The risks of a never-ending search for certainty in the energy market

Following last week’s post by Duncan Brack on the importance of consistency in climate change policy, Guy Newey of Policy Exchange explores the challenges of providing certainty in the energy market.

The mantra from energy investors was unrelenting during the Party Conference season. “Give us more certainty,” they demanded, promising to deliver new factories, turbines and gas infrastructure if only the Government would add an extra dollop of the magic ingredient.

Opposition politicians were quick to pounce: “Failure to deliver certainty is threatening British jobs,” they cried. Government ministers retorted: “We recognise the need for certainty and we will deliver it through the new Energy Bill. The opposition had 13 years…” And so on and so on.

So what do investors mean by certainty and why is the Treasury accused of getting in the way? Essentially, they want two things – a clear price for their power and a political commitment that the Government is not going to change course. Unfortunately, these two hopes will always clash.

First, a clear price. Those looking to build new nuclear power stations or offshore windfarms argue that if they are given a certain price, they can borrow money more cheaply and so the overall cost will fall.

The difficulties of eliminating risk
Giving certainty about future prices certainly reduces the costs for investors and developers. However, the risk does not disappear. Like a whack-a-mole, it just pops up somewhere else. In the case of energy policy, it is transferred to billpayers who may end up having to pay a higher price than they needed to (see solar FITs) or being lumbered with a technology that has soon after become obsolete (see historic support for some nuclear technologies).

The great paradox of energy policy is that the more you bring decisions into the political sphere, the more political risk you introduce. You can have subsidy or certainty, but you cannot have both.

The tortuous passage of the Energy Bill demonstrates these problems. The government is looking to give guaranteed long term electricity prices to particular technologies, including nuclear and renewables. That sounds like quite a lot of certainty. In a perfectly sensible effort to try and protect the consumer, the Treasury has come up with a cap on how much can be spent overall.

But then certainty-craving investors worry they might not get enough of the pie, and so they need more certainty that the pie will be big enough, in this case a limit on the 2030 carbon intensity of the electricity system. Does the presence of this sub-target really provide any extra certainty beyond the Climate Change Act? Will it shave anything off the cost of capital for investors?

But if government has to decide fixed prices for new nuclear and every different type of renewable technology, it then has to make similar decisions about new gas-fired power stations (through the proposed capacity mechanism). Decision after decision after decision. And until it does make those impossible decisions — there is no way anyone can have enough information to make them well — it risks creating an investment hiatus, the very thing it was designed to avoid.

If you create a situation where government has to make lots of decisions in the energy market, inevitably you will end up with a slow, bureaucratic decision-making process. Furthermore, the process is a never-ending one. Lobbyists will always push for just one more line in the legislation that makes it that little bit easier for them. Consumers groups will push back. Economists will argue over the best approach. Government will agonise and any minor utterance from ministers will be jumped on as signalling the death of an industry.

A question of communication?
The other part of what investors mean by certainty reflects the way the government communicates climate policy.  The chancellor could be making a pro-green call for challenging subsidy levels. He could have argued: “We are cutting subsidy because these technologies are coming down in price. Soon onshore wind could be cheaper than fossil fuels, keeping our energy bills as low as possible and tackling climate change.” But for some reason, he has chosen not to.

While Osborne is painted as the bogeyman, debates about the appropriate balance of climate policies would have been taking place, even with a Labour or Lib Dem government. This is because it is government’s job to balance the interests of investors with those of nervous billpayers. BIS and Treasury have always been suspicious of the future costs of renewables (renewable support is currently a small factor in bills – most of the recent rises have come on the back of rising international gas prices — but is projected to become much higher over the next ten years).

Government has to make interventions in the market to support development of new technologies and to cut carbon. But it should look to make as few decisions as possible. It should also endeavour to make them as quickly as it can. But hoping there will never be a battle when public money and politics is involved is unrealistic.

About Green Alliance blog

Green Alliance is a charity and independent think tank focused on ambitious leadership and increased political support for environmental solutions in the UK. This blog provides space for commentary and analysis around environmental politics and policy issues as they affect the UK. The views of external contributors do not necessarily represent those of Green Alliance.
This entry was posted in Energy demand, Low carbon energy, Policy, Politics. Bookmark the permalink.

4 Responses to The risks of a never-ending search for certainty in the energy market

  1. gabby says:

    While investors and governments wrestle over who will get the biggest piece of the energy pie and how, I’d like to remind us all as energy consumers that we have the opportunity to choose the “power to be independent” as this DIY solar panel company’s motto so perfectly states http://www.mysolarshop.co.uk/

  2. Mark says:

    Even with the Climate Change Act, there is no compelling narrative from Government as to how the UK will deliver the emission reductions required by 2050. If done properly, this narrative would help with investor confidence and provide the UK population with some clear reasoning as to why energy infrastructure is having to change.

  3. solchap says:

    Investors naturally want to reduce uncertainty where they can, but if they insist on certainty they shouldn’t be in business at all; they should be buying fixed interest Government bonds. So disregard all calls for certainty. What the Government has to do, without question, is to drive a transition over the next 30 to 40 years, preferably less, from using fossil fuels for power generation to renewables that entail minimal fossil fuel content and other GHG emissions in their construction (which puts a big question mark over nuclear, at least) or operation (which rules out a lot of current biofuels). Intelligent guesswork is therefore essential as to what is needed to effect that transition and, with hindsight, whatever is done will doubtless be seen to have been less than optimal. But done it must be, and if it entails some unnecessary costs, so be it. A small price to pay for helping to save the planet. A carbon tax on all relevant emissions might well require less guesswork elsewhere, and smaller unnecessary costs, but evidently that is not wanted either.

  4. DN says:

    The proposed Contracts for Difference and Capacity Mechanism can include flexibility to vary the extent and amount of payments in future. That’s fine, so long as what these mechanisms are, and even whether they’re going to be introduced, is clear.

    The trouble at the moment is being caused by Government saying, “We’re going to fundamentally change the rules – but we’re just not going to tell you how. Not yet anyway”. No-one is going to take a punt on a 20/30/40/50 year investment on that basis. Government needs to commit to its best effort now, and accept that power projects securing contracts in the first few years will be bound to the terms of the time (“grandfathering”). But the system can be refined over time, and for projects emerging a few years down the line, on the basis of experience and the flexibility you they should incorporate in the legislation.

    New plans rarely survive entirely unscathed from contact with reality – but you can’t hide from that reality forever (although the Government seems to be trying).

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