More Incentives To Bake Less Bread

Previously I pondered whether my local bakery will choose to make money or bread while there is a Covid-19 wage subsidy. They should be close to four times more profitable if they were to reduce bread production by two thirds. Now we rely even more on bakers altruism to get bread since the incentive to reduce baking has been further increased. Where the previous  rewards were provided from community resources, these new baking reduction incentives oblige landlords to chip in.

So far, I can report my local bakery has remained altruistic, or perhaps ignorant, and I can still get as much bread as I want at previous prices. While acquiring some of their delights yesterday I was able to check the assumption in the previous analysis that Covid-19 would not reduce sales.  They told me "on some days they are selling as much as $500 more than they would have expected and on other days less, but on average sales haven't changed".

The new incentive is an obligation on landlords to provide reduced and deferred rent. The Financial Review explains "In practice, if a qualifying tenant suffered a 30 per cent fall in revenue, then at least 15 per cent of total cash flow relief would be rent-free or waived and the remainder would be deferred." The Grattan Institute's program director of budget policy and institutional reform, who wants larger rent reductions funded by additional community assistance to landlords, says rent is usually 20% of normal costs. Updating the model for this new incentive gives the revenue distribution in figure 1 and profitability as a proportion of original revenue in figure 2.

Figure 1 - Comparison of bakery revenue distributions with Jobkeeper plus rent reduction scenarios. Source: Model

Figure 2 - Comparison of original profitability with Jobkeeper  and rent reductions
profitability. Source: Model

That gets absolute bakery profitability up by a factor greater than four so the bakery can generate more profit in the next six months of Jobkeeper  than would normally be achieved in two years. The landlord funded anti baking incentives are much smaller than community funded incentives but they make it a bit less likely the baker can ignore the temptation to increase profit and a bit more likely I'll have to eat less bread and more rice in a few months time.

Will My Bakery Choose To Make Money or Bread?

May You Live In Interesting Times

I delight in bread from the local bakery. The anticipation as I walk a few minutes from home to acquire the treasure, the smell of the shop, the choosing and the build in excitement as I head back home to savour the prize. It's especially good if it's still warm but will it still be affordable and available in the new world of wacky economic incentives?

Artisan Bread Is A Treasure

The bread is not much more expensive than factory bread and with everyone getting double the previous unemployment benefit or at least 70% of the pre coronavirus median wage it is a small luxury we should all be able to afford. I expect the demand for artisan bread will increase as the customer base sits at home pondering the delights of the next meal but the bakery owner has a strong incentive to leave  more than 30% of existing customers unsatisfied.

Without government incentive the bakery will be making at least as much profit as before and probably a little more but if turnover can be reduced by 30%  the bakery can make a motza. Flour is cheap so rent and wages would be most of the bakery's expenses, let's guess wages are two thirds. Staff work two shifts daily seven days a week and they are part time. From friends that have worked there I've learned they pay minimum wage, so the $1500 per employee will mean a pay rise for staff while taking out direct  wage costs for the bakery. There is still some staff overheads so overall staff expenses are reduced by perhaps 75%. The previous and new revenue distribution is shown in Figure 1.

Figure 1 - Comparison of bakery revenue distributions with two Jobkeeper scenarios. Source: Model

Profit before was perhaps 5% of turnover but now it is 11%. That is lot more profit as a proportion of turnover but on a 30% lower turnover, it's less impressive but still more dollars. But how is the bakery to achieve the turnover reduction? The best way is to increase prices but if a 30% price rise reduced bread sales by 30% turnover would be unchanged and the bakery still wouldn't get Jobkeeper. Assume prices are doubled to reduce by roughly two thirds the quantity of bread sold they open less days, then that will lower expenses again. Lets assume wage costs are halved again and other expenses are halved, but rent is fixed so that rises as a proportion of costs. This produces a fabulous 40% profitability but again on a lower turnover. The profit under all these scenarios as a proportion of original turnover is shown in figure 2.

Figure 2 - Comparison of original profitability with Jobkeeper profitability. Source: Model

There is still nearly four times the original total profit achieved.  In the next 6 months the bakery can generate as profit that normally would take nearly 2 years. How good is that? For the bakery great, but for me not so much. I'll probably have to go back to factory bread and if the factory responds the same way I'll be eating perhaps a third of the bread I eat now while paying twice as much.

I hope the bakery owner cares more about making bread than making money.

From 1988 - A Typing Service Plan

See: The plan.

I’m reviewing and disposing of detritus accumulated over a lifetime. It’s interesting to see what’s changed and what hasn’t. My engineering lecture notes of 35 years ago aren’t that much different to what my son, studying engineering now, is familiar with. The foundation subjects are pretty much the same but his handwritten lecture notes are less extensive. We used to take notes as it was explained, where now the notes are mostly online. Those notes were a useful reference for me, even years later but are useless now as the quality of search results is so much better than old lecture notes. To me, that the same things are taught 35 years later is an indication of the quality of what engineers learn. So much other stuff taught in universities 35 years ago proved to be  faddish. Amongst the detritus, I came across my plan from 1988 to start an international typing service. The internet didn’t exist, international phone calls cost the earth and fax machine adoption was growing fast.

Graph of adoption of fax machines versus time illustrates the actual and calculated adoption of fax from 1980. By 1994 approximately 59% of the potential market had actually adopted fax.  Source: Lyons, Michael & Adjali, Iqbal & Collings, David & Jensen, Kjeld. (2002). Complex Systems Models for Strategic Decision Making.

It was possible to rent a permanent satellite voice link to the Philippines for $A400 per day (A$950 in 2019 dollars) and send data over that link at the piddling rate of 9600 bps. Typist, even as a job description, no longer exists but typing services were big back then. Mostly the work arrived hand written and typists in the Philippines earned much lower wages than Australian typists. Modelling suggested it would be very profitable to provide an offshore typing service but the high fixed costs meant it had to be done on a large scale and  if I got it wrong and failed it would be painful. I also had the opportunity to move to an engineering role in the iron ore industry and that in the end is what I chose, so the plan was never tested.

Reviewing the plan with the benefit of 30 years of hindsight:-

1. It would have been exciting to have tried but the level of risk looks as scary now as it did then.
2. To minimise risk a slow start up strategy was planned that didn’t offer enough advantage to customers in the first instance. That in itself creates the risk that the service will never get to the stage where it works. If I did it now it would be boots and all or don’t bother trying.
3. The format which followed what I’d been taught at a TAFE business course still looks good.
4. In retrospect it would have been an opportune time for such a service. There was nothing like it and the technology it required was subsequently adopted widely. The early internet was only a few years away which would have reduced costs dramatically and typing service businesses lasted long enough for the service to have more than recouped costs. It might have been a good structure for adding other forms of outsourcing as they developed and translation is considered in the plan.
5. It was a comprehensive plan. I was trying hard to get everything right as a risk reduction strategy. A plan that detailed would change a lot in adoption but changes as they occurred could be made to the financial model to provide early indications of likely results.
6. Almost all typists were women with many leaving the job to raise children and not returning. This wasn’t controversial back then but it would be now.
7. Typists were earning about A$12 per hour at the time and the typing services were charging about A$25. The model estimated overheads of one third which I know for most businesses today is too low. I understand a rule of thumb is hourly cost is twice the hourly pay rate and CSIRO for example, when I was there was 2.7 times. Have overheads risen in the past 30 years or was my estimate too low? If double the hourly rate was appropriate back then typing services would have been struggling to make money at the prices they were charging.
8. Letters were expensive to produce back then which made them far more likely to convey useful information than the bumf we are deluged with today.
9. Mechanical typewriters no longer exist but it wasn’t that long ago and more than 80% of typing was done mechanically at the time. The use of word processing was predicted to double in the next year which is probably close to what happened, as mechanical typewriters disappeared fast.
10. Governments didn’t use external labour much in those days so typing for government wasn’t considered an accessible market. These days governments seem to outsource almost everything. The places I worked at the time all had typing pools and I still remember the fear of having to ask for something to be retyped to fix a drafting error. 
11. The marketing plan looks crude. I doubt that was ever my raison d'etre and I’ve since come to the view that quality marketing is usually more important than a quality product.

Paying People Not To Use Electricity - ACCC Submission

This is a response to calls for feedback on the ACCC Retail Electricity Pricing Inquiry - Preliminary Report^[1]. This response is intended to encourage the ACCC to look more closely at perverse forms of demand response. Background articles in this series are Paying People Not To Use Electricity - A Beautiful Scam, Paying People Not To Use Electricity - The Fatal Flaw and Paying People Not To Use Electricity - The Economics.

Thanks to colleagues at MakeHackVoid who provided advice on this submission, in particular Paul Harvey and René.

ACCC Submission

The ACCC Retail Electricity Pricing Inquiry - Preliminary Report ^[1] concludes demand response "has the potential to facilitate consumers reducing their demand at peak times, and could thereby reduce the need for costly new generation and network infrastructure."^[2]. Demand response though, takes many forms and the inquiry has thus far not considered a form of demand response that contains perverse incentives and which involves payment by volume for a volume that can't be measured. The preliminary report states the "ACCC will be mindful of the history of interventions in this market which have too often had unintended consequences to the detriment of electricity users." It is likely that the intervention in the  wholesale market to create mechanisms to provide payments to consumers and non consumption aggregators for not consuming electricity is  another of those interventions. The concept has got a lot of attention in the popular press^[3][4].

While not described this way by proponents the gist is to provide electricity to consumers at below cost and then pay consumers not to buy it. It is impossible to measure electricity not consumed so non consumption must be estimated from historical usage. This provides an incentive for consumers on fixed rate supply contracts to shift loads as far as practicable into times of high demand to maximise the payment for switching off, the opposite of what is desired. Air conditioners in particular could be more profitably run flat out whenever wholesale electricity prices are high as it is hot weather that causes wholesale price peaks and they provide a large load that can be switched off for payment. The argument for selling electricity at below cost is contained in a 2015 CSIRO study^[5]. It states,  "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."^[6] 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."^[7] Hardly surprising really, who wouldn't want to consume what they like at below cost and get paid if they don't.

The rational alternative for demand response is for retailers to sell electricity to consumers at cost plus a margin. This has the advantages that:-

• The amount consumed can be measured. 
• Consumers who choose to switch off can capture the full benefit of doing so rather than having to share it with a service provider. 
• Consumers can still seek assistance from a service provider when the effort of monitoring prices plus managing loads is too high for the benefit gained without assistance.
• The financial incentive is to shift consumption as much as practicable to times of low demand which aligns with the goal of reducing peaks in demand.

There is also a push to take this further and implement a scheme where non consumption of electricity can be used to increase prices for consumption of electricity by selling non consumption into the electricity market as if it was equivalent to electricity generation. The rationale for this is described in a ClimateWorks report^[8] where selling non consumption as if it were production is described as necessary because reducing consumption "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"^[9]. Therefore, non consumption should be able to be bid into the market as equivalent to generation which has the effect of increasing the wholesale electricity price.

There is an example of this being trialed currently. As reported in the Financial Review^[10], "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"^[10]. 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."^[10]

So this large consumer is already reducing demand during peaks by responding to price signals for their own economic benefit but is now to be paid extra to maintain consumption until asked to switch off. If that payment is to come from other electricity consumers through an increase in the wholesale price, as eventually intended, it can only result in a sub optimal economic outcome. It creates an obligation to maintain consumption when it is already uneconomic until asked to switch off, and an incentive to consume when uneconomic so as to have consumption that can be sold as available to be switched off. Funds extracted from other consumers through higher prices will be used to fund uneconomic consumption, to the detriment of other electricity users.

An attempt to introduce a demand response mechanism into the wholesale market was rejected in 2016. According to Finkel the "AEMC decided not to introduce the proposed mechanism on the basis that it would be costly to implement and that consumers can already contract with retailers and specialist providers, and can choose to be exposed to the wholesale market spot price through their retail contract"^[11]. The reasons given by the Australian Energy Markets Commission for rejecting this rule change request in the Final Determination^[12] under the headings "Demand response mechanism" and "Overview of determination to not implement the DRM" remain valid and should be considered by the ACCC in the interest of consumers. Finkel goes on to say "If unscheduled participation in the wholesale market as proposed in the 2015 rule change is not appropriate, there are other options in use around the world, including demand response participation in reliability markets in New York and Texas. The important thing is that a suitable option capable of unlocking the vital benefits of demand response is chosen"^[11].  The design of the NEM means the "suitable option capable of unlocking the vital benefits" is the exposure of consumers to the wholesale price and despite the claims of proponents "there are no DRM –like arrangements in any market that is designed similarly to the NEM"^[13]. Eastern Australia has a wholesale price, which can be 150 times the average price during peaks and many consumers, including Intercast & Forge^[10] are reducing consumption when the price of electricity is too high. Electricity plans that made wholesale plus a margin rates available to smaller consumers would make that opportunity available to all and encourage manufacturers to incorporate automation in devices that balanced desirability of device consumption against current price.

There is a variety of mechanisms suggested for paying people not to consume electricity but they all suffer the same fundamental flaw. The amount of electricity that would have been consumed in the absence of payment not to consume it is unknowable. Under a likely model, aggregators will be selling non consumption by volume into the wholesale electricity market when the volume can't be measured. In the interests of shareholders they will be obliged to sell as much as possible, so the aggregation business is likely to become another of those interventions with unintended consequences to the detriment of electricity users.

Further Reading

Some background material was also written in preparation for this submission which is available at blog.urremote.com

References

1. Australian Competition and Consumer Commission (2017), "Retail Electricity Pricing Inquiry Preliminary report", 22 September 2017, https://www.accc.gov.au/system/files/ACCC%20Retail%20Electricity%20Pricing%20Inquiry%20-%20Preliminary%20Report%20-%2022%20September%202017.pdf
2. ibid, pg 86
3. Charis Chang (2017), Households will be paid to reduce power consumption during peak periods, News.com.au, http://www.news.com.au/finance/money/budgeting/households-will-be-paid-to-reduce-power-consumption-during-peak-periods/news-story/5ce9fc72bdf789569d8069fdbdf45e39
4. Sheradyn Holderhead (2017), ARENA projects to prevent blackouts deliver 200MW of capacity to the grid, October 11 2017, TheAdvertiser, http://www.adelaidenow.com.au/news/south-australia/arena-projects-to-prevent-blackouts-deliver-200mw-of-capacity-to-the-grid/news-story/c9c3c7932d1d8797076d423d83786d09
5. Karen Stenner, Elisha Frederiks, Elizabeth V. Hobman and Sarah Meikle (2015), "Australian Consumers’ Likely Response to Cost Reflective Electricity Pricing", CSIRO, Australia, https://publications.csiro.au/rpr/download?pid=csiro:EP152667&dsid=DS2
6. ibid, pg 26
7. ibid, pg 6
8. ClimateWorks Australia (2013), "Industrial demand side response potential Technical potential and factors influencing uptake Initial findings and discussion paper",ClimateWorks Australia,  February 2014, https://climateworks.com.au/sites/default/files/documents/publications/climateworks_industrial_demand_side_response_potential_feb2014.pdf
9. ibid, pg 16
10. Mark Ludlow, Ben Potter, Angela Macdonald-Smith (2017), "Powershop, United Energy, metal foundry sign up for demand response trial ,Australian Financial Review, Oct 11 2017, http://www.afr.com/business/energy/electricity/powershop-united-energy-metal-foundry-sign-up-for-demand-response-trial-20171010-gyydxu
11. Dr Alan Finkel (2017), "Independent Review into the Future Security of the National Electricity Market: Blueprint for the Future, The Commonwealth of Australia, pg 148, https://www.environment.gov.au/system/files/resources/1d6b0464-6162-4223-ac08-3395a6b1c7fa/files/electricity-market-review-final-report.pdf
12. AEMC (2016), " (Demand Response Mechanism and Ancillary Services Unbundling), Final Rule Determination, 24 November 2016, Sydney, http://www.aemc.gov.au/getattachment/68cb8114-113d-4d96-91dc-5cb4b0f9e0ae/Final-determination.aspx
13. ibid, pg 18

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.

Paying People Not To Use Electricity - The Fatal Flaw

In the first article of this series I identified a beautiful scam. In this article I explore the fatal flaw that makes it possible. It wasn't obvious to me at first and given the community enthusiasm for paying people not to use electricity, it mustn't be obvious to most others either.

Without hearing the proponents pitch, people I've discussed this with have said that's daft I don't believe anyone would think otherwise, just as the implausibility made the emperors story unappealing when I was a child. However, my colleagues thought paying people not to use electricity was inspired. For me the concept is so obviously daft it defies belief that it could have lasted this long and grown into government policy

Once you know, it can never be seen the same way again. The genius can be admired but the wonderment is gone.

It led to this strange situation where I was trying to convince colleagues of what seemed an obvious truth and utterly failing. In retrospect I think, like Shawn Spicer's claim on the inauguration crowd, the greater truth was that if paying people not to use electricity was truly daft the personal consequences would be negative. It's better to prefer alternative facts. The other possibility is I was wrong and there is no fatal flaw. I've thought hard in the intervening thirteen years and I've not been able to devise nor have I heard a good counterargument. If there is no fatal flaw it would be painfully cathartic for me to learn the truth. 

The Fatal Flaw 

If you don't accept the fatal flaw as truth then everything in this series is waffle or perhaps there are multiple truths in accordance with epistemic relativism.

Everything hangs on this:-

• Contention: The amount of electricity that would have been consumed in the absence of payment not to consume it is unknowable.
• Corollary 1: The volume of electricity that would have been consumed if people hadn't been paid not to consume it can only be guessed/estimated. 
• Corollary 2: In any peak some consumers will consume less than estimated for reasons unrelated to being paid.
• Corollary 3: If you pay by volume for something that can't be measured people will sell you a lot of it.
• Corollary 4: A consumer not paying market price should consume as high a proportion as possible of their total energy at peak times so as to maximise the amount they will receive when responding to a request to switch off.
• Corollary 5: A consumer that can increase market price by not consuming should consume as high a proportion as possible at peak times while ever the increase in consumption cost is exceeded by payments for switching off. 

It is as simple as that but a lot flows from it. The whole purpose of demand management is to reduce consumption when electricity is expensive or more often shift consumption from times of high demand to times of low demand. However, the incentive scheme incentivises exactly the opposite until a payment is offered. As well, some would have switched off anyway, perhaps they were out that day.

So paying people not to use electricity means accepting their claims of how much they should be paid or at best guessing while incentivising behaviour that makes the problem you are trying to solve worse. All this when incentives could be aligned with desired behaviour by selling electricity at cost plus a retail margin.

Paying People Not To Use Electricity - A Beautiful Scam

Paying people not to use electricity is not on the scale of the WMD claim that justified invading Iraq but more exciting for me because I was there when the idea was born, just after that war. It started small and I expected it to die young but it has grown in stature to the point that it gets a mention by Sarah Hanson-Young on QandA, praise everywhere you look and there is now a demand response trial. The basic idea is to sell electricity below cost and then pay people not to buy it. Now that it's public policy, there's an option for the man in the street to climb on the bandwagon and win some pocket money extracted from the pockets of those that ignore the opportunity. Those that take advantage will be paid to help the wider community understand the fatal flaw, but anyone interested should do so fast as surely this one can't last long.

We are a nation blessed with an abundance of sun, wind, coal and gas and back in 2004 this was reflected in Australia having close to the worlds cheapest electricity. That was when a CSIRO team started work on the idea of paying people not to consume electricity. I was part of that team and for a short while shared in the excitement. Nobody is penalised or coerced into contributing to reductions in peak electricity demand but those that make the effort benefit. People can generate value by not doing something and get paid. What could be better than that? After a light bulb moment though, I could never view the idea this way again, it was so obviously daft. I pointed out the fatal flaw to colleagues and suggested we should try other approaches to demand side response. Other approaches though were boring, incrementalist and difficult to make cost effective at the low power prices of the time. Back then, I'd never have predicted that weaknesses in electricity industry oversight would be exploited so successfully that Australia now has close to the worlds most expensive electricity.

Growth in electricity prices over 10 years. Source: Rod Sims - National Press Club Speech, 20 September 2017. For a more complete analysis see a comparison of Australian and US electricity prices over time.

My colleagues were more prescient, the fashion for developing novel methods of extracting funds from electricity consumers was at its dawn. Electricity had been a boring industry for many years until that time. My insights got some support from my boss, who'd also been drafted into the project, but outright hostility from those in charge. They wouldn't confront the fundamental problem, and eventually I was no longer allocated to the project. I couldn't understand the hostility, I thought I was helping the team by suggesting we adjust our goals to avoid inevitable failure. In retrospect I've come to the view my colleagues were far wiser, they were pursuing a more useful truth.

A truth can be harnessed to achieve useful outcomes. A truth doesn't have to be absolute, true in particular circumstances is sufficient, even if that truth becomes untrue outside the relevant domain. We may scoff today, but Ptolemy's geocentric model for planetary motion was used to prepare astrological and astronomical charts for over 1500 years. No one scoffs at Newtons law of universal gravitation. It is a useful truth with continuing practical application but in Einstein's general relativity, gravitational force is a fictitious force arising from the curvature of spacetime. The most favourable outcome a research team can hope for in CSIRO is to be well funded and that requires exciting novel ideas. Boring incrementalist approaches will not be funded, researchers must promise something grander than anyone else. This is a fundamental truth, but everyone's proposals are grand so it's also impossibly hard. When there are many excellent weavers how does a weaver win the contract to supply clothes for the emperor. He must promise something others can not, the finest, best suit of clothes from a fabric invisible to anyone who is either unfit for his position or hopelessly stupid should do it. As a child I hated this story because I thought it ridiculous. I couldn't understand the desirability of keeping up the pretense. As I age, I find the truth it reveals to be profound. In the circumstances of the courtiers it truly was a beautiful suit, the quality of which contributed to their good standing with the emperor and continued well being. There can be no greater success in CSIRO than a world leading project that has managed to grow for thirteen years and become a major public policy initiative. It is a truly excellent project.

An emperors love of beautiful weaving provides for a great yarn which is often interpreted in different ways. A short and seemingly simple tale that's really quite deep.

The emperor looked a bit of a dill after the boy revealed a greater truth but he carried on with the parade. The weavers kept their fee and the emperor kept his throne, so no harm was done. Similarly when Hans Blix was urging caution, the best insider response was to ignore the doubts and discredit him. Those urging war would get to enjoy the spoils, so the existence of WMD was a useful truth even if it would eventually be mocked, much like the fate that befell Ptolemy's geocentric model. To maximise income from reducing electricity consumption in times of peak demand consumers must first shift as much of their consumption as possible to times of peak demand. This is the opposite of the purported aim. Paying people not to consume electricity will eventually lose favour but the emperor will carry on and the CSIRO heroes will keep their honors and promotions. Australians will pay a bit more for electricity but in truth, that doesn't really matter much.