Friday, May 24, 2019


There is a good case for more central direction and control for the power sector but many of  Labour’s proposals are either muddled or counter-productive.

The Labour Party is talking about plans to renationalise the Grid. The UK power sector certainly has some major problems. The utilities themselves, and current market arrangements, are neither popular with the public nor particularly effective in delivering on key policy objectives, especially on reducing the UK carbon footprint.  The institutions of the sector do indeed need a serious overhaul, but the emphasis of Labour proposals distracts from more fundamental issues that surround the difficult task of decarbonising the UK economy, and overcoming the failings of the liberalised electricity market. We need a better discussion.

The Labour party has unveiled plans to take the National Grid back into public ownership, with the stated intention of providing a correction to alleged excesses of asset stripping and profiteering at the consumers’ expense, and making the power sector more responsive to social and environmental objectives. One headline grabbing feature of the proposals has been to suggest that shareholders would receive less than full market value in compensation. Another important component has been proposals to assist poorer households with the installation of solar panels, simultaneously enabling them to cut their electricity bills and reduce overall power sector emissions of CO2.

The background is that National Grid is responsible for the nationwide transmission network, and transmission per se only accounts for around 10% or less of consumer bills. However, the Labour proposals extend to the much larger distribution networks and the aggregate of all the “wires” business is much larger, amounting to around 30% or more of domestic consumer bills. The tariffs that pass on these network costs to suppliers and consumers are regulated by OFGEM. The regulator’s main remit is to allow the network companies to make a fair, but not excessive return, on their assets, while at the same time encouraging efficiency and ensuring a high quality service.

Excess profits? If this is a problem it is easily cured within the existing regulatory framework.

OFGEM is a technically competent body and has 30 years experience in regulating tariffs. So, although private companies may always be seeking to outwit the regulatory regime and squeeze a little extra revenue, it would be surprising if large excess profits were a major issue[1]. If this were so, it should be a comparatively easy matter to tighten OFGEM’s regulatory regime. It’s also worth noting that the original 1990 privatisation is generally considered to have brought down network costs, although this was not the biggest source of cost reductions[2] for the sector as a whole.  The structure of the tariffs through which these costs are recovered is also an important but separate separate matter and one which we address briefly below.

National Grid currently discharges its main functions very competently, so proposals appearing to punish this part of the power industry may seem perverse and unnecessary. Proposals to confiscate part of the value of what are already closely regulated assets are particularly dangerous. If pursued, this could undermine the financial standing and credibility of the entire sector, as well as the borrowing capability of government itself. A serious unintended consequence would be to deter investment in the UK power sector. Raising the cost of either private or public capital, not just for the grid but for the whole sector, would make it harder for an increasingly capital intensive sector to maintain supplies to consumers at an affordable price.

Labour has also ignored some of the manifest weaknesses in supply competition[3], which in many respects is a more obvious failure to serve the consumer effectively.  It is far from clear that competition has been of any net benefit to consumers as a whole. The supply function per se adds little in the way of value, but supply margins have increased significantly[4] while there is little or no differentiation in the quality of service that suppliers provide, little or no innovation in tariffs, and consumer prices have to cover the additional marketing costs incurred by the supply companies.

There is however a very strong case, as Labour suggests, for using the grid and network companies as part of an intervention to promote environmental and low carbon policies.

There are good reasons for concern that markets as currently organised have some manifest failings in relation to environmental objectives. These are described in more depth on the Low Carbon Power page, but the main considerations are the following.

1.    There is a need to support investment that is a necessary component of decarbonisation strategy but cannot be delivered by the private sector in a market environment that continues to under-price the true environmental and social costs of CO2 emissions. A National Grid charged with an obligation to deliver national low carbon objectives could provide the mechanism and the expertise to remedy this. At present all low carbon generation investment depends on government support (through feed in tariffs or long term contracts) but government lacks the expertise to do this effectively.

2.    The need for coordination of choices made in transmission and generation investment is greatly increased in systems based on renewable or low carbon investment, in order to balance types of generation with different operating characteristics, storage and demand side response from consumers. An interesting illustration is the need for diversity in contracting for offshore wind power. Capacity auctions will most likely induce bids from the  most obviously attractive sites in terms of cost and output (site conditions and available wind), but solutions that work best will depend on selection of a diversity of sites that are not closely correlated in terms of weather. Market structures will not easily resolve these choices, but the Grid is ideally positioned to do so.

3.    Current consumer tariffs are quite dysfunctional in failing to provide the right economic incentives for low carbon. They fail to reflect incremental costs in ways which can penalise low carbon initiatives for consumers (such as domestic heat pumps) and arguably over-incentivise other forms of consumer investment, including solar. Getting the right economic signals in tariffs is particularly important in a future in which we envisage a much bigger role for various forms of decentralised energy provision. These arguments are discussed more fully in a recent blog[5] and report[6] commissioned by Energy Systems Catapult, but one possible resolution could be based on the transfer of supply responsibilities to the local distribution companies, who would have a much more explicit duty to encourage decarbonisation of the sector, very much in line with Labour’s stated objectives.

The essential point is that the National Grid, and the other network companies, will need to play a vital role in resolving these issues. Nationalisation need not be the only means to that end, with alternatives including the mandating of low carbon targets, or new statutory duties. But significant policy direction, and significant government support for low carbon investment, are likely to be essential components of any solution.

Labour is failing to make its case well

Labour has so far failed to make the comprehensive case that can be made for a more powerful National Grid, or for reform of the distribution and supply of power.  It has instead chosen to focus on greatly expanding the use of solar panels. This may please the solar lobby, and could indeed be part of a sensible overall strategy for the sector, but it is prima facie questionable to risk over-promoting solar power.  For the UK at least, solar power is counter- seasonal.  Solar output is highest in summer, but energy demand is highest in winter. This implies difficult technical judgements that an organisation like the Grid is better placed to make than either politicians or civil servants.

There are some strong arguments that opposition parties should be making, but they do need to do some better technical analysis, and avoid simplistic solutions that look attractive but fail to address the real problems.

[1] The structure of the tariffs through which these costs are recovered is a separate matter and one which we start to address later.
[2] Much more significant was the move away from British coal, towards coal imports and later towards gas as an alternative fuel. The second factor was in part coincidental with the rise of new technology in the form of combined cycle gas turbines.
[3] These were extensively criticised in the 2012 IPPR reportThe true cost of energy: How competition and efficiency in the energy supply market impact on consumers' bills. Much of this analysis remains valid.
[4] The Monopolies and Mergers Commission report on Scottish Hydro in 1994, before introduction of competition in energy supply, considered that 0.5 per cent was an adequate margin for regulated energy supply. Recent margins have been as much as 4.0% or higher.

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