Fairness, Subsidy and feed-in tariffs

Estimates from the Royal Academy of Engineering of the costs of generating electricity using different technologies in units are pence per kilowatt-hour. The blue section is the raw cost including the capital required to build new plant but not to decommission the plant at the end of its life. The green section shows the effect of a 20% increase in carbon fuel prices. The purple section shows the cost of running back up plant to cope with the intermittent nature of wind generation. And the red section shows the costs paying £30 for each ton of carbon dioxide emitted.

The decision by the Government to cut the feed-in tariffs for domestic solar photovoltaic (PV) installations has evoked cries of pain from the installation ‘industry’. Personally, I think the government acted precipitously, but that given the general state of the economy, the subsidy was probably unnecessarily generous. I am sure a compromise of an extended deadline or a gradual reduction in subsidy will permit an increase in installed Solar PV systems, while avoiding the ‘gold rush’ mentality seen in 2011.

On the graph of generating costs at the top of this page, Solar PV electricity at 43 pence per unit would be off the scale – 6 times more than the most expensive way to generate electricity in bulk (offshore wind). The proposal is to reduce the subsidy to 21 pence per unit, still off the scale above, but probably enough to keep the installation rate moving along. But wait a minute:

  • Why are we paying people so much to generate electricity?

As I thought about this, I realised that in order to answer the question I needed to understand how the UK produces and distributes electricity.

Since privatisation, the UK has had a complex electricity ‘market’ operating in a way which is almost invisible to everyday users. Like all markets it consists of ‘buyers’ and ‘sellers’. The ‘buyers’ promise to supply electricity to our homes and business at a fixed price, and the ‘sellers’ (or generators) promise to provide a particular amount of electricity at a particular time at a particular price. A buyer will in general purchase electricity in several contracts – some bulk purchases ‘at a discount’ and some ‘spot’ purchases sold at a premium at times of greatest demand. For all its byzantine opacity – this system has been responsible for supplying electricity without interruption for more than 20 years. However, the market is not very sensitive to the environmental (and political) requirement to produce low-carbon electricity.

In practice, it is much cheaper to make electricity from fossil fuel sources than from renewable or nuclear sources. The exact difference in cost depends on exactly what is included in the final sum (see the figure at the head of the article) and in general has a significant margin of error. Cost estimates for nuclear power in the data above do not include the cost of cleaning up the old power stations. And similarly, the price of gas and coal generation (currently responsible for ≈65% of UK electricity) does not include the cost of ‘cleaning up’ the carbon mess – mitigating or adapting to the effects of climate change and sea level rise. In principle, the EU Emissions trading scheme should automatically add a cost to all large-scale carbon emitting processes, but to put it charitably, the market is not operating efficiently.

So because the ‘market’ has failed to appropriately apportion costs to the different generating technologies, we need to explicitly subsidise technologies with low carbon dioxide emissions. Since customers always pay in the end, that means we need to charge people more for electricity than they would otherwise pay. Libertarians object and say that this ‘skews the market’ and the Daily Mail will object that this is ‘making poor people pay more’. Both these things are true, but both are  – in my opinion – desirable. Here is my case:

  • ‘Skewing the market’ towards low-carbon electricity is a great thing and we should be collectively proud that we have chosen to do this.
  • Times are hard and we don’t want to spend money on things which don’t actually work. But the truth is that generating electricity renewably is dramatically harder than using fossil fuels. And although we don’t want to spend more than we need to – the cost of new plant and technology has to come from somewhere.
  • Compared with other plant, Solar PV has almost zero maintenance cost – but charging a feed-in tariff encourages people to keep the panels operational. It also encourages investment in the best quality panels which will give best return on investment. And it is technology neutral: if a new technology performs better than silicon it will displace silicon PV panels.
  • Recovering the cost of the tariff by charging more for electricity is fair  – that way the people that use most electricity pay most.
  • The feed-in tariff paid to people with Solar PV panels is just one kind of subsidy.
    • We pay similar positive subsidies to wind energy providers, and although I don’t know what they are, I am sure  the government are essentially guaranteeing the return on investment for companies that want to build any kind of new power station.
    • But we also have negative subsidies, – real costs caused by carbon dioxide emissions which we avoid charging to the polluters. A carbon tax on emissions could in principle level the playing field but we don’t yet have an effective carbon taxation system.

So to answer my own question, the reason we are paying people to generate electricity in this expensive manner is because offering an explicit subsidy compensates for the uncharged costs of generating electricity from fossil fuels. So the ‘skewing of the market is designed to compensate for a pre-existing distortion in the energy market. At least that’s how I see it.

This is a link to the short and readable  Royal Academy of Engineering Report from which I generated the graph at the head of the page.

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