How we charge for Electricity

Guy Lipman
May 29 · 5 min read

Some thoughts on how we should charge for electricity, in order to more fairly reduce the overall cost of decarbonisation.

There is a debate going on (not just in Great Britain) about how we should charge customers for electricity. Historically, retail customers in Britain have been charged a daily standing price (in the order of 20p/day), and a fixed price per kilowatt hour consumed (in the order of 18p/kWh). However, the cost of maintaining the transmission and distribution network is increasing, we need to move from high carbon (which is mostly on-demand) to low-carbon power (which is mostly variable), and households can more easily generate and store electricity, as well as to flex demand. As a result, many people in the field agree that charging everyone on fixed rates is no longer the best way.

This is a topic I talk about a lot, but I sometimes struggle to convey what I mean. I have therefore written this blog post, not because I’m certain of the best answers, but to clarify my thoughts, and to make it easier for people to critique them. I consider three components— the need to better allocate fixed costs, the need for dynamic pricing, and the need to reduce the import-export price difference.

Allocating fixed costs

A large proportion of the cost of our electricity system have to be paid for, regardless of how much customers use in an individual hour. This includes costs from the distribution and transmission system, costs of environmental programmes, and fixed costs of the system operator. (I’m leaving out fixed costs of building generators, as these are only indirectly reflected in wholesale electricity prices.) As mentioned above, these fixed costs have historically been charged as a mix of a daily charge and a per unit charge.

When we allocate fixed costs via a per unit charge, I believe we are under-charging customers that generate their own electricity and buy very little volume from the grid. These customers nonetheless expect the grid to be available at all times, so I believe should pay their share of these fixed costs. (To be clear, when the costs are genuinely marginal, a direct result of consumption, I am fine with not charging customers that don’t consume.) Where we charge fixed costs via a daily price, it is regressive, charging the poorest customers a higher proportion of their income than the richest.

I would like to pay the fixed costs of our electricity system from general taxation, in the same way that we would for roads. This would go some way to reducing inequality from the system. It would also give us room to pass on some more of the costs that do result directly from consumption, which unduly hurting poorer customers who tend to be less able to flex their demand. (Although out of the scope of this blog post, I would also support programmes that allow tenants and those that are less well-off to reduce energy consumption, for example by improving insulation.)

More dynamic pricing

Secondly, I think we need to be doing more to promote dynamic pricing, such as Octopus Energy’s Agile tariff which I blogged about here. Such tariffs vary prices based on wholesale prices and distribution/transmission congestion, incentivising customers to shift their consumption to times of lowest cost, and to make optimal use of battery and thermal storage. This reduces the overall cost of delivering electricity to everyone.

To be realistic, I don’t expect most customers to use dynamic prices, at least not for most of their demand. Most customers will continue using electricity when they want, and have to pay a higher price for it. I recognise that this will hit hardest those that are less well-off who have less ability to buy batteries or to flex their load (for example parents with young children) — this is why I am so keen to shift the burden from fixed costs away from such customers.

However, we don’t need everyone to shift their consumption. If we can get to the point where 20% of our demand is flexible, that would make an enormous difference to the system. I believe we will get to the point where we have enough capacity in electric vehicle and other batteries, hot water systems, and flexible industrial processes, that properly incentivised, they can make the system stable for everyone else.

The import/export price difference

Finally, I believe there is too large a difference between the price at which customers can buy electricity from the grid, and the price at which they sell it. To my mind, if my electricity is only worth 5p/kWh to the grid at a particular moment, I shouldn’t be charged double (or more) to buy that electricity at that same time.

I recognise that arrangements for households to self-generate electricity have been a bit of a mess. Historically, rather than directly subsidising solar PV installations, the UK government has offered a bizarre feed-in tariff in which customers get paid a fixed price for their self-generated electricity, whether it supplied to the grid or not. This has encouraged customers to use as much of their electricity as possible, and encouraged the purchase of batteries — not in itself a bad thing, but these aren’t being used optimally from a system perspective.

With the cancellation of the feed-in tariff programme in 2019, customers that self-generate now receive at best a very low price. This has significantly reduced the roll-out of solar generation that this country needs. It also encourages customers to use their own generation, often inefficiently, rather than sell it. For example, customers are incentivised to heat their boiler at 4pm, rather than exporting that electricity to the grid and heating it later when grid demand is significantly lower.

I believe that customers on a dynamic tariff should receive only marginally below the import price for electricity they sell to the grid: that margin should reflect the actual cost of getting the electricity to the customer that will use it (likely very close by). If we do get to a point that so much electricity is generated in an area that it needs to be transmitted to other areas, it may be necessary to reduce the price for that area, but in that case it should be reduced for buyers as well as sellers.

For customers on fixed tariffs, I am more comfortable with the import tariff being significantly lower than the export tariff. However, in this case it should be because the retailer expects the export profile (when electricity is sold) to be very different from the import profile (when electricity is bought). If the retailer knows that the customer will only export when it is very sunny and demand is low, they should set a much lower export price. However, my guess is that if customers keep responding to such differences by using batteries or using devices sub-optimally, it should prove mutually beneficial to move these customers to dynamic tariffs.

Guy Lipman

Written by

Fascinated by what makes societies and markets work. Undertaking a PhD in sustainable energy at UCL. http://guylipman.com.

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