Jan 25 2012
The Public Accounts Committee and the Consumers’ Association were right to raise the issue of the cost of ‘smart’ electricity meters, but by not stripping away the misinformation that surrounds smart meters, it fails to identify two issues that, in the long-term, are potentially of greater significance: their impact on low-income and vulnerable households and their implications for consumer competition between electricity suppliers.
What makes a smart meter different to other meters is that they are connected at all times to a central data collection point that not only allows consumption to be continuously recorded, but also allows electricity suppliers to send information in the opposite direction, for example, changing the electricity price whenever they like, so-called time-of-day pricing. All the other claimed benefits of smart meters, that they will do away with site meter readings and estimated bills, and that they allow consumers to monitor more carefully their consumption do not require smart meters and could be achieved by much simpler and almost certainly cheaper means.
The rationale for time-of-day pricing is that electricity demand is uneven and meeting demand peaks, which might need a power station to be started up to operate for only an hour, is expensive. If demand peaks could be shifted an hour or two to the next demand trough by delaying use of an appliance or peak demand destroyed by simply encouraging consumers to switch off appliances, there would be significant savings. Smart meters do already work well in industry, where companies are often happy to change their demand patterns in return for a share of the savings made by shifting demand. The much higher electricity bills paid by industry mean the cost of the meter is a much smaller proportion of the overall electricity bill.
However, for households, destroying demand rather than shifting it is likely to be the major contribution of smart meters. When smart meters are talked about, the example always given is that consumers would be able to do their washing in the middle of the night at much lower cost. The reason this example is always used is that washing machines and dishwashers are the two major applications where demand could actually be shifted. Whether consumers would be happy to have their sleep disturbed in the middle of the night by their washing machine kicking into action just to save a few pence on their electricity bill is not clear.
The first problems that arise are how do we know when the cost of meeting electricity demand could be significantly cut by reducing demand and what marker should be used to set the time-of-day consumer price? The obvious answer is the wholesale electricity price. However, despite more than 20 years of effort in Britain trying to make the wholesale electricity market work, the liquidity of the market traded at visible prices is very small, at most 1-2 per cent. The rest is traded via confidential, usually long-term contracts, at prices that bear no relationship to the spot market and are known only to the two parties to the contract. Relating the consumer price to such an unreliable price as the spot price in a market that the companies have already been found to have manipulated would be an open invitation to the electricity companies to game the market by boosting the spot price and hence their income from consumers.
The second issue concerns consumer competition. At present, the regulator and the government continually encourage consumers to switch electricity supplier frequently so they are always with the cheapest offer. But the information needed to do this is not perfect. We know what the companies charged yesterday, but not what they will charge tomorrow, which is what we really need to know, especially in times when prices change three or four times a year. But at least we have some price information. With time-of-day pricing, consumers will not know the electricity charge until the moment of consumption, so what basis do they have for choosing between suppliers?
The issue of welfare concerns the extent of price signals needed to get a response from consumers. The level of prices would have to be high to make people change their consumption. How many people would turn off their favourite television programme or delay running the dishwasher or put off their evening meal till 10PM just to save a few pence? However, if consumers saw a price of £1/kWh, they might. But what would low-income or vulnerable households do if they saw £1/kWh on their meter on a cold winter evening when they need electricity to survive. Some would turn everything off jeopardising their health while some would just continue to consume running up a bill that they could not afford, putting new demands on the social security system.
The problem of the cost of meeting peak demands is real, albeit significantly overstated. The last power station needed to meet a peak in demand might be very expensive to run, but when the costs are averaged over the whole of consumption, the increase in overall costs is quite small. It is because we have adopted a commodities model for the electricity market under which all those contributing to meeting electricity demand should be paid the amount paid to the most expensive producer that the cost of meeting peaks seems so high. Nevertheless, as the contribution to the electricity system of intermittent sources such as wind power increases, the pay-off from being able to influence demand will increase so is there a way in which smart meters could be used in a more acceptable way?
Two years ago, the government and the electricity regulator belatedly acknowledged that the efforts to make the wholesale electricity market work were doomed to failure. The proposals as to what will replace the market are still being developed under the Energy Market Reforms (EMR) proposals. However, it is clear that we will move to a planned system under which new plants will be contracted to some central entity so that the amount of power bought and sold in the market, either the spot market or the contracts market, will wither away leaving the spot market as explicitly what it has always implicitly been, a short-term marginal mechanism to balance supply and demand with little relevance to the price of electricity.
As this process proceeds, the basis for retail competition will be whittled away. Retailers will not be able to compete on their skills in buying wholesale power because they will increasingly be buying from a central entity, the charges for using the network are the same for all companies and with smart meters, they will not even be able to compete on their efficiency in reading meters. If the sacred cow of consumer choice was abandoned and retail electricity supply went back to being a regulated monopoly, would this provide an acceptable role for smart meters? The introduction of a planned generation system would mean that consumers would know peaks in wholesale prices reflected real costs, not just manipulation by the companies. Replacing retail competition with rigorously regulated tariffs would remove the suspicion that savings from smart meters would go to the companies as extra profits rather than to consumers. However, the issue of how to protect low-income and vulnerable consumers from the fear that high prices would cause would remain, but in a monopoly system, it would be possible to identify such consumers and keep them on standard fixed tariffs.
However, going back to a more regulated system would not get over the issue of cost of smart meters. The estimated cost of installing smart meters in all households is £12bn, so consumers would have to save, on average, about £500 per household to pay for the meters. These huge costs come not from the meters, which are little if any more expensive than other meters, but from the physical connection to the data point and the cost of processing the mass of data the meters produce.
Past experience of major IT systems in the electricity industry for systems like the wholesale market and the retail market is not good. Both came in at three or four times the forecast cost at about £1bn each. Smart meters would cost an order of magnitude more and if costs were not controlled better, the bill for consumers would be comparable to the bill for bailing out the banks. It is notable that those pushing hardest for these meters, the government and the electricity companies, are not willing to risk any of their money on the project although they will not be averse to capturing the benefits. If the regulator required that the cost of any over-runs or any failure to produce the benefits expected were to fall on the electricity companies or the government, smart meters would be forgotten overnight.
Getting out of this mess will require huge political courage. Government has already had to acknowledge, albeit very quietly, that the attempt to create a wholesale electricity market has failed. Admitting that retail competition was also a waste of money and that smart meters for small consumers will not deliver the benefits promised will be even more humiliating. The government will also have to persuade the European Commission, which has mandated the introduction of smart meters. The route through this may be tackling fuel poverty – households spending more than 10% of their income on heat and power. This has reached the shameful level of about a quarter of all households in Britain and with energy prices expected to continue to rise, this problem is going to get worse. If instead of spending £500 per household on a device of such dubious value, we spent, say, £2000 on the houses of those suffering from fuel poverty, we could get a double benefit of reducing energy demand and solving once and for all a major part of the problem of fuel poverty.
Professor Steve Thomas, Professor of Energy Studies, University of Greenwich.