Electricity: The Price isn’t Right

Paul YoungEconomics, Environment

Specialist energy and economics consultancy Concept Consulting has released a new report looking at the economics of new energy technologies in New Zealand – solar PV, electric vehicles and batteries. The report exposes the big problem at the heart of our electricity market: poor price signals. Currently, the price ain’t right. This is economics 101: if you want the right choices made, you have to get the incentives (i.e. the price) right. And this clearly isn’t the case right now in New Zealand.

Why price signals matter

Ask any economist and they will tell you that for a market to function efficiently, the price signals need to accurately reflect the underlying costs.

When we’re talking about electricity, that means the prices consumers pay should reflect the system costs involved in delivering it at the margin (i.e. the price paid equals the cost of making the last unit of electricity). Both electricity and fuel prices should also reflect the damage being done to society from CO2 emissions – in economist-speak, an externality.

If we get this right, people’s investment decisions will be aligned with the least cost and the most benefit to society. It will also help drive the dollars towards where they will have the most impact reducing CO2 emissions.

If we don’t, NZ ends up effectively flushing money down the gurgler on transport and electricity, and our CO2 emissions are higher than they should be under fair, true cost accounting.

Electricity pricing – what’s wrong?

Most New Zealanders pay something resembling a fixed rate for their electricity, regardless of what time of day they use it. But the cost of providing that electricity varies massively depending on time.

To put it simply, our entire electricity system is designed to meet demand at 6pm in the middle of winter when everyone gets home, turns on their heat pump and starts cooking dinner. We need enough generation capacity to meet that demand (that is the reason we need coal and gas power stations at the moment), and a distribution network that can deliver the electricity to everyone’s home. This peak has a huge effect on the cost of the whole system.

The trouble is that the pricing system doesn’t reflect this. System costs are mostly bundled into the price per kWh, when as we’ve explained, the distribution costs are determined by the size of the peak. Most people pay a higher rate in winter time, and many have differentiated day/night pricing, but that only goes a little way towards reflecting the real costs of the winter peak.

In the long run, the way to reduce your power bill and make it easier to integrate more renewable energy is to smooth out the peak. New players like Flick Electric are trying to offer real time pricing to give consumers the incentive to reduce their peak demand (e.g. by putting on the dishwasher overnight), but even they are constrained by lines company pricing. New technology is emerging that gives consumers even more investment options – like solar PV, electric vehicles and batteries. But if we don’t fix the broken price structures then people will make investment decisions that aren’t ideal for NZ in the long term.

How this messes with incentives

At the moment if you use less power, obviously you will save money. Whether you are saving it at peak or off-peak won’t make much difference to you, but it will make a big difference to how much NZ benefits. If you use less power at peak, NZ is benefiting much more than what you are rewarded. On the other hand, if you use less power off-peak, you might be rewarded much more than you should be from a NZ Inc perspective.

By simply shifting your demand from the peak to off-peak, you could be delivering a big benefit to NZ. But under the prevailing flat all-day pricing structure there is no incentive to do that at all (unless you’re a Flick customer or opted for the cheaper night rate). Batteries would do a similar job, allowing you to effectively shift your power consumption around over short periods. No incentive here either. Likewise electric vehicles charging overnight, or feeding into the grid at peaks, don’t capture benefits of a variable electricity price.

Solar has the inverse issue – in most cases, over-rewarding generation which doesn’t contribute to peaks and thereby lower network cost. This is simply because solar delivers zero benefit when it is needed the most – at 6pm in winter. Overall our system is generally delivering stronger incentives to go solar than justified by national benefits – although there are always exceptions and solar might still be right for the individual.

The real cost of carbon pollution

The report also highlights the inadequate price on carbon being delivered by the Emissions Trading Scheme. As highlighted in our Carbon Cheats report, the price of carbon was at one point as low as a few cents per tonne, and while it has been steadily recovering since it remains lower than it should be. The report highlights (as we did in last week’s Whiteboard Friday) that the social cost of carbon pollution is actually far higher than this – potentially in the range $75 to $235 per tonne according to one comprehensive recent study. Taking the midpoint of $150 would translate to 42c per litre on petrol. This would significantly tip the balance in favour of EVs.

Meanwhile Climate Minister Paula Bennett has vowed to keep the $25 per tonne price cap in place for the foreseeable future. This is a short-sighted decision which is keeping New Zealand from transitioning to a low carbon economy, and will make our lives more expensive in the long run.

What’s the impact?

Whenever you get prices wrong, you get investment in the wrong place, which in turn increases long term costs. Concept have estimated the long term cost to the economy of these poor price signals impacting on the following investments:

  • Underinvestment in electric vehicles: “Overall, we estimate the associated economic costs to be between $300m and $700m.”
  • Inefficient investment in solar PV: “We estimate that the misaligned signals in existing electricity tariffs could encourage inefficient PV uptake costs of approximately $1.8bn over the next 20 years. This compares with the estimate of costs compiled by NZIER, which was $2.7bn to $5.0bn dollars (present value).”
  • Poor or misplaced investment in batteries – difficult to quantify but likely to run into the hundreds of millions too.

What’s the solution?

The electricity pricing system needs a thorough review, but the so-called “solar tax” being brought in by lines company Unison is not the way to do it. That’s trying to adjust for a broken system. Real-time pricing is the way to go. Not only is it a better and fairer way to address the issues around solar PV, it will remove the perverse barriers to uptake of batteries and EVs. Companies like Flick Electric are showing the way, but the system needs to shift to support their approach.

Electricity: The Price isn’t Right was last modified: June 23rd, 2016 by Paul Young
About the Author

Paul Young

Paul Young joined the Morgan Foundation in 2015. Paul has an academic background in physics and maths, and graduated with a Master's degree from University of Otago where he researched ocean wave power. He is one of the founders of Generation Zero - a Kiwi youth organisation that advocates for action on climate change. He is passionate about the role New Zealand can play in leading the way to a thriving zero carbon future. Paul conducts research for the Morgan Foundation on climate change and other issues, and writes the occasional blog post.