A New Electricity Market Is Needed
By Paul Homewood
London, 24 November – In a new paper published by the Global Warming Policy Foundation an eminent energy analyst makes the case for single-buyer electricity markets, arguing that they will prove more efficient in the long run.
In a single-buyer market, a central organisation is tasked with operating the grid at lowest cost to the consumer, and delivers on this objective by making long-term contracts for power delivery. Generators are paid an agreed amount to cover fixed costs, plus any fuel costs on top.
The author, power systems engineer Bryan Leyland, says:
"The single-buyer approach gives you the tight coordination of a centralised system, but with competition to ensure that generators are delivering at the lowest possible price. It should be much more efficient overall".
And Leyland says that single-buyer markets would have been much better for the consumer in the current crisis.
Currently, market prices are set by gas-fired power stations, so the high cost of gas has handed massive windfall profits to renewables operators. In a single-buyer market, renewables would have had to stick to their long-term contracts.
Commending the new paper, GWPF director Dr Benny Peiser called for politicians to take a serious look at the proposals set out by Mr Leyland.
“It is becoming ever more evident that the energy cost and energy security crisis cannot be fixed without significant reforms of a broken energy market. Europe’s astronomically costly energy policies have become unaffordable and won’t be able survive for much longer. Smart policy makers realising the urgent need for reform will want to read Mr Leyland’s paper.”
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NOT A LOT OF PEOPLE KNOW THAT 
It certainly is. A huge number of unscrupulous individuals and companies have been making vast profits from the current market which, was invented by incompetent bureaucrats and endorsed by incompetent government ministers (I need not name them, they are well known, many still active in politics and others benefiting financially from the market they set up).
A couple of things come to mind:
1. Intermittent renewables need to be made more responsible for the knock-on costs of their need for back-up, network connections and grid balancing.
2. It must be difficult to determine a price for a product that is so intermittent but the price should no longer include restraint payments if back-up facilities are not paid for by the generator.
Those ideas are much too sensible for the governent to implement them.
Makes sense
You must provide a base load of X per hour for the following hours ( varying for periods of 3 hours each. Based on historical consumption over days, weeks, months, seasons)
In return we will pay you Y
Maintaining production will be your responsibility whether through other generation methods, buying any excess available elsewhere or your storage.
Failure To comply will result in immediate penalty.
Excess production may be purchased at Z per MWH at the discretion of the purchaser.
Other wise you can stick your wind farm/ solar array as it is of no real use to us and just causes problems for the grid.
Can we be clear about one thing? We will still pay all the costs of the system. If there are balancing costs, we will pay them, regardless of which generator they are assigned to. They would also be difficult to assign for this exercise without a hugely iterative calculation.
At present, there are many vested interests in keeping the system as it is, very high prices at times of system shortages (£4000/MWh) for the peakers to jump in, many traders profiting from speculation, it really is a mess.
The fact that electricity cannot be treated as a regular commodity, because it is essential to life is overlooked and as it is not easy to store, you cannot class it in the same economic trading model as corn or tin or even battenburg cake.
The market distortion with all the ill thought out subsidies and carbon taxes is going to take a time to resolve. Mr Leyland has summed up the mess very well, but it will all be ignored.
How OFGEM are still in charge of this chaos, which they created by pushing to go green, totally failing to take into account the high prices and shortages that this policy gives, as well as approving the poorly financed suppliers that went bust 4 months before Putin invaded.
When Labour gets in at the next election I would not be surprised if they nationalised electricity, gas, water, rail as in the late 1940s. To be honest it would be an improvement on the present systems, which just do not work!
The head of Ofgem is Jonathen Brearley, one of the main instigators of the Climate Change law started by Parliament .
So as left wing as they come , and their main objective is to destroy the economies of Western countries so that the socialists can control the world .
Making electricity very expensive and not available all of the time is just part of the plan .And controlling the media so that most people will not know that carbon taxes have been one of the main reasons for the massive price increases is all part of how they are still getting away with it .
It’s not essential to life and so what?
Pretty sure food is actually essential to life but is traded all the time.
No electricity and pretty soon, no food!
I fear the root of the problem is the take or pay deal these intermittent generators have. Mandated by government, the grid has to accept whatever, whenever it is generated or pay for it.
British Gas used to operate as monopsony with all UKCS gas production landed in the UK, until the market was deregulated in the early 1990s.
However the deals it struck with producers were on widely varying terms and prices. The earliest fields had very low contract prices – little more than 1p/therm. That allowed huge profits to BG, who paid a levy to the Treasury. As the North Sea opened up and more gas was associated production with oil, the basis changed with the introduction of PRT, royalties and ring fence CT, so the levy was via taxation, and the prices paid by BG no longer gave quite the same huge profits. Additionally, significant supply came from Norway via the Frigg line, which provided a competitive benchmark. Deals to provide winter flex were at rather higher prices, reflecting the potential impact on reservoirs and on reduced average asset utilisation and the cost of providing high pressure ramping to meet demand peaks.
This is a good suggestion but it, ironically, is nothing more than a re-invention of the Central Electricity Generating Board that we used to have in the UK. This operated efficiently and always ensured a good margin between forecasted electricity demand and generating capacity. Then the politicians decided to “improve” the situation by abolishing it and fragmenting the electricity generating, distibution and supply into many different components, all competing with each other. That has not worked well!
When the CEGB left the scene the extent of gold plating they had indulged in was revealed, and there was a push towards much more efficient use of the assets. It actually resulted in falling prices. That started to unwind as government and the EU increasingly interfered. The freeing of the market produced the dash for gas, which was certainly the cheapest way to proceed while the UK was well supplied from the North Sea, although a good case could be made for limiting gas use and reserving it more for domestic heating and industry. But the interference started to impact bad decisions on nuclear and on coal restriction and closure and on renewables implementation, amplified by a switch to needing to import LNG. The real costs of renewables are really only starting to be felt in more transmission investment and much more curtailment, and expensive backup and ancillary services.
Rubbish. That resulted in falling prices and better service.
It is only since the government started to interfere in that market that prices have risen and supply become a problem.
Correct again. Perish the though of a re-incarnated CEGB. Labour will stuff it full of cronies, weirdo’s and unions and it will become just like the No Hope Service. Show me just one area where a nationalised or state run industry actually performs
“Single-buyer markets would have been much better for the consumer in the current crisis”
But the whole aim of this system is to make energy as expensive as possible. Didn’t some Green nutter once say that they didn’t want plentiful, cheap energy “Because people would just use more of it”…
Especially poor people in developing countries (excluding China and India of course!) despite which the JSO eco-nutters , inspired by the leader of their weird catastrophist death-cult, scream about billions of dead and refugees
‘In a single-buyer market, a central organisation is tasked with operating the grid at lowest cost to the consumer’
‘Tasked with?’ UK is ‘tasked with’ keeping your borders secure.
The fix is to get rid of wind/solar. Playing management games does not fix the problem; it is reorganizing the deck chairs on the Titanic. YOUR PROBLEM IS NOT MANAGEMENT. Even if it were, a ‘single-buyer market’ isn’t immune to corruption. Charlie/Parliament can screw up anything.
Correct. The real key here is a holistic market that optimises grid dispatch at lowest cost, and optimises longer term grid investment at lowest expected cost. The investment side is never going to be perfect. You can only postulate how much of the time coal would be cheaper than gas and vice versa to help decide how much of each you need to minimise long run average cost for example. But it would rapidly throw out substantial increases in renewables because of all the extra costs they cause.
The current grid dispatch ensures that the most expensive renewables are always dispatched when available. Curtailment is on a cheapest to curtail basis to meet the constraint. This inversion of normal logic is absurd.
On balance, I’d prefer that spivs had no part in domestic energy supply.
“Dear CEGB, please come back.”
The spins delivered significant reductions in price and significant improvements in service quality. As they have done everywhere. As they almost certainly would have continued to do so. But let’s put it all in the hands of a few geniuses who know the future…
” The spins delivered significant reductions in price and significant improvements in service quality.”
Does “spins” mean spin-off into the private sector?
I have attempted to find data re price of UK domestic energy over the decades corrected for inflation and also with an indication of affordability. I can’t easily find anything definitive and easy (for me) to understand; I have found some subjective comments:
https://www.businessjuice.co.uk/2013/09/14/history-of-electricity-part-3/
Both from 2013:
”
The average cost of energy in the UK has tripled across the last 20 years.
That’s the verdict from price comparison service Compare The Market, which says the average cost of domestic gas has risen by 221%, while the price of electricity has soared by 193%.
It notes these price rises outstrip those of all other goods and services across the economy, the collective price of which increased by an average of only 49%.
”
”
1982-90 – electricity prices climb steadily, but fall in real terms as the economy picks up.
1990 – the electricity industry is privatised.
2011 – electricity prices are more than double their rate of 1990, but are comparable to prices in 1940 in terms of affordability.
”
The construction cost for the “Dash for Gas” in the 1990s was obviously going to be far cheaper than building 10x twin-reactor PWR nuclear power stations as per the proposed 1992 construction cost of Sizewell C: £3.5billion. In 2022, 11 x PWRs and a few remaining AGRs would be paradise.
Sounds good to me!
The paper isn’t quite accurate in its description of the market. It doesn’t pay everyone the marginal price for generation. Generators are free to sell their output at any time at any price they can negotiate with a willing buyer. If they make a forward sale they are bound to supply against it, and the purchaser is bound to take the supply. If they are unable to supply from their own generation they must buy in supply from the market.
A gas generator might typically buy gas and sell electricity simultaneously to lock in a margin, which will have to cover other costs including carbon taxes. The much higher carbon taxes on coal are why it cannot usually make profitable forward sales. If as the time for delivery approaches it appears that there will be a large surplus of wind generation then electricity prices will fall relative to gas prices and the generator can buy from a wind farm to meet his supply obligation, and can resell the gas, with the unwinding of positions leaving a net profit. Only the amount of imbalance actually trades – not the entire volume of demand.
Coal generators now rely on the exceptional margins to be had when supply is short. They will be paid to warm up their boilers and then capture a huge margin on helping to meet peak demand. Keeping their powder dry for these opportunities means they do not sell ahead of time.
Wind generators will likely sell at least a portion of their expected output on a forward basis. These sales are for an even flow of power over a month, quarter or year. Because of the variability of wind they will seek to avoid being caught having power they cannot supply that they could have to buy back at a massive loss. So they will tend to be cautious about the volume they sell, leaving a cushion to be sold in the day ahead and even intra day markets when the weather forecast provides reasonable certainty. For those on CFDs, where day ahead prices provide the benchmark for CFD payments, there is no incentive to sell on anything other than a day ahead basis. The CFD provides the hedge, and doing anything else becomes speculation.
Without forward sales by generators it would be largely impossible for electricity retailers to hedge. OFGEM has tried to encourage retailers to hedge. In the current volatile markets hedges become risky, particularly for generators who might find the cost of buying back hedges if they are unable to generate high enough to bankrupt them. The result has been a sharp drop in hedged volumes, which has left retailers exposed to shortage pricing.
In New Zealand the hedge market is in tatters because the major trader in hedges has dropped out of the market because it is too risky. Nobody knows what is going to happen next.
Wind will rarely sell forward as any shortfall in its generation is almost certainly systemic (I.e.no wind anywhere), so the price of buying in will always be higher. Lots of wind generators all scrabbling to find power to buy in will also tend to spike the market – that’s the volatility wind has brought to the market which makes it less efficient. And volatility makes hedges expensive.
But there are ways to hedge other than physical deliveries but few if any retailers seem to have bothered. Ofgem seems to have noticed the problem but then done nothing about it, thus leaving all the risk ultimately with taxpayers who have no means whatsoever of offloading the risk – and didn’t know they were taking it anyway.
I’m late to the thread, but I’d like to comment on the proposals in the pdf.
“Ideally the single buyer is a non-profit organization, independent of the government. The aim is to optimise the system as a whole, so as to minimise the cost to the consumer”
What price dies the single buyer charge? The two immediate alternatives are the average cost of its purchases (which is consistent with non-profit) or the marginal cost of its purchases (which is not).
The average cost would expose consumers to a price which sits below the incremental cost of consumption. This mis-allocates resources as consumption is not sensitive to the cost of the next unit produced, and demand will increase above the economically efficient level described next.
The marginal cost would expose consumers to a price which sits at the incremental cost of consumption. This is efficient as the next unit of consumption is sensitive to the cost of the next unit produced. But it does two things: it brings the scheme back to all demand being priced at marginal cost (which seems to be a major complaint of the article) and it leaves the central purchaser with a profit (the “inframarginal rent” of all the lower costs producers).
These points significantly weaken the proposal.
“The aim is to optimise the system as a whole, so as to minimise the cost to the consumer.”
A market should do the same, and the present NETA arrangements are designed to support market trading (long-term all the way to short-term balancing). IMO, we need to understand what it is that is preventing NETA from operating before we replace it, otherwise the replacement might suffer from the same issues. This significantly weakens the proposal.
“There would also be a bonus/penalty regime for efficiency and availability. Power plants that are operated efficiently and exceed availability guarantees would make the highest profits.”
The NETA arrangements contain “imbalance” provisions to punish participants (buyers and sellers) who do not transact what they say they will transact (and reward good balancing). This is an important element of efficient operation which seems to be missing from the proposal. Likewise, the proposal seems to be inferior on this point.
“When assessing tenders for new generation, the single buyer would take into account the cost of providing any transmission lines needed and would also assess future fuel costs. The cost of backup for stations that cannot guarantee to be available when needed would also be a factor in the assessment.”
Who takes the risk on these “external considerations” in the valuation of a power project proposal. As the number of these external considerations increases, the evaluation process will be less transparent to developers, and it makes participation less attractive to developers.
“The single buyer would sell electricity to distributors and large consumers, with cost-reflective tariffs”
Who takes price and volume risk?
If it is priced into the long-term contracts, operators may be rewarded for keeping costs to a minimum, but then “good behaviour” will be criticised because they will appear to be paying over apparent cost. If it is not priced into the long-term contracts, operators will lack incentives to keep costs to a minimum and the central purchasing body will end up paying too much.
“The distributors sell electricity to the consumers, so there would no longer be any need for energy traders to compete to sell exactly the same product. This could represent a useful reduction in the cost to the consumer.”
And “cost reflective tariffs” leave the operators with no risk, all of the risk will be passed-through to consumers. We would be left with the unsatisfactory situation where consumers have no certainty in what their future energy costs will be.
All-in-all, colour me unimpressed.
In most countries nationally owned generation and transmission or, as in the USA, vertically integrated companies, delivered a reasonably reliable supply at a cost that is less than that now being delivered by the “market”. As Meredith Angwin said, areas with markets have higher prices than those with vertically integrated suppliers.
All my proposal does is eliminate the monopoly supplier of generation by separating out the management of the system from the supply of power stations. Opening up the supply and operation of power stations to open competition will almost certainly lead to better power stations at a lower cost. But it does retain the advantages of somebody operating and expanding the system as an integrated system, rather than a random collection of power stations.
So, all it does is improve on the system that, for years, provided us with a reasonably reliable and economic supply of power.
Thanks for your reply Brian. This is a big subject, and I definitely agree there are difficulties in trying to make an electricity market function.
I have quite often come here to offer my view that a market model is not sophisticated enough to deliver anything approaching an optimal service which approaches lowest cost to consumers (not to forget convenience). Your proposal is likely to be better at this because of the central planning element (I appreciate this is a red flag to some, but it becomes like Churchill’s comment on democracy).
One of the major issues is with the need to provide all sorts of reserve on opaque technicalities to secure electricity supply. All the way down the chain, from fuel security/diversity, storage, generation capacity margin/diversity, network operation and reliability. Markets are unable to value most of these, and to secure income from them. It leaves us with a monopsony ESO and a regulator to set rules to try to cater for it. Your proposal recognises this.
But I was being more challenging with my question “why replace NETA”. NETA is a really good attempt at arrangements for a functioning market, and it was in the original thinking (the design) that long-term contracts are supported. NETA lays the ground for private sector market entry and exit (generator and supply). So a point of interest is why doesn’t NETA do this? To repeat something in my earlier comment: if we just go and replace the market clearing mechanisms, do we just end up with the same problems?
So I was begging a question, which I’ll try to briefly answer now.
It is essentially: why is NETA is horribly short-term? (not functioning as a pathway to market entry).
* One important issue is the lack of consumer commitment. Switching supplier has become the be-all-and-end-all of consumer behaviour. To the supply chain, any long-term commitment (investment in new equipment or committing fuel supply for years ahead) can be characterised as a physical long position. It just creates the burden of a large, unsecured mark-to-market liability on their trading books. So the only investments we get today are backed by government-sponsored contracts, the costs of which are then “socialised” (see Paul’s more recent post on Levies).
* Consumers should be encouraged to enter long-term binding commitments for the technology of their choice. It’s a way for greenies to support wind generation (and bear the full cost including reserve/balancing instead of asking everybody to subsidise their preferences) and for nookies to support new nuclear investments (likewise). The NETA Energy Account arrangements should support this. If this choice could be given to consumers, I’d be pretty confident it would spell the end of wind and nuclear on measures of price and reliability. (It is odd that wind generation is criticised on reliability and disposal costs, but nuclear construction risk and fuel treatment costs are conveniently assumed away to naught.) The winning choice on reliability and price will be “unabated” fossil fired, maybe we could then return to the huge benefit we have enjoyed for the last couple of decades. Otherwise UK productivity will go through the floor (we’ll never compete with China and India).
* The government is too involved in technology choice for power generation, mandating wind and nuclear, banning coal, introducing a “carbon tax” to skew the market, and toying with very expensive ideas like CCS and H2. This all needs to stop because it is a deterrent to private sector investment and an obstacle to anything remotely approaching a market.
There is much we agree about, but I suggest your proposal is guilty of leaping ahead, and it is incomplete. It needs to do more to justify the replacement of NETA. And it needs to do more in areas like risk allocation, pricing and optimisation.
It is also a poor start to kick off by criticising marginal cost pricing. All markets will relentlessly pursue the opportunity cost of supply and the opportunity value of demand.
In a market, nobody will sell at their cost when the market offers the opportunity to sell at a higher price. And nobody will purchase at the higher price (the value to them of consuming product) when the market offers the same supply at a lower price.
So you have to ask yourself why your proposal gives favourable treatment consumers. If the marginal benefit of consumption (for individual consumers) is greater than the price of supply determined by the central purchaser, why should those consumers get the net margin of their marginal benefit over the central purchaser price? Why doesn’t the central purchaser oblige them to pay a price linked to their marginal benefit?
“Your proposal is likely to be better at this because of the central planning element”
And then along come the likes of John Selwyn Gummer…
Quis custodiet ipsos custodes?
I get your drift catweazle. I share your concerns and I share your preference for private sector.
However I would add that the private sector needs to be the more effective way to deliver services. If there are serious market failures, we’ve got to keep an open mind about whether a market model is the best way to go.
A large electricity system is a devilishly complex thing. For the market to function, it is not just a matter of pumping energy into one end and drawing it off at the other. To operate reliably, a power system needs a number of essential services and has to satisfy various measures. Repeating my earlier comment, these include primary fuel diversity, fuel storage (a “fuel security standard” to cater for uncertainty), a “supply margin” (or “generating security standard”) of total generating capacity over peak demand, diversity in generating technology, power network security (multiple routes), management of network voltage at all locations on the network, maintaining frequency, covering fault levels at particular locations on the network (be capable of riding through short circuits without frazzling stuff), and plenty of others.
These things come with material costs and risks. And there just doesn’t seem to be a way for a competitive market to form around them – they are just too opaque, and there would not be enough competitive interest in any case. They heavily interact with the operation of the competitive market (generation and supply), which brings competition concerns deterring the ESO from acting in a way which could be read as distortion of the competitive market.
But the ESO is best placed to take a view on where and how much service provision is required. It ends up becoming a matter for the ESO and the regulator to operate as a monpsony, similar to the proposal in this post (but more limited scope). And we already hae your question: who guards the guards themselves?
No coincidence that the CEGB was tasked with operating the combined Transmission and Generation assets. The privatisation model couldn’t go with this and split Transmission (a natural monopoly) from Generation (expected to compete). Transmission was to be an enabler of the power energy market, but this has never worked well. The interactions between Transmision and Generation frustrate the market model.
I would go so far as to say the split of Transmission from Generation has produced an unexpected result: the monopoly Transmission business competes with Generation. It has “played a blinder” to improve its lot. A visible example is interconnection and connection of wind assets. Today, the UK is highly interconnected (wires and not generating assets) and guess what: the UK is short of generation.
Whodda thunk.
You make many good important points. Electricity isn’t the only industry where there are many competing chemical/engineering/environmental/ economic issues that make optimisation difficult. It does tend to angle towards ever larger, more complex grids, although I recall a very interesting paper that suggested that European supply might be rather more robust if it were split into more local islanded grids with limited interconnection between them.
An idea I have suggested before is there should be competition for grid design. At the moment the only competition permitted is for solutions to problems created by ever more renewables. So we get new roles for batteries, and all the other smart grid ideas that you will find discussed in the green engineering press. National Grid’s pioneering work in measuring grid inertia is an example, designed to help in the procurement of suitable ancillary services. However, the basis of the design is to approach net zero, not to provide low cost, reliable supply. Indeed, reduced supply security is built in with paid for power cuts, a.k.a demand side response, massive TOU penalties, V2G, etc.
It is actually anathema to net zero to consider what a low cost grid would look like, because it would be so much cheaper, more robust, and seriously question the net zero approach. For all the wrinkles you allude to that cover issues such as stability, redundancy and robustness, etc. It is actually probably not all that difficult to get the essence of a good design even with simple back if envelope calculations (well, perhaps you might want a few spreadsheets). They key elements are to look for cheap baseload, and lowest cost ways of meeting demand flex and grid transmission requirements by siting generation not too far from demand. You can do some Monte Carlo on providing alternative fuels to reduce the risks of dependence, and on demand scenarios to try to explore what extremes might have to be coped with. You will not be far off what a fully sophisticated engineering study would conclude for the broad brush outline. Indeed, its role becomes much more the nitty gritty of substation design etc.
The French did this in the 1970s when they opted for nuclear backed by hydro and gas to replace an oil dependent system. They had the advantage of colonial uranium supply from Niger, and they suffered the disadvantage of making a wholesale switch in a short timespan, now hotting them with plants that simultaneously require old age care and replacement: that is another factor that should affect grid design. Assets that are replaced steadily do allow for implementation of the newest technology and also for rebalancing the asset portfolio to take account of shifts in costs between different technologies.
If you actually asked major firms to design a low cost, robust system in competition with each other I suspect you would get a high degree of convergence in the solution. You might also get rather more robust criticism of current plans than hits the public domain. The current BEIS Select Committee enquiry into plans for net zero generation by 2035 had very few critical responses. Mine and Kathryn Porter’s were among the few. Most submissions were angling for their place in the subsidy beanies.
In short, the prime problem is political: failure to ask the right questions.
As an unsophisticated consumer that has to pay for the shambles that is UK domestic energy, I want cheap, reliable energy that is relatively safe. There are “many people” paid with lots of my money to achieve this, but – in the UK – the “many people” have demonstrably failed.
The “many people” need to be sacked and replaced with competent people; I doubt that this can be achieved without declaring an energy emergency.
Jordan,
As I live in New Zealand, I don’t know a lot about the English market and, in particular, NETA.
You make some very interesting comments, but I think the most important factor is that with a single buyer and system coordination everybody takes a long term view. As it is almost impossible to imagine a substantial decline in demand – absent governments completely stuffing the economy –it seems to me that it is very obvious that power stations selected as part of a long-term plan will generate cheaper and more reliably, then power stations built for a quick return and a short life.
Thanks again Bryan, and sorry for mis-spelling your name. If I could summarise and conclude with three comments.
First, marginal pricing is not a flaw, but the norm of any market. If a market has plentiful supply (consumer power), price will gravitate toward the marginal cost of production (supply) and the cost of the most expensive producer asked to provide product. If the market is short of supply (supplier power) the market price will gravitate toward the marginal value of consumption as the value to the consumer who is most ready to turn down its consumption. A well-functioning and well supplied power market with variable demand should flip between these two states. Price should be characterised by occasional price spikes when supply is relatively short, and there should be “fear” in the market to price this into forward contracts.
Second, your proposal is too generous to consumers because it only considers cost of supply. If I recall correctly, it was Centrica (a UK energy supplier) who characterised UK customer tariffs as an option to consume for the contracted tariff rate (as opposed to an obligation to consume for that rate). Why should consumers have an option to consume at a price linked to the minimum total cost of producing power? Who takes all the option risk and where is it priced into the proposal?
Finally, you really must add a well developed consideration of risk, and risk allocation among participants, into any proposals to change the market clearing and settlement arrangements. It is likely to be the first question participants will want to have answered when they look at your proposals. And if the risk allocation is not right for them, they will not put their money behind it.
Thanks for the opportunity to share perspectives.