21/02/18 – The future structure of the UK electricity market

Speakers: Laura Sandys, CEO, Challenging Ideas and Helm review panel member; Peter Atherton, Cornwall Insight; Ro Quinn, Head of SO Strategy, National Grid 

21 February 2018 – meeting notes

All-Party Parliamentary Group on Energy Costs

The Future of the UK Energy Market

Chair: Lord Palmer

Chair’s Opening remarks

I’d like to extend a warm welcome to you all to this, the 40th meeting of the All-Party Parliamentary Group on Energy. I am Lord Palmer, co-Chair of this Group and an elected hereditary crossbench peer. Our meeting this evening is to discuss ‘The future structure of the UK electricity market’

There is much discussion about how energy will be “disrupted” by the digital economy. The government has a long-standing programme to install smart meters, which has been linked to the internet of things and better management of energy demand.  More recently there has been discussion of how blockchain could enable peer to peer energy sales and remove the need for energy suppliers and large generation. The Helm review sees the blurring of the distinction between the traditional roles of the licenced supplier and the distributor that manages the wires and suggests that separate licences are no longer required.

We have three excellent speakers tonight who can take us through the issues. I have asked them each for no more than 7 minutes opening remarks after which we will go on to our normal Q&A.

Laura Sandys, CEO, Challenging Ideas

I came out of parliament a couple of years ago, and having been in the energy sector for 35 years, I felt that the energy sector was still very old-fashioned, living somewhat in the past, and that consistently whenever we talked about energy prices, the consumer ended up being a victim at the end of the supply chain.

So I put together a little consortium and worked with lots of people from the energy sector, to start from the future. This is mainly because the sector has been trapped by the vagueness of the word ‘transition’: we’ve got to start identifying somehow where the road is leading us to.

We did a report (you have a handout of some of the slides which give you a flavour of it).

Ari Sargent said “the energy sector was designed and built by engineers, bastardised by economists and marketeers: the power industry continues to deliver one of the most successful consumer confusion programmes of all time”.

All we have been doing is tinkering round the edges. But how do you start to shape a system that starts with the plug and gives the consumer the demand power to send messages up the system to rationalise it?

We looked at a few other industries that had been similarly trapped between the past and the future, e.g. the food sector which in the past had ‘the big ten’ (Milk Marketing Board, Beef Marketing Board, etc.) and 300+ grotty products in the shop. Nowadays we have a very distributed system, which in many ways is where the energy sector is going to go.

But how is that regulated and how is it shaped? Certainly not through a ‘command and control’ system where production determines what the consumer receives.

We were also interested in fridge-freezers, because in the days when not everyone had one, daily shopping was the norm. Weekly shopping led to more affordable prices.

If you think of a fridge as a storage system, are we going to move into the world of storage, e.g. of EVs?

We looked at issues around consumer preferences. It’s interesting that one large energy company believes they have a good level of detail with six consumer profiles, when Amazon has 150,000 different ones.

We feel that there is a need to transform the system and certainly there are components coming through that will do that pretty radically. A key area is data, and the internet of things (IOT), so starting at the plug and not the power station.

Many people have an Alexa nowadays.  Or think of your local authority who will probably become a provider, or possibly your Nissan car – many of these companies are moving towards being ‘data’ companies because actually there is a new value streaming through the system and that is the value of data, because the data will inform demand much more accurately, and allow systems to balance supply and demand much more effectively.

So we see an Alexa not just giving information to the system operator about managing consumption – Alexa will also know about holidays, patterns of driving behaviour and demand will become much more textured if we allow the energy companies to modernise and embrace new technology and digitalisation in a totally different way.

We asked Big 6 energy companies about their data strategy, and in one case received an answer (“We have 89% of postcodes”) that demonstrated that they did not understand the meaning of the word ‘data’ or how to optimise it

Our proposals are for a different regulatory structure. The first is to regulate how consumers consume and not how businesses are organised. That proposal is around bundled products,

e.g. John Penrose has proposed having a consumer regulator for essential services. Let the regulator – the single ombudsman – unpick these packaged bundles and blurred products.

The second is that we shouldn’t be regulating generation assets: we should be looking at regulating optimisation, which is in many ways what the system operator will be doing. In many ways it is the data that is the value in that, and we need to demand more from less. It is still a system that is only 48% effective from power station to plug, and fundamentally we’ve got a real issue here: the productivity has increased by only 5% in 15 years. In any other business the rate of improvement in productivity would mean that you would be out of business. We need to start demanding more.

The third is open and transparent markets. I’m getting a lot of feedback from companies about strange things going on with brokers, for example invisibility of product costs. We need to open this up. Blockchain can be a facilitator of this, but we need a much, much clearer system.

And the last thing I want to mention is security of supply. Having worked as a bag carrier for DEC I have seen people from energy companies playing the ‘security-of-supply’ card with the Secretary of State, and putting the fear of God into him as if the lights were about to go out. It is interesting that on the whole, we overestimate demand year on year, and actually ‘security of service’ is what is most important to the consumer. On the whole there isn’t a generation issue: 95% is to do with distribution and engineering. We’ve got to re-calibrate what we mean by the term ‘security of supply’ and ensure that we are procuring the right thing for the right problem, whether that be through asset management or the capacity market or whatever.

One last little security anecdote about something that the National Grid is much more conscious of than anybody else, and that is the area of cyber security. At a recent conference a speaker from GCHQ asked 350 delegates (all senior people in energy) how many knew their cyber security policy and who was responsible for it. Only 3 hands were raised. We are very much an analogue business moving into a digital word. We will have new risks and different risks.

Ro Quinn, Head of SO Strategy, National Grid

My role is head of strategy for the system operator, which is considering what the future energy landscape looks like, what the implications for operating the gas and electricity networks are, and what that means in terms of the role of system operator and how we interact with our customers and the wider stakeholders.

We welcome the fact that Government is looking at costs of energy, because bills need to be as low as possible as we get through the energy transition. I recognise that ‘transition’ is a word that we use a lot and that we may have different understanding of what that means and looks like.

When I think about the future structure of the energy market, I think there are a few things to highlight:

  1. the level of change we are seeing now and into the future
  2. the opportunities and challenges that presents
  3. some thoughts to consider to make sure we can make progress through this

1. The level of change

It’s a game of two halves. There is the change we have seen over the last 5 to 8 years, and then there is what we are starting to see coming down the track towards us. In 2012 we expected that by 2020, there would be 1 GW of solar energy and about 28 GW of wind energy on the system. 12% would be connected at the distribution level. The reality instead is that we have 12 GW of solar and 15 GW of wind, and some 27% is down the distribution network and beyond the meter.

This is just a taste of what’s to come – there is much further evolution and change is still on the way. There are over 30 technologies providing electricity and participation in the balancing mechanism has increased by some 60%. The number of parties who are now able to provide ancillary services has increased by 40%. So it’s been a really busy period for the industry. A huge amount of work has been done to integrate these new players, these new technologies and new business models, because nobody has stood still throughout that.

Looking ahead, that pace isn’t going to slow down. We use our future energy scenarios to think about how the system might change and evolve, and to try to anchor some of the points of uncertainty. In this way, we have credible, consistent pathways that we can discuss and help people make informed decisions against a very uncertain background.

The scenario 2050 was built with engagement from over 400 organisations. The structure to date has considered how much we as a society are concerned about going green and how much money we have to spend on that. We’re currently in the process of reviewing the framework for that analysis as well as doing the analysis which will be launched in July.

We’re considering location much more closely and looking at the system in terms of centralised and decentralised split, and rather than thinking about going green and cost as separate things that have to be traded off, it’s now all about the speed of decarbonisation, how quickly we will get there, and what the interplays are between different fuel types.

Our analysis has already shown that there are a number of trends that will continue: there will be continued decarbonisation of transport and of the power sector. There will be continued change in the supply mix across the electricity system, which will have an impact on the role and the needs for the gas network. We expect to see continued innovation, so as an opportunity presents itself, somebody will understand how they can embrace it.

We expect to see continued demand for gas, although it will drop off, certainly in some scenarios.

Interconnectors will have a key role to play, and as Laura mentioned, flexible demand.

With those narratives there are some big dangers as well. To choose one: the numbers for electric vehicles keep changing, with some projections seeing 2m vehicles and some seeing 9m. How people use them will be crucial: the numbers are interesting but how they are charged is key.

When we think about future structures and the roles and obligations of the participants within the energy system, it has to be fit for purpose against that pace and level of change.

Looking at the opportunities and challenges, as location of generation changes, the need for distribution system operators rather than just network owners is really important.

We have to think about the whole system and not just traditional boundaries between voltages, but really think about the whole system in planning and operation and ensure that we can coordinate rather than control.

We’re also going to see an increased need for flexible sources of energy, both in the production side and the consumption side. We’ve made huge progress in the demand side response area, where it’s no longer seen as rolling blackouts but is seen now as a valid commercial opportunity that business can participate in. We want to see more and more of that and our ‘power responsive’ campaign really started that conversation and we see it as a key avenue to continue.

Thinking about flexibility, gas generation continues to be a big provider of flexibility. All the way through this transition consumers rightly expect enduring access to a reliable, secure supply of energy. But what this means in a decentralised world, and how it’s delivered and how we all feel about it, needs to be considered.

We’ve moved away from a world where there are a number of big generators on the system, towards a world of smaller generators connected in different areas. We will have to all get comfortable with this and work out how it all comes together so that consumers continue to enjoy security of supply in the most cost-effective manner possible.

All of this points to the need to think about ‘energy’ rather than ‘gas’ or ‘electricity’. We need to think about heat, we need to think about transport, and move away from separate networks of connection.

To finish I will give some thoughts on how we do that. We can’t think of energy in isolation. We need to think about how it is accessed, so how do we get energy from wherever it’s produced to wherever it’s consumed – what’s the infrastructure that will underpin all of that? How do we make sure it’s fit for purpose?

We recognise that the existing transmission and distribution systems have served consumers very well but that there is a need for change and we need to facilitate an efficient transition that ensures security of supply, that allows markets to maximise the value for consumer, that gives clarity, and encourages competition.

Consumers need to understand what they have signed up for. The price control framework that we have at the moment has delivered net benefits to consumers, and we would support that evolving and improving rather than being discarded.

Delivery to the consumer is key to that framework.

We think that the system operator can play a significant role in driving markets to deliver value for consumers, so we are working towards bringing much more transparency to our thoughts and our actions, in using more transparent platforms to procure the balancing services that we procure and making sure there is good quality information freely available. We think legal separation is really supporting that but it would be most effective to review that so that we fully understand what legal separation will be able to deliver.

The final point is around heat. Huge progress has been made on decarbonisation of the electricity system and there is great work being done on transport, and heat is the next one. How do we decarbonise heat in a way that is really cost-effective for consumers, and manage the disruption to their lives. Remember this is ‘boilers’, a subject very dear to many people’s hearts, so we have to find a way to manage all the way through that.

So – change – we’ve got used to it and it’s not going anywhere and the pace is going to continue. There are huge opportunities to make sure change can be enabled with consumers remaining very much at the heart of this.

Peter Atherton, Cornwall Insight

The future of any market is driven by three things: technology, economics and (in this case) public policy. As an equity analyst I spent a lot of time making predictions about e.g. share prices and future performance of companies. After doing that for 15 years or so I decided to go back over all my recommendations from the previous 10 years to see how accurate I had been.  Well, I beat chance – but not by a huge amount, so we have to be very careful when predicting the future.

So, when I get a question about the future, I tend to do lists to address the situation:

  1. what we know today
  2. what is likely
  3. what may happen
  4. what is unlikely

So to address this question for today’s meeting, I will pick a few of what I think are the most important ones from my lists

What is true today

As to what is driving things today, looking at energy globally, the most important thing that is happening is the shale revolution that is happening in the US. The reason that the global economy is going through a bit of a boom is that energy prices have dropped 50% in 2015 and 2016 and that’s driven a global recovery and is having massive geopolitical implications and is forcing the natural enemies, the Russians and the Saudis, to get together. The impact is quite profound. We tend to forget about it because it feels like old news, but it is very very important.

Another important thing that has happened recently in some (but not all) industrialised countries is that energy demand growth has decoupled from GDP growth. When I was at CEGB as a new graduate, I was told that when GPD goes up by 1%, energy demand goes up by 0.7%. That ratio was true from the 1950s until about 7 or 8 years ago when it suddenly changed. There are implications which we’ve only just begun to think about, and we don’t fully understand why this is.

Another important thing is that policy continues to be focussed on climate change. Presents and past governments of both parties get quite a lot of grief about changes to policy, but actually the broad policy has been quite consistent – the details have changed dramatically, but the broad pathway we are on (use energy as your vanguard sector to tackle climate change) is consistent.

Another factor that is true today is that about ten years ago politicians woke up to the problem of price differentials for domestic consumers. MPs seem to have a real issue with this and that drives a fundamental problem having a market delivering domestic energy.

The markets we have had have delivered with substantial price differentials, for good or ill, but the problem is that the politicians really, really don’t like it, and that has driven a lot of market interventions. You could argue that those interventions were driven by perceived failures in the market or whatever, but fundamentally they have been driven by the idea that politicians have that this essential service has big price differentials and that homogeneity is good. It didn’t matter so much when prices were really low and it wouldn’t matter so much now if the highest payers weren’t poor people

One other fact that I think is important to mention is that the European Utility Sector (a £500 bn sector and one of the Big 6 sectors in the stock market) has been the worst performing sector since 2010, even under-performing the banks. This is remarkable when you consider that during those years a substantial section of the banking sector was structurally insolvent. It’s been a terrible sector – unique to Europe, because the USA and Asia have done well. So there are characteristics about Europe which have driven that poor performance stock market-wise, and that in itself has led to a lot of restructuring.

What is likely and what is possible

Electric vehicles will be tested in the mass market now that we have got past the questions about whether they are viable etc. What’s interesting is that when we move into the millions of cars being sold rather than 10s of thousands, it’s far less easy for the industry to be policy-driven rather than economically or consumer-driven. This presents some very interesting policy issues because at the moment virtually all the economic benefit of having an EV is lack of excise duty. Electricity has VAT of 5% and petrol has an excise duty of 85%, amounting to £25 bn excise duty each year. As that gets eaten into with EVs, will the Government really be able to sustain that?

Are we on the cusp of a multi-decadal change in generation moving from centralised to decentralised generation? It looks like we are starting on that pathway, and it’s actually taking the industry back to where it was pre-WW2, because from the 1880s to WW2 the economics drove you to have small power stations in the centres of demand. It was cheaper to move the primary fuel, mainly coal, to the power stations, than it was to move the electricity from a remote station to the centres of demand.

Just before WW2 the technology moved on so we built the biggest power stations that we could right on top of the primary fuel and then we moved the electricity. We might be moving back – we’re at the early stages yet – but we might be building the power stations near to the centres of demand again because the primary fuel (renewables) is basically free.

My point there though is that the first phase (small power stations near to demand) lasted 70 years and the second phase (large power stations not near to demand) has also pretty much lasted 70 years so if we go back to where we used to be it’s probably going to be a phase that will last 40, 50 60+ years, it’s not something we have to rush into. We can let the technology and the economics play out.

I believe that the smart meter programme will disappoint everybody and there will be a real shake out in the supply market. We now have 60 independent suppliers and only a dozen or so are properly capitalised from both a financial and a human capital perspective. It doesn’t mean that the others can’t flourish and survive, but probably two thirds of the current suppliers will exit in the next five years, for a variety of reasons. There may be other suppliers coming in so the total number may not change massively but I believe that most of the suppliers on the market now will not be here in five years.

Another areas which is very likely is that network regulations will be significantly reviewed. I think this is the next major area that the Government will address.

Things which I think are improbable

Carbon capture and storage won’t work commercially. Modular reactors, much beloved of committee rooms I have sat in, probably won’t come to much. State-backed energy suppliers – these will not succeed as it’s unlikely they will make any money. It’s very improbably that smart meters and Hinckley Point C will be seen as value for money in 10 years’ time.

And the price cap won’t work in the way that it’s intended to work as there will be loads of unintended consequences that negate any benefits that we get.

Questions and Comments

A short Q&A session followed, during which time the value of data (to companies, individuals, suppliers, etc.) was discussed, along with how the 30+ different sources of energy will be identified now and in the future.

The meeting closed at 7 pm