Ed Birkett is a Senior Research Fellow at Policy Exchange.
The backbench Local Electricity Bill, supported by a cross-party group of 281 MPs, is due to have its Second Reading on Friday. The Bill would make it easier to set up “local energy suppliers” to compete with existing, national energy suppliers.
Local suppliers would supply electricity from renewable energy projects to customers in the same area. Last week, the Bill’s co-sponsor, Selaine Saxby MP, set out the potential benefits of the Bill in an article for ConservativeHome.
The Government is not currently planning to support the Bill, arguing that it would distort the wider energy market by favouring small-scale projects, which could ultimately increase the cost of Net Zero and raise energy bills.
Its proponents are right that local projects can contribute more to the UK’s energy supply. However, in its current form, the Local Electricity Bill actually risks raising energy bills.
There is a better way for the MPs backing the Bill to achieve their aims. Instead of local energy suppliers, the Bill should focus on “local electricity pricing”, something that former Energy Secretary Andrea Leadsom has previously called for on this website.
The Local Electricity Bill could have unintended consequences, raising energy bills. It would amend the Electricity Act 1989 by introducing a new class of “local electricity suppliers”, which would only serve customers within a geographical area. The regulator Ofgem would be required to make local licenses as “simple and straightforward” as possible.
It is not exactly clear how these local licenses would work, but it looks like the Bill attempts to exempt local suppliers from certain costs and regulations.
There are two possible unintended consequences of the Bill, both of which could increase energy bills.
Firstly, there are good reasons why it is expensive to set up an energy supplier. Suppliers have to buy energy in advance (known as “hedging”) and to hold cash in reserve in case prices go up. If suppliers don’t hedge enough or don’t hold enough cash in reserve, then they will fail when wholesale energy prices go up. This is what has happened this year.
When suppliers fail, they often leave behind large bills, which are socialised and recovered through higher bills for all customers. By one estimate, the recent collapse of Bulb and other energy suppliers could increase bills by £120 per household.
Given these recent failures, Ofgem is rightly looking at strengthening the financial requirements that it imposes on suppliers, as central banks did with the banks following the 2008 financial crisis.
Local energy suppliers would likely face similar financial risks to traditional suppliers, just at a smaller scale. If local suppliers were exempt from certain regulations, then these suppliers would be more likely to run out of money during periods of high energy prices.
Secondly, around one-third of the average energy bill is set by the Government and Ofgem.
For example, the Government requires suppliers to install smart meters and insulation in their customers’ homes, as well as giving discounts to low-income customers. In addition, Ofgem sets the charges that suppliers pay to use the electricity grid, known as “network charges”. These costs are all recovered through customer bills.
If local suppliers were exempt from any of these costs, then they should be able to offer lower prices or fund more new renewable energy projects. However, the electricity network will still need to be maintained and smart meters will still need to be installed. To make up the shortfall, other customers would have to pay more.
As currently drafted, the Local Electricity Bill looks like it will divert money to small-scale generators by raising energy bills for everyone else. It’s therefore not surprising that the Government doesn’t currently support the Bill, especially at a time when energy bills are rising sharply.
Here are two ways to improve the Bill.
Firstly, the Bill should not include the concept of “local energy suppliers”. Even without local suppliers, the Bill can still support small-scale energy projects. Local banks are not exempt from financial stability rules. Similarly, local energy suppliers should not be exempt from important regulations that aim to ensure financial stability in the energy sector.
We should also remember that local energy companies can exist within the current regulations.
For example, a local energy company can join forces with an existing licensed supplier to sell energy to customers in a geographical area, as the Mayor of London has done. This model, known as “white labelling”, does not require the local energy company to obtain a Supply License.
Alternatively, local groups can set up energy companies that install solar panels on local rooftops and deliver chargepoints for electric vehicles, as Hackney Council has done. Again, this model does not require a Supply License.
Secondly, the Bill should back “local electricity pricing”.
Under local pricing, the wholesale price of electricity would rise and fall in each area based on local supply and demand. Generators would receive different prices depending on their location. Depending on how local pricing is implemented, households would still pay the same price for their energy regardless of where they live. For example, generators could receive a local price whereas customers could pay the average national price, as happens in Italy.
Local electricity pricing would reward local projects that make financial sense, reducing energy prices overall.
We know that this approach works in other markets. Many jurisdictions have already introduced local pricing in their wholesale electricity markets, including some parts of the United States, New Zealand and Singapore. Local pricing is also likely to reduce bills here. Modelling for Policy Exchange found that introducing local pricing in Great Britain could reduce energy bills in by two billion pounds per year.
By focusing on local pricing, the Bill’s proponents would also give the Government and industry confidence that they only want local projects to be rewarded for the value that they create. This would reduce suspicions that they actually want a subsidy for all small-scale projects on the grounds that locally-produced electricity is somehow inherently better than that produced by large-scale nuclear power stations or offshore wind farms.
There are other areas where the Government could do more to support community energy projects. For example, the Government could allow groups of smaller projects to enter the “Contracts for Difference” auctions, which are currently only open to larger projects. However, these issues are best tackled separately to the Local Electricity Bill.
Local electricity pricing can support community energy projects and reduce energy bills.
The aims of the Local Electricity Bill are the right ones. Whilst most of our future electricity supply is likely to come from large-scale nuclear power stations, offshore wind farms and gas-fired power stations, smaller projects can make an important contribution to delivering low-cost, secure and low-carbon electricity. The current market rules don’t properly reward smaller generators for their contribution.
However, the Local Electricity Bill, as currently written, risks unintended consequences that would increase energy bills for all customers.
Instead of creating local suppliers, MPs backing the bill should focus on “local pricing”. With local pricing, community energy projects will receive a fair price that could be high but could also be low, which is how a competitive energy market should work.
At a time of high and rising energy prices, the potential for unintended consequences inherent in this Bill are a risk not worth taking. Individuals and local energy companies should be free to build community energy projects – but these projects should not be funded by higher bills for the rest of us.