This month, the government dismissed the idea of zonal pricing for UK energy. This would have seen areas with high energy generation and low demand, such as Scotland, pay lower bills than elsewhere in the country. Ultimately, it was deemed too complicated and disruptive. However, it removes a possible solution to the biggest conundrum of the decarbonisation process – how to get power to the right place, at the right time and at the right cost.
The UK does not necessarily have an energy generation problem. Rather, its energy distribution problem is more acute. The system was set up for a bygone era and as a result, is full of bottlenecks and plumbing problems. Energy moves around the system inefficiently and this adds cost. For example, wind and solar energy will occasionally need to be turned off, at significant cost, to manage the constraints of the grid as part of the ‘Balancing Mechanism’.
Ben Guest, portfolio manager at Gresham House Energy Storage Fund, says: “It is a system that is perfectly unbalanced, and yet requires perfect balance.” He points out that there are bottlenecks when moving energy from east to west and from north to south. “We’ve ploughed ahead with deployment of renewables, irrespective of where they are, using a network that is not designed for that layout, thereby creating serious issues in terms of how that power flows to the customer.”
Zonal prices was a potential solution. Alan Smallwood, fund manager on Gore Street Energy Storage fund, says: “We’re trying to fit the new net zero world into the old system and that was always going to be costly. Regional zonal pricing was one potential answer, but I think the complexity was that it would have been a complete change to the current system. It would have taken significant time and be disruptive, so there are a lot of people in the electricity market that are quite happy that we haven’t gone down that route.”
Charlie Wright, fund manager at Foresight Environmental Infrastructure fund, says is it widely accepted as a sensible decision, “that places pragmatism and delivery over the theoretical benefits of zonal pricing.” However, he says, the UK still needs to solve the problem somehow.
Guest says that a wholesale rewiring of the grid would be one option, but would cost around £100bn, more than the current value of the energy market could support. Batteries go a long way to solving the problem. Guest says: “This is not a perfect option, and you do need to double it up with more network reinforcement, but putting batteries either side of any network constraints is important. They can become a bit like a series of electricity waterfalls. Batteries become pools of energy that can be stored, and then trickle down. That removes the need for significant amounts of investment.”
Fortunately, the government appears to be on the same page. Energy and net zero secretary Ed Miliband has said he wants to remove the bottlenecks in getting power to market – building more grid connections and installing them faster. This includes battery parks to accommodate surges in power, and to distribute it afterwards.
This is happening already, says Smallwood. “National Grid and NESO (National Energy System Operator) have done a good job incentivised batteries onto the UK system. We have quite a large fleet of batteries and that is helpful on days when we have, for example, a lot of solar generation. The reality is that you are going to need an awful lot of batteries long-term. The demand is going to increase massively as well – we’re electrifying heat, we’re electrifying transport.” He says in the longer-term batteries may even be able to hold excess power and then export it for profit.
However, there are caveats. Batteries have suffered from the problem of ‘skip rates’. This is where the system operator skips over batteries to use more expensive methods in the Balancing Mechanism. High skip rates hold back investment and drive up consumer bills. This is now being addressed by greater automation of the Balancing Mechanism, which was previously a highly manual and human-driven process. In October last year, NESO said it is committed to a “level playing field” for all technologies within the market.
Smallwood’s view is that batteries get the UK most of the way there, but there will still be a need for “dispatchable technologies”. These might include gas with carbon capture, and pumped storage. “There are these other solutions that could play a role, but either way, batteries have a huge role to play, that’s why we’re in the sector.” Most renewable energy infrastructure trusts have a toehold range of technologies for this reason.
What does this shift mean for investors? Wright says that the decision on zonal pricing removes some uncertainty, “long-term zonal pricing could have had an impact on regional energy prices. We prioritise diversification across a range of technology, so were relatively insulated, but it removes what could have been a source of disruption.” It also makes the case for batteries even clearer.
It is also clear that while the decarbonisation process is bumpy, it is making progress. There are solutions to the problems with the grid, and a clear plan from the government to deal with them. In this way, the debate over zonal pricing was somewhat of a distraction, but it is perhaps a symptom of a market that is feeling its way to a better situation.
Wright says: “It’s a very politicised debate, but I don’t think it should be. It should be an economic and a social one. Certainly, economically and socially, the shift to cleaner energy has to happen. What are the alternatives? To continue to rely on fossil fuel would come at a huge short-term cost, as we’ve seen over the last few years, and then the long-term cost to society would be even higher. There will be political peaks and troughs.”
It would be tough to attribute the recent bounce in share prices for the renewable energy infrastructure sector to the abandonment of zonal pricing, which is too technical a consideration for most investors. In reality, it may have been a combination of the crazy low prices, extraordinarily high dividend yields and some much-needed corporate activity in the sector – mergers and acquisitions, plus buybacks and greater activity from the boards. However, any clarity is important for a sector that has had a tumultuous few years.
