Is fixing Energy prices a fix?

So summer’s gone and it’s time for energy to start hitting the headlines again. The not so subtle trailing of the impending October price hike by supplier or suppliers unknown has, this week, been superseded in its ability to create headlines by Mr Miliband. The heart of his letter to the energy suppliers is as below:

“Our intention is to now reset the market that has consistently failed to secure the confidence of the public or the investment Britain needs. Doing that requires two steps. First, it means legislating to build competition and transparency into the market, with a trusted regulator standing behind the system. Second, it means ensuring that in the time it takes to put a new system in place, up to the start of 2017, we ensure the prices paid by consumers do not rise. A fairer market for consumers must be matched by a better deal for investors. So we have also committed to set a 2030 power sector de-carbonisation target; hold to the system of contract for difference in the Energy Bill; create an Energy Security Board with responsibility for identifying our energy needs and providing a clear framework to deliver this; and give the Green Investment Bank borrowing powers to support investment.”

I should point out, as I have pointed out before, that large chunks of deregulation happened on Labour’s watch. Specifically the waiving through of the Big Six’s vertical integration policy as evidenced by the acquisition of generation businesses or supply businesses (depending upon which point they started from) from circa 2000 onwards. Price fixing, or capping, by the government is somewhat like deciding that in order to treat a gangrenous toe the obvious solution is to chop off the leg to which it is attached. I have seen nothing either in the speech or elsewhere that helps me to understand how a government driven price cap/price freeze increases competition and yet he appears to suggest that as an objective. The fact that he is committing to the 2030 de-carbonisation target would indicate that we won’t see a roll back of renewable initiatives – and indeed if he does back the CFDs at a proper strike price then I can’t see how he will preside over anything other than a rising price once his freeze has worked its way out of the system – with a bit built in either before or after to account for lost revenue in the intervening period. This is robbing Peter to pay Paul. And given the billions that are required for infrastructure and generation investment to ensure resilience and continuing light I can’t see the Green Bank being much good – it’s a bit like pitching up at a gun fight with a pointy stick.

So what’s the real situation then? The Big Six make their money, principally, through generating electricity not through selling it to you and me. This is because renewable sources of energy are expensive (and even gas isn’t that cheap anymore). These two facts keep prices high (they determine the marginal cost of generation in many cases); which mean if you run a coal plant or a nuclear plant where the capital costs were incurred in the long distant past then this is a license to print money. Right now a coal plant selling forward to 2015 is making a return of 15.7% on operating costs; whilst capital costs are negligible. Not that coal generation is the only benefactor here; renewable generation businesses are subsidised massively through mechanisms such as the Feed in Tariff and the Renewables Obligation as the government attempts to drive up our renewable sources of energy. Even efficient gas gets in on the act although the returns are much paltrier by comparison. This all means that if you are a generator you get to make decent returns as long as you don’t spend that money on capital investment – new generation plant let’s say, the stuff we need to make us resilient.

Looking at the Big Six books, they make very little money on supply and all their money on generation. Now, you ask, surely it’s just an accounting wheeze and if we weren’t here to sell the electricity to then they couldn’t generate, which means that irrespective of what their supply division says they are profiting from us. True. But that’s what you get when you allow the energy supply chain to vertically integrate; an activity that happened exclusively under the last Labour government. If you want to squeeze generator margins then you need to force the energy supply businesses to sell their generation assets to companies that are pure generators; and at the same time ensure multiple generation companies with multiple generation mixes for a competitive generation market. That is a much trickier nut to crack; and one that plays less well than price freezes in the conference hall if you are Ed Miliband and you were part of the team that ushered in this status quo.

So how will this cap work? In my view this is basically like renationalising the power industry but without actually having your hands on any of the tactical levers to ensure it does not bring with it a load of unintended consequences. So here are some simple questions for Ed to answer:

  1. In 2008 the oil price topped out at $143/bbl at a time when £ Sterling was relatively strong and we still saw wholesale prices soar by some 30%. Indeed at their height they were some 44% above current prices. If that price spike had been extended and became a ramp rather than a spike, as opposite to being flattened by the credit crisis; then any price cap issued before the new price level would probably have bankrupted every single supplier in the UK. How is this “Price Freeze” going to avoid this potential outcome?
  2. Some suppliers may be able to ride out a price cap if the market doesn’t move against them too much but the suppliers it is likely to hurt are those without their own generation assets – the small ones in many cases. Is reducing competition and driving new entrants to the wall really one of the objectives here?
  3. Will the UK Taxpayer stand behind energy assets in the event that some companies fail?
  4. UK Consumers have the option to fix their prices for three years right now and very few do. In what way is that different in outcome to this mooted price freeze?

electricity-prices-europe

The electricity and gas graphs herewith show the absolute electricity and gas price behaviour for the principle Western European countries up to the beginning of 2011. Now it may be that we have radically accelerated our increases relative to the other countries since 2011 but I have seen no evidence to back that up. Under this analysis the whole increase in energy prices is perhaps a more nuanced and complicated affair than Labour would have us believe. And it certainly suggests that there are a pile of people across the channel with even more reason to wince at their energy bill than we have!

gas-prices-europe

Much as the increasing cost of energy hurts every household in this country we cannot introduce price caps without understanding the full implications of their introduction and indeed whether they will cure our ails at all. There is every possibility that the suppliers shut down significant investment that doesn’t make economic sense in a price capped world and we end up facing possible black-outs or failing energy companies. Glibly saying let the energy companies go to the wall is all fine and well but they are not banks; they deliver real things, albeit invisible, that our daily lives depend upon. I’m all up for breaking down the 98% market domination of the Big Six but the consumers need answers that will work; not simplistic economically untested sound-bites that play well in Islington focus groups.

Sources:

OFGEM and DECC

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