Flex appeal

Achieving net zero carbon emissions means rapid deployment of renewables like wind and solar. As how we generate electricity evolves, so must how we use it. Fundamentally, the task is to move from an electricity system which is customer-led, with big, regional power stations ramping up and down at will to meet fluctuating demand, to one in which demand is more responsive to supply. The aim must be to do so in a cost-effective way that doesn’t pile the cost onto unsuspecting families, who are already struggling to cope with the high cost of energy. How to achieve that is the focus of this paper.

The key to delivering the electricity system we need is to increase consumer flexibility

The Government, the Climate Change Committee and the National Energy System Operator are all agreed that this means adding ‘flexibility’ to the system. That is, greater capacity for energy consumers to shift their demand at particular times, or from a particular location. Because estimates suggest that such flexibility could take up to £18 billion a year in current prices off the cost of the electricity system by 2040, the benefits of these changes are worth striving for.

Much of the benefits of flexibility will be industrial use, which will account for two thirds of electricity use by 2030. But to avoid high electricity prices – induced by the need to ‘overbuild’ the system, so it can accommodate high peak demand and transport electricity further distances – we also need households to do their bit. That will require exposing more families to the true costs of their energy use, which varies by time and place, so they are incentivised to flex energy use themselves. This inevitably means transferring more risk to households. So finding a path to a flexible system which protects families while minimising electricity prices is the key to success. To date, little focus has been paid to how the journey will affect families, especially those on lower incomes who feel energy price changes most keenly.

An important first step is to allow wholesale electricity prices to vary by location, but doing so comes with risks that will need to be addressed

Generating and supplying electricity has different costs in different places, reflecting local supply and demand and the costs of transporting energy. This issue is set to grow as we move towards renewables, which are geographically dispersed.

For the most part, this spatial variation is not reflected in wholesale (and certainly not retail) prices, leading to inefficiencies and higher bills. Constraints on moving electricity to where it’s needed – e.g. from wind-rich areas in Scotland to power-hungry English cities – could see us wasting (or ‘curtailing’) as much as a tenth of national electricity use by 2030 (31 terawatt hours), forcing us to switch on generation elsewhere (likely high-cost gas) to make up the shortfall. Doing nothing is a high-cost option. Curtailing such huge amounts of power could cost £3 billion a year in current prices, pushing up household bills.

There are plans to bolster the transmission network to address this: the National Energy System Operator has outlined plans to spend £58 billion upgrading the backbone of our electricity system by 2035. This would affect families, especially as the current approach is to recoup such costs through standing charges on energy bills – so there are considerable benefits from adopting a zonal pricing system (which varies retail and wholesale prices by region) that reduces transmission costs, as the Government is considering.

But moving to zonal pricing comes with some extra risks which will need to be managed, even if it would ultimately make the system cheaper to run. At a time of high investment need it is important to be mindful of the risk that reforming markets could increase uncertainty and so push up the cost of borrowing for energy generators. So if zonal pricing threatens the viability of investments in our energy system, the Government may be able to use GB Energy (for example through structured guarantees) as a vehicle to reduces the costs of uncertainty for investors. Another key risk with this approach is that prices may spike in parts of the country where electricity generation is more expensive. This can be addressed by shielding households by averaging domestic energy unit costs across regions, as is the case in Italy.

Families who are able to shift their energy use away from peak times should do so…

Delivering a low-cost, low-carbon electricity system will require households to flex their energy use across time to smooth through periods when energy is abundant and periods when it is not. That’s because the cost of delivering electricity at peak times (particularly between 4.30pm and 8.00pm, when residential and commercial demand overlap) is, on average, twice as high as other times of the day, meaning we have to use the most expensive generation types. And the best way to ease pressure on peak times is to incentivise energy use when it is cheap and disincentivise it at peak times through tariffs where the price of electricity varies through the day.

As a purely practical matter, however, families may find it difficult to shift their energy use significantly. This is partly because peak hours are when households are returning from work and cooking dinner: the proportion of adults away from home halves during peak hours, which also cover over half of all time that adults spend cooking. These are not schedules that households can reasonably shift. But it is also because current technologies do little to facilitate this. What are often referred to as ‘flexible appliances’ – essentially ‘white goods’ found in many homes – offer only a very limited ability to shift energy use through time. For example, shifting all dishwasher usage outside of peak times would save the average household just £30 a year.

But looking ahead, continued adoption of greener technology will mean some families have much more scope to shift their energy use. EVs are expected to account for almost three quarters of new capacity to shift energy use by 2030. Owners of key technologies could shift their energy use fairly easily, and stand to benefit most from doing so due to their high energy demand (£120 a year for typical EV owners). They also impose the biggest extra pressures on the system if allowed to continue with high peak use, inflating bills for everyone else: electric vehicles (EVs) and electric heating are set to be the main drivers behind a 40 per cent increase in residential electricity use by 2035.

This points towards a policy framework that leads to more energy-intensive, but potentially highly flexible, households facing the true cost of peak-time electricity. This might seem harsh, but those who own EVs stand to make a lot of savings from moving to a time-of-use tariff. Of course, there will always be some who don’t engage actively, but owners of flexible technologies are on average richer – we estimate that 30 per cent of EV owners will be in the top income quintile in 2030 – and so there should be relatively few concerns about the impact on vulnerable households. Variable tariffs could reduce the cost of running the electricity system by up to £14 billion a year by 2040 in current prices, equivalent to taking 3 pence (or 13 per cent) off the price of a kWh of electricity. Targeting those with the most to contribute would help to ensure that benefits also flow to the 86 per cent of the poorest households not expected to own an EV by 2030, in the form of passive bill savings as a cheaper system brings prices down.

…but again the Government must be careful in its approach to minimise the risks to households

Increasing the take-up of variable tariffs would be a significant change, given that only 2 per cent of households are currently on such tariffs. And it is one that must be done carefully given that energy bills are one of the largest non-housing outlays facing families.

The first-best option would be to put all with an EV onto a variable price tariff. But such an approach is unlikely to be possible, as energy companies can’t identify with certainty who is using them. For example, around two-thirds of new cars sold in 2024 were fleet and therefore registered to a commercial entity rather than an individual.

One way around this issue would be to use a household’s annual use of electricity as a proxy for EV ownership and set a usage limit above which suppliers would no longer have to offer a fixed price cap tariff, with variable pricing the default alternative covering all electricity demand. A reasonable limit would be five megawatt hours of electricity per year: this is almost double the current typical household consumption, but lower than typical consumption of a household with an electric car covering 7,500 miles per year (a mileage achieved by 38 per cent of drivers, covering 56 per cent of mileage).

But such a cut-off would also affect some families that have very high levels of electricity use without an electric car. We estimate that a 5 MWh usage cap would see a tenth of households in England impacted based on their current (non-EV) use. These 2.5 million households include 12 per cent of low-income households, a third of families with five or more members, and a huge four-fifths (79 per cent) of those with electric-resistive heating.

Not all of these households would see financial downsides to variable pricing: we estimate that it would have cost 29 per cent less to heat a home with electric resistive heating on a variable price tariff than under the price cap in 2024, even without changing behaviour, as most heating demand is already outside the peak times. But these are just averages. Given that it is very challenging to distinguish between households that are vulnerable high users of electricity, and those that are well positioned to shift their energy use, removing the protection of the current Ofgem price cap from all high energy users risks hitting lower-income families hard.

To get around this, a new Ofgem-regulated ‘time-of-use tariff’ should be introduced. This would force suppliers to offer a tariff that has higher prices at peak times than off-peak times, but where these prices are capped. This would create a regulated middle ground between the current price cap and fully exposing all high-energy users to volatile half-hourly prices.

Policy makers must get serious about changing how energy retail markets work to deliver cheaper bills

Splitting our energy market into zones across the UK, and a widespread shift to variable tariffs that change throughout the day are both big changes. But combined they would improve the efficiency of the energy system, cut emissions and reduce bills. The potential upside of both these changes has been pegged at up to £18 billion by 2040: equivalent to 4 pence off the price of a kWh of electricity by 2040, worth £200 per household on average. So if we get the balance right and expose households to price signals while maintaining adequate consumer protection, reform can ease the cost of living while also making a big contribution to achieving the Government’s net zero commitments.