By John Kemp
LONDON, Feb 19 (Reuters) - "Cripplingly high power costs are forcing some of Britain's heavy manufacturers to shut down their entire operation at peak times, with furnaces cooling and workers shivering in cold, darkened offices," according to an article in Wednesday's Financial Times.
"It costs us 27 pounds (about $45) to boil the kettle. We end up telling our workers to sit in the mess room together to keep warm, because we can't afford to keep going," Tony Pedder, chairman of Sheffield Forgemasters, a heavy engineering firm, complained.
Energy-intensive British businesses are curtailing their operations for as many as 20 or 30 days each winter between 4 pm and 6 pm to cut their power bills, part of an energy system which steelmakers describe as "third world". ("UK factories shut down to avoid high power costs" Feb 18)
In fact, the market is working exactly as intended. High prices are rationing scarce capacity on the transmission network by encouraging the heaviest users to shift as much consumption as possible away from peak hours.
And in future, smaller businesses and residential users are also likely to face some form of time-dependent pricing. It is all part of an effort to keep bills down by making more efficient use of the network.
Steelmaker SSI complained to the Financial Times that cutting power use at peak times "is not only a disruption to our operations but also a significant cost to the business".
But without those power reductions, Britain would need to build lots of additional power stations and transmission lines, which would only be used on a few hours each year.
The cost would have to be recovered either from energy intensive users, in which case it would be astronomically high, or smeared across all bills, in which case residential customers would end up subsidising steelmakers' peak-time electricity use.
Energy-intensive users may not like the current pricing system, but it is a rational reflection of the costs they impose on the transmission and generation system, and there is no reason to change it.
120 HOURS A YEAR
In contrast to the United States, where peak electricity demand is generally driven by air conditioning and occurs on summer afternoons, Britain's electricity network is most stretched on early evenings in the winter between November and February.
Demand is heaviest between 5 pm and 6 pm, or more broadly between 4 pm and 7 pm. Schools, shops, offices and factories are still open, the street lightning has come on, and at least some people have returned home, switched on the heating and started to prepare the evening meal.
The entire generation and transmission system is planned around meeting demand on these few hours (just 120 hours out of a total of 8,760 in a year).
It is a fundamental principle of pricing power, as well as most other goods and services, that the price each customer pays should be related to the marginal cost of supplying them.
In the case of electricity, the marginal cost largely depends on the amount of power used on those 120 hours.
National Grid, Britain's transmission operator, uses a formula to calculate the marginal cost for large consumers.
It identifies the three half-hour periods between November and February on which total demand was highest, separated from each other by at least 10 days.
Each energy user is then charged based on how much power it consumed in those periods, known as "triads".
The full list of triad dates and times since 1990/91 is published on National Grid's website. ()
Triad dates are calculated retrospectively, once the winter is over, which leads some firms to try to game the system by guessing which days are likely to be declared triads and reducing their consumption to secure a lower bill.
If a day is forecast to be unusually cold and comes at least 10 days since the last really cold day, there is a good chance a triad will be declared.
Cost-conscious businesses might order staff not to boil the kettle during this time or even shut down their operations altogether to save power. The cost and inconvenience is more than offset by savings from lower charges throughout the rest of the year.
Of course, if the next day turns out to be even colder, the likely triad date will shift, and the need for conservation will be repeated. This is why some companies complain they have to keep shutting down on so many winter evenings and complain their tariffs are based on the amount of energy they use on arbitrary dates.
At first glance, the triad system makes no sense, but a more careful analysis shows that it is in fact highly rational.
First, the system applies only to the heaviest energy consumers - those whose electricity use is metered and charged on a half-hourly basis - who put the most pressure on the grid at peak times.
If these users continued to run their furnaces and operations as normal through the worst of the winter cold, the country would risk running out of power.
If energy-intensive customers did not save power, the grid might have to ration supplies to offices, schools, shops and homes. As a last resort, the grid would have to order regional distributors to forcibly disconnect some small customers.
For the furnaces to stay on, lights might have to go off.
Second, triad charges apply only to the cost of using the transmission network, not to the cost of generating the power.
Since these users are relatively small in number but put most pressure on the network, it is reasonable to ask them to pay individual transmission charges based on their consumption during peak periods.
Smaller customers also pay transmission charges related to the triads, but these are aggregated and hidden within the quarterly bill.
Finally, the triad system is not as arbitrary as its critics claim. No one knows when the system might be most stretched during the winter. It depends on cold it gets, how dark it is, whether the day happens to be a weekday, weekend or public holiday, and whether one or more large power stations in the south of England is unavailable.
To safeguard supplies, the grid operator needs all customers to conserve as much power as possible between 4 pm and 7 pm on winter evenings.
Steelmakers are not the only ones actively managing their power use. Many office buildings ramp up their heating systems before 4 pm, then ramp them down until 7 pm, to heat offices as much as possible before the peak occurs and minimise power consumption during the most congested and expensive period.
By flattening out the demand profile - raising off-peak and lowering on-peak consumption - the triad system makes more efficient use of generation and transmission assets. The rationale is exactly the same as on-peak/off-peak pricing on trains and aircraft, which is uncontroversial.
For the time being, there is no way to encourage ordinary residential customers to save electricity during the winter peak hours, since most do not have half-hourly meters installed.
But the new generation of "smart meters", which will be rolled out to households by 2020, will permit half-hourly metering and by extension half-hourly charging.
Within a decade, residential customers are likely to be confronted with incentives to encourage them to think about whether they really need to boil the kettle, cook the evening meal or run the dishwasher before 7 pm, or whether they can wait.