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 report, The 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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