Friday, November 3, 2017

Paying People Not To Use Electricity - The Economics

In the first article in the series on paying people not to consume electricity I identified the idea as a beautiful scam and in the second explored the fatal flaw. Here I examine the economics of paying people not to consume electricity.

The Economics Of Paying People To Switch Off

Retailers buy electricity in the wholesale market at a price that is set every thirty minutes and sell this electricity to customers at a fixed price that reflects an average wholesale price plus a margin (see IPART Report). Consumers are paying of the order of $0.20 per kilowatt hour (exc. GST ACTEWAGL ACT November 2017) but at times of extreme demand the retailer will be paying the maximum market price of $13.80 for that same kilowatt hour (January 2015). Therefore there is $13.60  saved if the consumer doesn't consume that kilowatt hour of electricity, a portion of which can be payed to the consumer to encourage that outcome. So the funds for paying people to switch off comes from the savings made by not selling them electricity at below cost in the first place.

It is impossible to know how much electricity hasn't been consumed unlike the emperor who had to suffer the  ignominy of overwhelming evidence.

The economics is made more complicated by it being impossible to know how much electricity would have been consumed in the absence of a payment. Therefore, an amount of electricity not consumed does not necessarily equal a reduction in electricity generated. It is hardly surprising then, that when AEMO ran a trial "the funding round had well exceeded the 160 MW initially hoped for, and cost less than expected". Ultimately there is no limit to the amount of electricity that isn't consumed.

Rational Economics

An alternative to selling electricity at below cost then paying consumers not to buy it is to sell it at cost plus a margin. This has the advantages that the electricity consumed can be metered and the price signals encourage consumers to use less when the price is high. It's also efficient, the consumer captures the whole economic value by paying nothing for what wasn't consumed.

Why Not Rational Economics? - One Reason

To quote from a 2015 CSIRO study titled "Australian Consumers’ Likely Response to Cost Reflective Electricity Pricing" demand response is not being structured this way because  "Consumers are particularly resistant to real-time pricing and (especially) capacity pricing, presumably on account of their greater novelty and complexity (hence, perceived risk), and pervasive mistrust and rejection of the concept that electricity should cost more depending upon demand." Therefore a "flat rate tariff offer with money-back guarantee achieves an unparalleled level of consumer acceptance, unmatched by any other combination of tariff and risk relief."

That is the same argument that was advanced when I was part of this team back in 2004. So there you have it, consumers "rejection of the concept that electricity should cost more depending upon demand", is the intellectual justification for paying people not to consume below cost electricity. Hardly surprising really, who wouldn't want to consume what they like at below cost and get paid if they don't.

Why Not Rational Economics? - Another Unspoken Reason

When I was working on this electricity was cheap reliable and intervals of extreme pricing were rare. Genuine improvements were hard. I estimated there was very roughly $100 per year of value available for a residential consumer with an air conditioner, who avoided price peaks. Capturing this value required new interval metering, new electricity plans, information systems to convey price data automatically to devices and devices able to respond to price signals. This is challenging to do for less than $100 per year and framing the problem this way makes it obvious. If you can frame demand response as people getting paid for "reducing the need for supply-side infrastructure" which "delivers lower electricity prices to all consumers" and also add some mystery it is far more salable (Reducing electricity costs through Demand Response in the National Electricity Market A report funded by EnerNOC).

The product companies could sell is non consumption of electricity as if it was equivalent to generated electricity. It is an excellent boondogle. In the  emperor story - "I'll send my honest old minister to the weavers," the Emperor decided. 'He'll be the best one to tell me how the material looks, for he's a sensible man and no one does his duty better.' The minister however, fearing for his own position told the weavers - 'Oh, it's beautiful it's enchanting.' The old minister peered through his spectacles. 'Such a pattern, what colors!' I'll be sure to tell the Emperor how delighted I am with it." Similarly the researchers would be more successful in obtaining support and in turn provide credibility for the boondogle. Over time the researchers and the demand response industry intermingled.

Another Trustworthy Official

From our story - The Emperor presently sent another trustworthy official to see how the work progressed and how soon it would be ready... He declared he was delighted with the beautiful colors and the exquisite pattern. To the Emperor he said, "It held me spellbound." The government sent their chief scientist who concluded in Recomendation 6.7 that authorities "recommend a mechanism that facilitates demand response in the wholesale energy market" (Finkel review - Independent Review into the Future Security of the National Electricity Market, Blueprint for the Future, June 2017).

Taking It To The Next Level

If there is success in reducing consumption it "has the potential to reduce market prices at peak times when the marginal generator is high cost. However the benefits of the reduced price are shared by all market participants and cannot be effectively captured by the DSR provider." (ClimateWorks Pg 16). So to make sure reducing consumption doesn't reduce price, proponents want to treat reduced consumption as increased generation.

Under current schemes, the savings for paying people not to consume comes from consumers being able to buy electricity at below cost. This limits the people that can be paid not to consume to small retail customers. This innovation provides a method of extending the opportunity to large consumers who don't get electricity below cost. They too, will now have an incentive to switch loads into peaks to raise prices until they too are paid to switch off. The opportunity exists because of the extraordinarily high multiple of peak to average prices of approximately one hundred and fifty.

Depending on the algorithm used to calculate the consumption estimate, it may even be economic to burn electricity just to create an inventory that can be switched off for a payment.

A Case Study

Intercast & Forge is one of 10 companies which have won tenders to supply up to 200 megawatts of "demand response" electricity to help keep the lights on in the eastern states of Australia this summer.

Intercast & Forge have committed to deliver 10 megawatts of electricity off the grid when asked to by the Australian Energy Market Operator, for which it will receive $323,654 in funding from the Australian Renewable Energy Agency. (AFR Oct 11 2017)

The "company had already saved $600,000 on their power bills in the past three months alone - from being on the spot market rather than a long-term contract with a retailer as well as turning their four furnaces off for a total of 39 minutes, normally for five minutes or less, during peak periods." (AFR Oct 11 2017)

So here we have a large consumer that is already reducing demand during peaks by responding rationally to price signals for their own economic benefit but is now to be paid extra to maintain consumption until asked to switch off. The obligation to maintain consumption when it is already uneconomic, until asked to switch off, can only produce higher prices for other electricity consumers and creates an incentive to increase the amount available to be switched off.

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