John FitzGerald: electricity bills should reflect falling gas price

Although gas prices have fallen by between 20 per cent and 30 per cent over the last year, Irish households have not seen a corresponding fall in the price of electricity. Why have electricity prices not fallen when the price of gas from which much of it is generated has dropped?

The cost of electricity is composed of four elements: the cost of generating the electricity, which is reflected in the wholesale price; the cost of transmitting it to our homes through the grid; the cost of metering and billing by suppliers; and the public service obligation (PSO) added to bills to fund subsidies to wind, peat and other special factors.

There is an all-island wholesale market for electricity where, since 2007, electricity generators have competed to supply electricity to the grid. This market has worked reasonably well over the years, minimising the cost of generation. As shown in Figure 1, the wholesale price for electricity has tracked quite closely the price of gas, falling by around one cent a unit since this time last year.

In Ireland, unlike in much of the rest of Europe, the wholesale price tends to reflect the cost of generating electricity from gas rather than coal. While gas costs more than coal, pushing up the cost of generating electricity, a benefit is much lower emissions of greenhouse gases than in many other countries.

Another factor behind higher wholesale Irish electricity prices, compared with Britain, has been the need to pay for our major investment in generation capacity over the last decade. In Britain much of the capacity is fully depreciated. However, Britain will need major investment in replacement capacity in coming years, which will drive up its prices.

Because of our dispersed population the cost of getting electricity from the power station to our homes, via the grid, is higher in Ireland than elsewhere. This factor may raise Irish prices by two cent a unit or 10 per cent, reflecting the greater length of wiring required when the population is dispersed.

Limited capacity on some transmission routes is another factor behind our higher relative cost of transmission. Over time ongoing reductions in cost should gradually drive down the cost of transmission.

The cost of metering and billing should account for no more than 5 per cent of the household electricity bill.

Finally, the PSO accounts for about 1.5 cent per unit of electricity, up from just over one cent last year. A third of the PSO goes to subsidise peat, which is an expensive fuel and particularly bad for global warming, and less than a third funds the subsidy for wind.

Germany’s corresponding PSO is about 6.5 cent a unit – more than four times what it is in Ireland – because of a massive subsidy to renewables, more than 10 times the equivalent subsidy in Ireland. Ireland has, however, seen major deployment of renewable energy, giving much better value for consumers’ money in this area than in Germany.

Retail companies

In summary, given the available generation technology in Ireland, competition has ensured that wholesale prices are kept as low as possible. However, generating companies are supplying power to the grid, not to the individual consumer. The illusion of competition by the retail companies that supply households imposes a cost for consumers to pay for the billing systems and marketing efforts of the individual retail companies.

It does not appear that these costs are offset by significant downward pressure on other costs to compensate. In Britain, a much bigger electricity market than Ireland with more competing retail companies, their electricity market has proved, if anything, less competitive than the Irish market, suggesting the problem with the Irish retail market is not an isolated case.

One possible explanation for the failure of retail electricity prices to fall in line with gas prices is that retail margins here have crept up due to the lack of genuine competition since the market was deregulated – except at the margin for the minority who are regular “switchers” between suppliers.

Another possible explanation is a time lag in adjusting prices. Electricity companies may have factored in expectations of a higher gas price into their retail electricity prices and, in due course, their retail prices may come down, reflecting the lower gas costs. In that case the current very high price would be understandable, and temporary.

Captive market

Whatever the reason, the answer is not, as the regulator has suggested, more switching by consumers. The electricity market is not inherently a competitive one. Most households don’t switch back and forth, leaving suppliers with a mainly captive market.

This suggests that, as the ESRI noted in 2010, deregulating the Irish retail market at the time was not appropriate.

If electricity prices do not fall in the coming months to reflect the lower costs of generation, the Commission on Energy Regulation should regulate the appropriate retail margins and bring down prices. That is the best way to protect the interests of the consumer.

Irish households now pay among the highest electricity prices in the EU. There are some good reasons why electricity prices in Ireland today are above the EU average. However, the evidence suggests they are unnecessarily high.

If we do not see a fall in the coming months this problem may call for action by the regulator. Figure: Index of Wholesale Electricity and Gas Prices (moving average)