A two-tier energy market for the 21st century?

22 December 2016

Portrait of Dr John Rhys

by Dr John Rhys
Senior Research Fellow

Dr John Rhys was Chief Economist at the Electricity Council, which, prior to 1990, coordinated and regulated the state owned power sector in England and Wales. In 1987 he joined NERA Economic Consulting, later becoming Managing Director. He played a ...

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The FT recently reported that Andrew Wright, a senior partner at OFGEM, had argued that Britain could be moving towards a two-tier power market in which some households pay for reliability while their neighbours “sit in the dark”. Ignoring for the moment the selective reporting of a complex discussion, and a mildly hysterical media reaction to this proposition, we need to recognise that the world is changing. Different tiers of reliability, in which customers can choose their own combinations of price and quality/availability, are now both technically feasible and advantageous to consumers. There are deficiencies in current retail markets, so new formats for the “consumer offering” are both necessary and desirable. They will give us better control over our power systems and can even help with thorny problems such as those of fuel poverty.

Possible supply failures in which households “sit in the dark” are a source of nightmares for government ministers and are seen, often correctly, as a sign of political failure. The last national “black-outs” in the UK occurred in the 1970s with the miners’ strike and the 3-day week, resulting in political turmoil and the fall of a government. But, historically and internationally the more common cause has been either inability to plan for, or inability to finance, sufficient generation capacity. The UK safety margin in generation is currently at a historic low, so risk of failure is increasingly seen as real. Responsibility for maintaining adequate supplies, within the current institutional architecture, is largely left to the “market”, with a degree of oversight from OFGEM. Some of these issues, and instances of market failure, are spelled out in the page[1] dealing with low carbon power.

But Andrew Wright has raised different questions that deserve some very serious consideration, and go well beyond the simple question of whether we currently have enough capacity in our power system. They go to the heart of the ways in which consumers in future will and should be able to purchase electricity. Reliability is an expensive commodity and the idea of consumer choice over the standard of reliability required is one that can only benefit consumers and the overall efficiency of power systems. In most sectors of the economy the ability to choose combinations of quality and price that suit a consumer’s needs is well established, and indeed a normal characteristic of a vibrant market economy. An incidental benefit in the power sector is provision of an additional instrument to improve overall system reliability and, along with storage and interconnection, to assist in managing future low carbon power systems with operational features that include intermittency or inflexibility.

The changes that are coming stem from technological developments in control and metering systems that were considered futuristic in the 1970s, and were to a large extent inhibited by deficiencies in the structures of the UK retail market, including the adoption of load profiling. With load profiling, all consumers of a particular type are assumed to have the same time profile in their consumption pattern, implying a homogenous mix of peak/ non-peak, day/night and winter/summer loads. The supply business is then essentially commoditised. All suppliers provide the same product, with differentiation only on price. This undermines, or rather excludes from the market, any competitive benefit from offering consumers a truly differentiated service. Profiling inhibited UK development of sophisticated metering and control systems and tariffs, arguably for a generation[2].

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 very limited ability to differentiate on grounds of differing incremental costs.

Technology change is now forcing re-examination of this model and offers an opportunity to transform the market. Just as new low carbon generation and storage technologies, with very different operating characteristics and cost structures, will force us to re-examine system operation and wholesale markets, so should developments in metering, telecoms and control technologies lead to re-examination of the way consumers use electricity and control their own usage, changing the whole nature of the supply business. These developments have created an explosion of possibilities in metering and service provision, including sophisticated metering or even real time pricing, and sophisticated remote control of individual appliances. Given the interactive nature of these possibilities, utilities need to consider how end use should be incorporated into processes for the secure and efficient operation of the system. Consumer behaviour, and consumer choice, will be incorporated as a much more active element in the system.

What is needed is to redefine the “consumer offering”, defining 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, for example, a consumer wanting to charge electric vehicle (EV) batteries might request 75 kWh to be delivered in a specified period, over (say) 60 minutes for “instant” service, over several hours, overnight or over several days, and the consumer will pay for his 75 kWh requirement to be met within the agreed time but with the supplier choosing exactly when the charging takes place. Corresponding arrangements could apply to the purchase of power for heat, for refrigeration, and some other uses, designed in each case to reflect the nature of the load. Such services might even be packaged with the provision of appropriate equipment (eg storage heaters). Commitments to individual consumers would be made by energy service companies who would be able to aggregate consumer requests and in turn contract with network operators, for whom the flexibility would be an additional instrument in maintaining a reliable and efficient system.

Implicit in all this is the option to take electricity supply at varying levels of “reliability”. Most consumers will want 100% reliability for lighting or the ability to watch “Strictly” live, and to continue to pay a higher kWh price to get it. But many will be relatively indifferent to the exact mode of operation of their storage heaters (as they are now), water heaters, or EV battery charging. But in each case they will have a choice between a higher price premium service with guaranteed instantaneous delivery, and a lower price with delivery still guaranteed but with timing subject to some external influence.

For all households, but perhaps particularly those struggling to meet their energy bills, this choice can have a real value if, for major parts of their kWh consumption, they are no longer forced to pay the full price for a “gold plated” concept of reliability that they neither need nor want.

The development of such schemes still requires a great deal of research and product design work and public consultation, but Andrew Wright is to be congratulated on bringing to our attention an idea which will be of increasing importance for 21st century power systems.

A fuller development of the above ideas can be found in the author's paper published by the Energy Technologies Institute:MARKETS, POLICY AND REGULATION IN A LOW CARBON FUTURE

[1] (See panel of page headings above).

[2] The CALMU credit and load management unit was pioneered by Fielden and Peddie (then an Area Board Chairman) in the 1980s, and has enjoyed worldwide success. It died in the UK with privatisation and the adoption of profiling.

This opinion piece reflects the views of the author, and does not necessarily reflect the position of the Oxford Martin School or the University of Oxford. Any errors or omissions are those of the author.