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What does a 'fair' energy system look like?

It's widely understood that we are in the midst of an energy transition driven by the need to de-carbonise and the broader trends of digitalisation and decentralisation / democratisation. Sustainability First has been engaged in these debates from a consumer stand-point for a long time including running a major multi-party project from 2011-2014 which was one of the pioneering pieces of work on the role of the demand side.

However as the changes become more imminent and the regulatory framework starts to change radically in response to this new world, it is clear that there is a need for a strategic view of what the cumulative impacts of these changes might add up to for consumers, including in particular the distributional impacts of the various reforms.

Ofgem is currently engaged in root-and-branch reform of electricity network charges. These charges will become more reflective of the under-lying costs of the system but by unwinding some historic cross-subsidies and changing how fixed costs are allocated, will create winners and losers in the process.Ofgem have recently consulted on the Targeted Charging Review (which would lead to a larger portion of network charges being recovered as fixed charges per customer) as well as launching a major review of other elements of network charging – the Access and Forward-Looking Charges Review (which may sharpen time-of-use price signals or introduce some sort of capacity or locational charge). They are also considering the way forward on market wide half-hourly settlement (and hence the extent to which any new time-of-use network charges would actually be passed on to suppliers). We are also expecting a review of the retail market touching on the possibilities of new business models, peer-to-peer trading and what a post price-cap world might look like.

While it is understandable from Ofgem's point of view that they need to carve up the work to make it manageable, there still needs to be a strong sense of what this means for consumers overall. What matters to consumers is the cumulative impact of all these changes and whether the energy system that emerges is one that is seen as "fair" for all.

Sustainability First's current Fair for the Future Project is exploring changing expectations around fairness, from a socio-political, environmental and economic standpoint. Our strawman 'Sustainable Licence to Operate' for the energy and water sectors has proposed a 'typology' of fairness which we are now testing with key stakeholders. Part of our hypothesis is that as fairness frequently involves balancing different interests, and questions of value judgement, it is essential that there is a step change in how stakeholders are engaged in deliberations as to what is fair – in a way that is meaningful to them.

Sustainability First is generally supportive of the direction of travel as being to provide more cost-reflective price-signals to market actors. This in turn will drive innovation and incentivise retailers to find a variety of ways to motivate their customers to play their part in keeping the overall energy system in balance, leading to a more efficient energy system. We also recognise that a greater proportion of system costs will be fixed going forward, as low marginal cost energy becomes increasingly prevalent and given government's stated aim of "no free riders".

However, we are concerned to ensure that the critical dual goals of de-carbonisation and maintaining affordability of energy (given it is an essential service) are not jeopardised by the cumulative impact of detailed market reforms. To achieve this, we believe that there are some fundamental requirements:

  • the need to look at the full picture, taking account of the cumulative distributional impacts of the wide array of changes set out above and how they will feed through into end-use tariffs;
  • the need for a wider public debate on fairness and the principles for cost recovery in this new world (rather than having any discussion buried deep in the annexes of technical consultations);
  • the need for clarity on the respective roles of government and Ofgem, in particular on distributional impacts (given government seems to see these technical regulatory changes as being strictly for Ofgem and Ofgem sees re-distributive actions such as social tariffs as being for government);
  • the need for better data to underpin policy making and regulatory oversight in this new data-driven world (which we have been exploring separately through our PIAG project[1]); and
  • the need for radical, strategic thinking from a consumer perspective including being willing to consider some very different models of how we pay for our energy going forwards.

When thinking about the 'no free rider' principle and how to recover the fixed costs of the system there are a range of more radical options from an end-customer stand-point that could be considered – from more reliance on general taxation or the use of council tax bands as a basis for charging through to some sort of universal service charge with exemptions for certain groups of customers or for certain business models, or, having a fixed charge creating an entitlement to an essential level of energy at reduced rates. Or we could stick with the current usage-based charging but introduce a separate fixed charge for customers who want to export onto the system, directly targeting the "free rider" problem that is exercising policy makers currently. Ofgem considered and dismissed some of these options in its targeted charging review. Making such radical change might have seemed disproportionate in the context of only one element of network charging but if there ever was a time for such radical reform it must be now.

And while the early debate has focussed on the structure of network charges there needs to be a parallel debate on what these fundamental underlying changes may ultimately mean for retail prices. Should suppliers continue to be free to pick their own tariff structure ? Or, if the aim is for a 'fair' recovery of the costs of the system from every customer – should elements of that structure become mandated? Could that help as a step towards a price-cap free world?

These are big questions that go well beyond the remit of an economic regulator. It clearly makes sense that Ofgem and BEIS are working together on the retail market review and the proposed Energy White Paper provides another opportunity for government to provide some strategic direction. The energy transition certainly needs to support innovation and new products and services for customers in ways which are broadly cost-reflective. But, this can only evolve smoothly if we also actively address how certain customer groups, including those in vulnerable circumstances or with particular needs, can best be supported in this brave new world.

These themes are considered in an initial way in our Sustainability First response to Ofgem's Call for Evidence on half-hourly settlement. In the meantime, we will return to these matters in more depth later this spring in a forthcoming Sustainability First discussion paper.

[1] Public Interest Advisory Group on access to smart meter data for a 'public interest' purpose, convened by Sustainability First and CSE.

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