297 The Electricity Pricing Episode

I'm Gary, and this is Evie Musings, a podcast about renewables, electric vehicles, things

that are interesting to electric vehicle owners.

It's a lovely early morning here in the English countryside.

Sun's about to rise.

There's a very light breeze in the air.

Pretty soon, the renewable energy on the grid is going to be produced in lots of cheap,

clean electricity, and that's what we're talking about today.

Electricity and how the price is calculated, why does gas play into it?

A common theme on this podcast, and indeed for most EV drivers, is the price of public

charging.

We've talked several times about what public charging costs, why it costs so much, and

I've even wrote down how CPOs work out their tariffs, as many things in the mix that go

towards the price per kilowatt-hour that you pay at the charger.

Standing charges, capacity charges, lease and rentals, profit participation, capex costs,

etc.

But the one thing I haven't talked about in detail is the actual price of wholesale

electricity.

A lot more renewables are coming onto the British grid, the global grid every day, and

one of the benefits of that is that the overall price of electricity generation is decreasing.

However, in the UK, we're seeing electricity bills going up.

So today we're going to talk about why that is.

We're going to talk about CFD, Contracts for Difference.

We're going to talk about the Low Carbon Clearing Company and how that works.

Lots of other things.

We hear lots of conflicting statements and arguments about this.

More renewables will make electricity cheaper, wind power is the cheapest form of electricity

generation, but the next contract for wind energy is going to be more expensive than

gas.

The cost of gas generation makes up the majority of the price of electricity, which is why it's

so high, but gas is less per kilowatt-hour on a domestic bill than electricity.

So it seems there are lots of things that we need to look at on this topic.

Now today we're going to dig into this into a little bit of detail.

How are electricity costs calculated?

How does the source of electricity alter the cost?

Why is domestic gas cheaper than domestic electricity and what are the hidden costs of domestic

energy?

So let's get started.

The EV Musings podcast is sponsored by Zatmap, the go-to app for EV drivers, helping you

find and pay for public charging with confidence.

When we talk about electricity costs, we're talking of the wholesale price to use as such

as CPOs and the price the energy companies pay to the energy suppliers.

What's the supply chain for electricity and how are costs apportioned along the supply

chain?

How does the source of electricity alter the cost?

If your energy is coming from wind and solar, the price would be lower than gas or coal.

Even if everything else in the generation was the same cost, the fact that an energy

company needs to buy coal and gas to generate electricity means that this energy will be

more expensive than wind and solar, where the source energy has a zero marginal cost.

It's coming from the CERN or it's coming from the wind.

So what are the hidden costs of domestic energy?

Now electric costs are a mix of wholesale price, which is the price the generators charge

to use their electricity and retail costs, which is the price energy companies charge

to customers.

And between the wholesale price and the retail price are any number of items that are attributed

to this.

We'll look at those later.

The wholesale price consists of the costs of each kilowatt hour of energy from generation

and generation can be from any number of sources, wind, solar gas, oil, biomass, nuclear, etc.

And each generator will have agreed with the national grid what price they're willing

to sell electricity for.

And this is known as the strike price.

And this is used to enable wind farms, for instance, to know in advance what they'll

be paid so that they can budget that when they build a wind farm.

If you're producing a turbine output 750 megawatts, they know what each of those 750

megawatts is worth to the market.

John Shirley from AW Renewables at Dunstable has the large wind turbine, never a checking

word, a fantastic place.

Being see, being inside it, very impressive, but when you built that, you had to work out

in order to cover the costs of building depreciation and actually making a profit, how much was

he willing to sell his electricity to the grid for in order to be able to finance it.

So he determined what was called a strike price.

Now, I don't know what that strike price is for, for checkly wood, but we're going

to do, we're going to select a random figure and we're going to say 12 pence a kilowatt

hour.

With gas and with coal as it used to be, the strike price was higher because each kilowatt

hour of energy from gas or coal consisted of a cost to buy the underlying fuel and then

a cost to use that fuel to generate electricity.

And that's why gas is often marketed as the most expensive price.

So the generators, wind farms, solar farms, hydrodams, gas power plants, etc, sell their

energy to the grid.

But here's where the first wrinkle comes in.

The grid needs to know what energy will need at a given time during the day.

So they split the day into 24 half hour chunks and each of these chunks has a demand forecast.

And this is related to weather conditions, time of day and expected peaks.

You can expect the demand for energy at 6.30pm on a cold winter's evening to be more than

the demand for energy at 2pm on a warm summer's day.

So say for 4.30 to 5am, the demand might be x megawatt hours of energy.

The natural grid will buy that from the different energy sources.

They'll go to the cheapest energy first, energy from numerous wind and solar farms.

Then they'll go up to the slightly more expensive energy such as nuclear from size well be or

similar.

Each of these will be quoting a strike price for the energy.

So John Fairley, AW Energy in Chekliwood would be saying to the government, if you want

to use my wind energy, you'll pay me 12 pence a kilowatt hour.

The government keeps going until it calculates that it has enough little packets of energy

from all the sources to meet the expected demand.

And the problem is that these energies are mixed of lots of different prices.

Some cheap wind, some more expensive nuclear, maybe some energy bought from France or Belgium

through interconnections.

On top of that, they might need to use gas for some energy.

The problem with gas, as we've said, is that it's a lot more expensive than other sources,

let's say 20 pence a kilowatt hour.

But under the current electricity market, the wholesale price of energy is calculated

as the price of the most expensive source of energy used.

This is a concept known as marginal pricing.

So if the grid needs x kilowatt hours of energy, and 90% of that is sourced from wind, nuclear

and imports at 9 pence a kilowatt hour average, the fact that 10% is sourced from gas at 20

pence a kilowatt hour means that the wholesale price of energy to everyone is 20 pence a

kilowatt hour.

Does the energy companies buy the gas at 20 pence from the generators and sell the resulting

electricity to the customer, which could be you as an individual or a CPO at 20 pence

a kilowatt hour plus whatever they need to make their profit?

Now, job fairly AW renewables is contracted for a strike price of 12 pence a kilowatt

hour.

But now because of gas, he's been paid 20 pence a kilowatt hour.

Fantastic.

Think of all that extra profit.

Well, no, it doesn't quite work like that because he will now have to pay back the difference

between what he's been paid 20 pence and what his strike price is 12 pence.

And that's what's known as the contract for difference.

Now, the simple question to be asked is, if John Fairley is willing to supply energy to

the grid from his turbine at 12 pence a kilowatt hour, why would he then be paid 20 pence a

kilowatt hour only to pay back the difference?

Now, I asked this question on a LinkedIn comment thread that was discussed in this.

Now, I received two responses.

One was from a rather haughty sounding commenter who worked for a DNO and the other was from

an energy guy.

The first one said, the wind farm offers their energy at x pounds a megawatt hour as a result

of how the market works.

If the wind farm got paid what they bid, the wind farm would bid their best view of what

the gas peak was going to bid.

If they're good at guessing, the wind farm would bid two x, whatever it was, as per my

example, and this happens in most industries, which effectively said, that's the way it's

designed.

You can't beat the market.

But the reply from the energy guy was a lot more revealing.

He said, Gary, you asked the key question that deserves an answer.

A long time ago, we had a pool in which everyone paid the marginal price for electricity by

the half hour.

We decided that this was not a good idea and we moved to a contracts-led market where

originally significant volumes of electricity were traded between buyer and seller at an

agreed private price with only true marginal trades at a marginal market price.

This meant that the price to a buyer was a blend of contract and top-up marginal pricing,

not the full marginal price.

You might think this seems a sensible arrangement, so did we.

And it rebains to be explained how this has morphed into all electricity to be traded

at a marginal price.

Answers on a postcard, please.

End quote.

So the fact is, the market isn't working the way it used to, and there are inefficiencies

due to the contracts for difference, but it gets slightly more complex.

Under the CFT policy, if the cost of energy is so low that the government is paying less

than 12 pence a kilowatt hour for the energy that Chetley Wood has marked as a strike price,

then the government will pay John Fairley at Chetley Wood Turbine the difference if

it provides energy.

This happens on really windy days when there's a lowest demand and high supply.

At that point, John Fairley might be receiving 5 pence a kilowatt hour for energy that is

contracted at 12 pence.

These payments are managed through the LCCC, which is the low-carbon clearing company,

a government body that captures all the payments when gas is leading the pricing mechanism and

the suppliers are getting more than the CFT prices.

And paying this back to renewable energy operators when the price of energy is below

their strike price, 12 pence a kilowatt hour enough, fictitious example with AW renewables.

But the key thing to remember here is that none of this LCCC money is actually factored

back into the spot price of energy that the energy company actually pays.

Let's take an imaginary example related to 100 gigawatts needed for a single half-hour

time period.

It could be made up of the following amounts of energy and prices.

At 10 gigawatts of solar at 5 pence a kilowatt hour, 80 gigawatts of wind at 12 pence a kilowatt

hour and 10 gigawatts of gas at 20 pence a kilowatt hour.

The total amount of money that the energy costs under a standard bid will be solar, 500 pounds,

wind, 7,680, gas, 2,000 total, 9,730 pounds.

This is the amount the suppliers will ultimately get paid once the LCCC has netted off the

amounts.

But what the customers are being charged is 100 gigawatts at 200 pounds, which is 20,000

pounds, and this is why your bills are high.

The customer pays a grid 20,000, the energy only costs 9,730 and the difference is taken

by the LCCC.

Let's look at the other side and assume it's a lovely sunny and windy day and energy prices

are low.

Demand might be 50 gigawatts.

Wind farms and solar farms are producing a lot more energy than is needed, so the price

the grid is willing to go to pay is lower, a penny a kilowatt hour, 10 pound a gigawatt

hour.

So, 10 gigawatts of solar, 40 gigawatts of wind, total 500 pounds, but BERT the LCCC

will then have to pay back the difference between the one pence a kilowatt hour and the price

the wind and solar farms have contracted when they build.

Assume John Fairley still owed 12 pence a kilowatt hour and the solar farm is owed 5 pence

a kilowatt hour, so you've got solar, 10 gigawatts at 50 pounds is 500, wind, 40 gigawatts

at 120 is 4800, total 5,300.

They've already been paid 500 under the contract, so they're owed 4,800 from the LCCC.

It provides that money from the fund it manages when suppliers pay back amounts under contracts

for difference.

Again, the market will pay 500 pence for the energy they need, and this is one of the reasons

why decoupling the cost of gas and electricity will be difficult.

Sure, when gas is driving the price, it's easy to get money back from the other energy

suppliers, but when renewables are in large supply and demand is low, think a warm, slightly

breezy summer stay.

How are the wind farms going to be paid for switching off their turbines?

Where's that money coming from under the CFD if we've decoupled the prices?

Which brings us to another key issue with electricity, curtailment.

The benefit of gas and coal when we still had it was that if it was a nice warm day

in the middle of summer and demand for electricity was small, they could just dial back the gas

or coal burning.

They'd still get paid for what they actually generate to the grid, but this could be quite

a small amount.

But we wind and solar is not that easy.

If the sun's shining on a solar farm, the farm's generating energy.

This energy can't be stored easily at the moment, although there are options such as

battery storage or even conversion to hydrogen, but these cost money.

So what the grid does is curtail energy.

For solar farms, this means cutting the connection to the grid.

For wind turbines, it means stopping the turbine from turning.

But under the contracts that are in place, the solar farms and the wind turbines still

get paid for the energy they would have sent through, and this is known as a curtailment

payment.

And just in case you think this is relatively small, check out a website called renewables-map.robinhawks.com

slash curtailment.

This shows you how much energy has been curtailed this year alongside how much we've paid wind

and solar to not put electricity into the grid.

As I write this in late April, we're already over 4.6 terawatt hours of energy at a cost

of almost 125 million.

That's money billpayers have to pay because we can't use this cheap energy.

On top of that, a lot of curtailment is due to the fact that energy is generated in one

part of the country and used in another.

If the energy can't be moved from one place to another due, for example, to capacity constraints

on the wires between Scotland where most of the wind energy is produced and London where

most of it is used, National Grid has to then switch on gas pica plants in the south to

provide the energy that's been needed.

This expensive gas then also has to be paid for.

This year alone, we've spent 540 million pounds producing energy because we can't get

cheap renewables from where it's produced to where it's needed.

In 2025, the grid paid £1.4 billion to both switch off renewable energy sources and pay

for fossil fuel sources to generate energy at the same time in other places.

Typical example, on the 5th of August last year, they paid almost £8 million to switch

off wind turbines and a little over £12 million to buy energy elsewhere.

To put that in context, that's enough to power 57% of Great Bridge homes for a day.

Better transmissional storage would mean that the curtailment costs will be lower and that

money goes straight back into everybody's energy bills.

So let's look at electricity bills for a moment.

When you actually go and look at an electricity bill, you can break it down and you can go

right.

What's the cost of the electricity?

As a householder, you might pay £20 per kilowatt hour or £200 a megawatt hour.

And in that £200 a megawatt hour, you will find 50 or 60 quid of electricity price, you'll

find a chunk of contract for difference, you'll find renewables obligations, you'll find a

load of grid costs.

And then you'll find tax and some very specific levies for homeowners that are effectively

a collection of capital from the bill payer to pay for other people who are maybe poorer

than the bill payer to have efficiency measures applied to their homes.

And the obligation to provide these efficiency measures is on the energy companies.

And therein is another element of quite complex tax collection and hypothesization and management

cash flow associated with trying to improve the efficiency of our homes.

These levies for homes don't apply to business electricity.

So when you break down a business electricity bill, it's very different to a domestic one.

And generally, a business bill is cheaper because it doesn't include certain elements.

But a home bill is more expensive, which is why it also has 5% fat rather than 20% fat.

So a home bill has different levies in it, less fat, a business bill has fewer levies

for homes, different levies for business and 20% VAT rate.

Clear?

Let's talk nodal pricing.

Now, the concept of nodal pricing on nodal balancing points is that we have a long, thin

country.

We've built a lot of windy assets at the top of the country that generate electricity.

There's no one living in Caithness, the area that includes John O'Groats and that top-right

pointy bit of Scotland.

I mean, sure, there's a population, but there's 41 people per square mile.

I live in a rural area of Hampshire and the density is 1,421 people per square mile.

So for the purposes of this discussion, we'll say nobody lives in Caithness.

So all that wind being generated in Caithness gets pumped down to the borders, where there's

some people living, but we're also generating electricity in the borders and they need to

pump it down towards London.

So we balance our system on a national, notional balancing point and it moves around the country.

It's a theoretical concept around where we balance overall electricity usage.

California, I think, has 6,500 nodal points, of which 4,500 of them are specifically priced.

New Zealand is probably the most sophisticated electricity market in the world and it's got,

I can't remember how many nodal points, but it's got, again, a really clever balancing

mechanism to balance each of the nodal points.

So a good example could be it's a windy day in May, you live in Caithness, your electricity

is free.

You just use as much as you can, but you live in London, there's no wind blowing in London,

or very little.

Your prices are still quite high because you've got to import it through Northern England,

Midlands and down to London.

And there's no local generation, so you pay a higher price and it creates a geographical

price incentive.

And the biggest issue with this is that most of the billion engines for most of the suppliers

couldn't handle it until Octopus Energy's Kraken came along.

I believe it would be possible to implement a nodal balancing mechanism for pricing in

the UK.

So Greg Jackson, Jackson, Octopus CEO's argument is, hey, we've got all the technology now,

why are we not doing it?

And the often silent argument against nodal pricing is that it would, by definition, give

certain parts of the country much cheaper energy than other parts of the country.

If you're up in Caithness or around there, your electricity will be for all intents and

purposes almost free.

The generation is there and you can use it there.

But if you're in London and the Southeast, your energy will probably end up being more

expensive than it is now because of the reason I mentioned earlier.

No generation and the need to bring it down through the rest of the country.

You can see now why there are certain people who think that nodal pricing is an excellent

idea and these are usually the people for whom the energy costs will decrease and those

who think it's not a good idea at all, those for whom the energy costs will increase.

So my next big question about electricity comes down to a puzzling paradox.

We say that the price of electricity is often driven by the price of gas.

But when my mother, for example, looks at her energy tariffs, gas is a lot lower priced

per unit than electricity.

She might be paying 8 PKW for gas but 28 PKW for electricity.

If electricity is priced from gas, surely it should be cheaper if gas is cheaper, right?

Well, first things first.

None of the levies that we talked about previously applied to gas.

So all the warm home discounts make homes more efficient.

None of that applies to gas.

And it's one of the things that the electricity industry used to bang on about.

British gas loved it.

They sold a lot.

They had a lot more gas accounts than they had electricity accounts.

But gas accounts were cheap.

It incentivised people to build boilers.

They liked boilers.

So this was a great way of incentivising boilers.

Second thing to consider.

8 PKW gas coming into your home and a 90% efficient combi boiler means your marginal

cost of KW for heat is probably 9 PKW or somewhere around that.

Now, you know it's not going to be expensive.

It's relatively cheap.

The electricity price coming into your house is, whatever, 25-28 PKW.

Now, if you break that down, 5 PKW is electricity.

The wholesale price.

Remember, 50 PKW is about 5 PKW.

So our numbers are probably not perfect, but it might be 6.5 PKW electricity.

And then everything on top of that is additional costs and fees.

So that might be the renewables obligation to pay for people to build wind turbines.

It might be the CFD to pay for Hinkley Point.

It might be the capacity market to pay for the gas plant to generate in the middle of

the night when no one else is generating.

You've then got your levies, so your warm home discount, all that sort of stuff.

You've got your 5% VAT and somewhere in between all of this, you've got your cost to serve,

which is basically the money that an electricity company charges to run a call centre, generate

a bill and physically move the electron around.

Somewhere in there, you might have profit, although the reality is profits in electricity

supply are pretty thin.

Most electricity supply companies, when you break down their individual return, it's

negative stroke zero.

You can get that data from the Off Gem segment and reporting.

So what it comes down to is electricity as a wholesale product is not that expensive.

Your electricity bill is quite expensive.

So it's the additional top ups inside the bill that make it expensive.

Now admittedly, the 8 PKW gas also has some costs.

Running a gas network, provision of the metering at your house, all that stuff all has additional costs.

So there is something in there, but gas price stands at like whatever, 4 PKW, 8 PKW,

or something on a wholesale basis, 4 PKW.

So it's doubling, but electricity has got a lot more of that additional cost on it.

So where does this leave us?

Well, at its very basic, the cost of producing electricity, even with cheap renewables, is expensive.

And a lot of this is due to the way we price electricity through contracts for difference

and the additional levies.

Some of it is due to the way we add additional costs onto electricity to cover those levies

and simpler things.

But we also have an electricity system that's creaking slightly under its own weight.

And if we didn't have to deal with curtailment and regeneration fees,

we could instantly take about £1.5 billion per year off energy costs, and that's £52 per UK household.

If we could sort out the marginal cost issue with energy pricing,

we could reduce the price the energy company charges for our energy

by incorporating the CFD payments into the actual amount we pay.

Now, I don't know how much that would save,

because unfortunately on the whole CFD payments are generally net positive for generators.

In other words, they receive more money back from the LCCC when prices are low

than they pay to the LCCC when prices are high.

But I think that also in the contracts so that we don't price everything at the marginal price

will probably be a good start, don't you?

The whole area of electricity price is fascinating and very complex.

I mean, we haven't covered things such as price caps and how they work,

or levelized cost of ownership for renewables versus fossil fuel generation,

or how nuclear plants are priced and paid for,

and why we're paying now for nuclear energy we won't get for another 10 years.

What do you think? A topic for next season? Let me know in the comments.

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Now, I know you're probably driving or walking or jogging or in the shower or washing the car,

but if you can remember and you enjoyed this episode,

proper review in iTunes really helps me out.

I did go in and have a look recently as some of the most recent reviews.

Thank you very much for those who took time to do that.

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And thanks as always to my co-founder Simon.

You know he's such a dynamo, he generates all his own energy.

Thanks for listening. Bye-bye now.

297 The Electricity Pricing Episode

About this episode

CPOs

wholesale price

marginal cost of wind and solar vs gas or coal

zero marginal cost

grid

demand forecast

peak

megawatt hours

kilowatt hour

interconnections

wholesale electricity market

marginal pricing

strike price

contract for difference

Toyota A90

renewables obligation

CFD

capacity market

VAT

cost to serve

Off Gem

curtailment and regeneration fees

marginal cost pricing

levelized cost of ownership (LCO) for renewables vs fossil fuel generation

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