Saturday, April 9, 2016



Few topics compete with industrial energy prices for the level of misleading information and analysis they generate. The reality is that energy prices are rarely decisive in determining an industry's ability to compete, UK power prices in particular are high by international and European standards, but this has little to with Green climate policies and even less with Green policies imposed from Brussels. It may well reflect other issues in the way we have chosen to run our power sector. These deserve critical examination in any case.

Brussels attitude to energy intensive industry

David Buchan of OIES has commented on my blog on the UK steel issue, drawing attention to the link with Brexit arguments. His comment is worth repeating. "It is misleading to blame the EU for high energy costs related to renewable energy subsidies, when the UK’s own Climate Change act mandates more ambitious emission reductions than EU legislation, and to suggest that Brussels does not allow the UK to offset the extra cost of clean energy policies for energy-intensive industries."

David goes on “The Commission is keen to keep energy-intensive industries in Europe for the carbon leakage reasons you give”. It makes good sense, as I argued earlier, to encourage energy intensive industries towards countries capable of providing low carbon energy supply; currently this does not include China or Germany or India.

Moreover the Committee on Climate Change notes that “steel producers face EU ETS costs for their direct use of fossil fuels. However, they also receive a free allocation of allowances under the EU ETS and estimates suggest this has more than covered that direct cost”.

If Brussels is to be faulted it is for its failure to deal with German behaviour (contravening the spirit of a competitive internal market) or with Chinese dumping. According to the FT’s correspondent, [Kiran Stacy, 3 April 2016], “Germany has handed over 40 times more in energy subsidies to heavy industry since 2013 than the UK, highlighting one reason why British steelmakers are in such trouble.” Whether a UK outside the EU, and not part of any other trading bloc, could have made a better job of handling unfair competition from Germany, or the dumping of steel by China, is a very different question.

But how much do energy prices matter to industry anyway?

Industry lobbying suggests energy costs are a major factor in competitiveness, and one would expect this to be true a fortiori for steel.  But the same FT article quotes research from the Committee on Climate Change indicating that energy accounts for just 6 per cent of all the costs of running a blast furnace, and other evidence that it is about 5 to 10 per cent of production costs. In this instance it seems that, notwithstanding German subsidies to energy costs, it is other factors, mainly the very low price of steel, and dumping, that are the main problem for the steel industry.

One other macro-economic factor, not often mentioned in the debate, is the exchange rate. This is likely to be much more important than energy costs, since it relates to a much higher proportion of total costs, including labour and other domestic economy related costs, including much of the content of the energy costs themselves.

More deep rooted causes for high UK energy costs.

A historical perspective is useful and there are plenty of data sources. The International Energy Agency publication, Energy Prices and Taxes, gives a long annual series of prices for EU and other IEA countries. This international price comparison provides a useful historical perspective. In 1989, the last year the UK electricity sector was in public ownership, UK industrial electricity prices (excluding taxes) were about 7% above the IEA median and 20% lower than those in Germany. They were 25% higher than in rapidly decarbonising France.  By 2007 UK prices had climbed to be 42% above the IEA median, 15% higher than Germany, and 50 % higher than France. UK prices. 2007 was the last full year before the UK’s 2008 Climate Act, so the increase cannot be attributed to excessive zeal in reducing emissions.   By 2014, the UK was 44% above the IEA median, 58% above Germany, and 50% higher than France.

International comparisons are notoriously difficult, and a number of obvious explanations suggest themselves. These include the possibility of subsidies and cross subsidies in the German power sector, the de facto artificially low exchange rate that Germany enjoys within the Eurozone, and special factors such as shale gas impacting prices in North America.  The figures also reflect the very different fuel mixes in the IEA, France benefiting very obviously from nuclear power. And of course there may be many other factors, including geographical endowments, differences in reliability standards, and forms of ownership with different demands for a return on capital employed.

It is however rather disappointing that the UK should appear to be doing so badly, given its leadership role in the market liberalisations of the 1990s, and the exceptionalism that is sometimes claimed for the performance of UK liberalised markets. There is however little or no evidence that zeal in pursuing climate policies is a major factor, and none that European policies on emissions trading have had any impact at all.


Peter M said...

John, A bit slow to ask but is the UK price down to or at least in part to privatisation? peter m

John Rhys said...


A good question. The answer is that there were several distinct influences in the 1990s as a result of the 1990 privatisation, not all operating in the same direction.

1. This was the end of the road for the British coal industry, hitherto protected by governments allowing it to have the CEGB as a captive market. This could have been done at any time but privatisation was a useful handle, and meant that the government could subsequently wash its hands of the future problems of the coal industry. But it did imply a significant fall in generation costs, absolutely and relative to other countries, as the new owners were allowed to import cheap coal.

2. There were lots of other influences in the early years, 1990s and 2000s, including falling gas prices (and energy prices generally), and also some exchange rate movements. But these applied internationally, so would not necessarily affect the UK's relative position. They could have improved the UK or relative position or made it a bit worse, though I don't think these effects were very large.

3. Privatisation almost certainly improved efficiency, or at least lowered the costs of providing the distribution business, ie the wires. In fact this was built in to the regulatory structure of RPI - X.

4. I think the margins earned in retail supply went up quite a bit, perhaps from around 0.5% to about 4.0%, which would have offset reductions elsewhere by tending to push prices up. A lengthy IPPR report, to which I provided some input, talks about this area.

I can't really speculate on how things might have moved in the last few years had all else remained the same, but it does seem strange that the UK does not have a better relative showing within the EU.

Note the paradox, though, that if our currency falls (eg post Brexit)we shall look significantly better in the international comparison stakes, just via the arithmetic of conversion to a common currency.