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Smart and fair domestic electricity pricing

In an article first published in New Power (Issue 90, August 2016), Jon Bird, Sustainability First Associate, looks at the result of time-of-use charging trials in energy and water and finds there are winners and losers in making the transition.  It may be impossible to make it fair for everyone, but we must tackle the extremes.
Elective and mandatory half-hourly settlement (HHS) for domestic electricity customers, locational pricing for transmission losses, distributed generation embedded benefits, the future of distribution use of system charges – these are all currently being discussed as we head to a world of smart meters and smart electricity pricing for domestic customers.

What they all have in common is the aim of making different elements of the final electricity price more reflective of the actual input costs that go to generate and deliver the electricity to a particular customer.  Economic theory tells us that cost-reflective pricing provides the most efficient system as a whole, as well as the best incentives on retail customers to change their behaviour to keep their own costs as low as possible.  But does this work in practice and is it fair to all customers?  This is the subject of a recent paper by Sustainability First Associate, Jon Bird[1], and topic for a Sustainability First roundtable held on 13 July 2016.

Whilst these initiatives will increase cost-reflectivity for suppliers, their impact is diluted by the increasing proportion of the bill that goes to cover the social and green levy costs.  End-prices might also need to become more location-specific if they were to reflect the actual costs of dealing with a more decentralised electricity system.  Moreover, they are all costs faced by an electricity supplier – and not directly by the electricity customer. How the supplier turns these into a final retail tariff for the customer will be up to it and will depend on its own marketing priorities.  One major retailer is offering a new FreeTime tariff - with free electricity on Saturdays or Sundays. This is not strictly cost-reflective, but nevertheless aims to reduce weekday peaktime load.

Several recent trials of a time-of-use (ToU) tariff in the UK and Ireland have shown, on average, a positive response in terms of a reduction in peaktime use of electricity.  But more work is needed to see if bill reductions from peak-shifting can be replicated amongst all electricity users (not just trial customers) - particularly given the CMA’s concerns that many customers currently do not react to a much larger bill saving they could achieve by switching tariff.

Any change in approaches to pricing creates winners and losers.  This has occurred in the water industry, when water metering and charging by volume was introduced in water-stressed parts of the country.  Using data from the ToU trials shows that, whilst on average for each demographic group, the potential impact of introducing ToU tariffs (leaving aside any possible behaviour change) is small, there can be wide variability within demographic groups.  This needs exploring in more detail and indeed Ofgem has recently commissioned some work to explore just this.

One way to seek to avoid significant losers among retail customers is to make any change voluntary.  This is behind Ofgem’s push for elective HHS.  In this situation, a customer and their supplier could agree to move to HHS with a corresponding change in retail tariff.  But this would only be attractive to those customers likely to gain financially.  This would encourage suppliers to search out those customers at the expense of the remainder who would, assuming no change in the overall cost of supply, end up paying more.

A similar problem arises if the costs faced by a supplier become more cost-reflective, but customers can choose to remain on a standard p/kWh flat tariff.  In this case, customers who use more electricity than average during peak times would lose money by changing tariff.  So they would wish to stay on their flat tariff.  Some of these may be customers in fuel poverty who have little ability to shift consumption behaviour. But others may have high discretionary peak-time use, such as electric vehicle charging. These customers could be persuaded to move to off-peak times - or could opt to pay more for their peak-time use.

There is no easy answer that is fair for every customer. Policy makers need to be aware of the possible consequences for customers in advance of any change to half-hourly settlement - and find ways to deal with them.  The general view in our Sustainability First workshop was that it will be important to keep down the overall cost of power supply and therefore to continue towards greater cost-reflectivity in supplier charges – and also, to some degree, for customers. However, any problems and unintended consequences for customers will need to be addressed. In the end, it may be that we cannot come up with an approach which is fair – and seen as fair – for everyone. But we should at least be able to tackle areas of extreme unfairness - such as customers who are in fuel poverty with inflexible peak-use, or, at the other extreme, those customers with large peak-time use which may be largely discretionary.

There will need to be an informed stakeholder discussion on these fairness issues as we move towards half-hourly settlement, to enable a common understanding of the issues and explore  whether an element of consensus can be built around the way forward.

[1] “Smarter, fairer? - Cost-reflectivity and socialisation of costs in domestic electricity prices”

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