Fighting The Wrong Battle? A Critical Assessment of Arguments Against Nodal Electricity Prices In The European Debate

Abstract

Contrary to liberalized U.S. electricity markets that apply nodal pricing, EU power markets rely on uniform pricing in bidding zones. The EU’s zonal pricing model is challenged by an increasing mismatch between network and generation expansion within existing bidding zones, as well as the complexity of defining adequate new bidding zones. A potential solution is to transition to nodal pricing in the EU. The academic literature provides strong evidence of significant cost savings under nodal pricing as compared to zonal pricing. The question is: Why has nodal pricing persistently been discarded in the EU? It cannot be denied that implementing nodal pricing would require significant changes to the EU market design and potentially also the institutional setup. However, so far, the debate in the EU has mostly focused on perceived flaws of the concept of nodal pricing. In this paper, we identify the main arguments against the concept of nodal pricing brought forward by EU stakeholders. We group the arguments into the six categories: susceptibility to market power, barriers to unlock flexibility, market liquidity concerns, increased investment risks, unmanageable complexity, and political undesirability of locational price differentiation. Our contribution is to critically assess each of the arguments and to demonstrate that they do not explain, nor justify, the opposition to nodal pricing. Instead of devoting attention to mostly misconceived flaws of nodal pricing, we urge a reconsideration of a nodal market.

Keywords: electricity market design; bidding zones; liquidity; market power; flexibility