Could zonal pricing reduce energy costs?

New Statesman​

24-04-2025

Photo byThis article was originally published as an edition of the Green Transition, our weekly newsletter on the economics of net zero. To see more editions and subscribe, click here.
It's unorthodox to start an opinion piece both by explicitly avoiding taking a view and yet still expecting to piss everyone off. But it must be so when talking about energy market reform, the sector's issue de jour.
Energy market reform, more formally known as the Review of Electricity Markets Arrangements (REMA), was a policy developed by the previous Conservative government. But with a Labour victory at the general election came a new plan for the energy system – Clean Power 2030 – backed by an interventionist state. This complicated REMA. Government needs a lot of private investment to build the infrastructure to decarbonise power by 2030. REMA changes the rules, risk and therefore cost to government of that investment.
A decision is still expected by the summer and is vital to the confidence business will have in government's plans. But that decision now effectively boils down to one thing. Despite once being about every part of non-retail electricity markets, from contracts for difference to the balancing market and beyond, we are now essentially talking about one issue – locational, marginal, or zonal pricing.
On one side are the champions of a free-market policy where energy varies by location (let's call them the insurgents). Their argument is predominantly pro-consumer, that zonal pricing is a silver bullet for lower costs and an easier energy transition. On the other are investors, legacy energy companies and climate advocates, who worry that the risk of shifting to zonal threatens infrastructure investment and therefore decarbonising the energy system (let's call them the status quo). Their argument is predominantly about growth and investment. Both sides have the economic modelling to prove that zonal raises/lowers bills (delete where appropriate). There is no middle position, everyone must pick a side.
This is a nightmare for government, who have no off-ramp. We need a decision, the uncertainty either way is just as damaging to the UK's investment prospects. Politics means meditating interests to get to a decision. To help, advocates should think a little about the political process.
First, think about the evidence. Paying for more numbers to prove your point clearly isn't moving the dial. The best conclusion government can currently reach is that any decision has highly uncertain impacts which vary wildly on the underlying assumptions. At worst they will think that whatever action they take someone will accuse them of raising the cost of the energy transition. The mudslinging about incumbents, vested interests or profiteering may be good tactics for firms but they are terrible strategy for all those who care about net zero.
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Second, recognise the government's strategy. The Department for Energy Security and Net Zero (DESNZ) is planning a decarbonised system. It is going to have a concrete plan for where it thinks energy assets should go. How can it reconcile a free-market policy, which was developed under the previous Tory government, with its more statist instinct?
Clearly this government wants to be a reforming one. The status quo is not an option, and too often advocates against zonal stop at – 'just don't do it'. The government is already doing a lot of reform, not least on CfD terms, balancing market arrangements, or grid connections.
But 'we are already reforming so we aren't doing this' is not an announcement. It leaves open the question over whether REMA is paused, salami-sliced, killed or complete. There is no 'no-change' option available here, the world and energy system are already changing, fast. The government wants to be a part of that.
If zonal doesn't go ahead DESNZ will still need answers on things like maximising the effectiveness of storage or efficacy of interconnectors. If it does, it needs a plan for managing the politics of a situation in which different towns, cities and industries pay different energy prices.
With both sides only representing their own interests it's always going to be hard for government to mediate. In formulating a response, it can draw from both sides.
From those advocating for reform, the government can take a laser focus on consumers, and a clarity over where we're trying to get to and why. Being positive about the future carriers a lot of weight. DESNZ should talk about households and their benefits, not investors. From those lobbying to keep the status quo, the government should push that whilst it is already reforming, there are myriad more options to do so.
But it can't appease both; and the government must recognise not everyone will be happy. Government can go further than either side has in looking at more radical ideas for bill reduction that don't feature in the current debate. They include, returning to ways to finally break the link between gas and electricity prices, thinking about hypothecating carbon pricing revenues or rethinking how Ofgem calculates network costs?
Too often industry focuses solely on their thing and can't abstract it to a political process. But it's naïve to think that government can do that alone. There's a reason REMA has been three years in the making, it's hard. Time to start compromising.
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