There’s a deep malaise at the heart of the energy system. In this year’s spring budget, Jeremy Hunt announced that the government would continue to prop up the energy market through the energy price freeze, capping gas and electricity unit prices at around £2,500 for the average household for another three months. While the news that businesses and consumers will still be supported was welcome, the necessity of that support is not a good sign.
Market forecasters Cornwall Insight project that prices will remain high for the remainder of the decade. At the same time, more electricity than ever before is coming from renewables—consistently shown to be the cheapest form of new generating capacity—and profits for the biggest oil and gas producers and the UK’s largest energy supplier Centrica are at record highs. So, what is going on, and what further steps could government take to lower prices for homes and businesses?
At the heart of this discussion is the wholesale electricity market, where most UK power is traded. Wholesale power prices are set by the “marginal unit”—the last and most expensive unit of generation required by the system to ensure demand is met. All generators (unless separately contracted) receive this price regardless of their running costs, resulting in a single overall market price for power for each 30-minute interval throughout the day.
On most days the UK marginal generation unit is still provided by natural gas. In the last few years gas prices have quintupled, meaning the cost of energy, whether renewable or not, has rocketed. More than 50 per cent of power now comes from renewable and nuclear sites, whose business cases were developed to be profitable when wholesale prices were much lower than they are now. Moreover, under the Renewables Obligation, many of these legacy renewable projects receive a top-up subsidy, meaning bill payers are further supporting their revenues. This has resulted in huge windfall profits for older onshore wind and nuclear sites, which we estimate to have added up to tens of billions in the last year alone. Meanwhile, consumers suffer.
What can be done?
The first two proposals currently being trialled by the UK and the EU—a windfall tax on the profits of energy companies and a wholesale market price cap for those generating low-carbon energy—are likely to be short-term solutions with relatively minor savings for bill payers.
A third possible solution, proposed by the UK Energy Research Centre, is to invite these older low-carbon electricity generators, including large-scale wind and solar farms and Drax’s biomass units (which burn wood pellets) to shift onto fixed low-cost “contracts for difference”, whereby generators accept a fixed price for producing energy, regardless of the wholesale market price. However, this had limited traction with the industry—which unsurprisingly is unwilling to give up record profits voluntarily.
Two further proposals—to split the electricity wholesale market in two, with one market for low-carbon power and another for thermal power dominated by natural gas, or to effectively nationalise the retail system—could have a greater impact, although would be extremely complex and potentially costly to implement.
There is, however, a sixth option: a publicly owned generator, which would be to take older generation wind farms and nuclear sites into public ownership, through compulsory purchase, and then sell power into the market close to its marginal cost of generation. This is the solution proposed in a recent paper I led in partnership with the thinktank Common Wealth. We found this solution would drive the greatest cost savings for consumers of all the options examined—approximately £20.8bn nationwide or £252 per household per year on energy bills. As well as being a long-term solution, a publicly owned generator could democratise ownership of existing assets such as onshore windfarms, for example by inviting local communities to become shareholders. A further key aim of this publicly owned generator would be to drive future investment in green energy, supportive of the UK’s net-zero goals.
These ideas are consistent with the Labour party’s recent proposals for a publicly owned energy company, “Great British Energy” (GBE), that would focus on accelerating the UK’s expansion of clean power. When considering the value of an actor like GBE, Common Wealth previously highlighted how public power entities are commonplace in other European countries: consider Denmark’s Ørsted, Sweden’s Vattenfall and France’s EDF. Moreover, energy companies that are owned and controlled by the public sector can take a much greater interest in ensuring their domestic population see the benefits of the low-carbon transition through their decisions on which other firms to work with, where to source goods, whom to hire and where to invest. The Biden administration’s recent announcement of the Inflation Reduction Act (IRA) and the EU’s response Green Deal Industrial Plan have shown just how competitive this sector already is.
The IRA—described as the greatest US industrial policy intervention in the post-war period—will see over $369bn in tax breaks to US low-carbon industry as well as a raft of measures including local content requirements, which may eventually lead to over a trillion dollars in investment. Various commentators including IPPR, a thinktank, have outlined how the IRA could represent an existential threat to the UK’s goals to become a clean energy superpower. They highlight that in a world where the raw materials for renewable infrastructure cost more, interest rates are higher and the UK is, as a result of Brexit, more isolated, the UK stands to lose out to its bigger trading partners in the US and EU in the “global green race”. Indeed, there are growing signs that much of the UK’s existing pipeline of offshore wind projects in under threat—Ørsted recently announced that the future of the 3GW Hornsea 3 windfarm, planned to be the biggest in the world, is at risk without more UK government support. Recently, Renewables UK suggested that the Hunt Budget’s proposed £200m public subsidy provides insufficient incentives for the industry to invest in renewables at the required scale—further underlining the case for the state to coordinate and actively shape the green transition.
All this means that we need a more interventionist green industrial policy from the UK government to ensure the UK’s current leadership in the green transition translates into long-term prosperity. The establishment of a publicly owned energy generator such as GBE is one way to achieve this, ensuring there is focus on retrofitting the UK’s inefficient housing stock with energy efficiency measures, heat pumps and solar panels, and a rapid expansion of renewable power such as wind farms. Indeed, by targeting the root cause of current high inflation—high energy bills—GBE could build a foundation for a truly democratic, low-cost and low-carbon UK energy system.
