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The precarious state of British energy

    The composition of the UK’s retail electricity market has been dramatically transformed in recent years. The “Big 6” suppliers – who have typically been a dominant market force – now share the market with some 60 suppliers and subsequently have seen their combined market shares decline 4% in the last year alone. Moreover, the number of consumers switching electricity providers for better deals increased by 33% between quarter 3 of 2016 and quarter 3 of 2017.

    These figures, which portray a fairly competitive market, are threatened by Theresa May’s recent proposal to introduce price caps on energy bills. Further examination of policies implemented in the broader energy sector reveals a larger, equally alarming picture. There is a strong case for reform around carbon pricing to place further downward pressure on prices, and the security of Britain’s energy supply has decreased dramatically in recent times.

    Comparing the current state of the UK electricity markets with that of Australia’s uncovers both warnings and lessons for Britain against a number of its current policies and proposals. It reveals the case against government intervention in the market through caps and unilateral taxes, and cautions around policies which threaten energy security.

    May’s “Energy price cap”

    In her address to the 2017 Conservative Party Conference in Manchester, Theresa May alarmingly vowed to “put a price cap on energy bills”. Such a policy ignores recommendations from the Competition and Markets Authority and Ofgem, and signals danger to prospective investors. The price cap threatens to push some suppliers into the red, with two of the big six already making consistent loses in recent years.Not only will this deter the entrance of other firms into the market, it will also endanger the investment required to offset the close of many of Britain’s coal power plants.

    The detrimental impact of energy price caps can already be observed in Western Australian (WA). Synergy, the state’s sole household supplier, receives a subsidy from the WA government to offset the losses it incurs as a result of being forced to sell power at a price below its cost of production. Such a nonsensical market structure results in 85% of consumers paying less than the actual cost of electricity, requiring a  subsidy amounting to approximately £173m in 2016-17 financial year.

    Market distortions from price caps enforced in Western Australia have resulted in more taxes and have done little to improve the competitiveness of electricity prices. Rather than imposing price caps in the UK to “protect” uninformed consumers, current switching arrangements could be transformed to advantage consumers through collective switching arrangements and the proposed CMA database is a powerful tool to encourage competition.

    The Carbon Price Floor (CPF)

    The UK’s CPF was introduced in 2013, and means that UK generators of fossil fuel based electricity pay a carbon price over three times higher than their EU counterparts under the EU’s Emissions Trading Scheme.While the CPF is currently capped at £18 per tonne, the EU ETS is alternatively trading at less than €8 per tonne. The CPF creates an incentive for increased electricity imports by raising the price of emissions in the UK.

    Australia was the subject of a similar initiative from 2012, however the controversial carbon tax was eventually repealed in 2014. Approximately 75,000 businesses directly paid the carbon tax or paid an equivalent carbon tax through changes to duties and rebates. The Australian Treasury estimated the tax increased the cost of living to households by £5.74 per week, and increased the Consumer Price Index by 0.7%.

    Unilateral taxes which increase energy bills such as the CPF and Australian carbon tax disproportionately penalise lower income households and simply lead to the offshoring of emissions. The UK should follow Australia’s direction and review how its intervention in the market to discourage carbon emissions impacts consumers energy bills, perhaps by aligning its carbon price with that in the EU.

    Energy Security

    Whilst the poor state of the UK energy market has originated from domestic energy policies, EU legislation has further exacerbated threats to the UK’s energy security. EU directives have contributed to the closing of 11 of the UK’s coal power stations since 2012, with only 8 remaining in 2018.

    There has been no construction in equivalent amounts of baseload capacity to offset the premature closing of these coal plants, resulting in a large drop in the UK’s ability to reliably generate electricity. Foreign imports of electricity have increased by 43% since 2012, highlighting a concerning  trend in Britain to rely more heavily on electricity imports from EU interconnectors, which threatens national security of supply.

    Recent events in the South Australia – where the generation mix is a mixture of wind, gas, some solar and as of 2016, zero coal – poses a strong warning regarding the risks of heavy interconnector reliance. South Australia has become increasingly reliant on the interconnector from Victoria to provide supply. However, in September 2016 a storm resulted in that interconnector being severed and an entire state black out for a number of hours. Energy security continues to be an issue across the NEM, and a report by the Australian Electricity Market Operator (AEMO) estimates the likelihood of blackouts this summer in South Australia to be between 26 and 33%.

    The future of the UK’s energy security seems uncertain, and the events in South Australia should serve as a warning about the consequences of an over-reliance on interconnectors. The latest UK capacity auction for the procurement of capacity in 2020/21 saw new gas plants equating to only 15% of supply.  In the short term, the government must incentivise the construction of new gas power stations to shore up supply.

    Conclusion

    It is true that Britain’s energy markets require change to allow for a more competitive market place and lower prices. Further state intervention, however, distorts the very market mechanisms which are ultimately the only wat to deliver the greatest benefit to consumers.

    Comparison between the UK and Australian energy markets sends a powerful message regarding the importance of encouraging competition and reinforcing a secure electricity supply, and also cautions against unilateral carbon taxes. These lessons and warnings must be enacted in policy if the government truly wishes to deliver affordable, reliable electricity to all households in the long term. 

    Josh Adamson is a CPS Economic Research Intern from Perth, Western Australia. He joins us through the Mannkal Economic Education Foundation, which offers international scholarships to students with a passion for free markets. Josh studies economics, and aims to work in the financial services sector.  

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