House
of Lords Select Committee on Economic Affairs. The Price of Power. Reforming the
Electricity Market. February 2017.
The HoL Select Committee report
on the electricity market is a serious document that deserves discussion on
several counts, and I intend to examine over a number of blogs whether the
Committee has really grasped the extent to which market paradigms for the
sector are changing. One of the many elements deserving discussion is its
comparison of electricity prices and the international context. Two significant
features are the comparison of electricity prices for large industrial
consumers, and the alleged implication of flawed energy policies in the
comparatively high prices observed for the UK.
An overstated problem. High
prices for large energy users.
The Committee was clearly
subjected to some intensive lobbying on this subject, but remained intelligently
agnostic on the extent to which industry was badly affected, and on the
familiar issue of carbon leakage. In an earlier blog I quoted
“It’s a lament that rarely holds up under examination
of the facts. All too often, these complaints are part of a lobbying campaign
that is essentially political. And when that’s not the case, we usually find
there’s a lot of money at stake in industries that are reluctant to invest in
adjusting to future challenges. And even when corporate leaders know that these
investments are necessary, a majority of them still believe the cost should be
paid by the taxpayer. That leads them to threaten using their deadliest weapon,
the threat of job cuts and the relocation abroad of their factories and
production operations.”
This
might have been an opinion put in evidence to the Committee as a remark about
UK lobbying. Or it might have been a response to a recent Donald Trump attack
on the supposedly high costs of US industry. In fact the context is the
competitiveness of European and especially German industry in relation to a low
energy cost USA, and was written by a former German environment minister in 2014. The tendency of energy intensive industry to
blame energy markets and lobby for lower prices is a universal one.
The complaint by European industry lobbyists, that
energy costs are putting them at a “destructive” competitive disadvantage,
simply doesn’t stand up to scrutiny. Industry lobbyists will say either that the
costs of labour are too high, or that their big problem is the price of energy.
America’s historically low gas prices are at present the cause of yet more
European moaning.
The facts show how wrong they are. Energy costs
account on average for less than 3% of gross production costs in Germany,
whereas staffing costs account for about 20%. Even if you look at shares of
gross value creation, the energy costs don’t exceed the 10% mark. Yet,
industrial lobbies and trade associations continue to prophesy the end of the
Western world.
The
House of Lords agnosticism is fully justified in respect of their questions
about loss of industrial capacity in the UK and energy costs as a possible
cause.
But UK prices really are
higher
The report does highlight a
real divergence in UK prices. There is, unfortunately, a flaw in its choice of comparative
statistics however which significantly impacts the comparisons. The latest
statistics quoted in the report are for the first half of 2016 (H1). The 23rd
June referendum resulted in a depreciation of the UK currency by up to 20%
against other currencies, and this is not expected to reverse any time soon.
This has a corresponding effect on any price comparisons relevant to the
present and immediate future. It is prima facie larger than any of the supposed
disadvantages imposed by low carbon policies. Moreover this depreciation makes
the UK substantially more competitive across a range of costs, including labour
and other locally incurred costs, which are a much higher proportion of total
costs, even for energy intensive industries.
Even if the report exaggerates
current divergences, it is useful to highlight just how much higher UK prices
are (for large industry at least) by international standards. The UK has been a world leader in liberalised
market reform, and notwithstanding some of the implications of the report, has
arguably continued to maintain an aggressively market and competition-based approach.
So if one has confidence in the
superiority of the basic UK market model, then why should its prices, of which
the wholesale cost component is the largest part, been so far out of line? Other
EU countries have been slow and incomplete in following the example of UK liberalisation,
but this does not seem to have damaged their “competitiveness”. This ought to
caution against an uncritical acceptance of the assumptions of a liberalised
market ideology in the power sector.
The Committee attempts to pin
the blame on excessive UK devotion to a low carbon objective, but this does not
really hold water, as much of the evidence shows. Robert Gross of Imperial
College is rather scathing on this point.[1] Moreover while the UK may
have made mistakes in promoting renewable energies, it is hardly alone in this.
Germany is usually quoted as a fine example of how not to do it. The French
achieved a much lower carbon footprint much earlier, at very low cost, without
the benefit of a liberalised market and with a monolithic state-run power
sector. Again this is an inconvenient truth for an ideological approach to
energy policy.
A better understanding of UK comparative
costs really would be a worthwhile exercise for the Committee. There are numerous
other explanations that are a priori plausible. They are not considered,
and play less well with the Committee’s predilection for blaming low carbon policies and small
government.
Without prejudice to what some
good research might uncover, and in addition to the many well-known
difficulties of international data comparisons, I would suggest examining the
following possibilities:
- whether the UK has lesser natural endowments in power generation resources; it does not benefit from ownership of French nuclear or Norwegian hydro. Moreover compared to many EU countries it has less interconnection and hence less market access to low cost production elsewhere.
- some other countries have substantial implicit or concealed subsidies that impact on industrial energy prices; Germany for example has a long tradition of cross-subsidising industry.
- the effect of different market and regulatory conditions, and whether generation in other countries benefits from a lower cost of capital; what is particularly important in this respect is the degree of regulatory and policy security offered to investors (the report touches on this but only in a UK context)
- the operation of market forces in a UK system that is approaching supply/demand balance or “tight” capacity. More purist advocates of “free” energy only markets argue that high “scarcity” market prices are a necessary part of inducing investment, and that a capacity market is per se an unwanted intrusion by government. Higher prices, on this reading of the market, are simply part of the market process that is necessary to induce new investment. But market fundamentalists rarely emphasise this point in public debate.
[1] Robert Gross of UKERC and Imperial
College Why
we can’t afford to move post truth in energy policy
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