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Price shock absorber: Temporary electricity price relief during times of gas market crisis

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European policymakers are weighing possible responses to the extraordinary surge in energy prices and the consequences for citizens and industry. The European Commission expects to issue additional guidance in May, following analysis due in April from the Agency for the Cooperation of Energy Regulators. Targeted relief to vulnerable consumers should be undertaken in any case. Whilst RAP would urge caution in considering possible broader interventions in the electricity markets, if such a course of action is under serious consideration, we offer this proposal of a ‘price shock absorber’ for reflection as a measure best fit for purpose, designed to acknowledge and address the essential aspects of the current crisis:

  • This is a gas market crisis — it is an extraordinary event that is adversely affecting all sectors of Europe’s economy. The priority for the electricity sector must be measures that allow the electricity market to ride through this shock to the system, and similar future shocks, preserving its functionality whilst avoiding undue harm to consumers.
  • The midst of a crisis is the wrong time to take decisions with long-term implications that will be difficult to walk back once the crisis has passed. Our proposal acknowledges that the fundamental design of the electricity market is sound; whilst improvements are certainly needed, they have no direct bearing on the causes of or remedies for this crisis.
  • This crisis has revealed in stark terms the true cost of dependence on a volatile fossil gas market, including the risks inherent in the prominent position Russia will continue to occupy in global supply.
  • Consumers and industry have the power to contribute to the response to these risks, by procuring the energy services they need more efficiently and flexibly.

When responding to the crisis, policymakers should preserve and even intensify the electricity market’s role in mobilising and empowering consumers rather than concealing the true cost of ‘business as usual.’ The value of the only durable response — an accelerated transition away from fossil fuels — must remain visible to consumers in an equitable fashion.

The authors outline this price shock absorber mechanism as an additional market feature to bring consumers some measure of relief whilst preserving the market’s essential functions. These include valuing energy efficiency, rewarding beneficial demand and resource flexibility and ensuring a ‘normal’ level of expected inframarginal rent to incentivise and compensate investors in the energy transition for the value of their investments. If a decision is taken to intervene broadly in the electricity market, we suggest this approach offers a significant measure of relief whilst doing the least harm.

 

Time-of-use network tariffs

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The European Agency for the Cooperation of Energy Regulators asked Andreas Jahn to speak at an invitation-only webinar on time-of-use network tariffs for electricity on 16 November 2021. Mr. Jahn explained how time-of-use tariffs for electricity networks can effectively ease congestion on the grid, reduce peak demand and increase system efficiency.

Utility Business Models and Performance-Based Regulation

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​In a presentation for the U.S. Climate Alliance, Mark LeBel explored the promise of performance-based regulation as an alternative to traditional cost-of-service regulation for utilities.

History and Theory of Wholesale Electricity Markets

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​In a webinar for the National Governors Association, Mark LeBel reviewed the history and structures of electricity markets as well as the implications for state clean energy policies.

Zukünftige Anforderungen an eine energiewendegerechte Netzkostenallokation

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Mit fortschreitender Energiewende werden fluktuierende Erneuerbare Energien immer zentraler bei der Energieversorgung. Für ein kosteneffizientes Energiesystem müssen die bestehenden industriellen und größeren kommerziellen Verbraucher sowie deren anstehende Elektrifizierung der Wärme- und Produktionsprozesse (Sektorenkopplung) darauf reagieren. Strompreise signalisieren dabei die Knappheiten und Überschüsse der Erzeugung. Auch das Netz ist schon heute sehr unterschiedlich ausgelastet. Trotzdem gilt, dass auch Knappheiten, die nur über kurze Zeiten auftreten, maßgeblich über einen kostenintensiven Netzausbau beseitigt werden. Kosteneffizient wäre es, auch die neuen und bestehenden Verbrauchseinrichtungen im industriellen Bereich und zur Schnellladung von Elektromobilen (Verbraucher mit registrierender Leistungsmessung) für eine Netzoptimierung einzusetzen.

Hier gewinnt die Frage nach Anreizwirkungen, einschließlich möglicher Hemmnisse und Fehlanreize, die von Netzentgelten (neben anderen Umlagen und Abgaben) ausgehen, stark an Relevanz: Es geht nicht mehr allein um eine „gerechte“ Kostenallokation, sondern um die Frage, ob energiewenderelevante Entwicklungen durch ineffiziente Bemessung und Strukturen der Netzentgelte unangemessen behindert werden.

Dieses Projekt betrachtet, wie die heutigen Regelungen zu problematischen Wirkungen bei der Netzkostenallokation führen können. Geeignete Weiterentwicklungen können sich dabei jedoch nicht auf kleine, kurzfristig umsetzbare Anpassungen und Ausnahmen beschränken. Deshalb werden hier grundlegendere Optionen andisktutiert. Das Ergebnis der Ausarbeitung soll dabei einen Impuls geben und keine konkret und detailliert ausgearbeiteten Vorschläge unterbreiten. Es soll vielmehr einen grundsätzlichen Diskussionsprozess anstoßen, der in die konkrete Ausarbeitung von Details und Implementierungen in der nächsten Legislaturperiode münden soll.

DER Aggregation: Lessons Learned from Other States

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​In a Missouri Public Service Commission workshop, John Shenot explored lessons learned from states that have allowed third-party aggregation of distributed energy resources.

Process and Engagement in a Time of Change

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​​In a rate design seminar for the Financial Research Institute, Richard Sedano explored process options available to public utility commissioners as innovation accelerates in today’s changing power sector.

Sweetening the deal for heat decarbonisation

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Many governments recognise the link between sugar consumption, obesity and diabetes. As a result, sugar taxes are now in place in more than 50 jurisdictions, including nine European countries. The UK and Ireland introduced modest sugary drinks taxes in 2018. One year later, sugar consumption from soft drinks in the UK had fallen by 10%.

If only reducing carbon emissions from space heating were so straight forward: Stick a carbon price on the fuels used in buildings and emissions will fall. The problem is that carbon emissions and sugar are different beasts.

Sugar-sweetened beverage demand is price elastic — an increase in price leads to a bigger proportionate fall in consumption. Consumers can easily switch to low-sugar alternatives and suppliers can reduce the amount of sugar in their drinks.

Demand for fossil fuels used in buildings is very price inelastic — an increase in price leads to only a small decrease in consumption. Switching heating fuels is not as easy as reducing sugar intake. Building owners need access to finance to invest in new technology and often fabric improvements too.

Driving decarbonisation demand

Organising and coordinating a building retrofit can be complex. When considering new heating systems, we tend to stick with the technology we already have and are familiar with. People also tend to value costs today over savings tomorrow, meaning that they are disinclined to invest in more expensive heating systems even when they will be cheaper to run. Installers are often geared up to replace gas and oil boilers, but just with newer models burning the same fossil fuels. The list of market failures and barriers is too long for carbon pricing to overcome on its own.

Regulation, reinforced by a raft of financial and supporting measures, is needed to drive both the demand for decarbonisation and the supply of equipment. Minimum efficiency standards on heating equipment can effectively drive out the market availability of new fossil fuel boilers, as evidence from Norway and Denmark clearly show. Minimum energy performance standards on existing buildings can bring forward building renovations and heating system replacements by setting dates by which buildings must comply with energy or carbon performance criteria, as already effectively implemented in the Netherlands and Scotland. Clean heat standards, regulating heating fuel suppliers to make emissions reductions, could step up the rate of progress on buildings decarbonisation.

Does that mean that we don’t need to put a carbon price on emissions from the buildings sector? Quite the opposite. We need an all-of-the-above strategy, including carbon pricing, to deliver on more ambitious climate targets. By 2030, according to the Commission’s analysis, the buildings sector will be expected to decrease its direct carbon emissions by 60% from 2015 levels, driven by a combination of building renovations and switching from fossil fuel heating to electrically powered heat pumps. This is a massive task. Currently, the combined impact of taxes and levies on electricity prices reinforces electrical energy efficiency efforts but does nothing to support fuel switching. In fact, it positively acts against the electrification of heat, the main option available for low carbon heating in buildings to 2030. Across the EU, electricity is more expensive than gas, in large part owing to taxes and levies. In Germany and Belgium, electricity is more than five times the price of fossil gas. Rebalancing taxes and levies, to lower the price of electricity and increase the price of fossil fuel alternatives, is essential if we are going to be asking people to switch to electrically powered heat pumps.

Some EU Member States have recognised the need for carbon pricing. Sweden and Finland have had carbon taxes on heating fuels for decades and have very little fossil fuel use left in the buildings sector. Denmark, France, Germany, Ireland and Luxembourg are amongst the countries to have recently introduced or ramped up carbon pricing measures. What these Member States have in common are Effort Sharing Regulation (ESR) targets that require additional policy effort to meet. The ESR provides Member States with legally binding targets for emission reductions, including in the buildings and transport sectors. Increasing ESR targets across Member States, in line with the EU’s new 55% emission reduction goal, would maintain the environmental integrity of the EU’s climate target architecture. It would also allow Member States to introduce carbon pricing and other policy measures in a managed way, as part of a broader policy framework.

Managing a carbon price introduction

What would a managed introduction of carbon pricing look like? First, carbon prices should rise gradually and predictably, to better promote investment and shield vulnerable consumers from the risk of substantially higher fuel prices. This can be achieved through either a carbon tax or an emissions trading system (ETS) with a price corridor where price movements are limited. With Fit for 55-proof ESR targets in place, this approach to carbon pricing could be introduced either by Member States or at the EU level.

Second, carbon revenues should be allocated to buildings emissions reduction policies and targeted to support low income, vulnerable and energy poor households. To achieve a rapid and just transition, using carbon revenues as they are collected to fund targeted renovation projects will be insufficient. We will need to bring forward future revenues — for example through climate bonds — and supplement these with other public and private sources of finance, providing a huge wave of support for those on low incomes to renovate their homes and decarbonise their fuel supply. Carbon pricing, regulation and supporting measures must work together.

The buildings sector needs to decarbonise at a rapid rate over the coming decade, using technologies that are cost-effective from a societal perspective.  Regulation and supporting measures will be vital, but so too will carbon pricing. Right now, we are making the political choice to make electricity more expensive than other heating fuels. At the same time, we need to switch from fossil fuels to renewable alternatives. How can we expect people to invest in heat pumps if we deliberately make electricity more expensive than fossil gas, oil and coal? That’s like taxing water and subsidising sugary drinks. It’s time to act on pricing and sweeten the deal for buildings decarbonisation.

A version of the blog was previously published in Euractiv.

Unlocking electrification through rebalancing levies and taxes

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I frequently receive requests for advice based on my personal experience as an owner of a heat pump and an electric vehicle. Often I get asked whether I now pay more for my energy than before. People are more keenly aware today of the high costs of electricity and they hesitate to switch away from fossil fuels if it costs them more money.

This is concerning because in most, if not all, independent analyses of pathways to net zero, emissions electrification plays a critical role. Two sectors in particular can benefit from direct electrification: buildings and transport (although there is also significant potential in industry). Not only can electrification deliver substantial carbon reductions and immediate air quality improvements, it can also provide financial benefits to customers through energy cost savings.

But households often face an important barrier to electrification; the economics of switching away from fossil fuels may simply not stack up. Whilst electric cars already today deliver cost savings over their lifetime compared to petrol and diesel cars, the case is less clear for heat electrification using heat pumps. This is because the price ratio of electricity versus fossil gas is unfavourable in most European countries. Part of the reason for electricity being, on average, 3.3 times more expensive than fossil gas are taxes and levies on electricity (although there are also some levies and taxes on gas but at a much lower level). Much of this is a result of policy and regulatory choices and can be resolved through reform.

Electricity is, on average, 3.3 times more expensive than gas

In many countries the costs of renewable energy deployment and integration have been added to electricity bills. The most prominent example of this is probably Germany where the costs of feed-in tariffs have been added to electricity over the years and now make up about 20% of the average electricity price. In addition, the industry sector is sometimes exempt from energy taxes and levies that residential customers pay. This shifts the burden more to other consumers and thereby further increases the ratio between electriciy and gas prices for households.

Source: European Commission. (2020). Energy prices and costs in Europe.

Even though heat pumps — the most efficient form of heat electrification — can deliver heat at a very high efficiency of around 300% or more, the relatively higher electricity prices can prevent sufficient cost savings that would justify switching from fossil gas to a heat pump. It is for this reason that the International Energy Agency has called for narrowing the gap between electricity and natural gas prices to accelerate the uptake of heat pumps. Furthermore, whilst it might have been directionally correct to put most of the costs of decarbonising the economy on electricity when its emission intensity was very high, this is no longer the case. In many countries electricity is now cleaner than gas and the expectation is that emissions will fall even further as we deploy more renewables at record speed. This puts into question whether the existing tax and levy regime is appropriate anymore. Given the ambitious decarbonisation goals and the need for large-scale electrification, it is no longer fit for purpose.

Regulatory reform is underway

Countries looking at reducing heating emissions through electrification recognise this and have begun reforming energy taxes and levies as part of building a clear business case for electrification. The country with one of the highest penetrations of fossil gas heating in the world, the Netherlands, has recently decided to support the transition from fossil gas to low-carbon heating through energy tax reforms. The government will increase taxation of fossil gas by up to 43% by 2026 (compared to 2019 levels) and will lower taxation on electricity.

Denmark is currently implementing similar steps: The Danish Climate Agreement for Energy and Industrycommits the government to reducing taxes on green electricity for heating, while simultaneously raising taxes on fossil heating.

In other countries there is a lively discussion around energy taxation and levies in the context of net zero emission goals. In the UK, for example, the Environmental Audit Committee of the House of Commonsrecently pointed out that current electricity prices —  being about five times higher than gas prices — were an active disincentive to electrification. The committee has called on the government to set out its plans for rebalancing legacy policy costs to make heat electrification more attractive.

In addition to shifting levies to gas, some countries have opted for a carbon price on fossil gas — an approach that Germany has recently adopted. But the more existing levies and taxes we can rebalance, the lower any carbon price would need to be to have the same impact. And rebalancing existing levies and taxes will lead to no additional cost to the average consumer.

Shifting taxes and levies also faces some challenges. Over time, and as the amount of gas consumed for heating falls and the number of homes heated with gas declines, the environmental and social levies will fall on fewer customers and fewer units of gas being consumed. At the same time some legacy policy costs will eventually decline once past commitments have been paid off.

Low income customers need to be protected

When rebalancing taxes and levies, it is also critical to carefully assess the impact this will have on low-income customers. Shifting taxes and levies should be done in a way that has minimal net impact. Those customers heating their homes with elecricity would benefit from lower bills. This is important because in many countries — for example in the UK and Austria — a proportionally higher share of low-income customers use electricity for heating, which is often very expensive. These households would benefit. But low-income customers living in very ineffiicent buildings with a gas or heating oil boiler would pay more if they consume above-average amounts of gas. For these customers, additional policies will be needed to offset negative impacts through targeted energy efficiency and electrification programmes and direct social welfare payments towards their bills in the short to medium term, a mechanism used in some European countries already.

Rebalancing taxes and levies is a key ingredient in the energy transition towards more electrified end-uses. Of course we will need other policies to work in tandem with rebalancing taxes and levies, such as regulation that sets out a clear long-term trajectory for phasing out fossil fuel heating. Taking advantage of it means that we improve the business case for electrification at no or little additional cost to consumers. And next time someone asks me for advice, the question about the running costs would not even come up as the business case was clear.

A version of this blog appeared in Euractiv