Power games

15 February 2011
There is little doubt that the UK’s electricity markets need reform, and the proposals on which the government is currently consulting are a radical departure. However, a closer study of the consultation documents reveals real concerns. We are being encouraged to think that free market structures and the previous government’s lack of activity are to blame for our difficulties. While it is true that there has been a lack of clear investment signals to maintain security of supply through diverse conventional generating capacity, the market was in fact heavily distorted by state intervention, which took the form not of mere regulation but strong controls over market opportunity. The Climate Change Levy, the Renewables Obligation (RO), the Emissions Trading Scheme, and the Feed-In Tariff are all testament to the previous government’s attempt to steer the market towards particular outcomes, largely an extensive deployment of wind power. Against such a background the present government’s proposals appear to offer the reform of a distorted market with a fresh set of distortions. The costs of the previous instruments, particularly the RO, are already very high. The government says these policies will only increase bills by 1 per cent in 2020, but this is a confusion of prices and predicted future bills. In fact, even on the government’s own estimation, in the Annual Energy Statement, 30 per cent of the price of electricity to domestic consumers in 2020 will consist of policy-driven charges imposed by law (£160 out of £512, or 31 per cent), while business will be hit even harder, with environmental charges for the average medium-sized non-domestic user accounting for 33 per cent of electricity prices. The 1 per cent figure is based on the hope that energy-saving policies will restrain energy use, so that bills will be kept down in spite of policy-induced price loading. This is desirable, but improbable. Cost is not the only concern: there must be real anxiety at the complexity of the future UK electricity market. The proposals would see a large part of the sector under state control, which is unlikely to be efficient and may leave the sector fragile. The Contract for Difference, for example, where a top-up payment is made for low-carbon electricity if wholesale prices are lower than a predefined point, is interesting, but it is not yet clear how it will be funded. The comparable Spanish system has resulted in a large tariff deficit, with the government owing generators €16.5 billion (£14 billion). However, large UK energy firms will be guardedly content with the proposals. For over a decade government has been asking them to do very difficult and expensive things for environmental reasons. The reform proposals show that the government is willing to write a big, vague cheque on the consumer’s account to persuade the industry to meet the targets. Whether the consumer will honour the cheque is an open question. For more information, go to www.energy-show.com/whitepaper
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