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Can the next government solve the UK’s energy trilemma?

Prices need to go up considerably so energy companies make enough money to justify investment

By Prospect Team  

What's behind Britain's jobs boom? © Lynne Kirton

Where should the UK get its energy from, and how should we pay for it? Here lie two major puzzles facing any party vying for a turn in government in May. Not only must the country secure its future energy supply, it must do so affordably and in line with carbon reduction commitments. This “energy trilemma” formed the heart of a timely round table hosted by Prospect less than 70 days before the general election.

The discussion, supported by Climate Change Capital and Centrica, set out to describe the scale of the problem, the proposed solutions, and the appropriate roles to be played by government and the private sector. Shadow Energy Secretary Caroline Flint began by outlining Labour’s priorities – including an energy bills price freeze, a tougher regulator that could ensure wholesale price drops were passed on to customers, more focus on energy efficiency measures, and reforms to make the market more “competitive and transparent”, such as a stronger separation between generation and supply.

Flint was joined by a group of experts from the energy industry, think tanks, universities, investment advisors, trade unions and NGOs. All acknowledged that more money is urgently needed to support projects and encourage innovation. How to achieve this – through government contracts, private investment or taxpayer-funded contributions (such as those taken through energy bills) – dominated much of the conversation.

The round table took place just hours after renewable energy technologies were invited to bid against each other for government-subsidised contracts for the first time, resulting in a significant price saving for the government. Flint said the news was “encouraging” and underscored the pressure on politicians to spend money wisely and to take a “hands-on” approach with the sector. “Whether it is capacity auctions, CfDs [Contracts for Difference] or any of the other mechanisms of EMR [Electricity Market Reform], the government is probably more involved in energy than it has been since privatisation,” she said.

Resolving the trilemma

Striking a balance between government intervention and free market competition was a key concern for Ian Temperton, Managing Director of Climate Change Capital. “We can’t take politics out of this sector, but are we empowering or regulating customers? My latest gas bill said ‘have you considered switching?’ across it in large letters. I can honestly tell you that I don’t do that for my clients – so when do we let the market do its stuff, and when do we get paternalistic?”

Such balancing acts define why the trilemma is so difficult to solve, said Michael Grubb, Professor of International Energy and Climate Change Policy at UCL. He identified another trade-off between local impact and national need. “On-shore technologies such as wind or shale are less expensive but cause local concern, yet taking things off-shore is much more expensive,” he explained.

“A trilemma is not a fellowship of equals” added Malcolm Grimston, Senior Research Fellow with the Energy Policy and Management Group at Imperial College. He cited Japan’s retraction of its carbon reduction targets as a key example of how countries will shift their priorities under pressure. “Environmental requirements are the first to be thrown out the window. Cost is the second to go, but security of supply is the one that systems will die for.”

A fair price?

The conversation turned to pricing, which stirred lively debate. How could Labour keep bills down, while also freeing the market from subsidy-dependence and making it more attractive to private investment? Richard Howard, Head of Environment and Energy at Policy Exchange, summarised findings from the Competition & Markets Authority (CMA) when he said that energy companies may appear bloated, but in fact “[they] aren’t making huge profits and projects aren’t achieving their cost of capital.”

Grimston said the public is especially out of touch with the cost of electricity. He reminded delegates not to forget how “unusual” electricity is because it cannot be stored, meaning that – while consumers want a low price and a secure supply – it isn’t in energy companies’ interest to generate surplus. “The interests of producers and consumers diverge more on electricity than on any other good,” he said.

Grimston also warned that low-prices are inherently incompatible with energy security as they discourage private investment, leading to reduced capacity and the eventual risk of blackouts. “I am petrified by the talk of bringing prices down through political intervention,” he said. “It is patently obvious that prices need to go up considerably so these companies make enough money to justify the billions of pounds of investment we want from the private sector.”

Centrica’s Director of Public Affairs Sarah Richardson raised the North Sea oil fields as an example of how low prices can discourage investment and UK exploration. Oil prices have sunk by 60 per cent since June, meaning more expensive extraction and smaller profit margins. “We need to ensure companies aren’t taking their money elsewhere, and that there isn’t an early cessation of assets,” she said. “That’s why we need a supportive fiscal regime.”

Responding to the question of whether higher prices are inevitable, Flint reiterated that securing “a fair price” for consumers was uppermost in her mind. “Despite strong voices against our price freeze policy, nobody has been able to refute our analysis, based on data from 2009, which shows a significant drop in wholesale costs that was never passed on to consumers. The freeze is about compensating bill payers.”

The future energy mix

If creating the right fiscal climate for investment is imperative, then so too is finding the right mix of energy source. Views on renewables lacked enthusiasm – Temperton said solar and onshore wind are unlikely to de-carbonise the country in a major way, Grubb called the Green Deal “a disaster”, and Emma Pinchbeck, Head of Energy at WWF, said the sector didn’t see enough “long-term” thinking from government policy.

For Gary Smith, National Secretary of GMB’s Commercial Services Section, gas should be the obvious priority. “There are few jobs for ordinary people in the renewables sector, the North Sea [oil industry] is in meltdown, and new nuclear is just not happening,” he said, referring to the latest setbacks for Hinkley Point. “We’ve got wonderful gas infrastructure and it is far cheaper than electricity.”
On the topic of shale gas, Richardson lamented that planning decisions to tap reserves in Lancashire currently stand “on a knife’s edge”. “UK hydrocarbons are secure, safe, and don’t need to be imported from volatile regimes abroad,” she said. “We have the potential for trillions of cubic feet of gas and we are shutting doors.”

As the election looms, participants broadly agreed that greater clarity of direction is needed from government so as to boost investor confidence, and rebuild consumer trust. Indeed, the voice of public dissatisfaction weighed heavily on Flint’s mind: “So many issues – poor treatment of customers, low wages, life costing more – all come at a moment when they find their voice in the energy debate.”

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