Data that shows electricity market needs reform

ACE’s new report Electricity Market Reform: Generating Results, analyses the figures behind the sector in great detail. Here is a round up of some of the findings.

Underpinning the work ACE does is a desire to ensure it is built on a solid foundation of data analysis. To that end, and as the energy sector is a particularly sensitive topic at this time, it was more crucial than usual that our assertions were based on rigorous research. What we found was that the market was not functioning as well as it could be.

We began by examining average household fuel bills and saw that they had risen from £1,057 in 2011 to £1,232 in 2012 and hit £1,357 in 2013. These rises have been against a backdrop of low wage rate growth, employment uncertainty, and a general lack of consumer confidence, fuelling affordability concerns. Almost half (47%) of this latter figure was down to wholesale costs, while network costs accounted for 22%, with the remainder made up of environmental and social obligations (7%), supplier pre-tax profits (7%), and VAT (5%).

Switching between suppliers and tariffs is often presented as the solution to this, with direct debit customers seeing their gas bills £72 lower than standard tariff payers since 1998. Knowledge of the ability to switch is also high, more than 80% of consumers aware they can both switch suppliers AND switch to another tariff offered by their existing supplier. Almost two-thirds of consumers cannot recall doing so, however, mainly because they are happy with their supplier or feel the financial gain is not worth the time it would take to switch.

The data also indicates that there has been a shift towards more short-term ‘spot’ trading in recent years, with almost 40% of baseload, 90% of off-peak, and 60% of peak volumes being traded on this basis. This leaves consumers potentially at the mercy of day-to-day volatility when it comes to the price of their fuel, while also producing an environment in which energy companies are less able to take a forward view of future needs and invest accordingly.

Comparing the UK’s positions with domestic markets in the rest of the world was also revealing, indicating that on the whole the UK sits right at the International Energy Agency’s median, while also being the country with the second-lowest electricity taxes. This suggests that electricity in the UK might not be as over-priced as feared, but also that we are not proactive enough in reallocating resources from markets that are inefficiently accounting for the effects of climate change, pollution, and price volatility.

In addition, the data also shows us that for every 1p per kWh increase in taxation, there is an additional accompanying rise in the pure electricity price. In the UK this amounts to 7.4p per kWh, while the average rise across all countries is 0.53p. Indeed, the next highest rise is seen in Ireland, where prices rise by 4.3p per kWh for each 1p per kWh rise in taxes.

This is often a trade off by governments around the world, who use higher taxes to finance investment in new technologies and generation capacity. Over time, as the funding or long term purchase costs of these fall, so does the additional cost incurred on energy bills as a result of the investment. Essentially, as increased investment takes place the effect on electricity bills of increasing levels of taxation should decline over time.

All of this indicates that the electricity generation and supply market in the UK is not operating at its optimum. Investment is not coming forward as the incentives are not sufficient, consumers are subject to too much volatility, and the sector’s supply chain is unable to develop. All the while the prospect of future power supply shortages looms. Something must be done.

How the Priority Auction Mechanism would work

The purpose of the PAM is to provide certainty for how competition should be managed going forward, whilst also clearly showing how it integrates with existing regiemes such as ‘Contracts for Difference’ and the new Generation Investment Vehicles and baseload providers who are economically essential or in the early technology stages. 

The competition levels would operate as open exchanges where purchase of 50% and 75%, respectively, and the capacity put forward would be guaranteed on contracts of at least 24 and 12 months. All remaining and existing capacity would then have to
compete ‘over the counter’ on a
short term basis.

The establishment of two exchange markets would help to establish a clear and transparent reference price over time, as well as provide GIVs and CfD providers with certainty through guarantees of selling their capacity.

Additionally, this trading system would build on top of the
generators’ capacity that is locked in through baseload and technology benefits, and allow the flexible generators within the GIVs to enter markets where this is a significant chance of selling capacity. Only if a GIV were to price itself at unrealistic levels would it not sell any capacity until it hit the OTC market.