Losers are good at picking governments

Dieter Helm, 2017

The price of domestic electricity and gas in the UK has finally revealed to consumers the complete, irreparable failure of the British domestic energy market. The supposed “energy suppliers” who actually provide consumers only with invoices, have no solutions for the crisis, and now turn to Government to bail them out – along with everyone fated to rely on them for service; with the likelihood that this will ultimately be paid for, sooner or later, by no one other than the overwhelmed consumer. This new understanding of the reality of energy provision in the UK now also faces the politically critical SME business community, which generally operates in competitive markets, and not phoney energy markets, made up and tricked-up by Government. The SMEs have quickly found that they can no longer compete with off-the-scale energy price increases. This simply cannot go on; but it is.

In the middle of this crisis, so fundamental to Britain’s people and economy that it has become an existential threat for everyone, we are nevertheless transfixed, frozen out by an absurd Conservative election that excludes the electorate altogether, but requires the whole UK to prioritise and indulge the pettifogging rules of an endless Conservative Party leadership campaign that is lost in narcissistic self-entitlement. The low-grade wittering of the Conservative election contestants over ‘tax-cuts’ or ‘hand-outs’ neither addresses, nor even understands the scale of the energy market failure they have given us; or even that the domestic energy market itself has, to all functional intents and purposes, simply collapsed. We are now dependent exclusively, not on government, but a mixture of the inertia and stoicism of the British people in a crisis.

Let us look at the problem from the perspective of actual UK energy provision. Richard Murphy, of Taxresearch.uk (here: https://www.taxresearch.org.uk/Blog/2022/08/29/we-could-massively-reduce-the-price-of-energy-in-the-uk-by-changing-the-way-we-regulate-energy-prices/) has provided a very useful, if not quite authoritative summary of the current costs of domestic UK energy production, from its various generation sources. At the very least this analysis provides an invaluable ‘ball-park’ starting point for informed public debate. Here are the key Murphy estimates:

Even if these estimates are only roughly right, the gas price is currently somewhere around ten times the cost of other much more typical forms of UK energy production in the generation mix; yet the wholesale gas market price, virtually alone is driving the total price of energy paid by the UK consumer. The wholesale energy price appears to allow the most expensive producer (currently gas by a huge margin) to set the price for consumers across the board; but more critical still, it also appears to mean that the nuclear, hydro and offshore/onshore wind producers do not have the same cost structure as those “energy suppliers” buying gas at international market prices. The gas producers are of course making a market ‘killing’.

It should be noted that the UK energy market, created in all its Byzantine complexity by the British Government, has been designed to offer the UK domestic consumer an “energy supplier” which is very unlikely to be the actual provider of any consumer’s actual energy; even if the parent company of the “supplier” is itself an energy provider. The “energy supplier” in this strange marketplace seems little more than a pointless financial ‘middle-man’; attempting – and now failing badly – to profit off a gratuitous cut of the total energy profit margin, earned from the role of buyer and seller of energy at international market prices, and the mere issuer of invoices to the final consumer.

The essentially bizarre nature of this so-called energy ‘market’ will have been discovered by many consumers who suffered power loss during Storm Arwen. The consumer may have found in that adversity, that their ‘energy supplier’, supplied no information on solutions to the consumer’s loss of supply in mid crisis, but referred their contracted customer to a third party, the “network provider” (the network operator of the consumer’s actual energy supply), for answers and solutions; and discovered that the consumer’s “energy supplier” did not even have any responsibility for supply reconnection, and did not supply the consumer either with energy or compensation, which were all solely the responsibility of the “network provider”; a third-party of whom the consumer was hitherto, almost certainly, blissfully unaware even existed. The energy supplier’s answer to the consumer in this predicament was essentially: not me Guv. They are still saying it today.

Confirmation of the deep systemic flaws in the UK energy market may be found by turning to the work of Sir Dieter Helm, Professor of Economic Policy at Oxford University, who was notably the Conservative Government’s chosen specialist adviser to provide the ‘Cost of Energy Review’ for the UK government in October 2017 (here).

Helm’s opinion was sought by the British Government, effectively impartially to review its own policy; we thus have, if you will, an opinion from Helm the Government valued, and cannot easily dismiss. Helm’s critical analysis of energy policy in 2017 was however, prophetic of the deeply flawed nature of the domestic energy market the Conservative Government imposed on the public, under the disguise of ‘free market’ competition.

Helm’s ‘Findings and Recommendations’ to the Review are trenchantly summarised, and worth reading (D Helm, ‘Cost of Energy Review’, Key findings 1-24; pp.viii-xv). They have survived the passage of the last five years rather better than the feckless non-management of a growing energy disaster in the the making, conducted with casual indifference by this louche Conservative Government.

Confirmation of Helm’s brutal conclusions are to be found in Helm’s sudden re-emergence to comment on the current energy crisis now, to ‘The Independent’ (29th August, 2022) under the headline ‘Energy bills soaring because of government failure not Ukraine’; in a direct rebuttal of Boris Johnson’s intervention into the energy debate under his favourite, cynical smokescreen of the war in Ukraine.

It is worth exploring Helm’s principal findings from the 2017 energy review. For Helm the complex structure of the market means that, even in 2017, “(1) the cost of energy is too high” (D Helm, ‘Cost of Energy Review’, Key findings 1; p.viii). He continued: “(2)  Households and businesses have not benefited as much as they should because of legacy costs, policies and regulation, and the continued exercise of market power.

(3) The scale of the multiple interventions in the electricity market is now so great that few if any could even list them all, and their interactions are poorly understood. Complexity is itself a major cause of rising costs, and tinkering with policies and regulations is unlikely to reduce costs. Indeed, each successive intervention layers on new costs and unintended consequences. It should be a central aim of government to radically simplify the interventions, and to get government back out of many of its current detailed roles. This review explains how to do this.

(4) The legacy costs from the Renewables Obligation Certificates (ROCs), the feed-in tariffs (FiTs) and low-carbon contracts for difference (CfDs) are a major contributor to rising final prices, and should be separated out, ring-fenced, and placed in a ‘legacy bank’. They should be charged separately and explicitly on customer bills. Industrial customers should be exempt. Once taken out of the market, the underlying prices should then be falling” (D Helm, ‘Cost of Energy Review’, Key findings 2-4; p.viii).

Let us look briefly at one single issue here raised by Helm; CfDs. CfDs are operated through arrangements between energy providers (generators) and a ‘private’ company, wholly owned by the Government, the Low Carbon Contracts Company (LCCC); set up for renewable energy. Here is how the LCCC explains how CfDs work (here: https://www.lowcarboncontracts.uk/faqs?f%5B0%5D=filter_faqs%3AContracts%20for%20Difference): “The essence of a CfD is that the generator will be paid the difference between the ‘strike price’ and the ‘reference price’. The strike price is a price for electricity reflecting the cost of investing in a particular low carbon technology.  The reference price is the average market price for electricity at the relevant point in time.  If the generator sells its electricity at less than the strike price, LCCC will pay it the difference.  If the generator sells its electricity for more than the strike price, the generator will pay LCCC the difference” (CfDs, FAQs; ‘What is a CfD?’).

Notice the strike price is a cost of generation price; the reference price is a market price triggered when the market price varies from the stake price; to the considerable benefit of the LCCC in the current market. The LCCC, and therefore Government pockets the difference.This is how the Government is involved in, influences, and may benefit from the market in a highly complex system, but that is little understood by the public, and that Conservatives claims is a pure, free, competitive market that is determined solely by international markets over which it has no control.

The gas market is another complex system that requires very strange pricing and supply arrangements. British gas imports are not on the same scale as the problems of gas dependency now being seen in Europe. Nevertheless, Britain is far less dependent on foreign (especially Russian) gas supplies. This does not mean there is no gas supply (and pricing) problem for the UK, but it does mean the British consumers are being penalised on a scale totally out of proportion to the overall British dependence on foreign gas, international gas market prices, or the real cost of production of the energy portfolio British consumers actually use, taken as a whole.

Gas is an international market, and the UK is not immune from that. Nevertheless the UK, unlike many European states, produces around 50% of its own gas requirements. The other 50% is imported, but both domestic output and imported gas are subject to international prices, and it is the British consumer who has to pay these extortionate international prices (driven essentially by Russian policy), for their own domestic gas; unprotected by their own British Government.

The first responsibility of any sovereign state is the security and safety of its citizens; this security must include protection from market induced penury through the pricing of fundamental necessities, especially if these are domestically produced. Energy is such a ‘sine qua non’. This sovereign duty is not being honoured by the British Government, if something as essential to basic human life and family prosperity as energy, to say nothing of the special difficulties confronting the disabled, often with exceptional energy needs; for a necessity of life which is un-substitutable by households, but is being charged ultimately by Government, with complete indifference to economic and social consequences.

It is worth pointing out here that a domestic energy market cannot operate like most simple, conventional, broadly competitive markets, open to new entrants and rapid innovation. Almost all critical energy infrastructure requires massive ‘one-off’, ‘up-front’ capital investment, which takes years to construct, and pays back only over multiple decades. Once the capital is spent, and the new energy resource or plant is fully operational, the sunk cost changes the ongoing cost and risk profile of the energy resource. The ongoing cost of operation is often relatively small and stable (for example in renewables – hydro, or wind-turbine arrays). Nuclear is also low cost in this operational phase (but leaves a huge, un-costed and perhaps un-costable dismantling/disposal problem, determined principally by the ‘half-life’ of the toxic fuel residue).

The entry costs for all such major infrastructure projects are however typically colossal, and only commercially viable, if backed fully by sovereign Government, and largely paid for (one way or another), by or through the agency of Government: and a final consumer who has little choice in the energy options actually made accessible to them, by Government.

The investment criteria and timescales are so long for these major projects, it is misleading to think of energy as able to replicate relatively fast changing, dynamic, open competitive ‘markets’, as understood by consumers, or as experienced in the High Street. The scale of the industry entry costs totally exclude most commercial businesses, save those with the very deepest pockets. Even then, the reliance on sovereign Government is predominant. Governments are themselves obliged, by the vast investment commitments required in large scale technologies, with inordinately long development, operational and investment payback timescales, to determine centrally the terms of operation of domestic energy supply. Taking one seminal example; the new Hinkley Point nuclear power plant, currently has a £26Bn price tag. This may well increase over the long build time; but it establishes that this is not an operation that is, in any conventional sense an open ‘market’ process.

The timescales and technologies determine that these so-called ‘markets’ are closer to being what are often now termed ‘natural monopolies’. When we look closer at their operation the consumer can only rarely select their energy source. Supply is generally provided by power lines indifferent to the source of electricity flowing through them. Supply is determined largely by network providers, and a National Grid that turns different sources into a uniform energy supply (for all electricity). One of the adverse consequences of the Grid, is that the population in Scotland and the North of England pay a surcharge on supply, simply for living closer to the supply and generation sources of the new renewable future, which is over-represented in the north because of its natural advantages; the large population living in the South of England are, nevertheless provided with a Grid subsidy, in spite of their distance from the modern generation of the cheapest forms of energy. These are the anomalies we live with in this strange, phoney “market” system.

A badly conceived market for domestic energy was created by the Conservative Government, and has collapsed because of its deep, ideological, systemic failures. This is principally a Conservative Government failure, from which Johnson, Sunak and Truss cannot evade responsibility. The continuation of this failed market system is unacceptable and unsustainable. We simply cannot go on like this.