John is currently attached to the new ZERO Institute, Oxford. Recently with the Environmental Change Institute, and the Oxford Martin School Integrate programme. Former Chief Economist, UK Electricity Council.
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reported this week (FT, 12th December) that Andrew Wright, a senior
partner at OFGEM, had argued that Britain could be moving towards a two-tier
power market in which some households pay for reliability while their
neighbours “sit in the dark”. Ignoring for the moment the selective reporting of
a complex discussion, and a mildly hysterical media reaction to this
proposition, we need to recognise that the world is changing. Different tiers
of reliability, in which customers can choose their own combinations of price
and quality/availability, are now both technically feasible and advantageous to
consumers. There are deficiencies in current retail markets, so new formats for
the “consumer offering” are both necessary and desirable. They will give us
better control over our power systems and can even help with thorny problems
such as those of fuel poverty.
Possible supply failures in
which households “sit in the dark” are a source of nightmares for government
ministers and are seen, often correctly, as a sign of political failure. The
last national “black-outs” in the UK occurred in the 1970s with the miners’
strike and the 3-day week, resulting in political turmoil and the fall of a
government. But, historically and internationally the more common cause has
been either inability to plan for, or inability to finance, sufficient
generation capacity. The UK safety margin in generation is currently at a
historic low, so risk of failure is increasingly seen as real. Responsibility
for maintaining adequate supplies, within the current institutional
architecture, is largely left to the “market”, with a degree of oversight from
OFGEM.Some of these issues, and
instances of market failure, are spelled out in the page dealing with low carbon
But Andrew Wright has raised different
questions that deserve some very serious consideration, and go well beyond the
simple question of whether we currently have enough capacity in our power
system. They go to the heart of the ways in which consumers in future will and
should be able to purchase electricity. Reliability is an expensive commodity
and the idea of consumer choice over the standard of reliability required is
one that can only benefit consumers and the overall efficiency of power
systems. In most sectors of the economy the ability to choose combinations of
quality and price that suit a consumer’s needs is well established, and indeed
a normal characteristic of a vibrant market economy. An incidental benefit in
the power sector is provision of an additional instrument to improve overall
system reliability and, along with storage and interconnection, to assist in
managing future low carbon power systems with operational features that include
intermittency or inflexibility.
The changes that are coming
stem from technological developments in control and metering systems that were
considered futuristic in the 1970s, and were to a large extent inhibited by
deficiencies in the structures of the UK retail market, including the adoption
of load profiling. With load profiling, all consumers of a particular type are
assumed to have the same time profile in their consumption pattern, implying a homogenous
mix of peak/ non-peak, day/night and winter/summer loads. The supply business
is then essentially commoditised.All
suppliers provide the same product, with differentiation only on price. This
undermines, or rather excludes from the market, any competitive benefit from
offering consumers a truly differentiated service. Profiling inhibited UK
development of sophisticated metering and control systems and tariffs, arguably
for a generation.
The conventional utility model
has consumers able to treat electrical energy supply as “on tap”, with limited
or no differentiation between applications (e.g. as between lighting, heating
or mechanical power). Tariffs and prices for the most part approximate to an
averaging of the costs of supplying electricity, with very limited ability to
differentiate on grounds of differing incremental costs.
Technology change is now
forcing re-examination of this model and offers an opportunity to transform the
market.Just as new low carbon generation
and storage technologies, with very different operating characteristics and
cost structures, will force us to re-examine system operation and wholesale
markets, so should developments in metering, telecoms and control technologies
lead to re-examination of the way consumers use electricityand control their own usage, changing the whole nature of the
supply business. These developments have created an explosion of possibilities
in metering and service provision, including sophisticated metering or even
real time pricing, and sophisticated remote control of individual appliances. Given
the interactive nature of these possibilities, utilities need to consider how
end use should be incorporated into processes for the secure and efficient
operation of the system. Consumer behaviour, and consumer choice, will be
incorporated as a much more active element in the system.
What is needed is to redefine
the “consumer offering”, defining electricity as a set of services, rather than
a homogeneous commodity. This requires starting with a clean sheet in defining
the nature of the services that consumers will want, and the basis on which
they pay.So, for example, a consumer
wanting to charge electric vehicle (EV) batteries might request 75 kWh to be
delivered in a specified period, over (say) 60 minutes for “instant” service, over
several hours, overnight or over several days, and the consumer will pay for
his 75 kWh requirement to be met within the agreed time but with the supplier
choosing exactly when the charging takes place.Corresponding arrangements could apply to the purchase of power for
heat, for refrigeration, and some other uses, designed in each case to reflect the
nature of the load.Such services might
even be packaged with the provision of appropriate equipment (eg storage
heaters). Commitments to individual consumers would be made by energy service
companies who would be able to aggregate consumer requests and in turn contract
with network operators, for whom the flexibility would be an additional
instrument in maintaining a reliable and efficient system.
Implicit in all this is the
option to take electricity supply at varying levels of “reliability”.Most consumers will want 100% reliability for
lighting or the ability to watch “Strictly” live, and to continue to pay a
higher kWh price to get it. But many will be relatively indifferent to the
exact mode of operation of their storage heaters (as they are now), water
heaters, or EV battery charging. But in each case they will have a choice
between a higher price premium service with guaranteed instantaneous delivery, and
a lower price with delivery still guaranteed but with timing subject to some
For all households, but
perhaps particularly those struggling to meet their energy bills, this choice
can have a real value if, for major parts of their kWh consumption, they are no
longer forced to pay the full price for a “gold plated” concept of reliability
that they neither need nor want.
The development of
such schemes still requires a great deal of research and product design work
and public consultation, but Andrew Wright is to be congratulated on bringing
to our attention an idea which will be of increasing importance for 21st
century power systems.
The CALMU credit and load management unit was pioneered by Fielden and Peddie
(then an Area Board Chairman) in the 1980s, and has enjoyed worldwide success.
It died in the UK with privatisation and the adoption of profiling.
technology is becoming a hot topic for larger commercial consumers, and may soon
become a viable option for domestic consumers too. And National Grid is
contracting for battery storage as a back-up resource. But how batteries are best
deployed in today’s power networks is a complicated question. Today’s wholesale
markets and tariff structures are very imperfect and may be quite dysfunctional
in the world of fast moving technical change that includes communications and
control in power networks. Consumers investing in batteries to make or save
money are therefore advised to look carefully at the options, and the small
print in tariffs and contracts. There are opportunities, particularly in
wholesale markets and utility tariffs can change very quickly, and maintaining flexible
options is likely to be the wisest strategy for business consumers.
What led to this comment was a
request to talk on the subject of commercial opportunities at a recent energy
management exhibition (EMEX) held in
partnership with the Energy Managers Association. There is strong current
interest among commercial consumers, such as supermarket chains, in the
installation of banks of batteries. These can help to enhance security of
supply, but this is not a primary motive for a significant investment outlay.
Batteries are now proving to
be a valuable option for power systems, with several potentially useful
functions. These can include spreading national or aggregate system loads over
the day, providing emergency back-up and other ancillary services, and managing
thermal and voltage constraints in local distribution networks. A
two year trial of the largest grid-scale battery in Britain has proved it
can potentially transform the energy grid and play a major role in the
transition towards a low-carbon economy. The latest auction round for back-up
capacity is reported to involve procurement of 500 megawatts of new storage
The fact that batteries also have
significant value at the lower voltage levels of local distribution networks,
as well as in contributing to the management of aggregate demand and supply, is
very relevant since it means that the battery owner may want or need to have a
commercial relationship with both the National Grid and the local network
operator. It also suggests that, in relation to local networks, there may be a
premium on mobile batteries since load constraints on the network may occur in
different locations at different times.
Some new loads, such as
electric vehicles, are likely to further increase the need for batteries within
the control of the system operators, again both at national or system wide
levels and at key nodes within local networks. A good example is described in
experience described in an earlier comment.
commercial scale batteries operate in front of or behind the meter?
From a commercial consumer
perspective, the investment case for battery purchase and installation rests on
three possible sources of revenue or cost saving, arbitrage in the wholesale
market where there is regular opportunity to “buy cheap and sell dear”,
responding to use of network tariffs that are strongly differentiated by time
of day, and contracting directly with the network system operators.
Arbitraging wholesale markets.The risk in relying on trading in wholesale
markets is the volatility in prices from year to year. Wholesale prices are
expected to be high this winter, in early 2017, but this expectation is critically
dependent on capacity margins. Additional capacity or less than expected demand
growth can dramatically reduce prices and the opportunities for arbitrage. In
the medium term, it is increasingly likely that conventional wholesale market structures
and assumptions will be overturned in progress to a low carbon economy,
possibly reducing the importance of wholesale “spot” prices. Basing an investment
on the ability to exploit arbitrage opportunities needs to take account not
just of immediate market risk but also future structural change.
Exploiting distribution use of system
(DUoS) tariffs. Some published network tariffs are highly
differentiated by time of day, enabling consumers on these tariffs to make very
large savings if they are able to move their usage away from peak loading on
the local network, for example by using their own battery storage. In the case
of supermarkets this may also be possible by using a store of “cold” to reduce
their refrigeration load.
the key factor here is that these structures are often extremely imperfect economic
signals and are very crude devices to influence the shape of consumer loads. Exploiting
anomalies in the tariff structure is ultimately a zero sum game. Ultimately the
network operator is a utility that will
be allowed to earn a regulated rate of return. Its costs are composed mainly of
the fixed costs of the network, so the network utility will be forced either to
recover more revenue from other customers, (highly unpopular and subject to
regulatory intervention), or to rebalance the tariff to remove what may actually
be a distorting incentive. Again this is a commercial risk if this is the prime
motive for investment in batteries.
Contracting directly with the network
operator. Thisis a novel
developmentfor network operators
but, as shown in the recent auctions, it is a trend that is now under way. It
raises the more general question of whether it is more effective to have the
system operator managing batteries as facilities contracted from the battery
owner, or to try to manage the system through complex tariff structures which try
to second guess consumer behaviour. In the first case we might describe the
battery as “in front of the meter”, and in the second case “behind the meter”.
decision for the commercial consumer considering battery purchase, which of
course can also provide a small amount of extra security, would be to make this
investment as flexible as possible, to allow for direct contracting as well as
managing its own demand. In dealing with local networks, there might also be a case for making the batteries trailer
mounted, to allow further geographic mobility and to meet changing local
The institutional framework against
which investment decisions have to be made is critical to capital intensive
sectors such as power, and in consequence to promoting low carbon economies,
which in relative terms will often tend to be even more capital-intensive than
conventional thermal generation. Sound regulatory and market frameworks are therefore
a central concern for energy and GHG reduction policies. In the UK, for
example, one of the biggest single issues is getting infrastructure investment
against a background of policy uncertainty, one of the themes I have explored previously
in discussing low carbon
But worldwide there are also some
prior and even more pressing set of problems that can impact on the viability
and sustainability of the power sector. These relate to fundamentals of law and
good governance, and go to the heart of national political structures. The
corrosive nature of corruption and clientelism (sometimes defined in terms of
widespread patronage and the exchange of favours for votes) is a major
challenge for all political systems, but is perhaps particularly important when
there are serious resource constraints, and in the context of successful
economic development. This is therefore a big issue for many less developed
economies, which are of equal or greater importance to the achievement of a global
low carbon future.
electricity distribution sector is a national embarrassment, brought about by
decades of turning a blind eye to the misdemeanours of this sector. The
unholy trinity of the conniving State Electricity Board (SEB) employee, the
unethical and self-enriching domestic and industrial consumer and the
politician patronising theft, corruption, sloth and freebies has brought the
power sector to its knees.
Students of past performance of
many SEBs, with honourable exceptions, will be familiar with this harsh
judgement, with many of these criticisms confirmed in numerous World Bank
studies. High levels of illegal abstraction from distribution networks, tariffs
inadequate to allow SEBs to finance new capacity, and political patronage that
can view SEB management as a vehicle for distributing favours and jobs, are all
rife and in many instances both well documented and publicised. Unsurprisingly
many SEBs are in dire financial straits and are ill-equipped to support the
high levels of investment required to improve and increase access and supply,
let alone make the transformation to a low carbon economy.
The Indian power sector is an
important illustration, partly because a low carbon future for India is so
important to the world, partly because the power sector is intrinsically
crucial to this objective, and partly because the problems of India’s state
electricity boards (SEBs) have been widely acknowledged and openly discussed.
India is by no means unique in its lack of effective governance. Indeed the
open nature of Indian democracy means that the problems are at least recognised,
a first step to a possible resolution.
A recent article by Jacquelyn Pless
and Harrison Fell, “Bribes, bureaucracies, and blackouts: Towards understanding how
corruption at the firm level impacts electricity reliability”offers an interesting empirical example and
theoretical perspective for this discussion, pointing out that these
shortcomings in governance can also lead us to comparison with some familiar
problems of a common pooled resource such as fisheries.
The study addressed a particular form of corruption, using data from many
countries, and found empirically that firms with a propensity to bribe for
electricity connections experienced 14 more power outages per month and incur
22% greater losses as a percentage of annual sales due to power outages.
Propensity to bribe is closely
linked both to a perceived necessity for bribery (in order to get any power at
all), ie a resource constrained system, and to weak governance where bribery is
an effective, low risk and penalty-free option. Inevitably these include many
systems in developing countries with limited power generation resources
combined with weak governance and regulation. A simple example of the process
by which the reliability of the network is degraded is given below.
Imagine you are an investor in a
manufacturing plant invited to wait six months to connect a factory to the
electricity grid. The temptation is to bribe an employee of the local power
supplier to connect you next week. The bribe is a rational act and will benefit
your company, but we can assume that many other people will be doing the same
thing. Typically there is an actual or potential shortage of capacity in the
system, due to a lack of investment, itself a result of failure to collect
revenues that cover costs and of poor governance. This has frequently been true
of State Electricity Boards (SEBs) in India, power being a competence of
individual states rather than the federal government. Restricting new connections
is one of the means that the SEB is obliged to use to try to restrict demand to
a level that can be met with a reasonable degree of reliability. Unauthorised
connections will overburden the electrical grid, leading to a more vulnerable
system and less reliable power supplies for everyone.
In terms of impact, bribery to get
a connection is akin to theft, equivalent in its effect to the smaller scale
illegal “hook-ups” that are also commonplace. The company may subsequently pay
for actual kWh consumed (by no means certain) but this does not reduce its
immediate adverse impact. The fact that the SEB management is unable to control
connections, obtained by bribery or other illegal methods, means that it loses
control of system reliability. In other words a system that is open to corrupt
practices, or indeed to simple theft, will inevitably suffer either financially
or in terms of its ability to provide a reliable supply, or most likely both. It
has become a common pool resource for which no-one is prepared to pay to maintain
There is an interesting and broader
question of how to get to more socially efficient outcomes. Administrative
rationing, giving preference to incumbent consumers, is often the starting
point for electricity providers, given that they start from a position where
potential demand is greatly in excess of available supply, but may also be
economically inefficient. It also breaks down when subject to bribery and
corrupt practices. It has sometimes been argued that corruption is a form of
market pressure and can under some conditions improve social efficiency, by
allocating scarce supplies (of import licences or network connections for
example) to those who value them most highly.
Quite apart from any moral or
ethical objections to condoning rent seeking by corrupt officials, however, bribery
and corruption are by their very nature clandestine and non-transparent, and
are unlikely to be organised in a technically efficient manner, eg with transparent
markets or openly conducted competitive auctions. Our examples, and general
experience, suggest that corruption quickly gets out of control. World Bank economists have therefore preferred
to recommend solutions that focus on improving governance and enhancing the
financial capability of the sector, eg through cost reflective tariffs that
permit investment in increased supply.
The so-called Washington consensus
on economic reforms recognised the underlying problems but assumed that the
answer was markets and privatisation. In practice this approach has not lived
up to expectations, in no small measure because successful privatisation is
only possible when the basic elements of reform, including adequate tariff
levels and structures, and the depoliticisation of power sector management,
have already been achieved. Private sector management is in any case not immune
from corrupt practices in environments of weak governance.
I believe these will be continuing and
increasingly important issues within a global perspective on both economic
development and low carbon futures. Transparency, oversight, and enforcement of
high standards of sector governance will continue to be important objectives everywhere,
and they are closely tied to wider questions of political economy.
Fukuyama provides a thought provoking discussion of the general issue of
clientelism inPolitical Order and Political Decay: From the Industrial Revolution to
the Globalisation of Democracy, Farrar, Straus and Giroux. He also makes useful
distinctions between the closely related concepts of corruption, patronage and
clientelism. The book is also particularly interesting in its criticisms of the
USA, and reminds us that political systems are capable of decay as well as
improvement, with the ever present risk of reversion to clientelism in both
democratic and authoritarian societies
currently faces a tight supply situation through this winter, which may be
exacerbated by downtime on French nuclear plant and partial loss of capacity on
the submarine interconnector. National Grid as the system operator plays a key
role in keeping the lights on, by finding ways to manage these and other
unforeseen events, and balancing supply and demand in real time. It will also
face new challenges in managing generation supply that contains an increasing
proportion of renewable energy, with significant intermittency of supply. These
challenges increasingly emphasise the difficulties in separating the roles of a
transmission operator, managing and maintaining the high voltage network, and a
system operator, directing many aspects of the day to day business of power
generation. As I observed in an earlier comment, Low carbon network infrastructure. Not sufficient
arguments for breaking up National Grid.the
House of Commons Select Committee was ill advised to recommend the break-up of
National Grid on the grounds of an interpretation of regulatory theory that
addresses yesterday’s problems. Keeping these functions together implies that
the government has to address the problems of a difficult low carbon future,
not the outdated paradigms of the 1990s.
Three stories for the UK power sector came together in this
week’s FT, all focused on National Grid, who maintain the UK’s high voltage
long distance transmission network and also act as the system operator,
essentially controlling the operation of the UK’s generating plant in order to
maintain supply/demand balance and stability of power flows within the system.
The first story, National
Grid Powers up for a Renewables Future, describes how National Grid is refocusing
its business to cope with the challenges of renewables.
Some analysts believe we are on the verge of a
fragmentation of the power sector that will eventually lead to much more
emphasis on local power generation and battery storage, making the high voltage
grid redundant. I believe this extreme position is highly improbable, for two
main reasons. First, a very high proportion, at least of new low carbon sources
of power currently anticipated in most projections, is in sources of generation
that are intrinsically either large scale or remote from population centres.
This includes nuclear (excluding for the moment small modular reactors), carbon
capture (CCS) and large scale renewables such as offshore wind. These and
probably other options such as tidal lagoons, depend on access to long distance
transmission to make them viable.
Second, smaller local systems face much bigger balancing problems,
primarily because they lack diversity. Interconnection is therefore a
necessity. There may be some specific issues of network charging, if local
facilities believe local generation and lower “imports” allow them to escape
paying for the back-up services the local system needs, but it is not clear why
these issues should undermine the fundamentals of the National Grid business
It is true that the essentially intermittent nature of many
sources of renewable power will make the Grid’s job, as system operator, more
challenging. Viewed from this perspective even a system as large as the UK can
benefit from additional diversity and from the back-up potentially provided by
interconnection with other networks. This takes us to the second FT story, on
29 November, UK Grid
loses half the power from link to France.
Damage to the cable, possibly from a marine anchor, has temporarily
reduced the capacity of the link. Coinciding with some unanticipated downtime
on French nuclear plants, this increases the risk of a tight supply situation
this winter and a spike in short term market prices (one independent supplier
has already gone to the wall). The impact of this loss of capacity, on France
as well as the UK, emphasises the importance of interconnection for security of
supply, and also the role of the Grid.
This leads us to the third story, National
Grid to be spared from break-up, also on 27 November. The government has
sensibly rejected the recommendations of the Select Committee chaired by the
SNP’s Angus McNeil. As I argued in
an earlier comment, the drive
to a low carbon economy is going to bring profound changes to the power sector.
These start with questions of technology and scale but they have huge
ramifications, and conventional assumptions about markets, regulation and
governance are coming under increasing pressure. Given that governments lack
any technical competence in the power sector, the role of organisations like the
National Grid is becoming more and more important. Now is not the time to take the risks of disruptive organisational change for its own sake.
To embark on a
re-organisation of National Grid, in the absence of a clearer vision of where
we need to get to, and focusing on issues which in a sense are problems of the
old paradigm, may be a mistake. To do so without a clear direction of travel
will simply add to the policy uncertainties already identified as a major
problem for new investment.
Record global temperatures and unusually high Arctic temperatures, in particular, are starting to suggest some scary scenarios for the world’s climate, including the notorious “tipping points” which can accelerate the rate of change. This is a time when we need the best possible understanding of what is happening to the planet, not least because it can help preparations for a dangerous future. But US climate science, hitherto one of the most important sources of understanding, is threatened with budget cuts. This was predictable in the context of anti-science climate denial rhetoric but there have been signs that Trump, at least on this issue, is rowing back from his extreme positions and threats to scrap the Paris agreement. So now is not the time to cut back on the research that helps to anticipate the real global and regional threats that we shall be facing. This would be the equivalent of a pilot switching off the navigation system when he discovers he does not have enough fuel.
We have become accustomed to a string of global temperature records in the last two years, with 2016 likely to exceed 2015 for the global annual average; and we have also passed a psychological landmark with estimates that the world has now warmed by over 1o C since pre-industrial times. Recent weather in the Arctic has provided further surprises, including periods of several weeks where the temperature has exceeded seasonal norms by as much as 20o C. This difference is significantly higher than the average temperature gap between summer and winter in the UK and other temperate climates.
Climate science has for a long time indicated the likelihood of greater warming at the poles, and this dramatic anomaly is no doubt partly attributable to the aftermath of an el Nino event. However the scale of this increase has taken scientists by surprise and increased fears that climate change could move much more rapidly than has been generally forecast. There are several reasons why the Arctic matters so much, and these include the risk of some very serious feedback effects which have been characterised as “tipping points”. One is the potential reduction in “albedo”, which means that loss of snow and ice cover reduces the reflection of heat and leads to more warming. Another is the potential release of another powerful greenhouse gas, methane, from warming land surfaces and thaws in the permafrost. Big changes in Arctic conditions are also likely to have major impacts on weather across the globe.
These threats underline the importance of action on greenhouse gases. But they also start to put a more immediate focus on issues of adaptation. Given that more and more attention is now being given to the challenges of adapting to climate change, understanding the numerous climate processes that will affect individual regions and countries becomes even more important. Without that understanding there will be real dangers that adaptation is planned, and investments made, that fail to address the right issues. A simple example is whether to plan for heavy increases in rainfall (possibly the UK), or for prolonged droughts (possibly California).
This makes the suggestions of US cutback on climate research (affecting NASA, NOOA and others) a particularly foolish, shortsighted, and damaging proposition.
Modified policies on climate issues might have some surprising benefits for a declining US coal industry, and for the future of carbon capture.
President-elect Trump is having second thoughts about climate change, previously dismissed as a Chinese-inspired hoax. There are many reasons that might make this a perfectly rational response to the impending responsibilities of office.
First he is almost certainly now getting briefings from scientific and other experts both on the reality of climate science, and on the potential impacts of climate change.
Second the USA is now suffering major drought conditions in the South West. There are indications of a possible link with climate change and strong indications of possibly much worse “megadroughts” in the future. Most people in the US now accept the reality of climate risks, and for some people the potential costs are becoming apparent.
Third, and of more immediate political significance, it seems unlikely that a US withdrawal from the Paris agreement would be followed by any significant US allies or trading partners. Even more significantly, and as I have observed in earlier blog comments, climate policy will become increasingly tied in with trade. China’s Vice Foreign Minister Liu Zhenmin, for example, has made it clear that China will take other countries’ positions on climate change and the low-carbon economy into account when negotiating trade deals.
This is hardly surprising. No-one is going to put up with trading partners who free-ride on cheap but destructive energy sources with unabated emissions, undercutting competitors who adopt environmentally responsible policies. [The UK incidentally will have to recognise the same realities as it navigates a path to those sunlit uplands of new trade agreements. This will be a bitter medicine for ardent climate sceptics and Leave campaigners such as Lawson, Redwood and Rees-Mogg.]
But acceptance of the compelling arguments for action on greenhouse gas emissions could, in principle at least, also provide a lifeline for US coal communities, in the “rustbelt” that provided an important contribution to Trump’s election victory. The connection is carbon capture and storage (CCS) applied to coal. This is not currently a frontrunner as a least cost solution for US energy policy, and a substantial unknown is the extent to which Trump will be willing or able to fulfil his campaign promises to these neglected communities.
Coal has almost certainly suffered more from fracking and the resulting cheap gas than it has from federal environmental policies, so the connection may seem an improbable one. Proposed policies to spend on infrastructure, similar to those advanced by Obama but blocked by a Republican Congress, may provide a “Keynesian” stimulus to the economy. But directing them to benefit deprived areas may be much more difficult, particularly as the allocation of infrastructure spend is far from being in the gift of the President.
There are in consequence some potential merits in CCS that at least make this an avenue worth exploring. A programme to develop carbon capture and storage has several potential advantages, and these include benefits to economically depressed regions with high dependency on coal. It requires a very substantial infrastructure spend which is likely to be close to those regions. It may provide a more promising future for coal. And in terms of wider benefits, CCS is still seen by many policy analysts as an important or even essential ingredient of real progress to a low carbon economy, and could reduce the large number of coal fired stations that otherwise threaten to become stranded assets.
These are complex questions, and continued coal fired generation with CCS could still face many barriers, not least on cost. But the idea does provide at least a small element of hope for a fading industry.
major element of Trump proposals for US energy policy targets complaints that
energy costs, driven by supposedly excessive concerns over climate issues, are
disadvantaging US industry, notably in competition with China. As usual there
is a complex story to be told, probably too complex for a short comment, but
the following observations ought to provoke some thought.
“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
this sound familiar in a US context? Could it have been written by a US
commentator? I suspect it does and could. But, surprising as this may seem, it
by a former German environment minister in 2014. The context was not the supposedly high
costs of US industry, but concerns about the competitiveness of European and
especially German industry in relation to a low energy cost USA. He continues the
The complaints 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
made similar points in recent evidence to the House of Lords in respect of their
questions about loss of industrial capacity in the UK and energy costs as a
difficult to argue that there is a strong relationship between high energy
costs and the loss of industrial capacity in the UK. The following points tend
to support this sceptical perspective.
1. The Committee on Climate Change analysis suggests that the proportion of industry
and GDP for which energy costs are a significant influence on a firm’s price competitiveness
is quite small. [c 2.6% of GDP].If
analysis is confined to goods in extra-EU trade the proportion will be smaller.
rate movements are substantially more significant in their impact on cost
competitiveness. The recent depreciation of sterling will have substantially
improved the UK position in an international energy price comparison (except to
the extent that domestic prices embody international fuel prices). But the same
exchange rate depreciation will also have a much bigger and generally more
important competitive impact on firms through making their comparative labour
costs, and other domestically incurred costs, more favourable (since these are
a bigger proportion of total costs even for most energy intensive industry),.
loss of UK industrial capacity in the 1980s and 1990s has been strongly
associated with the advent of North Sea oil, sometimes known as the “Dutch
disease”, and strongly associated with the exchange rate impacts of North Sea
oil as well as of economic policy during that period. It had little to do with
energy prices per se.
general the association of energy prices with measures of competitiveness looks
weak.Many of our Asian competitors have
faced higher energy costs than the UK or EU. Germany, widely regarded as the
most “competitive” of the EU economies, also has among the higher levels of
energy costs, in spite of what is sometimes seen as an artificially competitive
exchange rate position within the euro.
are likely to be some “carbon leakage”
issues for particular energy intensive and internationally traded products and
industries, especially if competitors are subject to less stringent emissions
targets. This should not in principle be a problem in relation to EU
competition, assuming the UK were to continue to participate in a reformed EU
but may be a problem in relation to other countries, eg Chinese steel.
the appropriate response may be to consider remedies for each of the small
number of affected sectors on its merits, rather than to distort the general
pattern of UK energy policy.The
political and economic issues are very much akin to those of general trade
policy, anti-dumping etc. Anticipation of a changing post-EU trade environment
obviously adds to the potential complexity of this particular issue.
From all this we might deduce
the probability of a strong read across to the US, ironically with US gas being
a main focus of comparison for European “moaning”. The reality for the US is, I
suspect, closer to the following.
US coal, and coal communities,
will have been hit hard by the fall in US gas prices. Climate policies are a
convenient scapegoat in a political environment that includes a strong ideological
commitment to rejection of climate science.
There is also a very strong
perception that American jobs have been destroyed by competition from “cheap”
Chinese labour. Migration of some industry to poorer countries with lower
labour costs is an almost inevitable consequence of globalisation. We can and
do argue at length in every developed economy about how best to deal with that.
It is a serious issue of adjustment to globalisation and free trade. But that
is a debate for another day.
The real point though is that energy
prices per se seem unlikely to have much connection with concerns over “unfair”
Chinese competition, for the reasons given above.What dominate are first real labour costs,
and second exchange rates. Exchange rates are part of the process of adjustment
that allows trade to balance in response to differing comparative advantage
Inevitably someone will have a comparative advantage in labour costs and
someone else in energy or agricultural production.
Given its resource endowment,
the US has always been in a strong position on energy compared to Europe, and
it is worth noting that China is pressing ahead hard with an emissions
reduction agenda. So using competitiveness concerns as an excuse to avoid
ambitious climate targets looks like a particularly specious argument.
There have been other concerns
in Europe, mainly on the emissions impact of the unloading of surplus US coal,
but that is another and more familiar story.
What is challenging and
depressing is the apparent universality of almost entirely phoney claims for
the profound significance of energy costs in industrial competitiveness. A good
time to ask if the emperor actually has any clothes, or to shout “Cui Bono?”.
Reducing the UK’s carbon footprint and managing competitiveness risks,
Committee on Climate Change April 2013.
 In the sense that reversion to the DM
would make Germany much less competitive. But it should be noted that Germany
has also been accused of cross-subsidising parts of its heavy industrial
 Carbon leakage occurs if a country
exports its own industry emissions to another country solely as a result of
having a more stringent policy on CO2 reduction, possibly resulting
in the unintended consequence of higher global CO2 emissions.
 This point, and that the bulk of this
trade is intra-EU, is made in the 2013 Committee on Climate Change report.
 In fact the whole concept of industry competitiveness
becomes quite questionable in this context. But that again is another question for
Conventional wisdoms on the superiority
of unfettered energy markets, and their ability to incentivise investment and
deliver reliable electricity supplies, are coming under challenge as never
before. The failure to deal adequately with the social costs and externalities
of CO2 emissions is one massive market failure, but even the
resolution of that through carbon pricingdoes not address the
structural flaw in many wholesale electricity markets.The policy imperatives for a low carbon economy are reinforcing many of
these structural failures, but the seeds of trouble have been there for some
time. The UK, in many respects the pioneer of market liberalisation, the EU
which has since adopted these ideas with enthusiasm, and New Zealand, whose natural
resource endowment (hydro) has allowed it to move a long way towards a low
carbon power sector, present different issues, but all are forced to confront
the same basic paradoxes in electricity economics. Failure to resolve these
will ultimately threaten security of supplies, and the credibility of national regulatory
and markets underpin both efficient resource allocation and the basis for power
sector investment, and have always deserved theoretical and practical
analysis.But there are two separate
objectives. One is a set of market prices that incentivises investment. The
other is market signals that ensure the efficient use of an existing stock of
generation capacity. The fundamental dichotomy is the distinction between the short
term and long term. The cost signals essential for production efficiency from
existing assets relate only to short run marginal costs (SRMC), but adequate
returns to investment, and to a significant degree retail tariffs, require prices
that cover total costs including capital costs.
This is often described as long run marginal cost (LRMC). Both objectives matter.But it is the more limited SRMC, often equated
to the short term variable costs of fuel, that has become the key to most
wholesale markets, and in many ways the cornerstone on which liberalised market
based on SRMC are an outcome of the requirements for operational
efficiency.But it is intrinsic to SRMC
pricing that it is not sufficient to reward investment; nor will it signal to
consumers the full real costs of consumption which must include
investment.Allocative efficiency matters
in the consumption of electricity as well as in production; and in the wider
economy more cost reflective pricing for power will in principle reduce costs
and improve economic efficiency. For
both these reasons, the conceptual basis for electricity tariffs has often been
defined as LRMC, giving substantially higher prices that can cover investment
and other fixed costs. The structure of consumer tariffs can however
incorporate both SRMC and LRMC elements.
The UK 1990 model. When the institutional norms for the
power sector changed towards liberalised market structures, the LRMC/SRMC issue
was brought into sharp focus.“Energy
only” markets necessarily tend towards SRMC based outcomes, especially in
periods of surplus capacity. This does not cover investment costs or
incentivise new capacity investment.In consequence some market designs have
attempted, explicitly or implicitly, to build in features which will, at least
in principle and over the long term, be capable of rewarding investment through
a spot price alone. A prime example was the England and Wales pool introduced
in 1990, using an administrative mechanism to define value of lost load (VOLL),
and loss of load probability (LOLP), to provide prices which spiked
dramatically. In principle at least this provided incentives for investment on
the basis of long term price expectations.
The approach was
essentially a clever attempt to reconcile SRMC and LRMC through a device which
purports to act as a surrogate for the “market” in assigning a scarcity value
to form part of a single “spot price”, albeit done by administrative means.
However this approach proved hard to maintain in a regulatory context, partly
because it implies and requires the possibility of very substantial price
spikes, some of which must be expected to persist over long periods if they are
to provide adequate returns on capital. However even this model, with a single “spot”
price, depended on an administrative intervention, external to the market, to
set VOLL and measure LOLP. This in turn reflects a political or administrative
view of the level of security or generation adequacy to which the system should
Post liberalisation experience.This central intervention was one of the features that made the 1990
model unpopular and led, in the UK, to the NETA/BETTA reforms. Implicit in the
latter was the assumption that the market itself would somehow define an appropriate
level of security. The outcome was neatly summarised by John Kay in the FT.
privatisation failed to provide a stable framework for planning new electricity
generation. The initial regime reflected careful thought about appropriate
incentives for capacity installation, but this regime was swept away in 2001 in
favour of a simpler one modelled on other commodity markets and known as NETA
(New Electricity Trading Arrangements), subsequently to be Betta (British
Electricity Trading and Transmission Arrangements). As so often in commodity
markets, this structure worked rather better in the short run than over the
A return to central
purchasing.Predictably the UK is now widely seen as
facing very tight capacity margins and the possibility of a supply crisis. In
response it has reverted to what is essentially a central purchasing regime
through the introduction of a capacity market. This is an entirely rational
response but it represents a major step away from the unfettered market philosophy
that underpinned the original power sector reforms, and the first step to a
centrally directed system. The challenge will be to ensure that this new
function for government is conducted efficiently and effectively.
EU ambitions for energy only markets. The EU has generally opposed the idea
of capacity markets, perhaps partly on ideological grounds, but more
convincingly because national capacity markets are potentially a major barrier
to a “single market” in electricity. The power sector has always been a
national not an EU responsibility, so national capacity markets are a further
barrier to integration. Importantly a single market that includes capacity can
only make sense if there is a single security standard across the system. This
would need to be set centrally and applied in all EU countries participating in
the single electricity market. It seems unlikely that the German government,
for example, would be happy to see such a fundamental choice made in Brussels.
Will regulators allow price spikes? New
Zealand experience.A necessary (but not sufficient)
condition for a market to be effective in inducing investment is that the
political and regulatory framework can allow for major price spikes in which
the only constraint on prices is the willingness of someone to pay. General
experience is that this does not happen. New Zealand was brought to my
attention this week, and is interesting because of the high proportion of zero
marginal cost generation. As such it presents a foretaste of how this market
question might play out in other jurisdictions, as the advent of low carbon
technologies accentuates the gap between SRMC and LRMC, with SRMC falling to a
very low  or zero level, while LRMC,
ie the full cost of supplying power, rises. The story, for market enthusiasts,
is not encouraging.
Price spikes do
occur and are subject to regular complaints of an “undesirable trading situation”, allowing the regulatory authority to
intervene and remedy the problem. So the natural “market” development of supply
shortages, inducing higher prices to bring forward additional supply or curtail
demand, is heavily constrained.
this should make life difficult for the generation utilities. However most are
vertically integrated into retail supply, and there have also been complaints
about the margins prevailing in retail supply. If correct this suggests that any
damage to the financial viability of generation is offset at least in part by
the ability to sustain excessive margins in another part of the business, a
situation that would be strongly redolent of complaints made about UK energy
Ideology. In both New Zealand and the UK, there is
substantial tension between “energy only” free market enthusiasts and the
development of centrally directed capacity markets. Central purchasing has
entered the UK by stealth under Conservative or Conservative led coalition
governments. In New Zealand the left of centre Labour and Greens proposed a
central buyer model, only to be accused of Soviet-style economic vandalism.
We can expect
these controversies to continue and to accelerate as the world moves further
towards a low carbon, zero marginal cost world. But it is more and more evident
that conventional assumptions about electricity wholesale markets are no longer
“fit for purpose” and we shall in due course see further rounds of major
The Oxford Martin School Programme on the Integration of Renewable Energy will be returning to these and other questions, not just for the UK but in a wider international context.
 To be wholly accurate, we should distinguish actual
total costs from the concept of long run marginal cost, but for the purposes of
this particular exposition the distinction need not concern us very much.
is most easy to demonstrate for peaking plant, which can only earn enough to
cover its fuel cost even in the very few hours when it runs. But a similar
revenue shortfall will apply to almost all plant to some degree.