Zero emissions target will require significant investment in generation, networks and flexible energy resources.

In March 2021, Energy Systems Catapult (ESC) published its reform proposals for GB’s future power market – in Rethinking Electricity Markets – EMR2.0 – based on an innovation-friendly and consumer-focussed approach. Among the recommendations, we proposed that BEIS and Ofgem focus on achieving more efficient, dynamic and granular market signals in short-term wholesale markets to reflect power system status accurately by time and location. Improved price signals are key to improving system efficiency and achieving Net Zero at least cost.

Since March, ESC has undertaken a deeper assessment of locational energy price signals, with support from CEPA and TNEI. The evidence and our conclusions can be found in two reports, summarised below:

This report aims to raise awareness of nodal pricing as the first best approach to signalling locational value in a more deeply decarbonised, decentralised, and digitised electricity system. Our work suggests that adoption of nodal pricing in future GB power market design will be highly valuable in enabling an efficient transition to a net zero grid in Great Britain (GB).

The key advantage of nodal pricing is that it encourages generators and providers of flexibility to locate and operate assets (e.g. generation or storage) efficiently, taking account of the real physical constraints in the network. Over time this is likely to lead to more efficient location of new resources and efficient expansion of the network. It will reward innovation and development of flexibility in locations where it is most valuable to the overall system.

Nodal pricing (also known as locational marginal pricing (LMP)) involves determining market clearing prices for several locations on the transmission grid, called nodes. The price calculated for each node reflects the locational value of energy, which includes the cost of the energy and the full cost of delivering it including energy losses in networks and network congestion. Nodal prices are determined in real-time using an algorithm to calculate the incremental cost of serving one additional MW of load at each respective location subject to system constraints (e.g. transmission limits, maximal generation capacity).

Nodal pricing has been adopted in a number of jurisdictions around the world and enables the signalling of locational value mainly through short-term wholesale electricity prices (i.e. spot prices), instead of in network charges. We propose that nodal pricing be introduced as part of a wider reform package, as detailed in ESC’s recently published report Rethinking Electricity Markets – EMR2.0: a new phase of innovation-friendly and consumer-focused electricity market design reform (Keay-Bright & Day, 2021).

This report explores the role that locational price signals can play in minimising the cost of the future energy system. The focus of the study is on the role of energy markets and network use-of-system tariffs in offering locational price signals in operational timeframes.

Three potential approaches (‘straw-persons’) were developed to help explore market design questions and issues. Each straw person offers highly targeted signals of locational value in operational timeframes compared with the current arrangements in the GB energy market. In principle, each of the straw-persons is capable of enabling a net zero electricity system, but each also offers different costs and benefits.

Key points

• Nodal pricing is the preferred option for ensuring efficient dispatch of resources in operational timeframes and offers high potential for new business model innovations, but it may not be viably applied at lower voltage levels at present. Successfully introducing nodal pricing in the GB energy market would require careful consideration of the level of voltage below which nodal pricing would not apply, as well as establishment of in-depth market monitoring. Behind the node, locational signals can be sent through either local flexibility/energy markets or distribution network charges, though locational marginal pricing could reach lower voltages in time with growth in distributed energy resources and improvements in data, digitalisation and network monitoring.
• In relatively unconstrained systems, zonal pricing may achieve comparable outcomes to nodal pricing in operational timeframes without the risk of generator market power inherent in nodal pricing, and with far less change required to current system roles and processes to enable nodal pricing. However, constraints are expected to increase considerably over time due to high growth in distributed energy resources. Experience in other jurisdictions shows it can be highly disruptive and challenging to move to zonal pricing before moving again to the more sophisticated nodal pricing. It could therefore be preferable to move straight to the economically superior nodal model despite the major change, which would need careful management and transitionary arrangements. If zonal pricing is introduced, however, care needs to be taken to minimise the risk of inefficiencies from zone definitions, ensure consistency between day-ahead and balancing markets, and avoid double-counting between price signals in wholesale markets and in locational network tariffs.
• Much more sophisticated network use-of-system tariffs could be developed but they are still unlikely to accurately reflect the cost of energy supply in operational timeframes and will be second best compared to nodal pricing. Nevertheless, they can usefully complement nodal or zonal prices at lower voltage levels. Network tariffs also offer useful longer-term investment signals.