Reforming how we pay for electricity in a renewables world

In tackling climate change, we plan to rely more than ever on electricity to heat our homes and to power transport. And as part of a plan to decarbonise electricity production, we aim to use renewables to provide the vast bulk of the electricity that we need.

This increased dependence on electricity poses a number of difficulties. Security of supply is one. However, there are other problems – the increasing demand from data centres, scaling up the electricity grid and funding the huge investment needed in electricity generation.

In principle, the electricity market should incentivise the provision of a secure and carbon-free electricity supply at minimum cost. However, as suggested in a recent ESRI paper, the current market structure, while appropriate a decade ago, needs to adapt to deal with these new challenges.

As a former member of the Northern Ireland Authority for Energy Regulation, I was involved in developing the all-island electricity market which began in 2007.

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We considered whether to implement a complicated mechanism, with different prices for electricity across the network, to reflect where there were bottlenecks in the electricity grid. In the end, it was decided that a simpler approach was warranted.

However, an alternative mechanism was not implemented to ensure that key consumers, such as data centres, would be built where they could be cheaply serviced. This is now posing problems for the operation of the system.

Security of supply

We’ve all become more conscious of the potential risks to security of supply, whether from prolonged calm weather, from power stations being out of action or even from a cyberattack. The film Die Hard 4, where terrorists took over the electricity system’s control room, highlighted the chaos that could follow when the electricity system is disabled.

The original design of the all-island electricity market had incentives to make generation available when it was needed. However, the model was altered in 2018 to meet European Union requirements, to allow trading with Britain and to reduce the cost of ensuring adequate capacity.

This modified approach clearly did not work as planned. Initially, it jeopardised a key generation station in Dublin as there was no incentive for it to continue to operate.

The ESRI research argues that a new type of electricity market is needed. Compared with the early 2000s, the problem of designing such a market is more difficult today because of the need to dramatically increase the share of renewable electricity. Generators need to be paid for three different services they provide to society: the electricity they produce, for making power available when needed and for helping make the electricity system work as it should.

Making data centres provide their own back-up power when the wind does not blow may protect security of supply in the short term but it is not a suitable long-term answer. Because larger generators are more efficient than smaller ones, this solution is likely to lead to higher carbon emissions than if the electricity system was responsible for providing a secure supply.

Fixed charges

As renewables form an ever-larger share of supply, we are moving from a situation where, when you switch on the light more gas is burned, to one where you use electricity generated by wind. In the first case the more electricity you use, the more fuel has to be paid for. However, for wind energy, once the windmills are built, the electricity comes for free. All the costs arise from building the wind farms.

This means we need to transition from a billing system based on usage to pay for the fuel used in generation to one based on fixed charges to pay for the windmills. In parts of Australia, this is already the case: consumers pay fixed charges, not by level of use.

This approach is closer to the telephone services bundles which we buy, with individual calls and texts coming for “free”. Such a charging structure would be a more efficient way to fund an electricity system largely based on renewable energy.

However, as the ESRI points out, in a fixed charges system, poor households with modest electricity use would pay the same as rich ones with extravagant use, and this would be regressive. In addition, without any individual incentive to economise on electricity use, in aggregate we would use more electricity. In turn that would mean more investment in generating capacity, whose costs would be added to our bills.

Designing the optimal electricity pricing structure that sets the right incentives for producers and consumers, and is fair, is a challenging task.