Working paper
Zonal Pricing Volume Risk and the 2030 Clean Power Target: Working Paper
Apr 2025
REMA and the debate on zonal pricing
The UK’s Review of Electricity Market Arrangements (REMA) started in July 2022. It considered a rich tapestry of options for improving the way the GB market operates, with the aim of making it better able to attract the investment needed for the energy transition, and better adapted to efficiently operate with the new mix and location of supply- and demand-side technologies implied by a decarbonised system.
Three years later, this process has come down to an increasingly narrow focus around zonal pricing. Arguably, this is not because zonal pricing is the most significant element of REMA from a consumer perspective. The original REMA package included (and is still to resolve) some major policy questions, including, for example, changes to the Contract for Difference (CfD) scheme. CfDs are expected (and need) to mobilise £10s of billions of investment in low carbon power by 2030 and beyond, which is likely to have more significance for consumers than zonal pricing. But perhaps because CfDs are less contentious, they gather less attention and get less oxygen as a result.
At the risk of perpetuating this trend (we also publish on other topics!), in this blog we set out a brief overview of a new approach to thinking about zonal pricing, and why we think the Government should rule out zonal pricing for now, instead instigating a robust zonal review process for future implementation.
In a recent UKERC Working Paper on zonal pricing, we argued that although the day-to-day participants in a zonal market are the generators, suppliers and traders who are buying and selling power, perhaps the most important driver of prices in the functioning of a zonal pricing market is the transmission network. Constraints on the transmission capacity between zones are not only the key driver of price differentials between zones, they literally define the structure of the zones themselves.
A power system in flux
In a system where the transmission infrastructure is relatively settled, the pricing zones can have a stable structure, and investors can develop a sense of supply and demand, and pricing behaviour. In the jargon, this is called structural congestion – i.e. the congestion, or transmission constraint between zones is “capable of being unambiguously defined, is predictable, is geographically stable over time, and frequently reoccurs under normal electricity system conditions”.[1]
However, the whole GB electricity system is currently in flux, not least the underlying grid infrastructure. This is because the geography of the old system inherited from the fossil-fuel age (centralised generation in landlocked areas with good coal resources) is not well adapted to the new low carbon age (mix of offshore and decentralised onshore sites with good wind resources, together with a much richer mix of demand-side options).
Whilst transmission only accounts for around 1/8 of the overall asset value of the electricity system, grids dominate the structural and geographical aspects of the system. They are also one of the slowest elements of the system to build, create some of the longest-lived assets, and their network effects make them a natural monopoly. The need to centrally re-plan and rebuild the grid to match the future needs of a decarbonised system is therefore well recognised.
As a result, successive stages of transmission system planning are being carried out, including the Holistic Network Design, Beyond 2030, and the Strategic Spatial Energy Plan. The implementation of these plans will, over time, create the new backbone of a system adapted to a low carbon economy, and the basis on which market participants will then be able to buy and sell electricity.
In the horse-and-cart analogy, the grid is the horse, driving the physical relationship between zones. By extension, zonal pricing is the cart, creating an efficient commercial relationship between zones. Placing the cart of zonal pricing before the horse of grid build out would create unstable and unpredictable commercial relationships between zones.
Transmission investment and price formation under zonal pricing
Putting this in economic terms, grids will be a price-maker in zonal pricing markets. Our modelling suggests that new grid infrastructure arriving on the boundary between two zones will be a swing item in price behaviour, tending to close the gap between any price differences. Because of this, and because of the extended timeframe for investment decisions and build-out, investment decisions in new grid infrastructure will take little notice of such prior price differentials.
Therefore, placing the cart of zonal pricing in front of the horse of grid build out creates significant risks for users, generators and other price-takers in the market. In a zonal pricing system, price-takers become exposed to uncertainty over the timing and degree of grid build-out in different parts of the country, creating risks to investment, which translate to higher system costs for consumers. These uncertainties are currently very high, and will likely remain so in the short to medium term while the bulk of this new grid infrastructure is rolled out. Our paper evaluates one particular aspect of these risks, namely risks to investors in wind power of not being able to sell all of their electricity within the boundaries of a particular zone, and we show how these risks could potentially increase the CfD price paid by consumers to all generators in the country, raising the cost of meeting 2030 targets by up to £3bn per year depending on assumptions.
Assumptions are another key point of debate on the merits of zonal pricing. Some studies have indicated attractive (but still relatively modest compared to total system costs) levels of consumer benefits over a sustained period.[2] These rely on large levels of congestion rents (driven by price differences between regions) being passed back to consumers and represent a transfer from generators to consumers. Other analysis points out that different assumptions on the extent and location of generation, transmission and interconnector build can all significantly reduce these levels of structural congestion rent and so reduce the modelled benefits of zonal pricing.[3] As our own paper also points out, you cannot simply assume that generators will be able to absorb large transfers to the consumer without seeking to recover those costs via other means (like increased strike prices in CfD auctions).
While zonal pricing offers a seemingly neat solution for optimising the dispatch of flexible assets on a power system, the benefits case depends strongly on the assumptions made could erode further by other efforts to minimise operational inefficiencies within a reformed national pricing framework[4],[5], and could even be negative depending on impacts on the cost of capital and associated CfD bid prices for investors in the clean power mission.
A structured process of zonal review – avoiding a false dichotomy
A narrative emerging in the debate around zonal pricing is that the government is “damned if they do, and damned if they don’t” with their decision on whether to proceed with zonal pricing. If they do, this increases generation investor risks in the short term and undermines the prospects for meeting the 2030 target, if they don’t, these risks just get kicked down the road, perpetuating the current stasis for even longer.
However, we believe this is a false dichotomy.
Whilst introducing zonal pricing now could lead to net costs for consumers, doing so in future after the majority of the ‘great grid upgrade’ is complete could put the cart firmly back behind the horse, resulting in a more efficient, lower cost system that benefits everyone. The policy process for assessing zonal pricing once there is a clearer distinction between transient and structural congestion would have to be carefully designed to avoid creating a perception that risks were being perpetuated and exacerbated by delay. This could be along the following lines:
Protecting investor confidence and evaluating the case for zonal pricing
Defining this process now would avoid rushed decisions, address the current disparity in different economic analyses of the benefits of zonal pricing, and give time to develop the key facets of how a zonal market would be implemented in Great Britain. This could include details on how trading at different timescales would be facilitated within and between zones (what do markets for financial or physical transmission rights to trade between zones really look like in a decarbonised zonal British electricity system?). This would help build investor confidence in the policy, reduce costs for consumers in the short-term, and maximise the chances of success of a zonal policy in the long-term, should the review process determine that a move to zonal pricing would be desirable.
It could also strengthen Government’s negotiating hand in forthcoming CfD auctions (Allocation Rounds 7,8,9, AR7-9) by removing a major justification for high/no bids from the table. Removing the zonal risk ahead of AR7-9 will avoid baking in inflated auction prices and allow the benefits of moving to a 20-year CfD to be realised, alongside other actions to increase participation in the auctions and reduce costs to consumers. Some degree of linkage to the EU bidding zone review process could also help to align GB zonal definitions with zones in the EU which will be important factors to consider when taking interconnectors into account, including the coordination of development of offshore hybrid grid assets in the North Sea.
The UK is currently a safe haven for investors in clean power, but this needs to be future proofed. Uncertainty over the possibility of a move to zonal pricing now, ahead of planned transmission upgrades, is adding to the risks faced by prospective investors in AR7-9, essential to meeting the 2030 clean power target. Ongoing uncertainty over future implementation would have negative impacts on longer-term investments. The introduction of a robust zonal review process along the lines described above would help address both short-term and longer-term concerns. Clearly future Governments will be able to adjust the zonal review process, but if Government sets out a zonal implementation process this would provide clarity for investors of what they could expect to inform their investment decisions today. Indeed, elements of the review process could be inserted into legislation during this Parliament, further improving investor confidence that it can’t all be undermined by a future administration.
Conclusion
In summary, we suggest that the development of a robust and transparent process to assess structural congestion is the logical next step on from REMA’s evaluation of zonal pricing. Doing so would make it possible to avoid placing the cart of zonal pricing ahead of the horse of transmission build out, and avoid perpetuating delay and uncertainty.
[1] https://www.legislation.gov.uk/eur/2019/943/article/2
[2] FTI, Impact of a Potential Zonal Market Design in Great Britain: Quantitative Assessment of GB Welfare Impact Feb 2025 – https://octopus.energy/press/zonal-pricing-to-slash-more-than-55bn-off-energy-bills-major-new-report-finds/
[3] AFRY, Sensitivity analysis on the modelled benefits of zonal electricity markets in Great Britain, May 2025 – https://afry.com/en/sensitivity-analysis-modelled-benefits-zonal-electricity-markets-in-great-britain
[4] S. Gill et al, Locational Signals in a Reformed National Market: A review of options – https://ukerc.ac.uk/publications/locational-signals-in-a-reformed-national-market-a-review-of-options/
[5] Regen, A Progressive Market Reform Agenda For The Gb Electricity System – https://www.regen.co.uk/insights/a-progressive-market-reform-agenda-for-the-gb-electricity-system