There is no logical, technical, economic or political justification for operating the future energy industry as we have the past one, or to attempt to make these markets operate by common rules.
The Low Carbon generators are so totally different from the legacy scarcity generators, for example: fixed vs marginal costs, abundant cheap energy flows vs costly fuels, vastly increased customer interaction through addition of transport and heat vs customer apathy, distributed energy resources vs centrally planned, digital vs analogue.
The Cost of Energy Review 2.0 (“CoER2.0”)
It is the season for one man bands to tell everyone how the energy system should work and I didn’t want to miss out on that. Dieter Helm’s recent 200-page Cost of Energy Review (1) will no doubt sink into the mire of political reality as layer upon layer of advisers pick holes in it and political sandstorms erode its pointed edges.
What we need is an uplifting, innovative and thoroughly different ‘Cost of Energy Review 2.0’ (CoER2.0) and so I present mine here – why not? I take Dieter’s work as my reference but put back the missing bits and raise the innovation level a lot.
People of Britain, you have a wonderful opportunity to prosper with ‘free energy’ whilst at the same time cleaning up your environment. Let’s celebrate that and continue to support the fantastic new technologies that make it all possible, as they always have done.
A quite obvious omission by Dieter Helm is his commentary of the past that was dismissive of the subsidy of renewable technology. Subsidy of wind and solar has created an industry that has spectacularly outperformed on cost reduction, far greater that Dieter had ever imagined or forecast.
CoER2.0 Recommendation 1
Patient Capital is required to get new British low carbon technologies to commercialisation (2). Dieter has failed to support the increase in Patient Capital for hard tech in the energy market but does cover that in the report itself. Government could consider introducing a Patient Capital Obligation (PCO) on large institutional investors (e.g. pension funds, insurance companies, possibly also banks) requiring them to invest a small proportion of their overall assets in long term, patient capital funds that target industry sectors that match government priorities. There are various examples of government using such a mandate including in the energy generation sector with the Non Fossil Fuel Obligation (NFFO), Renewables Obligation (RO), etc.
| Cost Of Energy Review Recommendation | Dieter Helm | David Casale |
|---|---|---|
| 1 | The cost of energy is too high, and higher than necessary to meet the Climate Change Act (CCA) target and the carbon budgets. Households and businesses have not fully benefited from the falling costs of gas and coal, the rapidly falling costs of renewables, or from the efficiency gains to network and supply costs which come from smart technologies. Prices should be falling, and they should go on falling into the medium and longer terms. | When industry costs are falling and you remove legacy costs from the equation you can conclude that ‘energy costs are too high’; it is however slightly dismissive of the readers intelligence. Abuse of market power is mentioned but not followed up, how about there really is none or very little. The problem is and its becoming even more so a lack of customer engagement |
| 2 | Households and businesses have not benefited as much as they should because of legacy costs, policies and regulation, and the continued exercise of market power. | |
| 3 | The scale of the multiple interventions in the electricity market is now so great that few if any could even list them all, and their interactions are poorly understood. Complexity is itself a major cause of rising costs, and tinkering with policies and regulations is unlikely to reduce costs. Indeed, each successive intervention layers on new costs and unintended consequences. It should be a central aim of government to radically simplify the interventions, and to get government back out of many of its current detailed roles. This review explains how to do this. | So true! Energy is simple really but it is in regulators interest to make it complex, so they do, and this needs to stop. |
| 4 | The legacy costs from the Renewables Obligation Certificates (ROCs), the feed-in tariffs (FiTs) and low-carbon contracts for difference (CfDs) are a major contributor to rising final prices, and should be separated out, ring-fenced, and placed in a ‘legacy bank’. They should be charged separately and explicitly on customer bills. Industrial customers should be exempt. Once taken out of the market, the underlying prices should then be falling. | Legacy costs can’t just be wished away but the bit about separating costs on customers’ bills is worth pursuing. |
CoER2.0 Recommendation 2
The costs of energy supply are moving towards all being fixed cost in nature, using a universal prepayment (3), smart meter roll out the energy system is split into an ‘Abundant’ system and a ‘Scarce’ system, determined each 10 minutes of the day based on relative demand and supply. During energy Abundant periods (when low carbon generators are at high output and demand is low) energy is free or even customers will get paid to use it for certain purposes. During Scarce periods energy is priced in bands as follows;
- Band A – The Universal Service Obligation (USO) is set for each household in a similar way to Universal Credits to ensure the vulnerable citizens in our Great Britain are protected. The USO is a profile of consumption per day.
- Band B – The Scarcity insurance market, this is an insurance policy with a fixed premium that is the revenue model for the legacy generators that are needed at times of Scarcity. Band B covers a certain (profiled) level of consumption per month. Consumers buy Band B power against a monthly premium payment to meet their individual needs.
- Band C – The market clearing price for Scarcity periods using the old POOL model of marginal cost pricing. Expect these prices to be high but for ever diminishing duration as we move to 2050 and more low carbon generation assets are added to the system. Band C can be curtailed by the new Regional System Operators RSO thus introducing a rationing element to energy use; this stimulates energy efficiency further.
| Cost Of Energy Review Recommendation | Dieter Helm | David Casale |
|---|---|---|
| 5 | The most efficient way to meet the CCA target and the carbon budget is to set a universal carbon price on a common basis across the whole economy, harmonising the multiple carbon taxes and prices currently in place. This price should vary so as to meet the carbon targets. It would be significantly lower than the cost of the current multiple interventions. | Ok but, as the detailed analysis in the report itself says, this won’t actually work. This is a good economic policy but a hard-to-implement-in-reality policy. |
| 6 | There should be a border carbon price to address the consequences of the UK adopting a unilateral carbon production target. | I see so we tell Europe, once we have left, that there is a tax on carbon, I wonder how they will respond to that |
| 7 | The FiTs and other low-carbon CfDs should be gradually phased out, and merged into a unified equivalent firm power (EFP) capacity auction. The costs of intermittency will then rest with those who cause them, and there will be a major incentive for the intermittent generators to contract with and invest in the demand side, storage and back-up plants. The balancing and flexibility of markets should be significantly encouraged. | NO these are two completely different industries, they cannot and should not be blended together in some ‘expert’-driven averaging process (or EFP as Dieter proposes). It’s true you can’t teach an old dog a new trick but we need new tricks. Trying to squeeze the new technologies into the old format is unimaginative, overly complex, not possible for the Great British consumer to engage with and unnecessary. |
CoER2.0 Recommendation 3
Low Carbon Generation (4) is a technology that collects free energy and distributes it. It is more akin to the water industry of the 1970s, where investment was made in collecting and storing water (if it rains, the system works = Abundance), bills are per month not per cubic meter. So, in electricity, investments would be made to collect wind and solar energy and distribute it, auctions are used to drive down the costs and low carbon generators are paid an availability payment as long as the low carbon generation technology is able and does collect the available energy. The energy is supplied into the grid and acts as negative demand; it is not metered other than to support the technical availability requirements of the availability payment. If needed, wind and solar can be turned down; this is fine and typical of energy systems generally.
We have now created an Abundant and Scarce system determined each 10 minutes of each day overseen by the new Regional System Operators (RSO’s) with the National System Operator taking a back seat. As an industry we can market this; e.g. ‘use energy today between 2-4 pm, it’s going to be free to use’/’charge your car tonight at 11-12 pm its free etc.
’The availability payments are covered by a national taxation mechanism and become the same as roads and hospitals but charged to the consumer bill on a per kWh used basis (see CoER2.0 R2)
The POOL is brought back and all non-Low Carbon Generation bids its capacity into the POOL for Scarce periods. In effect this Scarce market is operated a bit like the RNLI Lifeboat crews over time, plants are not permanently staffed and when the ‘Scarcity red light’ goes on these trained staff take up roles to keep the lights on, prices for this can be quite low. This is a sunset market as over time, storage, demand side and interconnections mean that over time Scarce periods become increasingly well…scarce. The revenue model for the scarcity legacy generators is from the Band B insurance premiums.
| Cost Of Energy Review Recommendation | Dieter Helm | David Casale |
|---|---|---|
| 8 | After all existing commitments in respect of FiTs and low-carbon CfDs have been fully honoured, and in the transition to a proper, uniform carbon price and an EFP auction, they should be split into three parts: the construction and project-development phase; the operation of the plant; and decommissioning. The first should have a higher cost of capital, reflecting the equity risks; the second should be more akin to a regulatory asset base (RAB) in the utilities and closer to the cost of debt; and the third should be a charge to operating costs. The customers should benefit from the refinancing when the project comes into operation. | Yes, for the Abundant market an infrastructure finance approach is used; this is not new and well understood. For an availability payment backed by a highly credit worthy entity the cost of capital will be much lower. |
| 9 | The current RIIO (Revenue = Incentives + Innovation + Outputs) periodic review price caps for the transmission and distribution companies are already being significantly outperformed – in part because of mistakes in the assumptions – and have resulted in higher prices than need to be charged for the efficient delivery of their functions. Ofgem should consider what actions should be taken now. | Agreed. |
| 10 | For the networks, going forward, there should be no more periodic reviews in the current RIIO framework. Technical change is so fast that predicting costs eight–ten years hence is impractical. | Agreed. |
| 11 | The government should establish an independent national system operator (NSO) and regional system operators (RSOs) in the public sector, with relevant duties to supply, and take on some of the obligations in the relevant licences from the regulated transmission and distribution companies. The NSO and the RSOs should, where practical, open up the various functions and enhancements to the networks to competitive auctions and, at the local level, invite bids for network enhancements, generation and storage, and demand-side response (DSR) from energy service companies. | Agreed. |
| 12 | The separate generation, supply and distribution licences, at least at the local level, should be replaced by a simpler, single licence. | Agreed. |
| 13 | As a result of the above changes, the role of Ofgem in network regulation should be significantly diminished. | Agreed. |
| 14 | There should be a default tariff to replace the Standard Variable Tariff (SVT), based on the index of wholesale costs, the fixed cost pass-throughs, levies and taxes, and a published supply margin. | The old Supplier Model should be abolished; it has never really worked, it adds little value and prevents deeper customer engagement. The new suppliers would sell insurance for Band B, smart meter services and home energy management, batteries and electric car services, much richer engagement and much more fun. |
| 15 | Capping the margin would be the best way to meet the objectives of the new draft legislation. By focusing on the margin within the default tariff structure, competition would be enhanced, thereby encouraging new entrants. | |
| 16 | The government should issue an annual statement to Parliament, setting out the required capacity margins and providing guidance to the NSO and RSOs. | Yes identifying the expected Abundant and Scarce periods. |
Conclusions
1.0 There is no logical, technical, economic or political justification for operating the future energy industry as we have the past one, or to attempt to make these markets operate by common rules. The Low Carbon generators are so totally different from the legacy scarcity generators: fixed vs marginal costs, abundant cheap energy flows, vastly increased customer interaction through addition of transport and heat, distributed not centrally planned, digital not analogue.
2.0 A true revolution in energy, as proposed here, will happen in any case as these new technologies continue to emerge; the recognition of that by society and governments would lower the costs of the transition through greater engagement and increased speed of deployment.
3.0 The clear identification of the two opposite drivers of energy costs (The Abundant and Scarce Systems) would assist society to understand its own role, in this way both the Abundant market and the Scarce market would improve efficiency, demand side measures, batteries, electric vehicles and behaviours would change quicker.
4.0 This is not a fanciful proposal, it is technically feasible today.
5.0 This would result in £110bn of energy savings; I put this in hoping the media will pick it up, no justification is given here but I could if you want one?
Notes:
- See https://www.gov.uk/government/uploads/system/uploads/attachment_data/file/654902/Cost_of_Energy_Review.pdf
- See Turquoise response to the Patient Capital Review
- See https://davidcasale.wordpress.com/2016/08/03/universal-prepayment-in-the-national-interest/
- I take solar and wind power as my examples of Low Carbon Generation but this applies for all types of low carbon generation based on the premise of lowest cost first.