Ministers should leave the market aloneby Dieter Helm / September 18, 2014 / Leave a comment
Published in October 2014 issue of Prospect Magazine
This piece is part of our special report on energy policy. To read the second piece in the series, click here. To read the third piece in the series, click here.
When it comes to energy, most politicians say they want lower prices and more investment. The word “and” is altogether more palatable than the word “or.” All sorts of wheezes are deployed to put off the day of reckoning. Labour leader Ed Miliband wants to freeze prices while he makes the market competitive. Prime Minister David Cameron thinks it will be more palatable if taxpayers rather than customers pay for some of the more expensive policy interventions. Chancellor George Osborne thinks that nuclear investment can be paid for with Chinese money. Meanwhile Ed Davey, Secretary of State for Energy and Climate Change, holds out the fantasy that more investment will mean lower prices, because he knows that the price of gas (and oil) is likely to keep going ever upwards, until it makes even offshore wind economic. His certain knowledge of the future is not unique—both his predecessors, Ed Miliband and Chris Huhne, held similar views.
How did we get into this mess? And more importantly, how do we get out of it? Electricity is not that complicated: it requires fuel inputs, enough power stations to cope with demand shocks, wires and billing and metering. Many countries have managed perfectly adequately for the last 100 years. Why can’t Britain do this in the 21st century too?
Luck has compounded complacency, encouraged by the economic recession, which bought quite a lot of time, as demand fell away. Then there has been a windfall on costs, which customers should have seen. Over the last two years the price of coal has been falling sharply. Indeed, coal has become so cheap that the generators have ramped up the coal burn, while mothballing newer and much less polluting gas-fired power stations. In any normal competitive market this would lead to lower wholesale prices, and in turn lower retail prices. Not so in the British electricity market. The wholesale price of electricity is set by the marginal (gas) costs and not the average (coal) costs. Whatever happens to coal prices, if the gas price rises so does the wholesale price. Lucky generators pay lower average costs for the coal, and get the higher marginal cost from the gas.