This draft blog was 18months old but as I’ve just revisited the topic, I decided to finally publish it as a basis for thinking about electricity prices.
I believe that we should make our electricity free (or almost free) at certain times when we have surplus. This doesn’t happen very often at the moment but will happen more in future. Solar and wind power cost nothing to produce and the incremental cost of running power through under-used powerlines is tiny, we’ve already paid for that asset.
Our power lines spend an awful lot of time being under-used and each year South Australians fork out $1bn toward their cost. I would like to see us encourage twice the usage, maybe even three times as much on our system and then costs for everyone could come down. A renewable energy future looks more and more likely to be electric, so even if we can’t grow our electricity usage through economic activities (more on that in a moment), we should be able to grow it by providing renewable heat and renewable transport energy – taking over from gas and petrol.
How should we price electricity to encourage the transition we need?
This blog covers some of the things we need to think about. I think the principles behind electricity pricing are failing us. There is room to manoeuvre and I’ve explored below some of the issues we need to understand in order to rethink the challenge from scratch.
We know that electricity supply is mostly about big capital investments – electrical poles and wires, power stations, meters and billing systems. Our newer sources of electricity – wind, solar and batteries (on the horizon) are all about up-front capital investment. Once the investment is made, the cost to produce electricity every day is practically nothing. So I’ve tried to answer the question about how the cost of this capital investment should be spread around by looking at the alternative investments we might want to encourage.
We are already familiar with the cost sharing arrangements at the moment. Charge everyone by the amount they use (kWh)… or …the biggest user should pay the most (kW)… or …everyone should have some fixed charges just to access the service. In fact the electricity system uses a combination of all three charging types to try and send price signals to customers but there is an awful lot of averaging that goes on so the system is far from perfect.
I’ll start by framing up the issue with some of the perceived wisdom that currently determines our electricity pricing regime.
Networks – paying for a fixed asset
The cost of networks make up approximately 60% of our electricity prices. We pay for the poles and wires that bring our electricity to us. We have built a system that connects large centralised power stations to distant loads all over South Australia. We have built interconnectors between SA and Victoria to increase competition and give us access to cheap electricity. Much of this system is considered a monopoly – you wouldn’t build a second set of poles and wires just to make it competitive. And so we regulate the prices and guarantee SA Power Networks (and Electranet) a fixed amount of income each year to own and operate the network.
The perceived economics wisdom on network pricing is that customers should see a price signal for their peak load (kW) that equals the cost of building new network to accommodate their load. That way, new network will be built when the customer values new network more than it values reducing its load. This is called Long Run Marginal Cost (LRMC) and isn’t a simple matter to calculate and isn’t necessarily very accurate for signalling real costs to real customers. One of the biggest distortions is that costs vary by location and while there might be economic benefits of accurate, locational pricing, regulators have generally decided that it is fairer to charge everyone the same amount across the network, known as postage stamp pricing.
There are also annual operation and maintenance costs that can be distributed among customers in accordance with how much electricity they use (kWh). My understanding is that SA Power Networks consider these costs differently at different voltage levels so that only the small customers end up paying for the low voltage distribution network.
Then there are residual costs. Now this is interesting. If a network has no load growth then the bulk of costs can be residual. They are for large costs like paying down previous capital investments or smaller charges like managing the overheads of the business. The regulator recently investigated how such charges should be allocated among customers because there is no relationship between customer usage and costs. Networks, regulators and economists around the world offer different ideas about how these costs should be allocated. These costs should be of big interest to us because we are experiencing declining network demand at the moment. (The networks, however, are still being granted permission to invest in more capital infrastructure so investment costs remain and that is a debate for another day)
Traditional Generators – capital cost vs running cost
In the wholesale market traditional generators compete for the privilege of supplying electricity and they are largely dispatched in order of their running costs. Wind first at zero cost, then coal at under 2c/kWh, gas at around 5c/kWh, open cycle gas is closer to 10c/kWh and finally our peaking plants which can cost an eyewatering 40c/kWh to run. (These prices come from Acil Tasman’s estimates of Short Run Marginal Costs (SRMC) reflecting fuel and operating costs and don’t include carbon pricing).
The generators bid into the market at the prices they can afford. Given that they also need to pay off their capital and overheads, these prices will be based on estimates of how often they will get to run in the year in order to recover all their capital costs. As you may know, peaking plants are cheap to buy and expensive to run. They are installed to provide insurance to the retailers that they will be able to buy electricity during peak demand and they never intend to run for many hours in a year.
Renewable Energy Generators
Wind and solar have been the subject of over $5bn of investment in South Australia over the past 10 years. Both are subsidised under the Renewable Energy Target (about 4c/kWh) which everyone in Australia pays for (through electricity charges). In addition, many solar generators receive a feed-in tariff for surplus solar energy (16c – 44c/kWh) which is paid for by all South Australians (again through electricity charges).
Wind generators recoup their capital costs through interaction with the wholesale market. The most recent bid to ACT suggests that the Hornsdale wind farm only needs an unsubsidised 9c/kWh to commercially successful making it competitive with most new fossil fuel investments.
Solar generators recoup their capital costs by selling direct to the household or customer. These ‘behind the meter’ arrangements are worth over twice the value of wholesale energy arrangements because they avoid all the costs in the system including network charges, retailer costs and taxes. A recent article suggests the cost of utility-scale solar is set to drop below 8c/kWh and could be completely covered by the rising RET price.
There are also other costs (approximately 10%) associated with retailers and market charges but I will ignore those for the purpose of this discussion.
Now that you understand the components of cost, below are the graphs of my estimates of what we pay for in South Australia and who pays. (you need to note that the asset value is far short of replacement costs, it is simply my estimate and published figures of the amount we are still paying off)
The main conclusion here is that over half of our costs can be linked to capital investment only. In fact if you targeted fuel use as the only short run cost that you wanted to recoup through pricing then over 80% of your costs disappear at times when you might want to encourage uses of cheap power.
The main economics principle is that if you set the right pricing mechanism, the cheapest solutions and investments will emerge and this is economically efficient. So the next section will explore the cost of solutions. Be warned, I am a believer that if we get this right, we can have the cheapest cleanest electricity system on the planet. The goal of this discussion is to ensure we understand our options and reasons why the current system might fail to price these well.
It is also worth noting some other pricing principles that the regulators follow because there will be no changes if we don’t respect these:
- Fairness is a goal and usually interpreted as treating comparable customers the same. All households are considered a single customer class. SAPN has proposed to treat solar customers as a group, but the regulator has pointed out that then airconditioning users might have to be their own group – both having a rather peaky profile.
- Gradualism suggests that no one likes bill shock and changes to any cost allocation system need to happen gradually.
- Ramsey pricing is an economic principle that suggests those with inelastic demand should carry the burden of residual costs in order to leave the price signal pure for those who can respond by adjusting load. It might be a great idea in theory but it would be wrong and unpalatable to assert that the whole household sector has inelastic demand (as proven by those who’ve installed rooftop solar) and therefore should carry most of the cost (good way to cause an uproar).
There is a famous quote that Alexander Graham Bell would not recognize today’s telephone network, but Thomas Edison would feel right at home running our current electrical grid. Technology is changing that proposition and a smarter grid offers the chance for every user to interact on the system, every small generator to offer services and whole neighbourhoods to operate autonomously as micro-grids.
We need to start seeing electricity supply and use in a more nuanced fashion than we once did. I think we need to consider our energy use and supply as having a hierarchy of values:
- Essential capacity:
- Firm capacity: This should cover a customer’s day to day needs.
- Manageable (sometimes) capacity: For loads that can be turned off or down in response to peaks which occur for maybe less than 20 hours per year or an ability to make my solar surplus available for export.
- Flexible Load: My hot water for example that can be “charged” when it is best for the system.
- Flexible Capacity: Battery storage for example has a flexibility both when it is charged and when it is discharged.
- Emergency response: Most of us would happily turn some things off in preference to suffering a complete black out providing it only happened occasionally.
Here are some further ways to value electricity that we may not have thought about before:
- The use of our state’s electricity assets for value-added production supporting jobs and the economy;
- Finding higher value for surplus – which can be about timing, plenty of wind in the middle of the night, and can be about spare capacity, the network is 80% underutilised.
- Fulfilling basic needs. Energy poverty costs lives as it undermines people’s ability to manage health, comfort, cooked food etc.
- Community building if local generation is owned and operated by communities (relating to the subject of my Churchill Fellowship)
- Local resilience if the system moves toward a network of micro-grids and away from the vulnerability that exists in any centralised system.
The Electricity Act recognises social objectives and therefore places some value on the points above but it fails to explicitly articulate the environmental value of reducing the carbon intensity of our electrical production, which of course is the key reason we need a fast transition to clean energy.
http://cleantechnica.com/2015/05/27/the-past-present-future-of-electricity-in-australia/ – it has the price index graph