Tuesday, April 25, 2017

PRICE CAPS.  HYPOCRISY GOES INTO OVERDRIVE, BUT ARE WE WITNESSING THE DEATH OF NEO-LIBERAL PRINCIPLES FOR THE ENERGY SECTOR?


As we head at increasing speed for the policy train wreck of the forthcoming Brexit negotiations, the British political class (and MPs by an overwhelming majority) has chosen to divert our attention into one of the most pointless general elections of all time. This will inter alia call a temporary halt to the searching examination of false promises and expectations, and simple untruths,  that Hillary Benn’s House of Commons Select Committee on Leaving the European Union has been conducting. Readers not looking for the usual energy policy content of this blog may wish to read no further and refer instead to the Committee’s recent reports. These tend to be understated, but the material is there. In due course we will no doubt learn more about the effectiveness of EU exit in curbing immigration, boosts to our national income, the wonderful new trade deals on offer from Donald Trump, and much, much more.

POLICY TRAIN WRECK


However in the meantime the campaign will provide a useful opportunity for our leaders to hide from reality. Nevertheless connoisseurs of duplicity, smoke and mirrors, and hypocrisy, if not satiated by other aspects of the Brexit debate, can still find some rich material in campaign discussions on the subject of energy prices. The subject of energy price caps has come to the fore, just as it did before the 2015 election, with Ed Miliband’s promotion of the idea.

2015. RED ED'S POLITICS OF THE BANANA REPUBLIC.  like the pledge to cap energy prices, [these policies]  … merely serve to stoke up the politics of division. [Daily Mail].  “And despite the criticism of many experts, he remains committed to the principle of using State power to cap energy prices, with bills frozen by law until 2017, which strikes me as economically illiterate.” crowed another Mail columnist. BACK TO THE BAD OLD DAYS, the Daily Mail front page had screamed earlier in September 2013 on the same price cap issue. For the Spectator it had been MILIBAND'S LA-LA LURCH TO THE LEFT.

2017. But when the Mail reported earlier this month on Tory plans to take action on bills in the face of the latest rise by one of the big six energy companies, such statist intervention had become CRACKDOWN ON ENERGY RIP-OFFS. The Telegraph said prices would go up before Miliband’s freeze, while the Times and the Sun warned the “lurch to the left” risked blackouts. The Times’s editorial described his plan as “flawed in practically every detail”. [But] on Sunday, the Sunday Times welcomed May’s price cap as an “attempt to capture the political centre ground”. [Guardian]

The ironies in the contradictory treatment of the same policy when promoted by different factions are amusing. But actually there is a deeper significance to this volte face from the party of market fundamentalists.

As it happens I regard the use of price caps as misguided under most circumstances, now putting myself at odds with both Labour and Conservative. Obvious reasons are the risk that interventions confined to price will reduce supply and deter investment, and that it is better to address the disease (market failure) rather than the symptom. Nor do I entirely buy the view that the energy companies are making excess profits (see an earlier posting). But the endorsement by the Conservative party[1] of such a quintessentially statist, interventionist approach signals something more than simple electoral opportunism. It arguably represents the end of the road for the pretences of market liberalisation. This is certainly so in the UK, arguably the pioneer of deregulatory principles and their application.

Network costs, which can account for a third or more of a domestic consumer’s bill, have always been heavily regulated, even after privatisation in 1990. Generation investment is now almost entirely dictated by government, either directly through support for nuclear or renewables, or more indirectly through centrally controlled capacity auctions. The remaining element of the electricity supply chain, retail supply, has always been at best pseudo competitive, but that too is now being taken under the umbrella of government. What all this amounts to is the complete capitulation of the neo-liberal approach, at least in the energy sector.

It is surely time to recognise that this is a sector beset by market failure and that we need, not a series of ad hoc sticking plasters but a complete re-think of how we want the sector to operate and how we can better structure it to use the real dynamics that can come from competitive markets in driving efficiency and innovation. There is no point in pretending that we are still operating a laissez-faire competitive system, or that government can remove itself from the multiple policy choices and commitments that the sector, and particularly a low carbon power sector, will require.

There are further ironies and further opportunities for amusing speculation. The UK is not alone in wrestling with the paradoxes of the flawed neo-liberal paradigm. My last posting discussed a significant issue arising in a German and EU context. The EU followed the UK up the hill of unbundling and market solutions, but at least 15-20 years behind. The dawning realisation in the UK of the need to reverse direction and head downhill will shortly see it meeting an EU still struggling towards the summit.

But will this be an element in Brexit or future trade negotiations? And if we struggle to get back into the EU in (say) 2025 will be obliged to make further reverse policy changes to meet the EU energy sector and competition and state aid rules at that time. Or will the EU by then also have learned something from our experience as well as their own?



[1] This is after all the party of the ayatollahs of free market fundamentalism such as Redwood, Lawson, Lilley et al.

Tuesday, April 11, 2017

ANOTHER CLASH BETWEEN EU COMPETITION LAW AND SENSIBLE ENERGY POLICY


The EU has launched an investigation into German plans to create a strategic electricity reserve, exploring if the measures amount to illegal state-aid that will distort competition in the electricity market. (FT, 7 April 2017)

Prima facie this episode represents a failure to understand, let alone resolve, a fundamental dilemma of electricity wholesale markets.  This is a failure that potentially has quite profound implications for the ways in which European reliability standards and security of supply are defined, and for effective governance of the sector. The UK, originally a prime mover in liberalised markets and operating regimes that replaced the old style world of command and control, may think it is immune from these problems in the post-Brexit world. If so it is mistaken[1]. Pressures to remain part of some form of the single market will be intense.  

EU competition economists continue to misunderstand some of the fundamentals of efficient electricity markets. Most European markets are already, from the perspective of a free market purist, compromised by numerous policy interventions. From the perspective of theorists of the second best, they are also compromised by the inadequacies of EU efforts to introduce carbon trading regimes that produce a carbon price reflective of the true externalities associated with climate change. While low carbon policy is stuck firmly in the world of the second best, you no longer need to be a Nobel prize-winning economist[2] to appreciate that, in this sector at least, competition policy should be fighting an uphill battle to be taken seriously. This is certainly true from a perspective of maximising public and private good. (Politically the priorities are sometimes different of course.)

But the issue of energy-only markets is, in the context of electricity, even more fundamental. It is a simple to state but quite subtle problem. The efficient operation of energy markets has always been posited on the concept of a merit order of generating plant ranked in order of fuel costs (and in principle other short term variable costs of operation). The most expensive plant required to operate sets a “system marginal cost” and this is the basis for a wholesale market price.

Unfortunately this is a wholesale price that is intrinsically incapable of supporting investment in, or continued maintenance of, sufficient generating capacity to meet peak demands. To demonstrate this one has only to ask what reward be earned by a plant that operates only at peak, and, when it operates, is rewarded only by its own short run marginal cost. There is no reward for this plant, and indeed reliance only on system marginal cost pricing would ensure that all capacity was likely to be under-rewarded to some degree. A preponderance of low carbon plant (eg wind or nuclear), with low, zero or negative marginal cost in operation, will ensure that this issue – “paying for capacity” - is accentuated.

Two types of resolution can be proposed for this problem. The first is a “market” solution that relies on scarcity or supply shortages to raise prices to a sufficient degree to ration demand, and for sufficiently long to induce new investment. This is a “purist” solution that has, unsurprisingly, generally proved unacceptable to regulators and governments. It assumes generators will be “allowed” to make substantial excess profits over long periods (to compensate for the long spells of surplus capacity and ultra-low prices).

The alternative is to instigate some form of capacity market. However this necessarily represents some form of central intervention. Inter alia, within a system of capacity auctions, someone has to decide how much capacity is required, and this in turn requires a view on what is an acceptable standard of generation security and reliability of supply. While we might imagine [3], and possibly even create, a world where the reliability of the power supply is left entirely to the market, that is not the world we currently inhabit. The German government is quite sensibly taking steps to remedy some very clear deficiencies in the electricity market and to protect its own consumers and industries (and voters).

At the same time it is impossible to imagine, given the interconnections of the German power networks, that an intervention of this kind can take place without having significant effects on wider EU markets. The idea that a strategic reserve can be insulated from the market, or “held outside the market” is intrinsically unconvincing. If used it necessarily impacts prices during the periods of shortage on which investors are relying to recover their capital costs.

We can see instantly why devotees of the single market in energy have objected to the idea of capacity markets. Capacity markets raise immediately the question of who should be responsible for setting the security standard. The standard must surely be common across the whole market to avoid distortions, but who is to set the standard – Brussels or Berlin? Brussels, one suspects, is not yet ready to answer this question. It prefers instead to cling to the illusion that an energy only market can actually deliver reliable secure supplies across Europe without introducing market volatility and price instabilities.

The UK has its own conflicts to resolve in terms of getting markets to work efficiently in support of energy and policy objectives. But interconnection and other trade issues will ensure it is, even post Brexit, unlikely to be immune from the effects of security and market issues within the EU.




[1] A recent BIEE seminar addressed this subject, identifying the numerous questions that arise for the UK over continued participation in the emissions trading scheme and a range of interconnection agreements.

[2] We are however indebted to Nobel prize winners for pointing out what may now seem, to some of us at least, simple truths. The subject deserves a much longer posting, but a very quick summary of its flavour can be gained from reading a recent issue of Prospect magazine, and an interview with Nobel laureate Joseph Stiglitz.

Another recognised glitch in the elegant mathematical proofs of the wisdom of the invisible hand was known as “the theory of the second best.” This qualifies the presumption for unfettered markets with the caveat that as soon as you’re dealing with an imperfect world, then there is no guarantee that taking away any single distortion will make things better, rather than worse. [Prospect Magazine. October 2016]

In other words enforcing a rigid competition policy doctrine in a market already massively compromised by the carbon externality, may make things worse. It can and does, as we have pointed out in earlier postings. See for example: EU EMISSIONS TRADING SCHEME AND EUROPE’S CLIMATE POLICY. A FLAGSHIP FLOUNDERING.

Thursday, March 30, 2017

OVERTURNING THE OBAMA LEGACY ON CLIMATE.  OR IS TRUMP UNLIKELY TO TRUMP PARIS ?




END OF THE ROAD FOR FOSSIL DINOSAURS AND THE ANTI-SCIENCE BRIGADE.

The new US administration has been assumed to be bad news on climate issues. The Trump constituency, and indeed much of the Republican voting base, has been built around an improbable coalition that, inter alia, includes substantial direct vested interests in the form of the oil and coal business lobbies, right-wing ideologies and evangelical movements that reject a now incontrovertible climate science as an “inconvenient truth”, and a significant number of constituencies of the “left behind” in America’s rustbelt, where declining industries have been major employers of labour.

As an aside, there are some unsurprising parallels with the UK – Redwood, Rees-Mogg, and Lawson being just a few of the examples of a virulent and quasi-religious climate science denial,  and quite strong fundamentalist views on other political and economic issues. Brexit like Trump represented a coalition of particular "free market" political ideologies and a "left behind" rejection of a perceived elite. The current trio of Brexit ministers - Davis, Fox and Johnson, despite some equivocation for political advantage, have a distinctly flaky record on this subject.[1]

Ironically it has been reported (FT. 27 March 2017) that the ever unpredictable Boris Johnson is trying to persuade Trump not to withdraw from the Paris agreement.

Trump Follow-through on Climate Policies

The recent news on Trump regime activities has been more cheerful than might have been expected. Although his appointment of an apparently rabid sceptic, Scott Pruitt, as Environmental Protection Agency Administrator(EPA), was met with dismay, Pruitt has been refusing to overturn the so-called “endangerment finding" of the agency in 2009[2], and suffering considerable pressure from conservative Republicans as a result.

There is no doubting Trump’s dislike in principle of climate policies, but as with his dislike of Obamacare, it is proving slightly more difficult to express this in practical terms. His Secretary of State, former ExxonMobil executive Rex Tillerson, wants to keep the US in the Paris Agreement, and ExxonMobil, the world's largest publicly traded oil and gas company, is urging the White House to do just that.

The most powerful argument for the USA not to abrogate Paris is likely to be, sadly not the overwhelming human importance of climate change as an existential threat, but the damage to the US standing in the world, together with the loss of opportunities for US businesses in relation to low carbon technologies.

A Missed Opportunity

There was also an emissions reduction strategy that Trump could have followed to the benefit of his rustbelt constituents. It would have been to target infrastructure spending to the benefit of areas heavily dependent on basic industries and coal in particular. Carbon capture and storage would have been a natural choice and might even have offered a lifeline of sorts to a declining coal industry.

Limitations on Trump Damage

Trump is clearly not good news for ambitious climate policies, so a corollary of his current troubles is some degree of relief among those who do worry about future climate. But, apart from expectations of his possible impotence in key policy areas (cf Obamacare) the following considerations might allow us to be slightly more cheerful.

-The Obama achievements within the US were in any case quite limited. The practical consequences of a possibly quite short Trump presidency are therefore less important than they might have been, particularly if much of the US and indeed US business continues to “get on with the job”

-The real importance of Paris did not reside in achievement of legally binding targets (it failed on this) but in the universal recognition of the issues and the degree of commitment shown, at least in principle.

-US backsliding is unfortunate, but is very unlikely to be copied by China or other major emitters. It will, like most Trump policies, diminish US influence, but it will not derail the Paris process of gradually ratcheting up commitments.



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[1] David Davis 2009. BBC report. He said evidence suggested the earth was cooling, not warming, and that recently leaked e-mails had shown leading scientists "conspiring to rig the figures to support arlly their theories". [a wholly untrue allegation as shown by subsequent inquiry]
Liam Fox has generally voted against measures to mitigate climate change.
Boris Johnson. Telegraph article. I am speaking only as a layman who observes that there is plenty of snow in our winters these days, and who wonders whether it might be time for government to start taking seriously the possibility — however remote — that Corbyn [Brother of Jeremy and well known unofficial weather forecaster and contrarian on this subject] is right.

[2] The endangerment finding declared that greenhouse gas emissions threaten human health and welfare and made EPA legally responsible for regulating carbon dioxide. It later set in motion much of former President Barack Obama's climate agenda.

Monday, March 27, 2017

HEAT NETWORKS AND NEW INDUSTRIAL STRATEGIES


The Institute for Public Policy Research (IPPR) is intending shortly to bring out a report on heat networks and the decarbonisation of the heat sector. A recent workshop addressed some of the specifics of this subject and in particular the potential linkages with industrial strategy, a concept that is back in mainstream policy discussions after years in the wilderness. We should support strongly efforts to create a coherent policy for the heat sector but we should not underestimate the scale of the obstacles to achieving the objectives. These include getting a clear direction of travel on the evolution of the power sector, not least on the future of carbon capture, and also the sheer scale of what will be involved in retro-fitting a high proportion of the UK housing stock with connections to a heat network. A national body, with the scope to develop a coherent strategy, encourage best practice, and assist and advise local authority initiatives, should be part of the answer.

This blog has touched on the heat sector before[1], as it is clearly fundamental to achievement of UK (and other geographies’) low carbon objectives. Heat networks are also an important component of the future options, choices and scenarios considered by a number of bodies that are concerned with energy policy and decarbonisation, including the Energy Technologies Institute (ETI) and Committee on Climate Change (CCC).  So this is a subject that matters a lot and has several dimensions.

Industrial strategy.

A first reaction to the introduction of industrial strategy as an additional objective in the decarbonisation agenda should perhaps be caution. Industrial strategy is most often associated with overcoming barriers to the development of new technologies, eg by funding research and development or helping develop supply chains, and is sometimes loosely associated, pejoratively or not, with “picking winners”.

Heat networks, on the other hand, are very large investments in pipes to transport hot water, and then retrofitting buildings to make use of the heat provided.   This includes digging trenches, laying pipes, and a lot of construction activity, most likely as a retrofit. The network per se can be to a significant degree technology neutral, and indeed one claimed benefit for heat networks is that there is some flexibility over how they are fuelled. But the networks themselves do not represent any very radical technological shift. Linkages to supply chains and technology choice, the stuff of industrial strategy, are, on this reading of the problems, less obvious issues.

They might instead be more accurately be described as major infrastructure spend, which can have substantial macro-economic benefits, as a stimulus when this is appropriate, and as an instrument in rebalancing the economy, particularly if associated with efforts to prioritise relatively depressed areas. But in the broader context of influencing future patterns of UK manufacturing, the links with industrial strategy are prima facie less clear.

However decisions on future heat networks are also inseparable from other big choices and other big developments within a decarbonisation programme, since these introduce a number of constraints and preferences.  For example, one plausible direction of travel is to associate heat networks with generation based on fossil fuel with carbon capture (CCS). In this context the cancellation of support for a CCS programme in November 2015 is very unfortunate. But had it gone ahead, or were it to be reinstated, it would predispose early schemes to proximity with new CO2 gathering networks and facilities. And of course CCS would have had its own “industrial strategy” questions as to whether the UK would be a leader or a follower and an importer or exporter of the technology.

Energy Sector Choices for Decarbonisation

Embarking on a major investment in a new heat network requires, therefore, a clear view of what are the options for sourcing the primary energy input to the scheme. This in turn needs to be consistent with an overall approach to decarbonisation. Industrial strategy enters the equation as soon as we start thinking about management of primary energy sources, most obviously for carbon capture, possibly for “modular nuclear” (an ETI favourite), for hydrogen (if we go down that route), and possibly for heat storage technologies. Those are all areas where industrial strategy might determine whether we lead or follow, and end up as exporters or importers.

Institutional Factors

Operation of heat networks is correctly seen by IPPR as a function that belongs to a substantial degree with local authorities, and this in turn raises some important questions about the ability of local authorities to finance very substantial capital investments, and also about the subsequent regulation of the sector and the protection of consumers who may have had limited choice over their participation. These are discussed in more depth on the Decarbonising Heat page, but future issues include:

·         possible wide divergence between costs and prices in different towns and cities, reflecting geographical advantages (eg density), access to different low carbon technologies, divergences between earlier and later schemes, and so on.

·         a high proportion of fixed costs, where there is no obviously “correct” or unique methodology for charging; inter alia this allows significant price discrimination eg in favour of social housing.

These and other questions indicate the desirability of confronting these potential issues at an early stage in order to establish some principles for the future funding in construction and operation of large scale urban heat network schemes.
…………………………………
Taken together these issues make a strong case for an expanding role for the existing Heat Networks Development Unit, possibly as a new National Heat Authority, a body with a much greater ability to interact with the other major players in UK decarbonisation, including the energy companies, National Grid, and the Committee on Climate Change.



[1] See the separate page – DECARBONISING HEAT , a 2016 posting Policies for Decarbonising Heat., and an earlier blog Difficult Questions for Combined Heat and Power.

Tuesday, March 21, 2017

ENERGY COMPANIES. VILLAINS OR VICTIMS IN THE PRICE CAP DEBATE?


Theresa May’s Conservatives have been rediscovering the virtues of a number of what were once familiar Labour themes, but perhaps their most surprising volte-face is the threat to impose price caps on at least some energy utility tariffs.  Populist interventions in what are supposed, in theory at least, to be competitive markets, are often bad news from a perspective of efficient markets and effective policy. And Ed Miliband and Labour were pilloried for this suggestion. On the other hand there is little evidence that the current UK retail market is working effectively, there is evidence that “captive” or “loyal” consumers get a bad deal, and consumers appear to be no happier with their utilities than in the “bad old days” of nationalised industry.

The real problem, at least in the electricity sector, is that there are a number of features of current market arrangements that are seriously dysfunctional. This is in large measure a reflection of “energy only” approaches to the construction of wholesale prices that are “baked in” to much of current thinking. Energy only wholesale prices, based around short run marginal costs, are incapable of rewarding investment. This has been a problem of the UK market since the NETA reforms in 2000, and has become an increasing problem for the rest of Europe. The UK government is now grappling with the resulting problems, including threats to supply security, through the mechanisms of capacity auctions, but these are aimed primarily at incentives for new capacity.

This is by no means a problem unique to the UK. It has been very evident for German companies in the power sector, and has had a number of adverse effects on their balance sheets, and may have damaged their ability to invest in new low carbon or indeed any form of generation, most notably in nuclear power (for RWE and EON).

The fundamental issue is that investors in infrastructure require the support of assurances over their long term revenue stream, support that had in the past normally been provided either by long term contractual or government commitment, or by the security of vertically integrated monopoly. To a significant degree the owners of conventional thermal generating plant lost that support, and found themselves in possession of stranded assets that find it increasingly hard to earn revenue in a world where marginal costs are often zero. Many of the companies anticipated the strategic problem many years ago and found at least a partial solution through vertical integration into the retail business, where market imperfections allowed them to recover some excess profit to compensate for the losses to which they were exposed in respect of their stranded assets.

The utilities, in this interpretation of events, can be viewed as both victims and villains. On the one hand older thermal plant constitutes an asset that has been stranded, at least partly through government policies for the power sector. As victims of this process, their attempt to recover lost ground through vertical integration was a necessary and logical response to that position. However this does imply that vertical integration confers an ability to exploit some form of market power, and is in some sense anti-competitive. The power that accrues to the supply companies comes through the inertia of their customers. That allows them to be portrayed as the villains.

As an illustration of this undue market power, we might contrast typical margins in retail supply with the view taken by previous regulatory bodies.  Prior to the introduction of retail competition, supply margins were generally assumed to be very low.  Thus a 1995 Monopolies and Mergers Commission Review held that 1.0% margin for Scottish hydro supply business was too high and set it at 0.5%.  Retail supply is not capital intensive and the “value added” is limited. In setting price controls in 1998, Offer and Ofgas considered a margin on sales of 1.5% would adequately take into account the increased risks from the introduction of competition.

In the “competitive” UK retail sector, margins have varied but have often been around 4%. Prima facie this looks like the extraction of extra revenue from the consumer for a function, supply, in which the retailer adds next to nothing in the way of extra value. If we add to this some of the extra costs of competing to do business (eg marketing costs) this does not look like good value for the consumer. Suppliers compete aggressively to maintain or gain market share, but a large number of consumers do not want the chore of perpetually searching for the best deal, and would prefer simply to get an uncomplicated service at a fair and reasonable price.

However it seems unlikely that imposition of a government price cap will resolve the deeper underlying issues of the power sector. What we really need is a more fundamental re-think of what we expect from retailers. My own view, expressed in more detail on another page, is that retail supply should be playing a much bigger role in shaping the future of the power sector, and that there are ways in which retail supply could become genuinely innovative and competitive.



Tuesday, March 14, 2017

DEEPMIND ALGORITHMS JUST THE START OF A CONSUMER FOCUSED REVOLUTION IN THE POWER SECTOR.



Deepmind algorithms to manage the Grid could be just the start of a consumer focused revolution in the power sector. The need to manage much more complex low carbon systems means there are strong incentives to manage consumer demand more pro-actively. This could be good news for consumers, offering them more choice, and also defusing some of the concerns that sit around supply security.

Yesterday’s FT reports[1]: Google’s DeepMind is in discussions with the UK’s National Grid to use artificial intelligence to help balance energy supply and demand in Britain.  “… It would be amazing if you could save 10 per cent of the country’s energy usage without any new infrastructure, just from optimisation. That’s pretty exciting,” Demis Hassabis, DeepMind’s chief executive told the Financial Times. National Grid’s role in balancing the system has become more difficult in recent years, however, as intermittent renewable sources of electricity — such as wind and solar power — have become a bigger part of Britain's energy mix. DeepMind’s algorithms could more accurately predict demand patterns and help balance the national energy system more efficiently.

This is currently a task that is at least partially delegated to the market. The principle behind most “spot” wholesale markets is that generators declare their marginal costs of generating (per kWh unit of energy produced) and are then selected to run in ascending order of cost (the so-called “merit order”), with the cheapest chosen first, and the most expensive plant that runs setting the price. That principle will be increasingly dysfunctional or inapplicable in the real world, partly because such a high proportion of current and future generating plant has zero or negative marginal costs of operation, and partly because the operational efficiency constraints on the power system are becoming more complex, involving considerations of plant inflexibility, intermittency, and energy storage, rather than just a simple stacking by ascending cost. Sophisticated algorithms are prima facie exactly what is needed to replace a defunct merit order.

This implies moving beyond prediction of demand patterns, for which fairly sophisticated approaches already exist, and addressing predictions of intermittent supply as well. It also means developing algorithms to make operational decisions that make sense in terms of efficiency and the secure operation of the system. The promise of a 10% saving in energy may be an exaggeration, not least because of the dominance of capital costs, and relative insignificance of fuel, in low carbon generation. But the bigger contribution of an algorithmic approach lies in the broader options it creates for the ways that the power system is managed and the ways in which consumption is managed. This could allow leaner systems and also transform the way that we think about electricity as a service.

Future Options

The conventional utility model has consumers able to treat electrical energy supply as “on tap”, with limited or no differentiation between applications (e.g. as between lighting, heating or mechanical power). Tariffs and prices for the most part approximate to an averaging of the costs of supplying electricity, with limited ability to differentiate on grounds of differing incremental costs, and a common security standard for all consumers and all applications. 

Consumer behaviour needs to be incorporated as a much more active component.  What is needed is to redefine the “consumer offering”, with electricity as a set of services, rather than a homogeneous commodity. This requires starting with a clean sheet in defining the nature of the services that consumers will want, and the basis on which they pay.  So, to take a particularly dramatic example, a consumer wanting to charge electric vehicle batteries might request 75 kWh to be delivered in a specified period, over several hours or even several days (eg a weekend), and the consumer’s terms of supply might specify that this requirement will be met in full but with timing that is “at the supplier’s discretion”.  Different arrangements and different tariffs could apply to the purchase of power for heat, and for some other uses, reflecting in each case the nature of the load, the extent to which it could be time-shifted without inconvenience, and the level of reliability for which the consumer was willing to pay.  Commitments to individual consumers would be made by energy service companies who would be able to aggregate consumer requests and feed them in to become part of the Grid’s system optimization routines. Such services might even be packaged with the provision of appropriate equipment (eg storage heaters).

The role of suppliers is then to act as aggregators, and their essential function would be to manage the complex interaction between consumer loads and system balancing requirements, including shaping and managing the pattern of consumption. This provides a major opportunity for a much more innovative approach to all aspects of metering and for the terms on which consumers purchase power. Suppliers could at the same time enter into individual contracts with generators, or a system operator or other agency, which would reflect the economic benefits of their ability to shape consumer loads. They would also take responsibility for managing loads within network constraints at lower voltages, ie within local distribution networks.

This has some powerful advantages.  First it allows consumers to purchase power for particular usages in ways more akin to their purchase of other goods and services, as opposed to perpetuating the “instantaneous commodity” characteristics that have hitherto been a unique and constraining feature of the power sector. This can reflect what consumers actually want and need from a utility.  At the same time it would help make the services more affordable.  Consumers could still choose to take some power “on tap” and would normally pay a higher price for this.[2] Many of the issues associated with administrative setting of security standards would become much less significant. Security standards would be chosen in a market, not dictated by a central authority.[3]

This change is enabled by one set of technologies – those that surround metering, remote control, and system optimisation (Deepmind).  But it also helps to resolve the problems posed by another set of technologies, those linked to intermittent or inflexible sources of non-fossil generation and distributed generation.

………..

These ideas have also been explored by the author in Double standards for reliability in power supplies. Not such a bad idea. This was a defence of a controversial proposal from Andrew Wright of OFGEM on a proposal for consumers to choose the level of reliability that they want. They have been presented in a broader context in a paper, Markets, policy and regulation in a low carbon future, produced by the author for the Energy Technologies Institute (ETI), which  published a number of perspectives on low carbon futures in 2016.







[1] DeepMind and National Grid in AI talks to balance energy supply. FT 12 March 2017
[2] “Electricity Markets and Pricing for the Distributed Generation Era”, John Rhys, Malcolm Keay and David Robinson. Published as Chapter 8 in Distributed Generation and its Implications for the Utility Industry, ed. F. Sioshansi, Elsevier, August 2014.

Wednesday, March 8, 2017

HOUSE OF LORDS DOWNPLAYS CLIMATE ISSUES AND THE BIGGEST MARKET FAILURE OF ALL. [3 of 3]


House of Lords Select Committee on Economic Affairs. The Price of Power. Reforming the Electricity Market. February 2017.                                                            

Perhaps the most controversial element of the Committee’s report lies in those of its recommendations which would have the effect of downgrading the sustainability objective aimed at reducing UK emissions. Whether the Committee might have felt emboldened by the election of climate sceptic Donald Trump, or the success of the Brexit campaign[1], will no doubt be a matter for political scientists to discuss. A degree of comfort to climate sceptics might even be considered ironic, given the current House of Lords stance in relation to the triggering of Article 50.  What is more disturbing is the absence of any serious evidence or analysis in the report to justify such a major change of stance in relation to the “energy trilemma” of sustainability, affordability and security. Ultimately these choices are indeed partly economic, especially in the affordability/ security trade-off, but the main issues in relation to sustainability have become essentially ethical and political, involving as they do, inter alia, considerations of intergenerational equity.

The Committee began with the intention of examining market failure in the power sector. Inadequate means to reflect into actual costs and prices the irreversible environmental damage of CO2 emissions, the “social cost of carbon” externality, is arguably the biggest market failure of all by a significant margin. A number of those giving evidence[2] drew attention to the issue, but the Committee nevertheless proposes a downgrading of the importance of the corresponding policy objective. It does this without solid argument, and perhaps more importantly without having taken much evidence relevant to a comparative assessment of the urgency attaching to climate objectives. In global terms this includes both growing scientific concern with climate change as an existential threat (eg over Arctic ice), and growing political acceptance of the need for urgent action as manifested, despite its shortcomings, in the Paris agreement.

The Committee has preferred instead to retreat to the letter of the 2008 Act and the 2050 target, arguing for a slower pace of emissions reduction towards that single year target. This in itself is somewhat disingenuous, given that attachment to arbitrary target dates is criticised elsewhere in the report. It is a rather obvious truth[3] that the real objective in reducing emissions has to relate primarily to cumulative carbon dioxide in the atmosphere, not to an annual emissions figure for an arbitrary year. Inter alia this tends to imply that current emissions reduction should be valued even more highly than future reductions.

The proposal that the pathway to 2050 can be back-end loaded is beguilingly simple but in reality is very misleading.  A globally back-end loaded reduction profile implies substantially higher cumulative emissions, and earlier and bigger climate impacts. Early reduction in emissions in contrast has substantial options value in postponing by several years both cumulative CO2 and climate milestones, as well as the need to spend large sums on adapting to adverse consequences of climate change[4]. In each case this means more time to address the most difficult parts of the emissions reduction problem (eg aviation) and the unknowns associated with adapting to impacts of climate change.

The Committee’s proposal has therefore the potential to be extremely damaging, at least to the UK’s contribution to climate change mitigation, and, if copied elsewhere, on a global scale. The only defence for this position that can be inferred from the report’s approach is that because the UK remains a small contributor to global emissions (c. 3%), it should therefore be willing to free ride on the efforts of others. This is hardly a principled position. The Committee has made itself a cheerleader for those parts of the energy industries that hope if they can postpone effective action for long enough then the problem will go away. It won’t.

Overall, and despite some useful content and evidence, this is a disappointing report, failing to recognise a number of changing paradigms both in the nature of the electricity sector and in the global environmental challenge. But on the key issue of sustainability it is a shortsighted and retrogressive attempt to downgrade the most fundamental challenges for energy policy, the growing existential threats of unmitigated carbon emissions and climate change.





[1] Ideological leanings and demographics may play a strong role in determining views on both climate issues and Europe.  CLIMATE CHANGE AND POLITICAL STEREOTYPES   
[2] For example in the submission by Professor Hepburn and his colleagues.
[3] The arguments, for anyone not familiar with them, are spelled out on another page of this blog, CUMULATIVE CARBON.
[4] Fuller discussion on this topic can also be found in the author’s earlier paper. Cumulative Carbon Emissions And Climate Change: Has The Economics Of Climate Policies Lost Contact With The Physics?, John Rhys, OIES Working Paper EV 57, July 2011.