Performance based regulation

We students are helping set up a little conference down in Falmouth in a months' time and as part of that we are coming up with content to help promote the conference. I've taken this opportunity (or kick up the backside) to write about something mentioned a few weeks ago but that hadn't yet looked into: Performance based regulation. A guest lecturer from the USA said it how effective it has been on occasions (for example, utilities go down street by street with new fridges and swap them then and there if people bring out their old one). We had discussions about the ramifications of this, namely placing no emphasis on individuals to do anything about their energy use (but currently do they understand the problem/have the money/ability to change, is climate change such a problem that taking control from people is necessary/allowable?) So anyway, here's what I wrote:


The UK has set itself some rather challenging targets with respect to climate change and energy use. But while it is set to meet its Kyoto target, it is failing at others, from renewable electricity generation to eliminating fuel poverty. Current policies seem to either not be working fast enough or just not working, so is a change of focus required? From the Low Carbon Buildings Programme to the Act on CO2 advertisements, emphasis is placed on the individual to change and reduce their energy use. Getting information to people and persuading them to take action is notoriously difficult, so is there another way?

Take for example the electricity market. Currently in the UK, electricity is sold per unit (a kWh). Perversely the first batch of units cost more than subsequent units as the utilities also look to make a return on those who consume relatively little. This has several problems:

• There is no disincentive for the consumer not to use more energy when costs don’t progressively increase.
• There is no incentive for utilities to sell less or energy efficiency to the consumer, as they make more money the more units they sell.
• Cost cutting in a competitive market can mean reductions in operating and maintenance budgets, with resulting impacts on network safety and performance. The difference between 1 blackout a year and none is disproportionately large and as consumers suffer the effects of blackouts while utilities pay the cost of maintenance, it is sometimes not in their best interests to be 100% reliable.
• The most profitable course of action is not related to what is the most socially beneficial or acceptable one. For example, users of pay as you go meters tend to be those on low incomes and use smaller amounts of energy, but they pay more per unit than standard users.

So are there alternatives?

In parts of the US, they moved to performance based regulation after privatisation of the gas and electricity sector. This regulation revolves around regulators setting a base rate for each utility to charge consumers, with performance based targets giving those companies the chance to make their profits (or losses) and governments the partial ability to aid social goals. Targets might include employee safety, system reliability, customer satisfaction, lower pollution etc. The benefits of this system include:

• Cheaper and more stable electricity prices to the consumer. The base rate shouldn’t include the utilities profit margin, as profits would come from the bonuses awarded by governments for meeting or exceeding performance targets, so electricity would be cheaper. Potentially the overall cost through bills and taxes might be similar if targets are met, but if so, society should still have benefited due to the nature of the targets.
• By not restricting the methods companies choose to reach the targets, innovation is less restrained which potentially results in cheaper methods of supply.
• Switching the focus of energy efficiency measures away from individuals to utilities could take advantage of utilities larger capital reserves and greater buying power to speed up deployment of these measures
• The issue where a landlord pays for energy efficiency measures but the tenant gets the cost savings is avoided if the utilities take charge.

Performance based regulation does have its own downsides as well.

• The effectiveness is very dependent on the quality of the targets, too lax and companies can make excess profits (as has happened on occasion in California) or not well thought out enough, resulting in targets being met in undesirable ways or being contradictory.
• The cost of regulation is higher due to the effort in creating base rates and targets and overseeing the authenticity of utilities actions.
• The need for individual action or even awareness of climate change and energy use is greatly reduced. In the long term does the lack of connection mean you don’t take care of the solar panels on your roof or stop conservation measures after a few months or would it inspire you to go further?
• Does it place too much importance on the role of utilities in society, if they supply our energy and also decide for themselves how best to meet certain social goals?
• Does it permit a culture where governments see fit to take a more authoritarian role? (like ID cards etc)

This alternative viewpoint does promote interesting thoughts, but considering we have already gone down a different regulatory path post-privatisation, realistically is it possible to change? And although in theory it might be a better option, in practise how effective would it be? Parallels can be drawn to the EU Emissions Trading Scheme which is in theory the most cost efficient manner to reduce emissions in industry, but the structure of the scheme and other external factors have meant the actual reductions are questionable. Therefore would it be better to take certain parts of performance based regulation, for example more schemes in the idea of the existing Carbon Emission Reduction Target and combine it with changing the existing system to charge units more progressively?

*After showing this to Catherine and Bridget they say that the current system in the UK does have a lot in common with PBR, with CERT and EEC before it, and various transmission and distribution performances among others, but that they are limited in scope. So you learn something new everyday.

Market knows best... but needs a hand sometimes

Thanks to Bridget for showing me this article in The Independent yesterday: Market forces must make way for interventionism, says Mandelson

(Strangely the Guardian's view on this story was little to do with a fundamental change in Government outlook, rather on the various "extra £2 billion on this and 3.5% decrease here".)

But anyway quotage time:

The document insists the Government will not "pick winners", opt for state ownership of industry, "override market forces or ignore market signals". Its new activism "does not imply a fundamental change in our view of the relationship between the market and the state.... However, the way the Government sees its own role in the market needs to change in order to deliver a more coherent and effective approach." This means "a readiness to intervene where necessary" by "supplementing" rather than "substituting itself for the market" and "correcting significant market failures."

...

While not denying Britain "the huge benefits of free enterprise," the Government recognises that the private sector "has important limits."

Typically Government opinion (and the directives of most regulators) has been to promote above all else, competition, in the belief that it is the most efficient method of production and as such the best method for increasing growth and reducing inequality in society. It may or may not be the best method, but the argument that Government can choose not to 'pick winners' seems inherently flawed. The Government creates the laws governing society and so creates the field in which the market operates, directly or indirectly this influences different aspects. For example for selling electricity on the market. Agreements between sellers and consumers are sorted out an hour before delivery and failure to supply the agreed amount results in having to pay for that shortfall to come from elsewhere, plus extras (even supplying a surplus can cost money). This is obviously a rather big drawback to many renewable energy sources who cannot guarantee their supply in an hours time.

There's nothing concrete on what the Government will do from now on so we shouldn't get carried away believing this is a paradigm shift, it's not improbable that this is merely substanceless spin based on a knee-jerk reaction to public opinion (although in fairness I don't recall seeing too many calls for more intervention or nationalisation). Nevertheless the act of saying this does represent a somewhat significant moment, even if it only meant badly needed extra financing during the recession for renewable energy etc.

Is peak oil really a problem?

Following on from what I said in my last blog about that things aren't always simple, well I forgot to say something else that's crucial. Always be open to ideas, because the scientific method is based upon furthering knowledge by proving ideas wrong. Intuition isn't perfect because if it was we wouldn't need to do any research as we'd know it already, and history repeatedly proves this point.

So I found this article rather interesting because, as the author says, it's generally held that as production of commodities (primarily oil) plateaus and then falls, price will rise and rise since the demand is likely to continue increasing. He states that rather than supply constricted, prices are demand led. OPEC has spare capacity of 5% plus which tempers some price fluctuation, as well as alternative sources take up some slack as the market sorts out its equilibrium again.

It's certainly an interesting read. It's given me some new ideas, but his main argument of there not being a large and continued price increase seems to be okay only in a free market where there are suitable alternatives available and in sufficient quantities. If the fall in oil production isn't matched by increased development of alternatives to compensate (in cost and capacity), then surely prices would rise (although perhaps offset slightly as people reduce consumption where not necessary).

The author says "demand for any commodity is price-elastic" but I would disagree, at least in the case of oil. Oil is rarely used in electricity generation, rather it contributes 98% or so (page 14) to the energy used in transport, and people will usually swallow oil prices rises because of the necessity of getting to work or doing the work (food distribution etc).

The various graphs on this website make for interesting reading as well, the average price has been $20-30 a barrel depending on what timescale you look at. Maybe the peaks are merely bubbles caused for one reason or another (wars, lack of confidence in the market, commercial squabbles, temporary lack of exploration investment?) rather than a sign of long term increases.

So do we think the future is rosy and we don't need to worry about it because the market will find the solutions, or do we need to press the government to make commitments to creating sustainable alternatives?