One thing that I find hard to understand is how the electricity prices in the UK have gone up so dramatically (blaming gas prices) when a large amount of the electricity is not generated from gas. Is the price being artificially inflated?
Electricity prices in the UK (and most other places) are set by the marginal unit, which is the most expensive unit that needs to be turned on to meet demand. All other generation for that time period gets paid the same price. The marginal unit in the UK is usually gas, hence the sensitivity to gas prices
What price do you think we should pay for the electricity?
Suppose we insist we'll pay less than the price you agree to sell for. Obviously that's not a sale, that's robbery. This problem arises even if we agree to pay everybody the average, because some suppliers didn't bid average, their bid was higher, but we still claimed their electricity, so we are stealing from them.
OK, suppose we decide we'll pay all accepted bids at their bid price regardless of the marginal unit cost. If we do this the supplier is incentivised to guess the bid we will accept, so as to collect the difference between their actual price and the price we're willing to pay. If they're very good at this, we pay exactly the same as now, but, regardless of whether they're good at it the grid is significantly destabilized by the increased uncertainty due to lack of efficient price signals.
I don’t know much about it; that’s why I asked the question.
So the short answer is I have no idea, but I doubt we currently live in the best of all possible worlds.
It seems an odd pricing scheme which isn’t working well as gas becomes less desirable and renewables are a bigger part of the mix.
What you describe as paying at the bid price sounds like a free market to me - if you’re going to have a market mechanism perhaps it should use the market to efficiently discover prices, not impose a very odd pricing structure - if imposing nationwide prices, why have a market at all?
There are many possible alternatives:
Allow prices to float in a completely free market, and force suppliers to hedge (which they do anyway to some extent, but they could be required to).
Nationalise the national grid and energy production
Build interconnects and hydro storage to reduce reliance on gas plants and reduce the problem.
Set prices in regional markets to bring production closer to the areas with peak consumption.
Set prices by energy type (separate markets per type like fusion solar etc taking into account externalities).
Set prices by energy use (baseload, fluctuating, peak)
Defining pricing mechanisms is not robbery it is why we have a regulator!
The reasoning is that it incentives electricity producers to offer max amount of electricity at low prices without speculating how to maximize profit (as their sell offer will practically speaking have zero effect on the spot price). Nuclear plants, wind power, solar can just offer to sell at everything at around 0c/kWh.
It's claimed that another type of market would cause companies to speculate with their sell offers and thus generate less electricity. It would be interesting to see how this kind of market would work in reality, though.
There are many possible ways to decide (by region, by use, by type of energy production). At present we all pay exorbitant prices because the system is badly designed and badly planned.
My understanding is most wind was bought at a guarenteed price by the government at the time of construction, so a wind farm producing 1MWh gets paid say £40 regardless of the cost of electricity on the grid - even if marginal cost was £20/MWh
As users are then paying £90/MWh for gas, does the excess £50 go to the government or to the wind far owner?
The government. The mechanism is called Contracts for Difference, and as the name implies they work by ensuring the difference between an agreed strike price and the actual price - in either direction is paid
However, notice two further considerations:
1. Such contracts eventually expire. Exactly when varies. But the wind farm is still there, just now the energy price all goes to the operator.
2. Older government subsidies were not CfD. Ten years ago if you built a wind farm you got a direct subsidy. The CfD schemes come into existence from about 2014. They're one of a small number of good ideas the Tories had. They're in line with Tory ideology, but they also actually make sense in the world that actually exists.
The price of electricity in the UK is linked to the most costly supply in the entire mix. So if gas is the most expensive then we pay all other power-producing suppliers, regardless of means of generating, the wholesale price we'd pay for gas. It's a strange system.
The marginal price of electricity (i.e. the price of the most expensive source) is what drives the retail cost, because it's a liquid commodity that can't (to a first approximation) be stored. Imagine 90% of your electricity comes from wind and the last 10% has from gas because there is nothing else - the price of electricity is going to equal the price of gas because the wind providers can raise prices until they're just under the price of gas, since there are no other options. The most expensive form of electricity sets the price until it isn't needed anymore and is booted off the grid entirely, but once you cover that last 10% with wind then the price falls dramatically.
In theory this is what we want: the windfall profits on cheap power during periods of expensive energy are supposed to attract the market to build more of these plants and chase those profits, thereby accelerating the green transition. But it's possible what we saw last year was too much, and that the damage to the economy (nothing strangles economic growth like expensive energy) does more harm than this incentive does good. People are talking about renegotiating power agreements in Europe to pay fixed prices for renewables so this wouldn't happen again, but I haven't heard how likely this is to succeed.
The way it works in the EU—not sure if the UK participates in this market still?— is that every energy source is priced according to the most expensive energy source until demand is covered by supply.
So, for example, on particularly windy days here in Denmark, we pay almost nothing as our entire demand will be covered by wind energy. On other days we might pay a lot since we need to import energy produced from gas or other expensive sources.
There's a couple reasons. A small amount of electricity may be generated from gas, but that small amount is often crucial and in a lot of demand. Furthermore, peaker plants will produce less and less electricity as more renewables reduced their duty cycle. But the overhead cost of maintenance remains: reducing a gas plant from running 10 hours a day to 2 hours a day does not result in a 5x reduction of cost.
The whole system as detailed in the article seems pretty artificial and not great. For some reason prices appear to be set at the national level, ignoring the fact that Scotland has an excess of wind energy. If consumers could see that the price difference on their end, I guess there’d be more incentive to upgrade the infrastructure and get it down to England more efficiently.
If gas is setting the price as the most expensive form of energy, then it acts as an incentive to build cheaper forms of energy because your margins are that much higher.
Alas, England doesn't allow on-shore wind power, and there's not sufficient capacity (in terms of HVDC lines) to transfer enough power from Scotland down to England to move all of the excess energy.
That seems like a good way to spur early development. I wonder, though — if consumers could actually see the cost benefit of the wind power, might gas have been just priced out of the system by now? (Or relegated to some backup status). (Supposing the transmission infrastructure were upgraded to allow for the higher flow, or England changed its laws to be more in line with economic realities).
No, first understand the concept of market clearing auctions[1], then understand that the there is a dispatch stack (that looks like something like this [2]), and that gas plants are the marginal producer required to balance the market, as they are not baseload (nukes) and not intermittent (renewables) but are dispatchable (ramp up/down capacity as need to balance the market).
You can't base your electricity prices solely or even mostly on an unpredictable source of generation, which is nearly absent one day and generates more power than is needed on another day. Efficient storage is a long-term fix for this, but it ain't here. Natural gas is the most flexible source of on-demand power, so it (disproportionately even to its share of 1/3rd of all generated power) affects consumer electricity rates.
A couple possibilities. It could be competition from other countries with a different mix (e.g., the price in the UK has to compete with other countries or it'd be exported to the degree possible)
Power is also sold (ok, not sure about the UK) at the market price. So the most expensive generation needed to meet demand determines the market price. So even if gas is a small portion of the generation it could still determine the price.
