Last week, the twin pressures of pushing down energy prices and ensuring sufficient investment in capacity came into sharp tension. Centrica threatened that the competition investigation into energy markets would slow down investment in new capacity, potentially causing blackouts. Probably a situation that our politicians want to avoid. This week, the SMF hosted Professor Dieter Helm, expert economist on energy at the University of Oxford to talk about the state of energy policy at our ESRC sponsored Chalk + Talk series.
Professor Helm firstly showed how the energy market and energy policy as it stands is failing all on three of its key objectives:
- Despite wanting a reduction, our carbon emissions are actually increasing, due to coal-fired power stations.
- Energy bills have been rising, with trust in the market so low that the CMA is being called in to investigate the market.
- Investment in future energy capacity is insufficient to cope with demand. Only the “good luck” of an economic downturn has bought us an extra few years.
So where is energy policy going wrong? Essentially, there are choices to be made on whether we want the market or the state to dictate investment in capacity and prices. In the 1970s, we had a state-run system, with the Central Electricity Generating Board and British Gas centrally responsible for ensuring that demand for energy would be met. Under this system, there was more than enough investment, and in fact by the 1980s we had excess capacity. The move to privatisation and reliance on markets to deliver energy worked well in this context.
But now, we face a new challenge. Spare capacity is running out. What we need is a large uptick in investment in energy generation to cope with rising demand. In theory – and in the case of many markets – there is no reason to think that well-functioning markets cannot deliver new investment, although in some cases uncertainty and investment lead times may mean that there are delays. But in energy, relying on markets is not working.
The reason? Because society and Government would not be happy with the market outcome. Firstly, for companies to be incentivised to invest, prices have to rise. The last few weeks and months are enough to show that politicians would not view this as a good outcome. Secondly, in other markets for non-essentials, we might be happy for supply to occasionally not keep up with demand. In energy, supply not keeping up with demand means blackouts. So we, as consumers and voters, also expect there to be sufficient excess capacity to cope with situations where demand is higher than normal.
New investment is happening, for example, in renewables and in nuclear power stations such as Hinckley Point. But crucially, these projects are not driven by the market alone. Instead, Government is involved in setting contracts and standing behind investments. Effectively, we are creating two systems: a market-led one that involves low prices from sweating existing assets; and a state-led one that offers higher prices for new investment.
There is a choice to be made. It is not impossible to make markets work effectively. Professor Dieter Helm outlined one option, a two-stage auction, whereby we identify the capacity we need, and capacity slots go to the bidders who can produce the energy required most efficiently whilst also satisfying conditions relating to the environment or climate change. But this doesn’t look like the direction we are going in. Instead, we are moving towards a complicated situation where Government is ever more entwined in an industry that is supposed to be privatised. The danger is that in seeking to combine the best of both worlds – a state versus market run system – we get the worst of both. And, going on the current measures of affordability, capacity and progress on climate change, it looks like that is exactly what we have got.