The Government has this week appointed Dieter Helm, professor of economic policy at Oxford University, to lead a review into the cost of energy. He will chair a panel of experts including Nick Winser, executive director at National Grid and former Conservative MP Laura Sandys, who will examine the entire electricity supply chain and consider the cost implications of the changing demand for electricity and the role of emerging technologies such as storage, electric vehicles and artificial intelligence.

The remainder of the panel will comprise: Terry Scuoler, chief executive of EEF, the manufacturers’ organisation; Isobel Sheldon, engineering & technology director of Johnson Matthey Battery Systems; and Richard Nourse, managing partner of Greencoat Capital LLP.

Announcing the review, Greg Clark, the Secretary of State for Business and Industrial Strategy, said:

“The review will consider how we can take advantage of changes to our power system and new technologies to ensure clean, secure and affordable supplies over the coming decades.”

Professor Helm said:

“My review will be independent and sort our the facts from the myths about the cost of energy, and make the recommendations about how to more effectively achieve the overall objectives.”

The announcement comes days after the controversy surrounding the 12.5% price rise from British Gas, which brought the wider question of electricity pricing back into focus. While the UK’s domestic electricity and gas prices are relatively low compared with other European countries, costs for businesses are high – according to BEIS, the UK has the third-highest industrial electricity costs among a group of 15 core EU countries.

An interesting choice of chairman…

The choice of Dieter Helm for the review has attracted some criticism, given his previous criticisms of energy policy. In this paper from 2014, he was critical of the subsidy regime that has emerged from climate policies:

“It is one of those silly mantras that European Commission officials and national politicians trot out that climate change policies in general, and renewables in particular, are fully consistent with security of supply, competitive markets, and affordability.”

Helm believes that this view had its origins in a belief that oil and gas prices would continue to rise, meaning that any subsidies for renewable energy would be temporary since eventually (estimated to be around 2020), they would be competitive against more expensive fossil fuels. These assumptions have turned out to be flawed – fossil fuel prices have fallen significantly and renewables remain far from being competitive.

…critical of the growing size and scope of energy subsidies

Helm argues that and un-intended consequence of climate change policies is the degree to which subsidies set off a lobbying cycle where private sector companies exploit their information advantages to influence politicians to act in their interests. They seek to control the information available to ministers and create a belief that without certain incentives, desired investments will fail to materialise. Helm suggests that consulting companies produce reports further supporting corporate interests.

The problem of “revolving doors” also arises, where energy ministers and regulators often end up advising or joining the boards of energy companies. These companies acquire further influence by donating to political parties and supporting causes favoured by politicians.

Helm points out that this behaviour is not generally illegal, and is common in political systems round the world.

So subsidies can quickly get out of control – what starts as a simple and fairly narrow system can rapidly expand as pressure is applied to expand the scope to new technologies.

“So profitable were some of the early renewables that politicians tried to row backwards, correctly anticipating a consumer backlash when the bills eventually turned up. In an attempt to trim back the returns, the plan was to remove the wholesale price contribution and put all the renewables on fixed-price contracts. These were dressed up as contracts-for-difference, introducing another layer of complexity, and yielding rents not only to the companies but also to advisers, risk managers and financial institutions.”

According to Helm, the Government plans to develop technology-neutral subsidy auctions, but these would require renewables to be competitive, and wholesale prices higher, neither of which are by any means certain. If the conditions are unfavourable, more lobbying around employment and investments is likely to arise to protect their economics.

Further complexity has arisen due to the intermittent nature of the growing renewables base, giving rise to the need for capacity contracts to ensure thermal generation would be available to guarantee security of supply. This development means that every type of generation investment now requires a fixed price contract from the Government in order to be viable.

Helm goes on to describe the wider web of policy interventions, covering everything from energy efficiency and social policy, to the bulk of market regulation of networks transmission and supply. He highlights the scope and scale of these interventions and the fact they continue to increase, as illustrated by the following, non-exhaustive, table:

Helm energy price review

These interventions cover every aspect of the market, and mean that the regulator has grown from some 20 people at the time of privatisation, to around 600 at the time of Helm’s paper, with almost 1500 people working for DECC. Regulation itself has become an industry, and the market has reverted to many of the features of the old nationalised command-and-control model based around the Central Electricity Generating Board.

…supportive of a regulated default tariff for energy

Helm was firmly critical of the conclusions reached by the Competition & Markets Authority in its review of energy markets:

“When it comes to making the customers switch, the CMA thinks that establishing databases of those who have been too lazy, ignorant or poor to switch, so that they can be bombarded with mail shots from rival suppliers should do the trick. This (temporary) measure is required until smart meters come along and solve the problem.

The diagnosis and the conclusions are at best misguided, depending on a failure to take proper account of not only what is currently going on in this market, but also failing to undertake any serious analysis of the fundamental shift from wholesale to capacity markets. Future electricity markets are not going to be driven overwhelmingly by wholesale prices: capacity contracts, Feed-in-Tariff (FiT) contracts and system charges will make up more and more of the final bill.”

Helm argues that as more zero marginal cost generation comes onto the system, the wholesale prices will continue to fall. At the same time, all new investments in the system require some form of subsidy in order to be viable, meaning that capacity rather than energy increasingly drives electricity prices. The value of these subsidies is recovered through electricity bills undermining the benefits of switching as all suppliers have broadly the same responsibility for this cost recovery.

He suggests that as the market moves from variable wholesale markets to fixed priced cost-recovery ones, the Government becomes the single (monopoly) buyer where the role of suppliers is reduced to billing and debt collection. Supply is actually effected by the distribution companies who supply capacity.

In February, Helm responded to the price increases levied by the Big 6 suppliers (apart from British Gas who at the time announced a price freeze until the summer). In his view, the Government can either trust in switching ie assume that eventually all customers will switch to better tariffs, perhaps with the adoption of some policies to stimulate switching; or it could impose a default tariff on suppliers.

Helm believes the first option is unlikely to work due to the large economies of scale in the customer bases of the Big 6 suppliers. His view is that as supply is naturally oligopolistic, and although these economies of scale might bring in even bigger players cross-selling through the household broadband hub, this would take time, meanwhile loyal customers are exploited.

He believes that the second option is the one which a genuinely competitive market would deliver, and therefore the Government should impose it as a mandatory default tariff, where the only variation between suppliers would be their margin. This would make the tariffs very transparent and provide a clear means of competition.

Default tariff = Indexed wholesale price + fixed cost pass throughs + unregulated published margins

“My proposal is that this tariff should be the default tariff, and that suppliers would remain free to offer any other tariff. They would have to publish the details of this default tariff, so customers could see the different elements, and they would especially be required to publish their margins. The reason is obvious: the margin is the only thing that the companies really control and manage. Nobody can object to making this information – and indeed the costs of all the bits – transparent.

What would this tariff reveal? Embarrassingly it would reveal that there is a wide range of margins, partly reflecting different levels of efficiency (and inefficiency) and party reflecting the segmentation of the market and the extraction of premiums from different groups on non-switchers.”

…favours a complete re-set of energy policy

Last September, Helm wrote a paper suggesting the priorities for Greg Clark as he took up his role at BEIS:

“Greg Clark has a clear choice in these early months: he can try to do more patching up of what he has inherited, or he can try to reset the balance between the market and the state. If he follows the former, he will be dragged into annual doctoring of the capacity auctions, and continuous interventions to choose new “winners”. If he instead decides to make his mark by creating a longer term and more sustainable electricity industry, he needs to make some big moves. The most obvious is to merge FiTs and capacity markets into a single unified auction for firm power, incorporating full locational costs…

…There would still be the need to make sure the carbon budgets are met. The obvious market approach is to allow the carbon price to go to whatever level necessary to meet the targets. This may be a step too brave to take. Confronting business and consumers with the cost of their pollution is politically hard to do. If this is just too much, then the unified auction could be two stage: stage one unconstrained by carbon (other than existing carbon prices) and stage two taking account, in the light of stage one bids, of the carbon constraints.”

Dieter Helm has identified a number of serious problems with current policy collectively create upward pressures on energy prices. He is critical of the extensive subsidy regime affecting every element of the electricity system, and the creeping return to state control. It will be very interesting to see how he approaches his review. The political sensitivities of high prices are significant, as noted above, but an honest review would identify climate change policies as a major cause of the recent price inflation, and by how much, and would recommend greater transparency to inform effective scrutiny of the impact of energy policy on prices.

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