Electricity cost puzzles

Alan Ahearne in his post on the recent National Competitiveness Council report draws attention to the high electricity costs in Ireland relative to our trading partners documented in the report. Malore in his/her comment on Alan’s post suggested some reasons for this. These and other reasons are further explored in the Sustainable Energy Ireland 2008 report Understanding Electricity and Gas Prices in Ireland.

To this list we should note the cost of the Public Service Obligation which is a levy introduced in January 2003 related to the purchase of electricity from peat-fired stations in the midlands. A 2005 Department of Enterprise, Trade and Employment consultation paper put the average annual cost of this levy in its first three years of operation at €74 million annually, and estimated that it contributed 4% to the electricity bills of medium and large-scale commercial/industrial customers.

With higher oil prices in 2006 through 2008, the cost of the peat levy fell to €2.7 million in 2007 and was zero in 2008 (Commission for Energy Regulation, 2008). However, Tuohy et al (2008) from the UCD Electricity Research Centre calculate that it may be reasonable to assume that the annual public cost of support for peat generation is of the order of €60 million per annum. If we are required to purchase carbon credits to meet our EU burden-sharing obligations for the first Kyoto compliance period 2008-2012, then the social cost might be even higher (although the peat-fired stations were grand-fathered permits for a high proportion of their emissions under the EU ETS, pricing is supposed to reflect the cost of carbon so that there is an incentive to consumers to change their behaviour, but I am not sure about the extent to which this has occurred).

Richard Tol in his comment goes on to suggest that more competition in electricity supply would help to drive down prices. Certainly, greater interconnection with the liberalised markets elsewhere in Europe would help and two new interconnectors with the North and Wales respectively should be in use by 2012. He is supported in this argument by the DETE paper above which calls for the price-fixing power of the ESB to be eliminated and suggests various reforms to this end.

What puzzles me, however, is that Irish electricity costs were not always particularly high relative to our trading partners. In fact, a chart (figure 3) in the DETE paper shows that electricity prices for industrial users in Ireland were well below those paid in the EU-15 for most of the 1990s, and were still no higher on average than in the rest of the EU-15 in 2002-2004. Yet in 2008 Ireland was the second most expensive country for industrial users in the EU-15. According to IBEC, Irish companies have seen industrial electricity prices rise by 70% since 2000.

It may, of course, be sheer coincidence that liberalisation of the Irish electricity market began in 2000 with partial market opening and achieved full market opening in February 2005, a period which saw the beginning of the dramatic increase in electricity prices. There was also a sharp increase in transmission investment from around €30 million annually in the 1990s to around €100 million annually in the 2000s.

Nonetheless, questions remain. Were prices allowed to rise to ensure that there was a profitable market for new entrants? If the ESB is an inefficient generator of electricity and prices have risen as a result, why does a market with the second highest electricity price in the EU not attract private competitors? While in a market with a dominant supplier, there could be a temptation for new entrants to price-to-market rather than compete aggressively for market share, current rules (limits on the ESB’s capacity to generate and sell additional electricity on its own account) would seem to incentivise new entrants to price efficiently to capture market share. Whatever the reason, liberalisation of the Irish electricity market does not appear to have brought lower prices to consumers.

Incidently, Richard in a further comment suggests that energy costs are a relatively minor cost in production, less than 2% on average and more than 10% of costs for a handful of companies only. These figures are broadly supported by the DETE paper. However, percentages can be much higher for service sectors where the DETE paper (based on 2001 data when electricity prices were relatively much lower) reports electricity expenditure shares only (i.e. less than total energy) of total cost at 5% for R&D enterprises, 6% for retail trade and 9% for hotels and restaurants.

7 thoughts on “Electricity cost puzzles”

  1. Alan, two links below which might interest you in relation to competition and investment in the grid.

    http://www.cer.ie/en/information-centre-newsroom.aspx?article=c25a1f5a-0f5e-4be3-a47f-d968145284e8&mode=author

    http://www.eirgrid.com/EirgridPortal/uploads/Announcements/EirGrid%20GRID25.pdf

    Its a sorry coincidence that the introduction of competition into the Irish market through new entrants and coupling with the North (Single Electricity Market) also saw fossil fuel prices reach all time historic highs. There is no getting away from the fact that our heavy reliance on these fuels for generation has led to our high electricity costs (Section 2.2 Table 1 of the SEI).

    And yes the solutions – (1) More renewable energy on the grid, wind being essentially free to generate will presumably push down the market price and (2) Greater interconnection with the UK and European partners.

  2. The fuel costs of wind are indeed zero. The capital costs are not. Without subsidies, wind barely competes — even in Ireland where the climate is favourable and other electricity is dear. Wind also has negative externalities for other power generators, first and foremost in its demand for reserves but perhaps also in higher cycling costs.

  3. The sources of excess electricity costs in Ireland are numerous and will not be addressed by shooting for the world’s highest levels of wind penetration. They include uneconomic peat generation, excess cost in ESB powergen as documented in the Deloitte report (on Dept Energy’s website), excess concentration in powergen, failure to take the natural monopoly transmission and distribution businesses out of ESB, etc etc.
    The fact that, as Richard Tol points out in an earlier post, energy costs are a small cost item for most businesses is beside the point – we need to eliminate excess cost, however small.
    As for wind penetration targets, there is only one question worth asking – is the Government’s very high target justifiable as a component in the least-cost abatement strategy?

  4. There are a number of factors affecting what is happening to electricity prices in Ireland relative to our EU competitors. One of the most important is that demand for electricity in Ireland has risen considerably over the last twenty years. By contrast demand has shown little growth elsewhere over the same period. For many other EU countries the last decade has, asa result, seen excess electricity generating capacity. This has meant that there has been a tendency to price at short-run marginal cost. Much of the generating capacity in countries such as the UK, France or Germany is already fully depreciated.

    For Ireland, because of the need to maintain a high level of investment, it is correct to price at long-run marginal cost. This is reflected in the structure of the Single Electricity Market. The half-hourly price reflects the short-run marginal cost. Firms are then remunerated for their capital costs through capcity payments. The combination of the two elements of remuneration for generators means that they should be paid roughly the long-run marginal cost of electricity.

    Change is coming elsehwere in Europe as existing plant ages and needs to be replaced. Also the rising cost of carbon and other EU regulations will mean that electricity prices will probably have to rise elsewhere. There is a real concern that the sclerotic planning process in GB and regulatory uncertainty could see GB undersupplied in the coming decade. Many coal stations will have to close through old age or failure to meet environmental standards. If the lights are not to go off in GB investors will have to be incentivised to provide new capacity – prices will have to reflect the long-run marginal cost.

    This could have implications for Ireland once there is a higher level of interconnection to the UK. Already there have been significant flows of power to the GB market, reflecting the fact that prices some of the time were higher there. With enhanced interconnections, a failure by GB to provide adequate capacity could be good for Irish generators, but bad for Irish consumers.

    The issue of the public service obligation for peat and its cost for consumers has been correctly identified as a factor in higher prices in earlier years. With high oil and gas prices in the past year peat, when the plants were actually available, was probably temporarily profitable. However, with a rising cost of carbon they should be let fade out as and when they prove more costly than the alternatives.

    On wind, so far it has probably proved good for consumers. Because it has zero marginal cost, in an uncertain world where future prices of fuel are unknowable, a significant weighting of wind in a generation portfolio can reduce risk . In addition, with a rising cost of carbon wind should enjoy a further advantage. The jury is still out on what the optimal share of wind is in the system. However, it is certainly higher than it is today.

    The lack of competition is not a very significant factor in determining the wholesale price of electricity. However, where lack of competition and resulting excess costs are a serious factor is in the development and operation of the distribution and transmission system. As we have previously argued (See Aspects of Irish Energy Policy – ESRI, 2005) what is needed is a move by the ESB to contract out much of its work to subcontractors who would compete on price. Such a move would bring competitive pressures on the natural monopoly elements of the electricity system.

    It is noteworthy that labour costs are very high in the utilities sector relative to other sectors with similar levels of human capital. To some extent this is true in other countries. Nonetheless, increased competition in provision of services to the ESB could do much to reduce these costs in the long run.

  5. There is little or no place for peat in a competitive electricity market. There is little or no place for some of the practices at the ESB in a competitive labour market.

  6. Apologies for posting a year after the event. It’s a little ironic that this post was posted the same day that a new entrant into the market began trading!

    There a major issue when we compare electricity prices casually across european nations – a casual analysis would imply that Irish electricity prices are actually rather competitive. Adjust for the presence of a capacity market however, and the picture is distorted considerably.

    As for peat – the fact remains is that despite the rationale that as an indigenous source of energy it deserves a place as part of the portfolio, it really has no place. You need to do some significant massaging of your market models (negligible carbon prices, high brent and gas) to get them to dispatch at all! But then again, depending on the time horizon, some would say the same for wind – but apparently 40% penetration is the right thing to do…

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