The future of electricity prices in a carbon-constrained world

This is the first of an occasional series that looks at some of the unexpected consequences of current trends. Here SAMI principal Martin Duckworth considers the future of electricity prices in a carbon-constrained world.

We are in a world of increasing energy costs. The issue of climate change is getting more and more urgent, and it seems inevitable that governments and the EU will have to increasingly curtail carbon emissions. This could be through carbon taxes or tightening the limits available under the emissions trading scheme – but both would have the same effect of pushing up the price of carbon-based energy.

There is uncertainty over what the future price of carbon will be, but we can assume that prices will rise to the point where they are sufficient to induce changes of behaviour. We can therefore safely predict that these price signals will in fact reduce carbon use, and promote the economics of carbon-free sources of energy, principally wind energy and nuclear power.

Raising the cost of carbon will inevitably raise the cost of electricity in the UK, but the effect will not be uniform. It is quite possible that at some times of day, the cost of electrical energy will decrease. To see why, it is necessary to understand something about the national electricity supply.

Electricity Demand and Supply in Great Britain

The national grid in Great Britain supplies electricity 24 hours a day. Because electricity cannot be stored in significant quantities, the National Grid company that manages the service must at all times match the power generated to the demand. Supply and demand vary throughout the day, and throughout the year. In the first half of 2007, for instance, total demand has varied from 22GW (in the early hours of 23 June) to 57GW (in the late afternoon of 24 January). Average demand in this period was 38.5GW.

Late at night, at times of minimum demand, the base load of electricity is provided by nuclear power stations and coal-fired plant. These are efficient plants, but often expensive to build. They operate continuously as it is not easy to alter their power output on an hour-by-hour basis.

During the day, as demand builds up, more coal-fired plant is brought into use, and gas turbine generators are started. At times of peak demand, more and more expensive generating capacity is brought on stream.

The price of electricity is determined by a free market mechanism, but overall price levels are set by the marginal cost of production at any instant. The wholesale price of night-time electricity is typically around £15-£20/MWh (1.5p – 2p / unit). Day-time prices typically settle at around £30-£60/MWh, depending on circumstances, but can peak at £100/MWh or even more .

New Low-Carbon Generating Capacity

Wind Power

Wind power generation capacity is increasing. The government has set a target for 20% of electricity to be generated from renewable sources by 2010:

“To reach our aspiration of 20% of electricity supplied from renewable generation by 2020, approximately 20GW of renewable capacity would need to be connected to the GB transmission system. The majority of the new renewable generation is likely to be variable onshore and offshore wind.”

Installed wind capacity already exceeds 2GW. A further 1.2GW of renewables capacity is under construction; 4.6GW has consent; and 11.4GW is in planning processes across the UK. So we can predict that soon after 2020, the peak capacity of wind generation will exceed the 22GW demand at times of lightest load.

Wind power is very intermittent; average output over a year will be only about 30% of the capacity figure. But by 2020, we can confidently predict that wind-generated electricity will, on the windiest nights, provide the majority of off-peak electricity demand.

Nuclear Power

Nuclear power stations currently account for 11GW of installed generating capacity. Most of this capacity is due to close over the next 20 years, but the government is clearly moving towards a policy of replacing these with new nuclear plants.

“Apart from large-scale hydro – the opportunities for which have been largely exhausted in the UK – nuclear power is the only low-carbon form of base load generation, which is proven on a commercial scale.”

We believe the most likely outcome is that new nuclear power plants will be built in the locations of existing plants, where local opposition is likely to be muted. The capacity of any new plants will be greater than the capacity of the plants that they replace – perhaps around twice, in the way that Sizewell B was twice the size of any previous UK reactor (and six times the size of Sizewell A). We can reasonably assume therefore is that nuclear capacity in Great Britain will rise, to perhaps 15-20GW, over the next 20 years. This by itself will be close to meeting the base load demand.

Implications

Over the next decade or so, increasing nuclear power and wind generation will together eat into the base load, and eventually they will exceed off-peak demand. This will happen first during windy nights in autumn, but as capacity grows, it will happen on more and more nights throughout the year.

This leads to some interesting forecasts about the price of electrical energy and the implications for various users:

Electricity Prices

• Night-rate electricity prices will fall. Since there is no cost benefit in switching off nuclear and wind plants, the marginal cost of generation at times will fall to zero. If the UK maintains a free market in electricity pricing, then the wholesale price of night-rate electricity will fall – not to zero, but less than today.

• Day-time electricity prices will rise - as carbon taxes and/or emissions limits start to bite. Wind and nuclear plants will make their profits during the day.

• The price difference between night and day electricity will widen substantially.

Implications for Electricity generators

• Wind farm developers could afford to offer incentives to local residents – “free night-time electricity on windy nights” – to encourage local support for their projects.

• The widening gap between day and night-rate electricity will greatly increase the economic incentive for electricity storage technologies.

• New nuclear plants should be designed if possible to provide variable power outputs – but only if doing so reduces costs such as uranium consumption.

Implications for Industrial electricity users

• Many more industrial processes than now will become economic to operate over just the eight-hours off peak, rather than using plant continuously.

• Other heavy users should design their plant to maximise their use of electricity at night, especially if it is used for heating, where there is scope to store night-time heat for day-time use

• Electricity prices will tend to fall the most in those parts of the country with substantial wind resources and low demand. There is scope for an industrial renaissance in the Highlands and Islands of Scotland on the back of low energy costs.

Implications for Domestic Users

• Most domestic users are insulated from these effects by a single price-per-unit tariff, and will simply see their unit price rise. Economy 7 users will be able to take advantage of the increasing difference between day and night rates. If the principle of carbon taxes is applied to domestic gas supplies (which may become necessary, but would be politically difficult), then the implications for domestic energy use would be:

• Electrical heating of homes is likely to become cheaper than gas. This is particularly so for houses using ground-source heat pumps to provide domestic night-rate heating and hot water.

• Houses with high thermal mass (i.e. that keep their heat in the walls over the course of a day) will in general be cheaper to heat than equally well-insulated homes with low thermal mass, which need to top up their heating during the day.

• Electricity suppliers will have an economic incentive to introduce more sophisticated domestic meters with hour-by-hour metering.

• Current trends to convert domestic hot water systems, with hot water cylinders that can store night-time heat, to instantaneous gas-fired condensing boilers may well prove to be an expensive mistake.

• The appeal of plug-in hybrid electric vehicles (PHEVs) will improve as they will be cheap to recharge overnight.

Long Term Implications

If we are correct in our predictions, we will see day-time electricity prices rising substantially, but off-peak night-time electricity getting cheaper. This will occur over the next twenty years or so, as existing wind and nuclear technologies penetrate the industry.

In the longer term, the increased day-night price differential will provide economic incentives for new energy storage technologies. There is limited scope for pumped-water storage in the UK, but the technology of flow batteries (fuel-cells with unconstrained storage capacity) is developing quickly. And if PHEV’s become common, they will collectively provide a huge energy storage capacity. Every electric car could take cheap electricity from the grid at night and return it during any day that the car is not in use.

Such developments will limit the effects we describe in this article, but the technologies will take years to perfect and years to roll out, so will only have an effect over the longer term.

Martin Duckworth

September 2007