In which I geek out about the electricity market
May 16, 2011
Tim Worstall is simultaneously wrong and right:
“We don’t actually give a shit about which technology provides us with low carbon power. We care only that we get low carbon power. So, of course, incentives and subsidies should be simple and unique. One system for all.Onshore wind should get the same deal as offshore wind, as solar PV, as tidal, as wave, as nuclear, as hydro. For what we actually want to have is that low carbon power in the most efficient manner possible. So set that one incentive and may the best system win.”
He’s absolutely right that we should aim to ensure that every single type of power generation gets the same deal for its power, to ensure that we move towards a low-carbon grid at the lowest cost possible. Unfortunately, the Government’s reforms to the energy market probably won’t achieve that. It’s because the electricity market is hellishly complicated, because balancing the electricity supply is hellishly complicated.
Let me give a (very) brief overview of how it works. The National Grid, every half hour, announces how much electricity it thinks it’s going to need in half an hour’s time. Generators then bid a certain price to supply that power, and NG picks the cheapest ones (not always, because of something called the merit order, but generally). They agree a contract that says in half an hour’s time they’ll supply that amount of power. This happens 48 times a day, every day. In the event that National Grid gets it wrong, it either has to pay generators a premium to produce less or to produce more. Somehow, this all works, and our lights stay on – we’ve never had a total grid failure since the National Grid was set up, although NG engineers are still required to train for what to do in the event of a wonderfully dramatically named Black Start.
Demand varies throughout the day, by around 20GW, or around twenty Sizewell B-sized nukes. Obviously, when demand is higher, the price that generators can bid with is higher. And herein lies the problem with the Government’s preferred option for supporting low-carbon energy.
It’s based on something called ‘Contracts for Difference’. Basically, a low-carbon generator agrees a long-term contract with the Government to supply a certain amount of energy over a given period, say, a year. They’ll still sell their electricity on the wholesale market as above, but they’ll have it ‘topped up’ to an agreed level if it goes below a certain rate. It effectively sets a guaranteed price floor for low-carbon generation.
This is great for nuclear, because nuclear is always on. At night, when demand and prices are low, their generation is topped up. During the day when prices are high, they can extract a premium. However, it could very easily bone variable renewables, like wind, because they have no control over when they produce electricity and could find that the majority of their income comes at night, on the lower rate. This privileges nuclear even if wind is cheaper at the point of production.
Now, Tim might want to come back and say that’s great, because it’s a clear incentive for nuclear plants to produce more during the day, getting us our low carbon electricity more cheaply. The problem is that nuclear is incapable of responding to that market signal – you can’t ramp nuclear up and down with incurring significant expense, which to make economic would require another incentive payment for flexible response. The Government is also considering something called ‘capacity payments’ which are broadly payments intended to deliver that sort of flexible response services, but they’ll be pitched at a price which would only be worthwhile for gas, rather than nukes. It’s an example of a Government intervention in a market which requires further Government intervention in the market after they cock up the first intervention, and this is what Tim Yeo is getting at.
If you want low-carbon electricity, then you can pay a premium for it or tax carbon-intensive generation more heavily. The Government is doing both, but cocking up the former.