Talking tough on energy markets is no way to woo investors

Do you know Rema? 

No, not the Nigerian singer whose track “Iron Man” featured in Barack Obama’s 2019 list of song recommendations. I mean the somewhat less lyrical review of electricity market arrangements, which is on the UK government’s summer playlist with a consultation due in July.

You’ll be hearing more about Rema one way or another. Not least because the Treasury appears to be seizing on these broader market reform efforts as cover to row back on the plans announced in May to hit electricity generators with a windfall tax. 

The rationale is that reform could tackle “excess profits” in the sector by unshackling the price of electricity from the soaring wholesale cost of gas — a linkage that makes less and less sense given the rising proportion of zero marginal cost renewables in the UK’s energy mix. 

But conflating an extremely complicated market overhaul that should take years with short-term political whims around windfall taxes is odd and unhelpful.

The best reason to ditch a windfall tax on generators, after the sudden conversion to the cause of hitting North Sea oil and gas with a levy, is that it was never a good idea in the first place. 

The investment needed to hit the UK’s target of a decarbonised power grid by 2035 is vast: Cornwall Insight reckons £200bn is needed in wind, solar and battery power, let alone what might be needed to upgrade networks, say, or for nuclear and carbon capture technology. Flip-flopping on policy doesn’t help hit that goal. The idea of a windfall tax on generators was unfeasibly complicated in any case, given that hedging would have reduced the apparent profits being enjoyed by some and the multitude of different contracts used in the sector.

The idea that energy costs might have to be severed from marginal gas prices as part of the energy transition isn’t a new one: it was part of the cost of energy review done by economist Dieter Helm for the government in 2017. It’s just very difficult to do well, or quickly. 

Rema will look at pricing, alongside other issues like capacity, system flexibility and efficiency, in an effort to shift from a system designed for coal and gas to something fit for a decarbonised grid reliant on multiple technologies. (Splitting the market with renewables priced differently from fossil fuels is only one suggestion out there. An average cost of generation is another. National Grid has separately talked about nodal pricing, dividing the market into hundreds, or even thousands, of different markets to fine tune the incentives for investment.) 

This is a whack-a-mole effort, attempting to balance the need for a well-planned system, with huge investment requirements with, yes, the eventual goal of lower bills — and where every change affects other parts of the system. 

And “wholesale pricing touches everything,” says Tom Edwards at Cornwall Insight: new contracts are needed, existing contacts must be recut, the tariff price cap recalibrated and the knock-on effects to policy, balancing and network costs or capacity markets considered. Edwards puts the reform process done properly at five years, hardly a quick hit against this year’s profits. Knee-jerk moves in the near term to smooth price spikes also risk unintended consequences: Spain’s cap on power prices boosted cheap exports to France and increased gas demand. 

Meanwhile, the government is asking investors to step up spending in UK infrastructure and green energy, even as it tears up the market arrangements which will underpin their returns and could also hurt the economics on existing projects. To avoid an investment hiatus, major reforms have previously required expensive bridging contracts to ease the transition. And the business department was this week hosting international investors at one of a series of roundtables on energy transition, trying to woo capital on the promise of consistent, well thought-out policy. 

As Rema gets started in earnest, the government should be wary of hitting bum notes.


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