Every six weeks Andrew Sissons - director, sustainable future - assesses the most important signals and trends underpinning the UK’s energy transition. Andrew is a specialist in climate change and economic growth, as a previous chief economist of the Environment Agency and civil servant in the Cabinet Office.

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In the last energy edit, I wrote about how to lower the underlying cost of electricity, including by reducing the fixed costs of the electricity system and leaning more into flexibility.

There is one major tension these issues throw up that I deliberately ignored: the growing attractiveness of going off-grid for electricity. For many households and businesses, it is often possible to significantly cut energy bills by generating their own electricity, avoiding the fixed costs of the electricity grid.

But this leaves those who remain on-grid potentially worse off. This is because many fixed costs associated with running our electricity system - such as the cost of running and upgrading the electricity grid itself - are spread across consumers’ and businesses’ electricity bills. If more people move off-grid, there are fewer ‘on-grid’ bill payers to spread these costs between.

This is becoming one of the thorniest issues in the electricity system, so I’ve set out some thoughts on how we might resolve it in today’s newsletter.

Going off-grid is becoming more attractive

I recently wrote a short paper on Britain’s high industrial electricity costs, and how to lower them. One of the most important options, which has received too little attention from policymakers, is to help businesses manage their energy use more effectively. That includes helping them negotiate better contracts and taking advantage of flexibility, but for many businesses it also includes generating and/or storing their own electricity.

Generating-your-own is an attractive option for any business that has the space, capital and permission to do so. Solar panels are of course now incredibly cheap – any electricity-using business with a large roof not already covered in solar panels has probably made a mistake somewhere. But there are other forms of micro-generation besides solar, even including diesel generators and private gas power plants. Businesses can, in the right circumstances, create their own micro-grids, generating electricity from a range of sources. Adam Bell wrote a fascinating, provocative piece last year on how this microgrid approach could become a mainstream option for many businesses.

Households are also beginning to do a similar thing at scale. Rooftop solar is finally taking off again after its government-induced bust in 2016 (as the chart below shows), and the UK government is actively encouraging it, making a “rooftop revolution” the centrepiece of its Warm Homes Plan.

Most of these businesses and households, of course, retain access to the electricity grid. They can use their home-made power when the sun shines, but fall back on the grid when they need to.

This creates a problem for the grid: it still needs to provide a functioning connection to all users, with all the fixed costs that entails. However, it means selling less electricity to spread those fixed costs, as a big chunk of previously purchased electricity is generated off-grid. That means grid users who can’t generate their own energy paying more for their electricity – in turn making going off-grid even more attractive. That can become especially problematic if it is wealthier households who have the capital to opt out of the grid, while less affluent ones are left behind facing higher costs.

However, there are some important benefits to self-generation as well. Micro-generation can reduce pressure on the grid, especially in cases where electricity demand grows rapidly. For new energy-hungry industries, or households with EVs and heat pumps, micro-generation can help manage unexpected increases in demands on the grid, especially if accompanied by batteries.

Data centres are a central example of this. The growth in electricity demand from data centres has been rapid, and very hard to predict, which makes it very hard for the electricity grid to respond to. In fact, in some cases pressure from data centres has held up all development in whole areas, even before the AI boom. It makes a lot of sense to encourage new data centres to meet some or all of their electricity needs themselves, to ease the uncertainty for the grid.

Balancing the benefits and drawbacks of moving off-grid

So how could we strike the right balance between the benefits and costs of grid defections? The current status quo effectively enforces high prices on everyone, and needs to change. But how?

First, I would focus on encouraging micro-grids in specific places where they make sense. In clusters of energy-intensive industries, there is a strong economic case for enabling cheaper power by letting businesses do it themselves. Having dedicated zones where building clean power is easy and which operate outside the main electricity grid could go some way to resolving Britain’s industrial energy problems. It could, in effect, be a route to get some of the benefits of zonal pricing without rolling it out nationally.

Likewise, data centres should be encouraged – maybe even required – to generate their own as part of their development. Rather than subsidies on-grid power, as the current AI Growth Zones provide, data centres should be given expedited permission to build clean energy and storage on or near their sites. In return, they should offer waste heat to nearby buildings, becoming an important anchor for heat networks.

For households and rooftop solar, the goal should be to pair solar with batteries and with electrification, to use the extra electricity. If the “rooftop revolution” happens alongside a big rise in flexibility, storage and home electricity use, it will ultimately make the electricity grid stronger and bills lower. Increasing the amount of electricity we use will ultimately help us manage the fixed costs of the system, especially if we can minimise peaks.

The thorniest area, perhaps, is how we bill for electricity. Standing charges for electricity have increased dramatically since 2021 (see chart below) and do not help low income, low energy use households. A “falling block tariff” – where you pay more for using small amounts of electricity – is an obvious non-starter for the same reason. But loading costs on to electricity unit rates is only likely to make the problem of grid strikes worse.

In all likelihood, we will need to keep electricity standing charges, and possibly even increase them further, to make sure that users who only occasionally dip into the electricity grid pay their fair share of fixed costs. There may be ways to mitigate the impact on low income households though: for example, via a targeted standing charge rebate for those households most in need. In addition, there is a much stronger case for removing the gas standing charge for households, and pushing the costs on to gas unit rates. Having a standing charge for electricity but not gas may be the best way forward.

The other key solution to the off-grid problem lies in time of use tariffs. When self-generating electricity customers want to use the grid, it will usually be during times of constraint – so they will most likely pay high prices. When they are self-generating, electricity will probably be more abundant, and therefore should be cheaper for those who rely on the grid. The average cost of using the grid should then be lower for people who do it all the time than for those who only dip in occasionally. Getting most people on to time of use tariffs and using them effectively - alongside a continued standing charge - ought to be the best way to make the grid work for everyone.

While it may be tempting for policy makers to want to prevent people moving away from the electricity grid, this would be a mistake - self-generation is, after all, one of the great economic opportunities of renewables. The challenge is to make sure that the electricity grid remains fair and affordable at the same time. In an electrified, flexible energy system, it should be possible to prosper either on or off the grid.