A gentler way

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  • Block pricing for electricity

    Introduction

    Electricity prices in Great Britain are widely regarded – by politicians, businesses and the general public – as being too high.  Yet from an environmental perspective, our consumption of electricity (and energy more generally) has obvious consequences.  How do we balance socio-economic concerns on the one hand with the state of the environment on the other?

    This article outlines an alternative approach to the pricing of electricity, one that would support the domestic consumer’s right to a minimum quantity of this essential commodity; and simultaneously encourage the consumer to reduce consumption above this minimum level.

    Although this article focusses on electricity, the suggested mechanism could also be applied to our consumption of natural gas for home heating.  Similarly, the mechanism could be applied to the non-domestic chunk of the electricity sector; and, indeed, to any sector of the economy where consumer demand has a significant (and adverse) environmental impact.

    Mechanism

    The basic concept is that everyone is eligible for a certain amount of electricity for free, but pays at a higher price than currently for additional consumption.  The free amount could be calculated per domestic property, registered voter, or occupant – to be decided.

    As a first step, let’s assume that only the wholesale component is free; and that supplier charges for transmission, distribution and environmental levies are unaffected.  In this step, the supplier should not ‘notice’ any financial impact – the free electricity is essentially just passed through from wholesale generator to customer[1].

    The free amount is an opportunity, not a given.  It is determined as an available amount per time period – kWh per half hour – for each half hour of the day, for each day of the year.  The available amount varies from one half hour to the next.  Together, these half-hourly amounts give an annual profile of available free electricity over the year.

    The annual profile may be determined as follows.  An appropriate body – National Energy System Operator, for example – estimates the total national generation from low-carbon sources (nuclear and renewables[2]) for each of the 17,520 half hours of the year.  This forecast could take account of seasonal variation in solar and wind output, and the diurnal profile of solar irradiation.  Of course, it is not possible to forecast output perfectly, but certain patterns are predictable.  The forecast could also take account of annual power station and grid maintenance (e.g. planned nuclear outages).

    The profile could then be scaled for the domestic sector[3].  There are many ways to do this: one simple approach would be to use households’ annual share of total national electricity demand as the scaling factor[4].  A key feature of the scheme is that the total volume of free electricity that is made available to domestic users should be less than their total demand, in order to encourage energy efficiency and demand reduction[5].

    Having produced this annual forecast, the appropriate body (NESO or whoever) then divides it equally between all households or all registered voters/occupants, for each time period.  This gives a specified personal or household quantity of available free electricity in each half hour of the year.  If the household/person uses more than the available amount in a given half-hour, then they pay for the excess.  If they use less than the available amount, then their consumption is free in that half-hour, but the difference between the available amount and actual consumption represents a lost opportunity.

    The supplier determines from meter readings the total ‘free’ consumption in each half hour, and further calculates it as a percentage of total supply.  The supplier’s purchases are then scaled back by this percentage.  In effect, counterparties (generators, exchanges, etc.) pay back this percentage.  All purchases[6], regardless of source and price, are scaled back by the same percentage (for that supplier, in that half hour).  Equivalently, the supplier is deemed to have reduced its wholesale demand by that percentage across all of its contracts and spot market purchases[7].

    This is the concept.  The following sections describe in turn the advantages and practical considerations.

    Advantages

    The are several potential benefits of the scheme, both economic (points 1 to 3) and environmental (points 4 and 5).

    1. Essential commodity: to the extent that electricity is essential, it should be freely available in an ideal society.  The difficulty is defining how much is ‘essential’.  Equally, caring for the environment should be regarded as essential.  Implementing this mechanism would make significant progress in addressing the former whilst respecting the latter. 
    2. Economically progressive: the allocation of free electricity is more significant, as a proportion of income, for poorer households than for wealthier households.
    3. Encourages registration: there is an incentive for the occupants of a property to be registered voters or citizens in order to qualify for the free electricity.
    4. Encourages energy efficiency / demand reduction: as envisaged, the total supply of free electricity will be significantly below current domestic consumption.  The difference between these two quantities will be charged at a price that is inevitably higher than current tariffs, because generators will be having to recover their costs and margins over a reduced volume of sales.  Consequently, consumers will be incentivized to reduce their consumption overall.
    5. Better demand profiles: the mechanism encourages consumption patterns that are more closely aligned with the national profile for low carbon generation.  If the profiles are out of alignment, then domestic users will not be able to benefit fully from the freely available electricity.  This sharpens the incentive to use appliances at the best times from an environmental perspective (and, in due course, charge electric vehicles, program heat pumps, etc. at times that ‘fit’ with low carbon generation).  The mechanism will also aid the implementation of battery storage to improve consumption profiles.

    It should be noted that the mechanism can work in conjunction with existing time-of-day tariffs offered by suppliers.  These tariffs will still work for the additional electricity that is consumed over and above the free electricity.

    Practical considerations

    1. Demand forecasting: as envisaged, the energy volume sold by generators is effectively scaled back, i.e. reduced on the basis of the actual ‘take-up’ of freely available electricity in each period.  Percentage scaling factors (per half hour) are not known in advance, because they depend on actual consumption and how it relates to the freely available quantity.  There is in consequence an extra element of uncertainty in demand forecasting.  However, this difficulty should be manageable for the following reasons.  First, it is already necessary for power companies to forecast demand in each period.  Second, domestic consumption patterns are reasonably. predictable.  Third, companies will become more skillful with practice/time at predicting the relevant scaling factors.
    2. Existing contracts: from a legal standpoint, it may be that existing multi-year contracts have to be exempt from this mechanism.  However, most electricity is contracted on a short-term basis, with a 1-year tenure being broadly typical.  It seems likely that the mechanism would need a phase-in time of at least a year, which would mean that it could be applied to the bulk of a supplier’s purchases without infringing contractual terms and conditions.
    3. End-users: as envisaged, the scheme would be applied to the domestic sector, but the basis of the mechanism should still work if non-domestic sectors are included.
    4. Determination of annual total: it is suggested here that there is an annual projection of low-carbon output (nuclear and renewables) with half-hourly granularity.  However, the total volume, the exact profile, and the frequency of updating, are all details that can be decided after the basic mechanism has been agreed.
    5. Half-hourly metering: it is assumed that half-hourly metering is in place.  However, the mechanism could still work during an interim period while the metering is still being installed.  For instance, for homes with monthly/quarterly meter readings/estimates, there could be standard assumptions about the level of take-up: perhaps assuming the same actual demand profiles as in homes with half-hourly metering (on average), with periodic true-ups based on aggregate consumption.  
    6. It will need to be determined whether the free electricity profile is assigned per household, per registered voter, per registered occupant or in some combination of these and potentially other factors.  This is soluble; the basic mechanism works however the final ‘recipient’ is determined.
    7. There is no need to create a new public company or other body; the mechanism should work with the existing structure of the electricity industry and its members. 
    8. The mechanism does not discriminate between different generators, although it should encourage consumption patterns that are more aligned to low-carbon generation.
    9. Related to the previous point, the mechanism should improve battery economics.

    The mechanism can ‘work alongside’ other environmental measures, such as carbon pricing and renewable generation support measures.

    Footnotes

    [1] Although this article only considers a free wholesale element, the logic that is applied here to generators could also be applied to suppliers.   The costs of supply could be spread over a smaller base: ‘excess’ domestic demand and non-domestic demand.  

    [2] ‘Renewables’ contentiously include biofuels in government data.  Biofuels account for about 14% of total generation in GB.  Unless they are equipped with carbon capture and storage, there is a good argument for excluding biofuels in the calculation of renewable generation.  However, this is a detailed point that should not detract from the main argument.

    [3] This paper assumes that free electricity is assigned to the domestic sector ahead of the non-domestic sector.  This assumption could be relaxed without altering the basic mechanism.

    [4] Currently about 30%.

    [5] It is just possible that in future there will be so much low carbon generation nationwide, and sufficient storage and flexibility, that there is no need for fossil-fuel generation or fossil-fuel based imports and hence no need for us to reduce demand.  We are a long way from that: currently around 100 TWh per annum are generated from fossil fuels and net imports account for a further 30 TWh per annum.  Biofuels account for another 40 TWh p.a.

    [6] Including self-supply if the supplier has its own generation.

    [7] This is straightforward mathematically, and independent of actual wholesale prices, because the first tranche of electricity is free.  If instead there was a (low) positive price for it, then the commercial arrangements would be significantly more complex.

  • Reeve’s solution for Reeves

    About a year ago, the television presenter Simon Reeve did a one-man show in my home town. He entertained the audience with his tales of adventure in the world’s wildest places. But while all this was good fun, there was a serious side too to his performance: getting us to engage collectively with the most vital of questions … What can we do to save the planet?

    This question brings to mind the usual stuff that we hear about who we work for, lobbying our politicians, and – at an individual level – adapting our diets, reining in our appetites for stuff and travel, insulating our homes … But the point that Reeve made during Q&A that night, quite forcibly, was one that gets less attention: pensioners need to engage actively in where their pension money goes.

    I remembered this talk when the chancellor Rachel Reeves unveiled her budget a couple of weeks ago, on 26 November. That budget may best be remembered for the furore over whether she mislead the public about the state of public finances, in order to lay the ground for tax rises. But whether it transpires that there is an annual surplus or annual deficit of a few billion pounds this year, we are still faced with the following stark reality. Total government debt is close to £3000 billion, broadly comparable with national GDP, and – discounting the prospects of global revolution or extinction – this will be the case for many years to come. Paying the interest on that debt costs more than national spend on education.

    Debt, or rather debt service, seriously hampers government activity.

    And this is where pensions come in. Because those of us who are lucky enough to have reasonable pensions are part of the problem. About a third of government debt is held by pension funds. If we pensioners were willing to accept lower returns on government bonds, the impact on government activity would be significant. If we increased our demand for bonds, yields would fall. The government could then afford, as just one example amongst many desperate needs, to spend significantly more on education.

    The pension industry seems to have got stuck in the following cycle. Pensioners tend to rely on their financial advisers to grow their pension pots. They might well avoid certain sectors or regions with the worst records on human rights or health, but for the most part pensioners are relatively passive. Advisers feel obliged to find good rates of return, which pensioners come to expect. Advisers are largely remunerated on a percentage basis, which adds a personal financial incentive to get the best returns for their clients. That includes attractive yields on bonds.

    I am not sure this is inevitable. We are creatures of habit. It’s become habitual to expect our pension providers to put financial returns first (albeit with the above caveat about certain no-go sectors or regions). There is an entirely plausible future in which pensioners and their providers put ethical and environmental considerations first and financial returns second. Not last – I am not saying returns don’t matter at all – but second.

    What would it take? Just that we pensioners ask our providers/advisers to put more of our pension money into certain sectors, products and industries. That in so doing we are not deterred by instances of greenwash or malpractice, because we don’t need to be rocket scientists to know broadly what those sectors and industries are, or to understand that a few bad apples don’t characterize the entire crop. And perhaps for advisers and fund managers to be remunerated more on a fixed basis than a percentage one.

    Of course, Reeve had nature restoration and protection in mind; I don’t suppose he was thinking more widely about human rights, or government bonds, or long-term public projects, or essential infrastructure. But the same principle applies.

    It seems very doable. If only we lucky pensioners can tweak our mindset and get on the front foot with our financial advisers.