Monday, March 6, 2017


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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