GOVERNMENTS CAN NO MORE STAND
BACK FROM SYSTEMIC FAILURES IN THE ENERGY SECTOR THAN THEY CAN IN MONEY,
BANKING AND FINANCE.
Recognition of the limitations
of the market in the energy sector is rapidly becoming universal. The Comment
in today’s FT by Martin Wolf, possibly the most widely respected economic
commentator in the UK, hammers this point home. The immediate focus of Wolf’s
article is the Hinkley decision, but his arguments have a much wider
resonance. For the energy sector, and the power sector in particular, the
problems (and the market failures) run even deeper than those for infrastructure
projects in other sectors. And governments can no more stand back from systemic
failures in the energy sector than they can in money, banking and finance.
……….
“This
decision had to be taken by government. No competitive market process would
have reached such a decision or even been allowed to reach such a decision. …. But if government or its agencies are to take
such decisions, they must also take them well. … Regulatory regimes must be designed to
address the complex attributes of sectors with significant externalities.
Decisions in such sectors are often very lumpy and politically difficult. They
cannot — and will not — be left to decentralised market processes.” [Martin
Wolf. FT. 16th September 2016]
This is an excellent summary
of what I have argued at greater length in the page on low carbon power.
The essential feature of infrastructure, from the perspective of any private or
institutional investor, is that the asset is immobile, has few or no
alternative uses, and depends on revenue streams over a long period. Moreover infrastructure
usually relates to essential services whose management and conduct is subject
to various forms of policy and regulatory intervention. It is no accident that
the historical development of public utilities has been strongly associated
with regulated monopoly, which protects the utility as much as the consumer,
with vertical integration, and with long term contracts and government guarantees.
These all offer the investor some protection against political or regulatory
opportunism, and the temptations to expropriate the investment once the costs
have been sunk.
In addition the power sector
has some particular market failures of its own. The case for and value of almost
all low carbon investment stems from its contribution to reducing emissions and
hence limiting the damage of climate change. In the continuing absence of
effective and reliable means of pricing CO2 at levels consistent with the
policy imperatives of mitigating climate change, there is no way that any
private investor can capture this value from any of the existing market
processes.
Supply security might in
principle be susceptible to a “market” solution, but the NETA reforms in 2000
effectively removed the previous mechanisms that had been designed to
incentivise new capacity. Energy only wholesale markets, essentially the
lynchpin of current market structures, cannot reward capacity properly, and
their weakness is reinforced by the increasing proportion of plant on the
system at zero marginal cost. Capacity markets may be part of the solution, but
these have to be implemented by some party, the government or its agent, who
can specify how much is required and then monitor, control and pay for its
delivery.
Existing markets were largely
designed by and for fossil fuel fuel generators, the CEGB and its successor
companies. They depend on the particular technical and economic features of
fossil generation – flexibility, and fuel driven marginal costs – to replicate
the merit order in a market driven optimisation of plant scheduling and
dispatch. The conditions for this to work successfully cease to apply in
situations with more complex technical constraints, such as plant
inflexibilities (nuclear) and intermittency (solar or wind).
And of course there are also
the many questions linked to the operation of complex transmission and distribution
networks, to the influence of external sources such as interconnection, to the
use of storage technologies and to the much closer engagement of consumers
within future systems. We should also add the strong possibility that technical
factors, especially around renewable technologies and storage, will lead to a
power sector with much more decentralised operations and decision taking,
alongside a continuing need for large scale transmission and interconnection.
Identifying the need for some central
and strategic decision making is just the first step. Improving the quality of
those decisions, and their execution, is vital. There is a strong case for an
agency at arms length from government, and hence more removed from political
pressures. It is also easier to build the essential technical and commercial expertise
within such a body than within a government department.
The wisdom of the Hinkley decision itself is a more controversial question. Entities such as the Committee
on Climate Change or the Energy Technologies Institute, charged with examining approaches
the UK’s low carbon targets, tend to positions that assume significant components
of nuclear or carbon capture. There may have
been serious questions for EdF around the choice of Hinkley technology, and for
the UK government around the negotiation of the price, but, assuming delivery, there
is no hard evidence that this is a bad deal. The frequent comparison with
current wholesale prices is largely irrelevant since it is quite clear that
these are unsustainable as the basis for rewarding investment in a future low
carbon power system. The government process may not have been impressive, and
it may be quite seriously sub-optimal, but it has at least now made a pressing
decision, and we should hope that the Hinkley venture is as successful as the
French nuclear programme of the 1980s.
The wider questions, looking
beyond Hinkley, are around what institutional changes may be required, in order
to exploit rapidly changing technology options, implement the policy
imperatives of sustainability and security, and make effective use of markets.
All this is calling for a new “system architecture”, a comprehensive re-think
of the way the sector is regulated, new market designs, and how networks are
managed at local, national and trans-national levels. Expect to hear a lot more
about system architecture!
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