A changing energy landscape & the critical role of consumer technology
On September 26th, 1881, the world’s first public electricity system lit up seven arc lamps and thirty-four incandescent lights in the little town of Godalming in Surrey. The system was powered by two waterwheels and hence also represented Britain’s first hydroelectric power station. Basking under the renewably-powered street lighting in 1881, the townsfolk must have revered electricity as a wondrous creation.
Spin the clocks forward to 2022 and the UK electricity system has become an entirely different entropic beast, with news headlines dominated by rising energy bills, collapsing suppliers and a grid creaking under the pressure of growing electrification and renewable penetration.
While it’s easy to read the headlines and think all is doom and gloom, we at Eka Ventures remain optimistic by recent developments within this space and the role technology can play in reversing consumers’ experience of energy towards something worth marvelling at.
A changing energy landscape
Price hikes
Let’s address the gloomy developments first. Gas prices have skyrocketed in the last year to around 4x what they have been in the past twenty years. Reasons for this include a particularly cold winter in Europe, Russia’s invasion of Ukraine, outages at nuclear reactors and a fire at a French inter-connector. This has resulted in both increased demand for gas from a heating and electricity generation perspective, along with historically low stock levels at gas storage facilities in Europe.
High demand + low supply = graph below:
Approximately 41% of UK electricity comes from gas power plants and hence the increase in gas prices is pushed through to electricity:
Bankrupt suppliers
Every six months, Ofgem takes a view on what the underlying costs to supply energy will be and sets a limit for how much an energy supplier can charge for their default tariffs under a mechanism known as the price cap. This is designed to protect the consumer, ensuring they pay a fair price for their gas and electricity.
Energy suppliers buy their energy in advance (known as hedging) to match the expected demand of their customers and protect themselves against price volatility. If they don’t hedge enough, they must top up by buying on the spot market, which is energy sold at real-time prices.
What we witnessed when the small suppliers went bust is that they hadn’t hedged out far enough and hence were more exposed to the dramatic increase in wholesale prices. Once their cost of supplying energy increased beyond what they could charge each customer due to the price cap, they began to haemorrhage cash and had to file for bankruptcy.
Rising price caps
Evidently, all suppliers will eventually become exposed to the higher wholesale prices if they continue to remain at their 4x level. Therefore, Ofgem has had to increase their price cap dramatically, to almost double what it has been previously as can be seen in the chart below. They are also now planning to adjust the price cap every three months to more accurately reflect the changing underlying costs of supplying energy and avoid another raft of bankrupt suppliers.
From an economy theory perspective, the events of the last twelve months have been a landmark chapter in the story of UK energy. Since British Gas was privatised in 1986, the government has encouraged a free market approach within the energy sector. However, state influence is increasing with the price cap representing a clear clash against free market thinking. For example, it’s likely that if the price cap did not exist, suppliers could have avoided bankruptcy by just increasing their prices to reflect their cost of supplying energy, effectively allowing their customers to switch to other suppliers who were better hedged and hence able to maintain lower prices for longer. It will be interesting to watch how energy policy develops in tandem with technology developments over the next five years.
Smart meter rollout
Now for the more positive trends. It’s likely that your energy supplier will have approached you in the last couple of years about getting a smart meter installed and hopefully you accepted. This means that rather than relying on the archaic system of manually submitting meter readings and having estimated monthly energy bills, your actual gas and electricity usage is automatically submitted every 30 minutes resulting in accurate monthly bills.
There has been a big push in the last five years to increase smart meter rollout and currently around 45% of domestic energy meters are smart. All suppliers now have binding annual installation targets to convert their remaining portfolio to smart meters by 2025. These new meters are a key enabler for the transition towards renewables and will also allow consumers to better manage their energy usage, save money and reduce emissions as described below.
Time of use tariffs
To understand the potential of smart meters, it’s first important to understand the basic market mechanisms of how energy suppliers trade energy to supply their consumers. Both generators and suppliers trade electricity on the wholesale market in half-hourly periods. A settlement process then occurs, which reconciles differences between the electricity a supplier purchased and the actual demand of its customers. Currently, most customers are settled on a ‘non-half-hourly’ basis using estimates of when they use electricity, based on a profile of the average consumer usage as shown below and their own meter reads (taken over weeks and months).
Electricity suppliers traditionally charge their customers a standard rate throughout the day, with the current price cap being around 30p per kWh of electricity used. Therefore, regardless of whether the cost of energy was cheaper to purchase during that half hour, the customer will still be charged the same rate. This means that while the supplier will make a profit on the electricity they supply you with, there’s no incentive for you to consider the immediate impact of your energy usage.
Ofgem announced its decision to implement the move to Market-wide Half Hourly Settlement (MHHS) in April 2021.This involves transitioning to new settlement arrangements over a four and a half year time period so that meters that are capable of being half hourly read should be settled on a half hourly basis.
Half hourly settlement is expected to introduce a raft of new products that will incentivise customers to move consumption away from peak demand periods, a practice which is known as load shifting. This is important as without significant levels of storage, the grid is built upon the foundation that supply must always equal demand, otherwise events such as blackouts will occur. Electricity demand throughout the day is peaky, as can be seen in the graph below, which requires excess generation capacity to meet the short peaks in demand.
Ultimately, the more severe these peaks are, the more expensive a consumer’s energy bill becomes. Therefore, using smart meters to encourage load shifting will help to reduce the overall supply capacity needed as it will make electricity demand less peaky as people shift usage towards half hourly times where demand and hence prices are lower. The benefit to the consumer is that by using their energy at times when there is less demand, they will avail of cheaper energy and hence be able to reduce their annual energy bill.
Renewables, storage and EVs
The contribution made by renewables to UK power generation has more than doubled since 2014, accounting for 43% of the 312TWh of domestic power generation in 2020. Historically, the core reason for the growth of renewables was due to climate change policy, with wind and solar being heavily subsidised to accelerate their rollout and improve learning curves.
The cost effectiveness of an energy source is typically measured using a metric called the Levelised Cost of Energy (LCOE), which is the discounted lifetime cost of building and operating a generation asset, expressed as a cost per unit of electricity generated ($/MWh). The figure below shows how the LCOE of wind and solar has decreased dramatically over the last decade, making them the cheapest forms of energy available and that’s before taking recent hikes in gas prices into account.
The sun doesn’t always shine and the wind doesn’t always blow which means renewables are intermittent i.e. the generation capacity isn’t always available. Therefore, energy storage projects are becoming an increasingly important part of the energy mix so that electricity can be stored when renewables produce more than demand requires.
Finally, the last piece of the puzzle is the growth of battery electric vehicles (BEVs). This growth has followed a similar path to renewables in that they have traditionally been more expensive than petrol or diesel cars and subsidies have helped accelerate their growth. However, in the last couple of years, BEVs have approached price parity and hence it’s not just the forward thinking climate activists that are purchasing them. The UK has also banned the sale of new petrol or diesel cars beyond 2030. All of this means that BEVs are estimated to grow from 2% of registered vehicles on UK roads in 2022 to 46% by 2035.
The power of consumer technology
The electricity system has historically been demand led, with new generation capacity built to meet increasing demand. To facilitate the transition towards a grid powered by renewable energy, this trend will need to reverse somewhat to a more balanced system, where demand can be flexed to meet supply. To encourage this behaviour shift, there will likely be various market incentives that consumer technology products will be able to leverage which will help to both reduce the consumer’s energy bill and assist the transition towards a decarbonised grid.
The following outlines the areas we’re particularly excited to see innovative technology products built around:
Staying warm (and cool)
Decarbonising domestic heating is a major challenge for the UK to achieve its net zero policy. Heat pumps are seen as an integral part of this decarbonisation effort. Air source heat pumps in particular are growing in popularity due to their affordability and ease of installation. They work by taking the thermal energy in the outside air, even when it’s freezing, and use this to heat the home, which is effectively the reverse of how a refrigerator works. In light of the recent heat wave in the UK, it’s also worth noting that they can provide cooling during hot summer periods.
In 2020, the UK government set a target of installing 600,000 heat pumps per year by 2028 to reach a target of having 19 million households with heat pumps by 2050. For reference, around 47,000 air-source heat pumps were installed over the prior decade. Typical costs of installation vary between £7,000 to £13,000 but households are eligible to a grant of £5,000 under the Boiler Upgrade Scheme. The annual bill and CO2 savings compared to incumbent heating systems are shown in the graph below.
EVs for more than just transport
There is growing excitement about the potential of EVs to operate as a flexible energy storage asset through vehicle-to-grid (V2G) technology. This will allow a consumer to charge up their car when energy is cheapest and then export that stored energy back into the grid when demand and prices are high, hence enabling them to profit off the difference in prices.
A case study in 2021 revealed that consumers could earn up to £725 a year just from leaving their car plugged in through V2G. The main barriers to adoption of this technology are the prohibitive cost of the bi-directional chargers (around £4,000), the lack of vehicles that are V2G compatible and the difficulty for domestic flexibility services to obtain ancillary market access.
Another area that is less talked about but perhaps even more exciting from the perspective of saving consumers money is vehicle-to-home (V2H). This is the same as V2G but rather than exporting the stored energy to the grid, it is used to power the house. This in essence allows a home to buy energy when it’s cheapest but consume it whenever. It’s also likely that this would save a consumer even more than V2G as the cost of importing energy from the grid at peak times would be more than what they would get from exporting it.
The home as a power plant
Microgeneration refers to energy production that typically occurs at a domestic level at the location where the energy is needed. This increases efficiency by removing distribution costs. In the UK, the majority of microgeneration comes from solar power.
UK solar installations decreased dramatically in 2016 when the government slashed the subsidies it would pay to those who exported solar energy to the grid via a mechanism known as the Feed-in Tariff. In 2020, the Feed-in Tariff was replaced with the Smart Export Guarantee, which requires certain suppliers to pay small-scale generators for the energy they export to the grid. It is up to the household to shop around to find what supplier will compensate them the most but the general range is 1–10p/kWh. UK solar installations are now beginning to grow again due to the hike in energy prices and the continued decreasing cost of solar panels, with more residential solar panels installed in the first six months of 2022 compared to the whole of 2021.
It quickly becomes apparent that if you’re exporting electricity for 5p/kWh for but importing at 30p/kWh, you’re better off storing it for when you need it rather than exporting it. This is why many solar installations will be accompanied by a battery or similarly, smart EV chargers will make sure that your car is charged when your solar panels are generating.
The Amazon of decarbonisation assets
It should now be clear that there are a plethora of options that can help a consumer reduce their energy bill and decarbonise their home, from double glazing and insulation to solar panels and heat pumps. Based on each household’s configuration and disposable income, there will be a different ideal roadmap of what to purchase, when to purchase it and how to finance it. There are also varying degrees of quality amongst installers. In short, for a household intent on decarbonisation, the path forward is woefully intimidating.
We’re excited to see technology plays that demystify this journey for the consumer. Based on datasets such as satellite imagery, Energy Performance Certificates, smart meter data and even smartphone LiDAR, it should be possible for a data driven marketplace to recommend the optimum decarbonisation roadmap for each household. Layering the household income and mortgage on top of this, it should be possible for this marketplace to recommend appropriate financing options, with the benchmark being that the monthly financed cost of the product is less than the amount it saves you on your energy bill. Finally, we’d like to see this marketplace work closely with installers to ensure the journey from asset decision to installation is seamless.
Smart asset control
Once these assets are installed, you now have to think about how to optimise their operation. Many people will be familiar with the Nest thermostat and how it can optimise heating control so that you remain comfortable whilst saving money and the planet. A fun thought exercise is to think about what a similar control system would look like for a house with:
- Solar panels, a battery, two EVs, a heat pump and smart appliances
- Connected to a grid that operates on half hourly settlement with time of use tariffs allocating different import and export prices for every half hour of the day
- With occupants that have varying behaviour patterns throughout the day
- In a country known for variable weather patterns
Evidently, simple questions such as when should the washing machine be turned on or when is best to charge an EV quickly become PhD topics. We’re excited to see how technology can tackle this problem and potentially the role that reinforcement learning could play. We think one product will need to control all your assets to achieve true optimisation. We also have a hunch that unless they change their model, it won’t be the energy retailers who will build this as the goal of the control system is to reduce your energy bill which would also reduce an energy retailer’s margin. For example, a cynic might think that the reason no serious V2H trials have been conducted in the UK is because the energy retailer stands to make less margin from that than V2G…
Virtual power plants
Finally, it’s important to return to the grid and the increased need for balancing due to increase electrification and renewable penetration. That same product that is controlling the energy assets within your home will be able to aggregate the potential of these assets across thousands of households to create what is known as a Virtual Power Plant (VPP). If the grid experiences a surge of demand, the VPP will be able to provide flexibility by imperceptibly lowering usage across thousands of households. Similarly, if there is a surge of supply, the VPP can off take some of that demand by increasing usage through charging up EVs, batteries, etc.
This provider of this flexibility service will be financially rewarded and hence some of these savings can be passed through to the households. To enable this, the grid will need to become smarter and adopt new technologies to allow seamless integration into ancillary market services from third parties. We were excited to see the announcement earlier this year that Arup is helping build the world’s first energy system digital twin, which will create a virtual environment that will allow the grid operator to share, model and predict scenarios to support its decarbonisation efforts.
Conclusion: Energy is becoming exciting again
Taking a step back, there is something poetically fitting in the transformational shift occurring in the electricity system, where rather than focussing on satisfying consumer demand at all costs, households must shift their behaviour to protect the sustainability of supply. Is this not what climate change requires of us in all walks of life? However, thanks to the rapid advancements in software and artificial intelligence, we believe that new technology products should mean that this behaviour shift will be beneficial and exciting to the consumer rather than painful.
Building these products will require bold visionaries capable of rethinking business models and developing new ones to create positive (energy) system change. If you are such a founder, please get in touch.
(Thanks to Karl Bach for his sage advice and well done for reaching the end. If you’re interested in better understanding the demand supply dynamics of the grid, treat yourself to this bonus YouTube video of what happens at National Grid HQ when EastEnders finishes.)
