The ‘soft renationalisation’ of the energy sector

The UK was the first European country to liberalise its electricity market. Will Britain now be the first European country to roll back the market and effectively renationalise the sector?

Britain has so far provided a successful market model to the rest of Europe. The EU itself has drawn extensively on the British experience for its own directives, although it has couched them in a language that continental Europeans can understand (a language which, admittedly, might sound unpleasant to British ears!). On the other hand, other EU countries, including Italy, have been going through the very same problems that Britain is currently trying to address – and the same ‘solutions’ have been adopted.

In fact there is little doubt that the draft Energy Bill, that the DECC published just a few days ago, would radically reshape the British electricity market, giving the government a much more crucial role than is currently the case. In the past decade or so, energy regulation has made a comeback, disappointing the expectations of the framers of the liberalisation of the energy sector, who thought regulation would gradually decrease as market forces became stronger. On the contrary, regulation never disappeared and, to some extent, it has come increasingly to affect the behaviour of market actors (for example, under the guise of consumer protection) and investment decisions (most notably as part of the ‘environmental’ agenda). But the proposed bill is a quantum leap that endows the government with the power to decide which technologies should be employed to produce energy, when, and in what amount.

The Trojan horse of this ‘soft renationalisation’ is the green economy. Under the assumption that energy production’s carbon footprint should be reduced, and that this goal can be achieved only through regulation, the UK has heavily subsidised low-carbon technologies, particularly renewable energy sources. Oddly enough, other technologies with little carbon content (such as nuclear power) have not enjoyed the same political support. Indeed, if the real goal is to let market prices reflect the alleged ‘social costs’ of carbon emissions, a carbon tax would be a more efficient policy tool than the complex regulatory schemes that have been adopted both at national and EU level. A carbon tax would create a competitive environment for cleaner technologies. Instead, subsidies allow the government to pick winners and losers - and renewables have clearly been winners.

Renewables, particularly wind and solar power, may have several advantages over conventional sources, but they also impose major costs on the system. Being intermittent, non-programmable sources, their variable output tends to be both inconsistent with the nature of energy markets (which are driven by day-ahead bids) and a major cause of network imbalances. Imbalances are economically costly and technically challenging for the network operator. Moreover, since modern societies require continuity from electricity production, spare capacity must be maintained in order to offset the volatile ‘green’ generation.

So, what’s the bottom line? As DECC recognises, the security of electricity supplies requires a ‘capacity market’ to be established - whereby generators are not paid for producing energy, but for maintaining under-used power plants. Moreover, a number of regulatory constraints or subsidies would be introduced in order to ensure that investors do not invest in the ‘wrong’ technologies - i.e. that they create the generating mix the government envisions. Such instruments include contracts for difference (CfD) (or ‘long-term instruments to provide stable and predictable incentives for companies to invest in low-carbon generation’), investment instruments (‘long-term instruments to enable early investment in advance of the CfD regime coming into force’), transition arrangements ‘for investments under the renewables obligation scheme’ and the Emissions Performance Standard.

All the above would result in two major consequences. Firstly, as far as energy pricing is concerned, fixed costs (to be recovered under a regulated regime) would greatly overshadow variable costs (that usually set market price), leaving little and decreasing room for price competition. Secondly, as far as electricity supply is concerned, there would be less competition in the market - because generators would no longer be free to decide their investments according to their own assessment of a competitive generation portfolio - and more competition for the market. In other words, competitive markets for energy will gradually be turned into monopolies that may be operated by private actors, but are ultimately directed by government.

Carlo Stagnaro is Director of Research and Studies at the Istituto Bruno Leoni.