Zonal pricing - the conversation we need to have.

Zonal pricing has dominated the energy news over the last two weeks as we approach the summer auction season. Energy Secretary Ed Miliband and Labour will need to decide if this is the right approach to the UK energy market and at the right time.

But what is zonal pricing?

How does it affect the UK energy market?

Is it the right solution to rising energy costs, which are some of the highest in Europe?

Although the arguments for and against have some intriguing points, they highlight the overarching problem with energy in the UK. It is not fit for purpose, our system is still stuck in the age of fossil fuels, when our energy mix has over 40% of renewable sources in the mix.

What is zonal pricing?

Currently, everyone in the UK pays a flat rate for electricity across the country, which is set by Ofgem, the independent energy regulator – zonal pricing seeks to rework this based on where pricing is based on where you live. The UK would be split into several different regions or “zones” where each will have a different price for energy based on how much energy is being produced, consumed, and available grid. Areas that have high energy supply and low demand, like Scotland, will pay a lower price for energy than areas that have high demand and low supply, such as the south-east of England.

Those championing zonal pricing, such as Octopus Energy CEO Greg Jackson, see this as the way forward in an efficient renewable market that reduces grid constraints, allows for more flexibility in the system, while lowering consumers' energy prices. Those who oppose argue that this will increase energy prices and slow down the installation of large renewable projects, as investment and financing will be working in a market with extreme price volatility.

Increasing or decreasing energy prices

The central pillar in the conversation surrounding zonal pricing is the impact on the cost of energy for consumers. The UK energy market has faced increasing costs since the invasion of Ukraine in 2022, and now has some of the highest prices in Europe. However, the pro-zonal pricing camp argues that this should not be the case with our abundant energy resources, and the implementation of zonal pricing will rectify this, wherein Scotland would have some of the cheapest energy prices in Europe.

In fact, Greg Jackson claims that zonal pricing will save consumers a considerable £55 billion by 2050, citing a report by FTI Consulting. One of the biggest culprits in rising costs that zonal pricing would address is the expenses incurred by grid constraints.

Renewable sources such as wind are variable in nature, which means at times, we overproduce energy in areas such as Scotland and are not able to transport it south to where it is required. Not only does this waste vast amounts of green energy, but in our current system, the solution is to shut off the turbines in which energy companies must pay producers to do. The firing of gas plants is then used to supplement gaps in the power supply for the country, increasing costs. Grid constraints added £1.5 billion to British energy bills in 2024 and are expected to reach £1.8 billion by the end of this year.

Counter to this, Renewables UK, who represent the major energy developers across the country, argues that any potential savings from a move to zonal pricing could be wiped out by the increasing costs to finance projects. The UK Government’s modelling suggests that the move could save between £5 billion and £15 billion. However, developers, asset managers, supply chain companies, and financial institutions signal that the new market is high-risk, which would lead to an increase in capital of between 0.3% to 0.9%, with analysis suggesting it could even reach 3%. This means any savings incurred by zonal pricing.

Adding on to this is the assumption that geography-based pricing would impact behaviours to move installations. Only certain parts of the country are suitable for the installation of on and offshore wind turbines, hydroelectric plants, and solar PV. It is the main reason we see so many wind turbines in Scotland and solar farms in the southwest of England.

North vs. South

Further impact on the argument for zonal pricing is the north-south divide in the country. A recent poll by Opinium Research for Renewables UK demonstrated that 58% of people in England and Wales oppose zonal pricing, with 59% of those seeing it as unfair. Despite this being a small sample of 3,000 people, it points out the overwhelming attitudes of people who would be most impacted by an increase in their energy bills when we are already facing growing costs.

The impact on industry and manufacturing would also be significant, as large sites cannot easily pick up and move to where energy prices are cheaper. As we have seen before, an increase in electricity pricing results in an increase in the cost of goods and services as producers must absorb the rising costs.

However, there is potential for energy-intensive industries to take advantage of some of the cheapest electricity costs in Europe to expand their businesses in Scotland. Bringing jobs, growth, and spending to areas that are traditionally underserved.

Making the UK a digital leader?

One such industry would be data centres, as the use of digital infrastructure and AI continues to rapidly grow. Data Centres currently account for more than 2.5% of the UK’s total electricity consumption, and they are not slowing down. In an industry whose total consumption is expected to grow to 945 TWh by 2030 (more than the total electrical consumption of Japan), grids are already struggling to keep up with demand.

Supporting the UK’s ambitious plans to be both a leader in green energy and AI, the implementation of zonal pricing could appease both. Data centres could take advantage of the abundant supply of energy in areas where costs are lower to build and expand operations. Fuelling the economy and the installation of renewable sources in these locations.

Though the question at the end of the day is how long this will last, and it is sustainable for both the digital industry and surrounding communities?

Is zonal pricing a fit for the UK energy market?

While arguments for and against zonal pricing in the UK have their advantages and disadvantages, it has brought up a crucial point. Our current market set-up is no longer fit for purpose.

We are now transitioning into a new age of energy wherein renewables are king, and fossil fuels are being left behind. However, we are still operating as if we are in a fossil fuel-dominant market, which does not reflect the varied nature of renewable sources. Solar only generates energy when the sun is shining, hydroelectric is dependent on the consistent availability of water but is affected by rising temperatures, and wind turbines are not always operational given the availability of wind. Whereas fossil fuels are there to meet our energy demands when we need them.

In this new renewable age, we need to shift our consumption habits, where zonal pricing and signal pricing can help support this. Additionally, the increase in use of battery storage across large installations ensures less energy is going to waste and gives greater flexibility in available energy.

Whatever the result is, the zonal pricing debate has highlighted the need for a transition in our current set-up if we are to continue with our net-zero efforts and bring down consumers' energy bills.