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.

There's no competition anyway, Carlos. The UK's Big Six energy suppliers carve up the market more or less equally. EMR will indeed turn them into state-directed, essentially regulated utilities. The UK government had no choice, it openly says as much. In the end, privatization was a miserable failure. Without state intervention the lights would have gone out. There is no greater market failure than an economy literally switching off.
The UK government had no choice. Assets have been sweated to death and it's time to build new plant. In the end, the UK's ultra-liberalized version of privatization has proven to be a failure. Without state intervention the lights would have gone out. Is there a greater market failure than an economy literally switching off?
These comments (especially Tim Proberts) are difficult to understand. In the post war period, the privatised model has lasted nearly as long as the nationalised model. Not only have prices been relatively cheaper - using any reasonably metric (international comparisons etc), but any blackouts have been trivial. I remember much of the previous period when blackouts were very regular indeed and security of supply was hardly apparent. Of course, investment has been choked off by a combination of policy uncertainty and green initiatives making the most efficient plant much more effective, but it is hardly fare to blame the market for that.

@Tim Probert - Are you forgetting about significant investment in new power stations during the 1990s, in the so-called 'dash for gas'? Moreover, the current requirement for new plant is partly the result of EU environmental regulation (e.g. the Large Combustion Plant Directive). Many coal-fired stations are being retired early as a result.

@Phillip. It's failed. Left to our ultra-liberalized market, only gas would get built. Gas already accounts for 50-60% of generation, this is steadily rising. You don't need me to tell you that being overly-dependent on fuel source is the road to perdition. @ Richard Wellings. I refer you to my response to Philip. I'm rather glad that the EU places a higher value on public health than other jurisdictions, but I realize that they and other green policies rather get in the way of a 'free market' (!).
@Tim - you don't mean that the approach "failed" you mean that it has not produced the outcome you would have liked. That is not the same thing. I must say, that the nationalised system did not produce a desirable outcome either - costly and/or dirty fuel sources and technologies determined by political interests leading to unreliable supply
@Philip. Not at all. All I'm saying is that it was simply not possible for the UK's ultra-liberalized energy market model based on price signals alone to deliver the necessary long-term investment in power generation. It failed and it's being replaced with a capacity market for low-capex, high-opex plant like gas and state-backed PPAs for high-capex, low-opex plant like nuclear. Of course, if you'd like to argue that the market can deliver nuclear on its own, please go ahead, I could do with a laugh.
Who said I believed that we should have nuclear? That is what I mean. You seem to believe that the answer is nuclear and if the market is not providing nuclear it has failed. That is not what is meant by "market failure" insofar as that term means anything. Having experienced two different sets of institutional arrangements, I know which I would prefer from all points of view.
I don't believe in perfect solutions, be they technology or market. The current market arrangements would only build gas. With no regulations at all, probably coal. I'm arguing that if you want a mix, with less pollution (CO2, methane, SOx, NOx, particulates etc), and I think we'd all agree that we do, then an energy market based on price signals alone cannot possibly deliver. It hasn't and it's failed.
@TimPropert I'm not sure the current arrangements would only build gas. True, following liberalisation measures most investments were in gas-fuelled power plants. But that may be a consequence, among other reasons, of previous over-investments in base-load technologies (coal and nuclear). In fact nationaised systems tend shift investments towards technologies dominated by fixed costs, whatever the reason, whereas liberalisation tends to result in a more balanced generation. Without pervasive environmental regulation, we would have probably witnessed a growth of either coal or nuclear (or both) in the next few decades, as old power plants are closed and newer CCGTs are not appropriate to cover baseload demand, for both technological and economic reasons. Moreover I would not qualify the UK market as "ultra liberalised": the British energy market in fact was liberalised, but regulation never left the stage and now it is literally driving any single investment decision. Even if a liberalised market were about to fail, regulators and politicians were faster in creating the conditions for a regulation-driven failure before it could happen.
I have to disagree with your comments Carlo. Nuclear will never be built without massive state subsidy. Vincent de Rivas CEO of EDF recently admitted as much. TimPropert is correct - left to the market we would have only gas. Oil and gas shocks of the past give us evidence to suggest this is a bad idea, so we diversify our fuel types by rigging the market (ROCS, EMR etc.). The worst thing to happen to the sector was the abolition of the old electricity boards. Now instead of expert engineers, we have a feeding frenzy of consultants, with hapless civil servants and politicians caught in the middle (none of these groups really understands electricity). This inevitably results in the policy direction changing every 5 years or so as new adminstrations come and go, or at the whims of the gas price. Liberalisation of electricity hasn't been obviously disastrous – in the short term prices fell. But in the long term it has been a disaster because energy is fundamentally a strategic resource requiring a long-term view, and big infrastructure investment cycles such as the one we are approaching scare off private enterprise, leaving the public to fund it all indirectly through additional tariffs and subsidies. To top it all off, the profit making part of this sorry process is almost universally foreign-owned.
What a very confused discussion. Markets are neither good, or bad, as a matter of intellectual principle. The question should be framed: what system of market management produces the lowest 'whole system' cost of energy? The peculiarity that the balance of Capital and Operational costs in long lived assets is highly dependent on future variables, which are difficult to forecast, is not unusual. How do you value the long-term costs, price of products and profitability of factories, ocean liners and petrol refineries, etc? Businessmen regularly have to make these long term decisions, based on highly imperfect information. Often they make good profits, sometimes they go spectacularly bust, and the assets get recycled via the market 'clearing house' of liquidation. My engineering and environmental activist colleagues, to a man, appear to prefer State control of energy production to private business, and invariably rely on the State mandating, or subsidising, their preferred energy sources. They want the State to pick their preferred technology winners, and for consumers to pay the resulting costs, over which we consumers have no control, or choice. Were OFGEM or DECC to publish the real average internal transfer cost per unit energy within the vertically integrated Big 6 generator/suppliers, would consumers then chose to buy their electricity from the supplier of the cheapest 'whole system' energy mix, with the presumed highest profit per unit energy, or would they prefer go on buying their power from the more expensive, but lower profit suppliers? Without transparent costs and prices, the consumer is left at the mercy of an Unholy Alliance between the Big 6 and the regulator. The subsidising of non-dispatchable high cost renewables, thus putting renewables at the opposite end of the merit order from where they should be, and Electricity Market Reform is only going to make the alliance more unholy still. The alternative of a liberalised energy market with an 1.74% pa annually tightening carbon cap on all forms of energy, is a slow but steady method of squeezing out CO2 emissions. It is unclear why politicians having set that mechanism in process could not leave well alone, but instead have seen it their business to rush to Save the Planet by subsidising renewables? Neither decarbonisation, nor renewables are a utilitarian 'good' in their own right, nor can they justified by referring solely to the Precautionary Principle, without reference to the other utilitarian 'good' of low cost energy being a 'key' driver of economic growth and all its associated welfare benefits. Let high and low carbon energy resources compete transparently for market share within the predictably tightening carbon cap, but with no special favours, exemptions or get out clauses. Price and profit competition will then produce winners and losers. Dear me, some companies will make bumper profits and others will go to the wall, and their assets get snapped up by sharper operators. Tough. The real objective of technology and policy should be to drive the unit cost of decarbonised energy lower than the cost of incumbent fossil fuels. Then we can all be clean, green and warm simultaneously. My own efforts are directed towards developing storable and dispatchable carbon negative gas at a lower cost per unit energy than fossil Natural Gas, with 4 year simple payback on the capital investment. What is there not to like in that? Clean for the Planet; profitable for investors, and cheap for us consumers. Best wishes Tony Day

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