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.

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4 Responses to “In which I geek out about the electricity market”

  1. “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.”

    I’m afraid I don’t believe that. My opinion is that Tim Yeo is defending the companies and producers that he’s got investments in.

    Cynic? Moi?

    • Adam Bell said

      Perhaps I’m being too charitable to Mr Yeo – but, in fairness to him, I think he’s got a point about the proposals. Even if he is motivated entirely by avarice.

  2. Mr Potarto said

    I don’t quite grasp your argument, or at least what you think the alternative should be:

    Nuclear produces energy all the time and can scoop payments across the full period. Wind is variable and unpredictable, therefore wind may not be able to produce electricity at the times we need it most, therefore they may lose money.

    If wind can not be relied upon to produce electricity when demand is highest, maybe we don’t want wind turbines?

    • Adam Bell said

      The question to hand here is how you achieve a low-carbon grid. Nuclear can’t be ramped up and down, so you need something to cover peak demand and probably a top slice of the baseload to represent seasonal variation. Over the next ten years, our options for peak generation boil down to wind and gas or gas by itself. Wind and gas comes out as cheaper overall, even factoring in the additional capital costs, as wind represents a fuel saving – see OfGem’s Project Discovery scenarios.

      Post 2020, your options broaden to include other renewables, but you need to be looking towards 2035-50 before you can rely on renewables for peak generation entirely.

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