Why Green electricity follows the price of Brown electricity.

A better explanation of our recent price rise.

I recently wrote to all of our customers explaining that we needed to follow the recent price rises (of the Big Six) and why. In it I tried to provide a simple explanation of why green electricity prices go up when brown electricity prices do. I received a number of e-mails and letters from customers who had further questions about that and related issues.

I’ve spent the last few nights considering how best to approach this and writing what follows below - it’s a more detailed explanation of why our prices need to follow the market (for now). I hope in the process to better explain the way the electricity market works, how this affects what we do and at the same time cover the majority of questions asked.

Here we go...

Perhaps a bit too simple

In my letter I gave a simplified version of why we had to put our prices up to match the Big Six, which focussed on the fact that green and brown prices go up together. A number of our customers pointed out that they accepted this for energy from the market but Ecotricity self-generates 30% of its own energy from windmills. A good point.

The letter required a simplified explanation of things because for one thing most people don’t want the nth degree of detail and for another we had just the one sheet of paper to work with (ideally) and a lot of other information to include. All letters require some form of compromise on detail.

Here, I’ve no such constraints. Best be seated with a cup of tea when you tackle this...

Types of questions asked

I had e-mails from both New Energy and New Energy Plus customers, with the same question at their heart.

A number of our New Energy customers read the price rise letter and said “OK we get that green and brown electricity prices go up together, but 30% of our electricity (the green part) is self-generated from the wind, why has the price of that gone up?” and that’s a very fair question (the answer to which is coming).

Other customers said “I’m on your 100% tariff (New Energy Plus) so why are my prices going up at all?” I tried to be clear about this in the price rise letter - basically green and brown prices go up together, just because it’s green doesn't make it immune to price rises - if it comes from the market it’s linked to the price of brown. And for our 100% tariff - 70% of the green comes from the market. That’s further explained below.

In the market - there’s only one price for electricity

For both of our tariffs, 70% of the electricity we supply to you comes from the market - with New Energy, the 70% is brown electricity and with New Energy Plus the 70% is green electricity.

The first thing I want to try and make clear is that this 70% - in both cases - goes up and down with the market price. It absolutely does, there’s nothing we can do about that - and the reasons are that the market sets the price for electricity at one level - green or brown, coal, gas, oil or nuclear - it doesn’t matter where it comes from or what it costs to produce (and they all have different costs to produce) - there’s only one price to buy.

When you buy green electricity what you actually do is buy non-descript (brown in reality) electricity from the market and you buy something called a REGO to go with it. A REGO is Renewable Energy Guarantee of Origin certificate - something that is issued to generators for each unit of green they produce and which is used to ensure that greenness is only sold once - it’s a European-wide standard. And it works.

This is important to understand. The market sets one price for electricity, be it from coal, oil, gas, nuclear or green - there’s one price only. To buy green, you buy electricity and add a REGO, or you buy electricity with a REGO - either way you pay a brown price for the electricity and a price for the REGO - it’s the same end result.

So for the 70% that we top up our New Energy tariff from the brown market, we pay the market price and for the 70% we top up New Energy Plus from the ‘green market’ we pay the market price - and there’s nothing we can do about it. With New Energy Plus we also pay 0.5p per unit, which is the premium on this tariff - for the REGO. This makes the 70% top up green.

That’s my first point. 70% of our power, whichever tariff you may be on with us, is linked absolutely to market prices.

What about the electricity we generate ourselves?

Leaving the very good question that a number of customers have asked “so what about the 30% green electricity that Ecotricity generates itself, why does that become more expensive?” It’s an excellent question.

And this is where the simplified explanation in my letter (the O level version?) falls over - we need the A level version. For that we have to dive into the complexities of energy trading. Here we go -

Our price policy and promise is to match the price of brown energy from the Big Six. In that we think we’ve got a simple and fair position. Green for the price of brown and our total commitment to new build thrown in. We also assume that we can operate within the margins the Big Six set for themselves, we set ourselves the goal to do that, and invest those record amounts in new build at the same time.

But there are several costs that we bear that the Big Six don’t, because of their size and their purchasing power. There are other costs we bear when supplying our own green electricity, that are additional to the cost of supplying brown electricity. Two basic areas where we lose out when matching their price.

Hedging

The first is about ability to purchase power ahead of time - it’s called hedging. We reckon most of the Big Six are hedged between six and twelve months forwards. This means that when the market price for electricity goes up, they are largely unaffected for a period of time - I’d guess a good six months. And this is borne out to some degree by the delays we see between wholesale (market) prices going up and then retail (Big Six) prices following. I think they move while they still have some hedged myself, and this may be supported by the reported rise in profits that often accompany a rise in retail prices - that the Big Six say are ‘only’ to match their purchasing costs - there’s an overlap basically.

But there’s a lag too, from our point of view.

To buy energy on the forward market and therefore fix the price you need large sums of cash unless you have a top credit rating (which all the Big Six have). As a small independent you need cash. You also need cash to pay security deposits for the costs of transmission and distribution and for the costs of balancing (more on that in the second category here) - in short you need a lot of cash tied up. The fact is small independents cannot hedge to the extent that the Big Six can and do. So when market prices rise our costs rise more quickly, because we buy from the market much more immediately than the Big Six do. Six months later maybe, the Big Six put their prices up and we follow. Our costs are now better matched by our sales prices but for six months we’ve been losing significantly.

That’s how it works in a rising market. Our prices, because of our policy to match the Big Six, only go up months after our costs have done so, and when I said in that letter that we would have had to put our prices up soon if the Big Six hadn’t - I absolutely meant it.

The need to balance.

The second category of costs we absorb, that don't exist for the Big Six and their brown tariffs (the prices of which we match) are the costs of supplying green electricity. These are essentially costs of balancing.

The wind of course blows when it does, and stops when it stops. That’s the nature of wind energy. Across the whole grid it’s no big deal, there’s plenty of supply and demand movement to smooth things out. But as a supplier we have to balance what our customers take from the grid, with what we put into the grid - every half hour of every day of the year.

When we fail to balance, and it’s inevitable for all suppliers but more so for small ones (that’s due to statistics and the error probabilities of large and small data sets - plus the added issue of variable wind), we find ourselves in the ‘balancing market’ which is the market of last resort - it’s also a penalty market. You either buy (if you have too little) or sell (if you have too much) at very bad prices.

We all take electricity when we want it, night or day, whatever the weather. We take that for granted. But wind energy is intermittent and is far harder to match to customer demand - almost impossible. So we buy and sell (our wind and our imbalance) through the short term (or ‘prompt’) market and through the balancing market. When our electricity goes through either market like this two things happen - suddenly there’s a link to the market price (from something we generated ourselves and should in simple theory be immune to that) and there’s a ‘buy sell spread’ that we are exposed to (like when you buy or sell currency for your holiday) as well as the balancing penalty which can be very significant. And the higher the market price the higher the penalties, they travel together. And therefore the ‘price’ of our own green electricity is suddenly hitched to the market price. And we have increased costs.

So, there’s two areas where our costs are bigger than the Big Six and both impact our ability to separate the price of our own green electricity from the market price.

The absolute truth

This is the best I can do to explain how things work. I’ve been in electricity for over ten years. It’s the most complex thing I’ve ever been involved in and I’m not sure I fully get it yet.

But I promise you all when I say we need to match Big Six prices to carry on doing what we do. I’m telling you the absolute truth. We’re not profiteering in any way whatsoever. Our margins this year will be worse than last for sure, we currently estimate 30% lower. But we will carry on, matching the brown price, working within (and below) the margins the Big Six get - and spending record amounts building new sources of green electricity. I still think that’s a great achievement.

And one day, when we have sufficient of our own green electricity (a much higher proportion) and when we have a way to better handle balancing costs (we have plans for generation side management to smooth the peaks and troughs) - we will be able to detach ourselves from the brown prices of the Big Six and from the market and give our customers a discount for their green electricity. That’s our intention. We will at that time be cheaper than the Big Six.

I hope this explanation gives a better insight into the many factors we wrestle with every day to bring you green electricity and continual investment in new green sources - and of course electricity when you want it. And a better insight into our plans for the future.

I hope this explanation won’t be taken as overly complex - I’ve tried to be thorough. To nail this issue.

Cheers.

Dale Vince
Founder - Ecotricity

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