Sunday, October 06, 2013

Energy Policy: Omnibus Post

For most of the time we are all capable of sailing serenely on in ignorance of how fundamentally our world-views differ from those of others; but once in a while the chasm is illuminated by a bolt from the blue.

One such event happened when Miliband launched his 'energy price freeze' policy.  I and many others in the 'sphere and MSM alike immediately clapped our hands to our heads and proclaimed, that's it ! - he's completely lost it, and shot himself in the vitals on prime-time TV to boot.  We clearly thought the lunacy of it would be obvious to all.

But not a bit of it, because the reaction of other commentators was: a price freeze - so what ?  No big deal, even if it's not something we particularly applaud; and anyhow, the energy companies had it coming. 

In other words, there is no general consensus or shared understanding on some pretty basic energy market concepts.  So here are some responses to the interesting exchanges between 'Timbo', 'BE' and 'BQ' on the comments thread to a recent C@W post.  I'm going to focus on short- / medium-term, (say, out to 15 years hence) because the really long-term stuff is unknowable, thanks to technology shifts we can barely guess at.  (In which latter category I place Timbo's fascinating comments on electricity storage, the Holy Grail of energy policy which would transform the landscape.)

The paramount fundamental is that electricity has staggering high 'utility value', i.e. people (in developed economies) will pay almost any price to get it.  Second only to food, for most people.  (Water comes third because you can generally makes your own arrangements, up to a point.)  By this standard, as Timbo wrote, " cheap the grid is.  It's dirt cheap".  And when people will pay almost any price ... things can go horribly wrong.

Notwithstanding various developments in micro- and distributed-generation, and predictions of more to come, the kind of electricity and energy we all want - permanently available, in bulk, almost everywhere we go, and relatively cheap - requires centralised 'organisation' (grids, despatch and balancing systems), if not actually 20th-century style centralised generation.  And this isn't just power for domestic use, schools and hospitals: as BQ said, "you can't run a blast furnace on wood".  The saintly George Moonbat tried very hard to run a self-sufficient smallholding in Wales, and just about managed OK for a couple of years until he had a bad winter - after which he suddenly became a convert to nuclear power.

It used to be thought (and still is, in some dark quarters) that only centralised ownership, or at least centralised control, could deliver the goods: but this was comprehensively disproved in the UK and other regions with the advent of full bilateral (self-despatching) markets at the beginning of this century, which not only confounded the statists dirigistes by working at all, they worked better, and reduced electricity costs as their proponents (incl. yours truly) said they would.  Even the Labour Party still signs up for this, (see Caroline Flint on Brillo's Sunday programme: and the changes that brought it about in in the UK 2001 were put through Parliament by Mandelson) so dissenters are up against it politically.

But there are problems.  Firstly, bilateral market structures, though basically robust, are vulnerable to large-scale interference by the heavy-handed and dull-witted.  This includes many politicians and almost all civil servants.  In particular, there is a limit to how much ill-considered (indeed, sometimes actually infeasible) 'decarbonisation' policy can be loaded onto a market framework without it buckling.   Of course, in this country the rot started under Miliband lui-même when in power - oh the irony - but has been further perpetrated here by t'Coalition (and on an even more manic scale in Germany).  

(As an aside, the chronic state of our Heath-Robinson energy policy makes it very easy for any politician to score a few easy and populist points against it.  That Miliband is the first one to do so on a grand scale, is just hilarious.)

The second point is that those bilateral market structures are relatively new and by no means perfected, even before they started to be messed with.  In particular, (a) liquidity in some parts of the power markets, here and elsewhere, left quite a lot to be desired.  Liquidity, for those who don't have an instinct for it (this includes many politicians and almost all civil servants ...) is absolutely vital for markets to deliver for consumers. Ofgem, which had this forcibly brought to their attention nearly a decade ago, has been farting around ineffectually on the issue ever since.

(b) A related point: the state of competition is unsatisfactory.  There is no reason why the current UK  'supply' set-up - 6 massive players plus a host of lesser ones - shouldn't make for a competitive market.  It is, in fact, more competitive than many people give it credit for.  But there's a damaging, mutually reinforcing effect at work:  unsatisfactory wholesale liquidity makes suppliers migrate towards vertical integration (i.e., becoming generators as well), which further reduces liquidity ... etc etc.  

[To illustrate: Centrica set out in 1996 intending to be a capital-S Specialised Supplier (of gas and power), with no power generation at all and limited gas production of its own (the 'merchant', or 'Enron' model).  But over the years, they found liquidity in the wholesale markets less than satisfactory.  So they have slowly become more and more vertically integrated, to the point where now they have about 75% cover for their supply obligations from their own 'upstream' assets (power plants, gas fields and some large long-term purchases).  This means that, where once they were trading in the wholesale markets for almost all their needs, they are now only trading for 25% (net) of their needs, plus some spec trading etc.]

Two dreadful policy decisions have gravely exacerbated this situation.  The first was to allow large-scale vertical integration by acquisition.  This was of course re-integration, because throughout the whole of the 1990's, Ofgas and Offer (the worthy predecessors of Ofgem) had been preoccupied with breaking up the old verticals (themselves the products of the two big privatisations of the 1980s).  The worst examples of vertical integration by acquisition were (1) Powergen's purchase of Eastern Electricity and other UK assets, followed by E.on's subsequent purchases of both Powergen here and Ruhrgas in Germany; (2) EDF's purchase of British Energy.  These should have been stopped by UK and EC regulators - not because vertical integration is intrinsically wicked, but because the markets weren't sufficiently liquid at the time.  (In fact, truly liquid markets make vertical integration a very dubious commercial proposition - which is the virtuous-circle side of the liquidity picture.  We are stuck with the vicious circle.) 

The second disaster for the liquidity/competition downward spiral is the manner in which decarbonisation is being pursued.  In the UK this means the ridiculous 'Electricity Market Reforms', which - take it from me - undermine liquidity still further, even as ministers and Ofgem continue to pay lip-service to the need for better liquidity.  It's hugely perverse, because several critical aspects of EMR are wholly dependent on there being deeply liquid markets in existence.  They will fail miserably, and piecemeal government interventions of the most grotesque kind will result - the civil servants can hardly contain their excitement at the prospect.  And they will probably keep the lights on, because we can and will pay (see above) - almost any price.

Which brings us back to Miliband's 'price freeze'.  I've banged on too long already to dissect this in detail.  Suffice to repeat: it's bonkers, it's a cheap populist shot, and will have negative consequences far outweighing any limited relief it may deliver to consumers.  Interestingly, in answer to Brillo's questions Caroline Flint (who, it must be said, was quite well briefed) quickly mentioned the really significant new Labour policy, which is to re-introduce something akin to the 'Pool market' (i.e. an end to the bilateral / self-despatch system) which was how things were run here in the 1990's.  It wasn't a disaster, but it was definitely very inefficient.  And - oh, how these things go full circle - it was dreamed up by Oliver sh*t-for-brains Letwin ! (Who still hankers after it, I can tell you, as do civil servants and all the old CEGB dinosaurs.)

This post first appeared on the Capitalists@Work blog

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