Locational Pricing Puts Consumers in the Driving Seat – Ben Shafran

Comment by Ben Shafran, Head of Markets, Policy & Regulation, at Energy Systems Catapult.

Citizens Advice have made a welcome contribution to the debate on locational pricing with their latest report, It’s all about location – Will changing the way we price electricity deliver for consumers?

The report delves into how reforms to the electricity market can deliver on sustainability and affordability for end-consumers and highlights the benefits that locational marginal pricing (also known as ‘nodal pricing’) can deliver such as:

  • Ensuring potential constraints on the network are considered as the system operator dispatches generation and other assets in the wholesale market.
  • Encouraging improved siting of low carbon technologies in areas where they are most needed.
  • Reducing energy consumption in homes and lowering household bills.

This chimes with our work on locational pricing that we completed on behalf of Ofgem in partnership with FTI Consulting. The results of which indicated that we could deliver electricity system savings of as much as £50 billion – equal to £120 (approx.) of each household’s annual energy bill. By implementing locational pricing, we have an opportunity to put consumers in the driving seat and help them save money on their bills, while helping to decarbonise the grid.

Our work with FTI Consulting demonstrated that all regions of Great Britain would be better off under a system of locational marginal pricing. The introduction of any new pricing system will require us to revisit consumer protections and ensure that individuals and households are afforded the protections they may require.

The Citizens Advice report highlights the diverse range of protections that could be introduced if there are concerns that some consumers might be disadvantaged (e.g., because of their energy use patterns). Such protections could include:

  • Shielding by type of user.
  • Phased exposure to more granular signals.
  • Averaging across larger areas or zones.

To maximise the benefits to consumers, reforms in the energy retail space should be progressed in parallel with changes to the wholesale market. We have explored this in our work with OVO Energy on the changing role of energy retailers.

With any new system, there will always be concerns about the potential impacts it could have on investment. Citizens Advice’s report does draw attention to potential concerns about the impact locational marginal pricing could have on renewable investment – particularly given the need to scale up renewables in the next 10 years.

Through our work with Octopus Energy to inform government’s Review of Electricity Market Arrangements (REMA), we have highlighted how locational marginal pricing is not an obstacle to large-scale investment in renewable generation. Markets in the United States for instance, have generally seen high levels of investment. For example, despite limited support for investment in renewables, New York and California have seen more than 2.2GW and 3.5GW of wind capacity, respectively, come online since those markets introduced LMP.

The work we undertook with FTI Consulting also shows a growing proportion of electricity markets in developed economies are moving towards locational marginal pricing alongside a rapid growth in installed capacity. We also found that markets that adopted locational marginal pricing tend to see more investment in storage – a key element of ensuring that we move to a system where flexibility is used to maximise the benefit of renewable generation.

The report from Citizens Advice is an important addition to advancing policy thinking on the role of locational marginal pricing in a Net Zero electricity system. Britain does not need to choose between a market that works for investors in renewables and a market that works for consumers – both are compatible under a reformed system that is built on granular locational signals.

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