Sunday, January 27, 2019
HITACHI PROPOSES NATIONALISATION OF NUCLEAR. HAS PRIVATISATION PROVED COMPATIBLE WITH LOW CARBON POLICIES?
Hitachi unwillingness to proceed with the Wylfa project represents not only a crisis for the future of large scale nuclear projects in the UK, but also casts doubt on the competence of our governments to implement low carbon policies, or for the country to secure the investments it needs within the current market and ownership arrangements. It follows on from cancellation of support for carbon capture, after the private sector had sunk hundreds of millions of investment, and more recently for the renewable tidal lagoon programme. For this and other reasons it is time to question many of the basic policy and economic assumptions that underpin the current organisation and governance of the sector.
The comparison of prices to large industrial consumer prices, which are a closer measure of generation costs, show a similar picture.
"Time for a realistic appraisal of our liberalised market experiment. Is this the end of the road for the wilder free market fantasies of the 1990s?"
We are in the UK currently witnessing a number of testaments to the failings of structures set up in the 1990s, and after, as an important and widely acclaimed part of the Thatcherite revolution to reduce the role of the state and re-invigorate the disciplines of the marketplace. This has been most evident in the spheres where permanent contact, and conflict, between public policy and private incentives is almost unavoidable. For the UK the most salient current examples are probably:
· Transport, where public dissatisfaction with prices and service quality on the railways is reaching new heights, and, some allege, the level of subsidy exceeds that given to the pre-privatisation network.
· Health, where the notorious Lansley reforms have proved to be either useless or counter-productive in making the NHS “internal market” more effective.
· Electricity, where Hitachi’s effective withdrawal from UK nuclear power construction threatens a fundamental plank of the UK’s energy policy.
· Oil, where the failure of the private sector to make adequate provision for North Sea decommissioning places a potential bill on taxpayers estimated at £24 billion, a number not much smaller than the £39 billion the UK will be paying as it leaves the EU (and the latter number is much less likely to escalate).
This is a big subject, so today’s comment is confined to the power industry and a little bit of its history. We do of course need to recognise that electricity privatisation did indeed achieve some important gains. Most notably the move away from self to independent regulation and into private ownership created the financial incentives for efficiency in electricity distribution, where costs fell substantially. It’s also true that the previous governance structure of the industry was far from perfect. As a 1980s Chief Economist at the somewhat dysfunctional Electricity Council, then tasked with the sector’s regulation, I observed that the old CEGB had a degree of professional arrogance, a tendency to goldplating investment and poor investment decisions, and also disregard for the interests of consumers and the downstream distribution sector. It was in some ways far too independent of political control. On the positive side, it was always highly professional and inter alia contributed substantially to UK science research efforts in ways that have since been badly missed.
The structure set up at privatisation, to which I also contributed, was also a success, at least in the short term. Its most remarkable achievement, however, was to replicate the reliable, efficient and internationally admired operation of the National Grid. This was to change from a centralised command and control of plant dispatch in ascending order of cost, the so-called merit order, with a market system that could, as a matter of both principle and practice, deliver the same performance from the existing collection of power stations. The seamless transfer from public to private, and from command and control to a free market and private ownership, was achieved without the misfortunes that were to dog the privatised rail network a few years later, where the network management in essence “lost control of the assets”, inter alia leading to some tragic accidents.
But if operational efficiency was maintained, and distribution costs reduced, successful transition to dependence on private sector investment was much less clear. The market arrangements were designed to allow the threat of power shortages to induce price rises that would incentivise enough capacity through very large “price spikes”. Together with initial animal spirits and the coincidence of radical technology change (combined cycle gas) with cheap gas, along with guaranteed markets for some of the investors, this all worked for a while, but it was not long before the cracks started to appear. Government and the then regulator refused to accept the logic that deficient supply could in principle drive higher prices and that these would be essential, in the absence of any other commitments to investors, to get new capacity built. The original market mechanism designed to act as a signal for new capacity was abandoned with the new trading arrangements in 2000. Since then there has been no substantial new investment in generation that has not relied either on long term contractual guarantees, as with the nuclear programme, or on similar levels of guarantee through feed-in tariffs.
The government has in practice been wholly unable to escape responsibility for sector investment. As the Hitachi episode, among others, shows, this has brought its energy policy, and the pretence of relying on private sector finance, close to collapse. However that pretence has brought its own costs. Complex financial structures, as with private finance initiative (PFI) projects, have been successful mainly in raising the cost of capital, as compared to keeping projects on the government books.
These are far from being the only problems with the new market structures that have been allowed to evolve since 1990 and 2000. Others include the continuing EU wide absence of carbon prices necessary to promote low carbon policies, failure of the sector structure to promote rational tariffs either now or for the future, inappropriate loading of social and other costs into consumer prices, and widespread dissatisfaction with energy supplier profit margins. All of these subjects are extremely important and deserving of more analysis.
Nor is there any evidence, on the basis of international price comparison, that the UK, or at least its consumers, have benefited from the path breaking reforms of the Thatcher era. The table below compares UK and French domestic electricity prices over the last three years. The relative position of the UK benefits significantly from the exchange rate decline after the 2016 referendum. France, a near neighbour and similarly sized economy, is chosen as an interesting comparator because it has had a much more centrally controlled system, and, unlike the UK, has benefited from a successful nuclear programme.
This shows the small but significant improvement in the UK’s position attributable to the post referendum fall in the exchange rate. But the larger gap, as compared to households, also suggests that UK “competitive failure” has been manifested mainly in power generation.
All of the above leads to the suggestion that all is not well with energy sector governance in the UK. Widely acclaimed as leading the world in the 1990s, the reality has been that the UK’s liberalised market frameworks have simply not delivered within a 21st century environment. Surely this is the time for a comprehensive re-appraisal.
 A number of these tariff issues are discussed much more fully in the author’s paper prepared for Energy Systems Catapult, and published by them as
Cost Reflective Pricing in Energy Networks. The nature of future tariffs, and implications for households and their technology choices. April 2018.
 A much fuller discussion of these points is also given on another page on this site, Low Carbon Power, and also the author’s “think piece”, published in 2016 by the Energy Technologies Institute on how to deliver efficient networks for a low carbon future energy system. It aims inert alia to set an agenda for a future power systems architecture.
Enabling Efficient Networks for Low Carbon Futures: Options for governance and regulation. 2016
 Price comparison data is taken from sources published by BEIS and is readily available online.
Saturday, January 19, 2019
Michael Mackenzie wrote in yesterday’s FT (18 January) that Brexit was weighing heavily on on investment confidence in the UK.
“… one opinion has held sway among professional custodians of money for some time: steer clear of the UK.” Investors are increasingly wary of investing money in the UK economy, partly because of the dangers associated with a disorderly exit from the EU, partly because a UK not in the EU is a far less attractive proposition, and partly because of continuing chaos and uncertainty in government.
This is clearly one of the factors behind Hitachi’s decision to pause construction on the Wylfa nuclear power station in Anglesey. But another is the sheer difficulty and complexity of putting together private sector financing for massive energy projects. “Foreign companies are increasingly leery of British infrastructure projects”, according to Nick Butler, also writing in the FT. And this problem transcends Brexit, although it is certainly amplified by it.
According to FT reports (17 January) “People involved in the Wylfa project said a lack of firm financing commitments made it impossible for Hitachi to keep pumping in its own cash.” Hitachi intimated that their involvement could only continue if the project were kept off their balance sheet, limited further investment was required and there was a prospect of adequate profit. FT reporting commented that “… to meet these criteria is likely to require a significant change in the UK government’s approach to financing nuclear power.”
This is a huge blow to the government’s plans for early decarbonisation of the power sector, and hence for its contribution to internationally agreed targets for combatting climate change. It is widely argued that the costs of other renewable sources such as solar energy or offshore wind are falling sufficiently rapidly that this should not be a concern, and that these technologies are already more than competitive with nuclear power.
However, the government has also effectively killed off the Swansea Bay tidal lagoon project, a renewables energy project with the potential to overcome some of the objections to wind and solar power, that it was insufficiently predictable to provide a complete answer to the issue of supply security and reliability. Once again there is a strong suspicion that the government was unwilling to support financing arrangements that would have given this project a sufficiently low cost of capital to make it viable.
In spite of nuclear travails, it remains difficult to envisage a low carbon future without some elements of nuclear power. “It’s difficult to see a low-carbon energy system in the future which has no new nuclear,” says George Day, the head of policy and regulation at the government-funded Energy Systems Catapult. Moreover the government has previously killed off prospects for early adoption of carbon capture and storage (CCS), another prime candidate for non-intermittent baseload power generation.
In my view there are a number of clear lessons to be learned from this debacle.
First, it is clear that almost any form of long life generation investment in the power sector represents infrastructure that will only be created when investors have a very clear policy and regulatory commitment from government. In many instances, as with the feed-in tariffs to support renewables, this will often amount to essentially a long term government guarantee. The arguments are explored more fully on another page on this site, but it is currently very difficult to point to any form of generation investment that is not supported either by long term tariff arrangements or explicit guarantees.
Second, there is clear evidence that the government’s insistence on private sector finance, and keeping the government’s involvement “off the books”, runs the danger of raising the cost of capital and also of performance failure. The Hitachi debacle may be another illustration of the weaknesses and very high capital costs exposed both in the private finance initiative and the blunders associated with the public private partnership for upgrading the London underground . The risks include an impact both on cost – these are all extremely capital intensive projects, and hence on affordability. But, if not delivered, they also imperil the other energy trilemma objectives of security and sustainability.
Third, from a public policy perspective, we are reminded once again that projects that may well be essential to address fundamental concerns such as greenhouse gas emissions (GHG) and climate change, will almost always appear as “uneconomic” when there is no means for them to capture the value of full human cost of greenhouse gas emissions. Current carbon prices are nowhere near the level required, either to match the future damage those emissions will cause, or the likely cost of capturing carbon from the atmosphere, something that will almost certainly be required to meet temperature targets such as 1.5o C. Contrary to some conventional assumptions, an even higher value attaches to reducing current CO2 emissions compared to those in twenty years time. (Again this issue is explored in more detail on another page.)
Fourth, it seems impossible to escape the pernicious consequences of the Brexit traincrash, even though the energy sector might be seen as one of the least affected, at least directly, by question marks over future trade with Europe.
Fifth and finally, and this is a challenge for my own involvement in the Oxford Martin School programme concerned with renewables, we need to focus more attention on defining, and if possible increasing, the extent to which we can meet future requirements from a combination of intermittent or variable output sources combined with storage and the management of consumer loads. Not least this could help to mitigate the failure to bring forward either carbon capture or nuclear investment in sufficiently timely fashion.
Energy Systems Catapult is part of a network of world-leading centres set up by the government to transform the UK’s capability for innovation in specific sectors and help drive future economic growth. Its aim is, by taking an independent, whole energy systems view, to work with stakeholders across the energy sector (consumers, industry, academia and government) to identify innovation priorities, gaps in the market and overcome barriers to accelerating the decarbonisation of the energy system at least cost.
Catapult modelling has tended to support both nuclear power, including smaller modular nuclear technology, and carbon capture.
 The Blunders of our Governments, Ivor Crewe and Anthony King. 2013. Its treatment of the London underground fiasco, and the very high cost of capital incurred, is particularly scathing.