ELECTRICITY TARIFFS IN A LOW CARBON WORLD

 

We can start from a few basic principles and realities.

 

1.     Spot markets as conceived in the UK are increasingly irrelevant and/or dysfunctional. Originally conceived to replicate the optimisation of the merit order of fossil plant, and designed by the operators of such plant, they provided price signals consistent with efficient operation of an existing collection of generating plant. The provision of signals for inducing the right quantities and types of investment were always more problematic and for some time spot markets have increasingly been seen as wholly inadequate for this purpose. However we now need to recognise that with low carbon systems based around renewables, nuclear and storage, they will increasingly be irrelevant even in the first function, that of price signals that result in efficient least cost operations.

 

2.     What should really matter to us is not pricing structures in the wholesale market per se –  more or less a legacy structure of institutional arrangements in need of serious reform - but the nature of the tariffs that get passed through to final consumers. We should try to follow the general economic principle that the structure of tariffs needs to reflect the structure of costs. Failure to do this almost invariably results in major economic distortions that come back to bite us, through adverse selection and other unintended incentives and consequences. Current and recent institutional and structures and regulatory approaches have not encouraged more cost reflective tariffs.

 

3.     Reliability planning is fundamental, particularly as electricity expands into heating and transport (EVs), where the security/reliability requirements are very different from those of “traditional” load. The old VOLL approach is no longer appropriate since we really need very different types and definitions of reliability in the new world. Addressing reliability questions, in terms of what we are prepared to pay for, is essential.

 

4.     At least for domestic and smaller consumers, politically the most important category, a very high proportion of costs rests in the provision and operation of transmission and distribution. These are network costs which are essentially fixed costs that do not vary much (on a long term basis) with the volume of throughput. These are however recovered, typically, by averaging over kWh supplied. This method is widely accepted as “fair” and equitable, but will inevitably produce some major distortions. Other approaches are possible which are more economically efficient and can do a better job on redistribution objectives. 

 

5.     Metering, communications, control and information technologies allow for a range of feasible tariff options that would have been unthinkable a few decades ago. These include supplier managed loads, choice over reliability standards, and charging by type of use, as well as more familiar ToD pricing and load management techniques. These are of much greater significance in a low carbon world when there is less flexibility in generation and therefore there has to be more flexibility in either consumption or storage.

 

6.     There have been particular concerns expressed that prices can be set by, for example, very high spot prices dictated by the marginal (gas) plant when gas prices are high, even though most of the power may be coming from low cost renewables. The analogous situations in traditional “vertically integrated” power systems arise when incremental growth is met through different generation technologies, and it can work both ways. For example load growth in some countries can exhaust cheap hydro, and utilities, if they can price at long run incremental  cost (LRMC), can then enjoy a potentially large economic rent from their legacy plant. Legacy costs or surpluses (as an offset) can of course be put with other fixed costs if it is decreed that they have to be recovered from consumers.

 

7.     Economic efficiency and the requirement for adequate revenue generation are clearly not the only considerations. Political acceptability and distributional issues are also key. There are no trivially easy solutions but there is a lot that can be done to improve matters in the future.

 

8.     My idealised solutions rest heavily on technical  assumptions about metering, communications and control systems, but might include some combination and selection from the following:

 

·      Recovery of far more of fixed cost through other “distributional” means, eg via linkin standing charges to property values (cf water), more use of rising block tariffs, and type of use tariffs. 

·      In addition to the above means, price inelastic EV charging might legitimately be expected, as a premium use, to carry a higher burden of infrastructure cost than price elastic and politically sensitive heating load, where we need low unit rates to encourage a switch to heat pumps.

·      Recognition that it is really only the “traditional” loads that need the instantaneous supply response that underlies the VOLL approach, and also dominates conventional definitions of reliability. We need different conceptions and definitions of supply reliability especially in systems that rely on storage. 

·      Consumers will place different values on reliability depending on the application, and this needs to be reflected in reliability planning and in tariffs.

·      Consumer options to designate certain uses as “supplier managed”, with an appropriate tariff incentive for a lower unit rate.

·      Differentiated reliability standards for different uses, with selected uses (eg lights, TV, computer) always the most reliable; default to this standard for less vital services available at a premium.

·      Various methods for reflecting periods of “system stress” into tariffs - eg the French “red light” approach.

·      Continued development of possible time of day or seasonal pricing.

 

WHAT ARE THE REAL ISSUES WITH LIFESTYLE AND CLIMATE POLICY?

 

Arguments about the supposed war on motorists operated by a Labour London mayor, with ULEZ, the Welsh government with its 20 mph speed limits , and, allegedly, its  planned extension to England becomes ever more bizarre, as do the allegations of a prospective tax on meat, the likely household cost of replacing gas boilers, and anything that the culture warriors of the Tory party think can be turned into a populist rallying cry. So perhaps it’s time to reflect on what are the elements of truth about lifestyle and climate, and what are simply creative approaches to reality, or lies and falsehoods as they might be called by the less charitable.

 

Let’s deal with some of these in turn.

 

ULEZ

 

Actually this has little or nothing to do with climate policy. It was first mooted as a sensible proposal by Tory London Mayor Boris Johnson. It’s primary purpose is to improve air quality and public health. It may have increased CO2 emissions slightly in the short run, by driving out diesel cars faster than petrol cars, but this will have been offset by encouraging a faster take-up of electric vehicles.

 

Congestion charging

 

Again the primary benefit for this has usually been argued as the reduction in congestion and the substantial saving in the time drivers have to spend at the wheel. There is an important secondary benefit in reduced particulate emissions and in reduced CO2 emissions, because the stop-start involved in congestion reduces overall fuel efficiency.

 

Some of this benefit was negated by the rather illogical exemption of electric vehicles from the London congestion charge. At a time when most vehicles are still petrol or diesel, EV vehicles will still have increased congestion, and hence emissions from all the other non-EV vehicles on the road. When all vehicles are EV, there will still often be a strong case for congestion charging, or road pricing, even though the incremental health and CO₂ benefits have become minimal. 

 

The reality therefore is that there is a climate policy case for congestion charging, but it is not a case that has been promoted particularly vigorously.

 

Speed limits

 

Reduced speeds will generally tend to reduce fuel and energy use. This is a matter of simple physics. But the effect in residential areas where the limit is already 30 mph is likely to be relatively trivial. Much more significant would be a reduction from 70 mph to 60 mph on motorways and dual carriageways. In the 1970s US governments imposed 55 mph limits in the face of the OPEC cartel and global oil price hikes, primarily in order to reduce fuel consumption.

 

There are therefore strong arguments to be made, on climate policy grounds, for reduced speed, at least while the majority of vehicles are petrol or diesel. But, at least for the UK, climate has never been the most significant consideration. The drivers for speed limits have always been road safety, and, more recently, air quality.

 

Once again truth is the first casualty of today’s politics, so we might note, inter alia, that:

 

·      Most Tory members of the Welsh Senedd supported the 20 mph default limit.

·      It is subject to local decision making and is not a “blanket” limit.

·      Minimal analysis shows it has almost negligible effects on most journey times.

·      There is no evidence that it has caused congestion or traffic problems.

·      There is evidence that lower speed limits reduce injuries and fatalities.

 

Significant emissions reductions could, fairly obviously, result from limiting higher speeds, for example on motorways, or from enforcement of existing limits, but this is not currently a plank of policy in the major parties. Meanwhile the 20 mph limit has already been widely extended to English cities, with little comment.

This issue, bizarrely given its relative insignificance in relation to either economic activity or climate, is the one that has produced the most insane claims of economic damage, with Welsh Tories claiming it could have economic impacts on the Welsh economy of between two and nine billion pounds. We await any form of explanation for this number.

 

Heat pumps and the end of gas boilers

 

This is perhaps one of the hardest energy sector transitions for the UK, and heat pump issues are hard to cover adequately in a short post. But there are a few important points to note. The first is that major infrastructure transformations are possible in the UK, for instance in the rapid conversion from town gas to natural gas. A second is that we should expect further efficiency improvements and cost reductions for heat pump technology, and a third is that the era of cheap gas (from the 90’s onwards) is coming to an end, reducing the cost barriers for consumers wanting to switch to heat pumps.

 

Of equal importance is the need for tariff reform so that the price per additional kwh of electricity use more closely reflects the actual incremental cost of supply. This would have a dramatic effect on the competitiveness of heat pumps against gas. It implies a radical restructuring of electricity tariffs to change the way that fixed and legacy costs are recovered, but this simultaneously provides an opportunity to deal with some of the other issues on the distributional impact of current tariff structures. 

 

 

Less meat and dairy consumption

 

This really is a major lifestyle choice that would have a major impact on emissions, given the amount of land used for raising crops that are then used as animal feed. It’s potentially much larger in scale than what we have discussed above and will persist as a significant question even after transport has been fully decarbonised.

 

It is also, undeniably, a social trend that many more people are choosing to eat less red meat, in particular, on health grounds, and that vegetarian food has become more popular.

This is certainly an important area of debate for the future, although even the greenest of climate campaigners tend to focus on reducing meat consumption rather than eliminating it. We also know that some meats are intrinsically less carbon intensive than others. And it’s quite clear that none of the major parties in the UK are currently in a hurry to demand meat bans or meat taxes.

 

Looking ahead we might expect that the pressure on food resources, especially if accentuated by a changing climate, will increase the price of many important commodities, including both grains for human consumption and animal feed, and this will affect the price of meat and hence consumption. In terms of lifestyle changes, this really is a huge question, affecting as it does national and global agricultural systems as well as personal diets and elements of social life. Agriculture and land use is also a hugely complex subject.

 

Time for an intelligent conversation

 

It is time to step back from the more hysterical arguments that attempts to limit environmental damage somehow threaten important personal freedoms of all kinds, or the fundamentals of modern life. There are undoubtedly potential conflicts, although, as shown above, few if any lifestyle initiatives have so far been driven primarily or at all by climate objectives. Health and safety have been far more salient factors. 

 

But this may need to change, and it would be good to see more serious discussion of the choices that we may in future have to make as the existential threats of climate change become increasingly apparent, and alarming.

MORE DISINFORMATION ON NET ZERO. COINCIDENCE OR CONSPIRACY?

Sadly we have become accustomed to the routine parade of untruths in government. But what should concern us almost as much is the peddling of ridiculous theories, misleading statistics and nonsensical arithmetic by bodies that pretend to offer some kind of independent analysis. Nowhere is this more evident than in the numerous self-styled

think-tanks and “expert” groups that set out to dispute the scientific consensus over climate science, or the relative costs of climate change versus mitigation policies.

 

One such has been the All Party Parliamentary Group on Fair Fuel, a lobby group composed of numerous climate sceptic MPs. (It should be noted that APPGs do not have an “official” parliamentary status and are very different from the Parliamentary Select Committees who do excellent work and produce well-researched reposts. They are in fact often just lobby groups for MPs pursuing particular agendas). I dealt with some of the “analysis” provided by this APPG in earlier posts.

 

THE CASE FOR ELECTRIC VEHICLES IS STRONG ENOUGH TO SURVIVE ATTACK FROM THE ICE LOBBYISTS, 

 

and

 

COSTING AN ELECTRIC VEHICLE FUTURE. IGNORE THE ALARMISTS.

 

The latter showed the lobby report had got its numbers wrong by a factor of 50, largely because of a failure to understand either elementary physical principles of energy or the units of measurement it chose to employ.

 

This level of incompetence was however surpassed by another “think-tank”, Civitas, which was sufficiently shamed to withdraw its report on account of “factual errors” after a withering assessment by Simon Evans in the Guardian. Some of the “errors” in this case were of the order of millions. 

 

How a think tank got the cost of net zero wildly wrong

 

Losing six or so zeros might merely be seen as carelessness. But as the Evans article demonstrates, it indicates a much deeper failure of understanding. It is failure to grasp the difference between power (kW) or capacity, on the one hand, and energy (kWh), on the other. This translates, unsurprisingly,  into order of magnitude errors on cost. For those not familiar with the units used for electricity, this is akin to confusing the cost of a button with the cost of the factory that produced it.

 

There seem to have been other errors in the report, such as an equally inexcusable failure to understand the difference between the total cost of investments made under a particular policy, on the one hand, and the net costs or benefits of that policy as a whole.

 

We await with interest the revised report. Civitas, on its website, claims to “… strive to benefit public debate through independent research, reasoned argument, lucid explanation and open discussion. We stand apart from party politics ….”

Odd, then, that this report should appear immediately following Sunac’s alteration of course on UK net zero. Readers will no doubt form their own view of its “independence”, as well as the competence of its authors.

ROYAL SOCIETY REPORT HIGHLIGHTS LARGE SCALE ENERGY STORAGE AS A KEY ISSUE

I was recently asked, as one of the major contributors, to comment on the recent Royal Society report on large scale energy storage. This had been a major exercise, impressively managed and directed by the lead author Chris Llewelyn Smith, involving the examination of how a UK system based on weather dependent renewables might measure up against the actual weather variations observed over 37 years of weather data. My contribution was confined to general observations on how power systems work, and in particular how operational and investment choices can or should be managed in a market economy.

 

This was the subject of a previous post, but readers are recommended to refer not to my earlier comments but to the report itself and to the policy briefing. Links are given at the foot of this post.

 

The results were interesting and to some extent surprising. The work indicates a very large scale of storage requirement, driven primarily not by seasonal but by inter-annual variations – runs of years when wind may be below average, and a host of other interesting findings and questions. I was asked just to comment on what I saw as the core economic and financial implications regarding large scale storage.

 

Economics in his context is clearly about securing the right combinations of generation and storage, the principles to guide our decisions, and the mechanics of getting where we want to be. The objective is to find market or other mechanisms for the outcomes we want, ie getting to low or zero carbon at an affordable cost compatible with an acceptable level of reliability and energy security. It follows that this has to be much more than just a theoretical optimisation, but has to cover national policies, institutions, coordination, markets, regulation and infrastructure?

 

There are several particularly important general lessons from the report that have general economic and policy implications:

 

1.     First is the potentially huge scale of storage. With both scale and major economies of scale, we have typical infrastructure characteristics, that need to be financed as cheaply as possible. 

 

2.     Second, interactions between storage and generation choices and multiple other factors: including the demand side. The report illustrates just how complex this is.

 

3.     Third, conversion capacity, for moving energy in and out of storage, will matter and has perhaps hitherto been largely overlooked. 

 

4.     Fourth is the whole issue of policy and planning for reliability of supply. Traditionally this was mostly about adequate margins of generation capacity required over peak demands – so-called needle peaks. But the new world demands a quite different understanding of reliability, when we are talking about, for example, wind drought. The issue then is of kWh energy rather than kW capacity – a major distinction.

 

So the report raises some very serious questions. We can treat each of the above in turn.

 

First, it is clear that the storage need has all the characteristics that we associate with large scale infrastructure. This includes possible or probable incidence of natural monopoly, certainly substantial investment costs, long lived assets that are highly use specific, and a financial necessity for a cost of capital as low as possible. For private capital that would mean a high level of reassurance over future revenue streams and the future market and regulatory environment.

 

Second is the issue of the very complex choices, and their coordination, in systems that rely on storage. It’s important to recognise that there are two distinct timescales here. One is operational - operating the system as efficiently and economically as possible with whatever is the current mix of assets. The second is about necessary investment -  creating the best mix of assets for the future. In a perfect market efficient solutions on both timescales might be expected to result from market prices.  But in the new low carbon world that looks increasingly like a pipe dream.

 

The conventional view of power sector markets was that the price signals  in a competitive market derived from the immediate needs for the efficient operation of mainly generation assets, replicating what might happen in a fully optimised system such as the merit order. It also had to provide an incentive for adequate capacity.  Various extra mechanisms have often been added that attempt to put a valuation on reliable supply; this is sometimes referred to as value of lost load or VOLL.  In principle it was hoped that all this collectively would  incentivise the right mix of assets, generation, networks and storage for efficient and affordable future systems. In practice the most that can be said is that experience has been mixed.

 

So what is new. Traditional spot markets were developed to deal with gas and coal powered generators, and to replicate a merit order based on SRMC. They were also largely designed by the employees of those generators They do not translate or adapt easily to low carbon technologies with more complex, probabilistic, intermittency and operating constraints.​ Storage adds new dimensions, by being intrinsically multi-period, requiring in addition that attention is paid to conversion capacities, and the very different nature of the reliability issue.

 

The simple metrics of short run cost that sit behind conventional market mechanisms do not capture the information or the complexity required. Investment choices, on the four-way balances between generation, transmission, storage, and conversion capacity, pose further questions, implying a need for coordination. Discussion at the Royal Society brought out some additional questions on the subject of conversion capacities, my third point.

 

My fourth point may well be the most important public policy question for the future – the security and reliability of electricity supply. We all know that governments cannot stand aside from issues of energy security, and electricity security in particular, however much they might wish to. However this is another dimension where the economic and policy calculus has to change radically, with some very different metrics.

 

Historically supply reliability in the UK has been about generating capacity – kW, and occasional insufficiency of kW to meet needle peaks. But future crises, if they relate to sustained weather related shortages, will be about kWh rather than kW.  Threats of months of energy rationing require an entirely different way of thinking about reliability. Possibly once in a generation events, like the 1970s 3-day week, a covid crisis or curtailed gas supplies, may mean looking at not just energy supply planning but also the overall energy resilience of the economy. 

 

Answering all these questions means great attention to the institutional and market structures of the sector. We have to decide who should own and operate large scale storage, on public or private ownership, integration with grid operation, guarantees for private capital, who should make the decisions on energy security and reliability, and so on.  

 

All these issues are closely inter-related, and the report offers an indication of where we might find the answers. These must rest on some combination of the following:

 

·      Novel market mechanisms and incentives to reward provision of storage capacity and conversion capacity.

 

·      elements of long-term contractual assurance for infrastructure providers,  eg a regulated asset base approach, or government guarantees.

 

·      Centrally driven coordination of investment plans. Quite common internationally (eg France’s EDF and Germany’s Energiewende).​

 

 

·      Enhanced role for the National Grid 

 

·      The creation of a ‘central buyer’, to procure capacity, but also to buy power from generators and sell to retail suppliers and large consumers.

 

·      Close cooperation between energy companies who implicitly assume collective responsibility for reliability  (the US ‘power pool’ model) 

 

In summary the economics for me is about:

 

·      balancing the roles of markets, thus retaining a role for competition, and central coordination

·      financing storage as essential infrastructure, and 

·      re-evaluating the policy approach to planning for reliable future systems

 

Possibly the most important observation of all, though, is that all these things take time and the task is urgent. That means starting to address these issues now.

 

 

Large-scale electricity storage report

https://royalsociety.org/-/media/policy/projects/large-scale-electricity-storage/Large-scale-electricity-storage-report.pdf

 

Large-scale electricity storage policy briefing

https://royalsociety.org/-/media/policy/projects/large-scale-electricity-storage/Large-scale-electricity-storage-policy-briefing.pdf