“All consumers will benefit from the removal of Embedded Benefits,” Targeted Charging Review, Ofgem, November 2019
I have been asked to expand on my assertion in the previous post that re-nationalisation of the British power sector, as per Labour party policy, would be bad. So here goes. Synopsis: the sector has performed reasonably well over the last thirty years, if one’s criteria are costs to consumers, security of supply, and decarbonisation. So why rip it up at great expense?
Profit is a useful signal
It is easy to feel sympathy for the view that essential services should, in an ideal world, be run on a not-for-profit basis. However we need to examine how they work in practice, on a case-by-case and non-ideological basis. Excess profit is not the only evil that can afflict service provision; and it is not necessarily the worst. Profit, viewed dispassionately, provides useful information on the deployment of resources.
When the electricity industry was privatised in 1990, coal was meeting around 72% of Britain’s power demand, heavy fuel oil 6% and nuclear 20%. The Central Electricity Generating Board (CEGB) was the mainstay of the national coal industry and had plans for more coal capacity, as well as three new PWR nuclear stations following on from Sizewell B. The PWRs, based on the history of nuclear in Britain before and since, would have been particularly expensive.
After privatisation, the new owners ditched the plans for coal and nuclear and chose to build gas-fired combined cycle gas turbines (CCGTs) instead, during the “dash for gas” of the 1990s. By 1996, the generation market share of coal and heavy fuel oil had more than halved, from nearly 80% to less than 40%. This dash for gas might have happened to some degree anyway – opinion is divided – but given the CEGB’s relationship with coal, approach to investment and general inertia, it is unlikely to have happened as quickly as it did.
Overall, the build cost was much lower than it would have been, and the energy produced was cleaner that it would have been, had the CEGB survived and continued with its operations and development plans. The carbon emissions from the new CCGTs were around 40% of the level, per MWh of electricity, produced by the coal stations they displaced and pre-empted. During the 1990s, renewable energy costs (wind and solar) were several times greater than they are today; and few people working in either the private or public sector at the time thought it was realistic for them to contribute a large percentage of our energy needs. At least gas was an improvement on coal.
(More recently, renewables have been profitable, and have grown to a level where their output is similar to CCGTs’. The only really poor investment decision of recent years has been the Hinkley C nuclear project; and that was taken by the Conservative government under Theresa May.)
The new owners were, of course, keen to make a profit: it was this incentive, whatever one thinks about it, that drove the rapid change that was much needed in the industry. The CEGB did not have the same profit motive, which was laudable in terms of a public service ethos, but the downside was less financial discipline. As those who remember the CEGB can attest, it was inefficient, influenced by lobbying groups, and had costs running out of control.
Efficiency isn’t everything; and there may well be some key services – health, rail and mail could be debated – where the merits of the public service ethos outweigh the financial discipline of the private sector and its ability to respond more quickly as the world changes. But power, in Britain, in 1990, was not one of them.
It is notable that the major economies in Europe (and elsewhere) have to a large extent followed suit in privatising their energy sectors in recent decades. The OECD Public Ownership and Market Regulation Index (PMR) for the European electricity supply industry has more than halved since 1990. There are some exceptions – Scandinavia in particular – but the general trend has been to privatise; and most detailed analyses (e.g. European Commission in 2016, BNetZ, NERA in 2019) have concluded that the private companies – on the whole – work better than the public ones.
Profit is a small percentage
Power prices have risen since 1990. But we need to ask why that is – not leap to a conclusion that it’s because we are being ripped off. The brief answer – at least prior to Covid-19 – is that international fuel prices, which comprise most of the station running costs, increased many times over.
In his otherwise excellent book What We Need To Do Now, for a zero carbon future, published in January 2020, the green economist Chris Goodall contests that we need a complete overhaul of our power sector and to follow the ‘German model’. In Germany, local utilities known as Stadtwerke, many of which are publicly owned, distribute over half of the country’s electricity. Municipal ownership “helps to hold down costs”, he says, adding “the situation couldn’t be more different in the UK, where the small group of private distribution companies, many owned by private equity funds domiciled abroad, act to maximise profit rather than the public good”.
Germany is an interesting example. In recent years, there has been a wave of re-municipalisation following the expiry of private sector network licences set up in the 1990s. But this wave of activity has not been successful based on its own criteria. The independent German regulator, Bundesnetzagentur (BNetZ), assesses the relative performance of network companies; their analysis suggests the private ones generally outperform the public ones in terms of cost efficiency and quality of service.
Unfortunately for the argument in What We Need To Do Now, the German public now pay the highest electricity prices in Europe. As of March 2020, medium domestic consumers paid 26.98 p/kWh in Germany and 18.54 p/kWh in Britain (source: Ofgem/BEIS or Eurostat). In Britain, these standard tariffs are about at the European average (our gas is cheaper than average, by the bye).
Personally I think there are strong grounds, on the basis of sustainability, for saying that most of us pay too little, not too much, for our home energy. But that is beside the point, which is that the evidence doesn’t appear to support the claim that we power consumers are being ripped off by non-domiciled equity funds, to the extent that a fundamental overhaul of the industry is required.
Energy profits are a political football and hence often in the news. In January 2020, the National Audit Office issued a report that estimated consumers have overpaid £0.8 billion in excess profits to network companies during the current regulatory period (2013-2021). This followed a previous report in 2017 by Citizens Advice that estimated consumers had overpaid £7.5 billion over an eight year period. Using the earlier and significantly higher estimate of excess profits, and rounding up, let’s assume for the sake of argument that network companies are being paid an excess £1 billion per annum. In aggregate, British consumers now pay around £42 billion per annum on electricity, so this high estimate of excess profit amounts to an overpayment of circa 2.5% on our bills in recent years.
Taking all activities into account – generation, networks, supply – the profit element of the typical domestic bill in Britain (Northern Ireland is part of the Irish market) is around 5%, or nearly 1 penny per kWh. Is that too much? I am not sure, but even with this maximised profit, our domestic bills are typical for Europe, and in Germany they are 46% higher.
Yes, it is possible that some energy companies are making excess profits – though the case is far from proven, as our networks in particular need serious levels of investment. The excess is, perhaps, up to a few percent of our bills. Differences in underlying costs, between countries and over time, are much more significant.
The privatised industry has made environmental progress
Whereas coal and heavy fuel oil accounted for around 80% of British generation in 1990, in 2019 they accounted for 2%. Over the same timeframe, renewable generation has increased from about 3% to 37%. The carbon intensity of our electricity has fallen from circa 0.7 to 0.2 tCO2 per MWh generated. It would be fair to say that the energy sector has made more progress in decarbonisation than any other sector of comparable size in the British economy.
The story is similar in most of continental Europe, though some countries, including Germany, still use lots of coal, and have higher carbon emissions in consequence.
There is no room for complacency given climate breakdown; and we need to work to divest ourselves from our current reliance on natural gas for 40% of our demand. But there is no evidence to support the argument that privatisation has hindered decarbonisation in the British power sector. The counterfactual is unprovable, but it is unlikely that as much progress would have been made if the sector had been in public hands all this time.
Re-nationalisation would be expensive
It would cost tens of billions of pounds to buy the generation capacity and development projects from the private sector owners, and a comparable amount to buy all of the network assets. There would then be restructuring and settlement costs to add in. The overall acquisition would probably stretch to twelve figures, leaving aside ongoing operational costs.
Local grids are a mixed blessing
Much of the recent anger has been levelled at network companies’ profits. Data for Britain overwhelmingly shows that since privatisation, their operating costs have fallen, customer interruptions have fallen, and capital investment has increased. There does not appear to be any evidence to suggest that public ownership would be helpful. Yet that anger exists, and has led to calls for local grids; and the German model of re-municipalisation.
Let’s consider a few myths surrounding local grids:
(i) Benefiting neighbours
In an ideal world, we might live in tightly knit communities with mutual sharing and cooperation. Power generation would be part of that community: we would get all our energy from local renewables such as wind and solar; and share it with our neighbours. This utopia featured in the film 2040 (Sri Lanka) as well as What We Need To Do Now (Orkney islands).
Chris Goodall comments that microgrids and virtual energy islands – the latter match demand and supply in small areas – are “really good ideas”. But whilst that is often the case, these ideas are not new and they are not necessarily good. If wind output in a locality is unusually strong, the generation is unlikely to go to waste in a transmission-connected system, but the benefits will be shared at the national level. Higher wind output will reduce national costs and put downward pressure on national prices. The price effect may be small, but it will pertain to millions of households. And this raises an interesting question: why should people in a locality benefit ahead of people in the country as a whole?
Benefiting neighbours sometimes means not benefiting strangers. There is a need for co-ordination and security of supply, which national and regional networks provide. It is interesting that the recent focus of Ofgem, in its Targeted Charging Review, has been on free-riding, on ensuring that local or ’embedded’ generators and customers pay properly for the network services that they enjoy without perhaps realising.
(ii) Long-distance waste
There is a common misconception about the ‘waste’ of transporting electricity over long distances. With our high voltage transmission – a feature of every EU country, including Germany – the heat losses are only circa 2%, significantly lower than the heat losses in low voltage local networks. There is an analogy here with seaborne freight: less energy may be required to transport apples from a port in New Zealand to a port in England, per apple and on average, than to transport it from the English port to the local supermarket by lorry. (The long distance saving is even bigger for power.)
In parts of the world where high voltage grids do not already exist, the arguments for local grids are much stronger. Let’s not apply the Sri Lankan model to Great Britain without checking on the infrastructure first.
(iii) Faster low-carbon take-up
Without supporting evidence, there are frequent claims that we would decarbonise much faster if the industry was in public ownership. In private hands, the British power sector has decarbonised faster than the rest of the economy. Germany has re-introduced a lot of municipal ownership; but it retains a significantly higher carbon footprint.
If we ignore their coal and lignite capacity for a moment, it is true that Germany generates a higher proportion of its electricity from renewables than Britain. But their development owes more to national subsidies than to local ownership, i.e. to the German Renewable Energy Sources Act, or EEG, which came into force in 2000. Although renewables have been subsidised in Britain as well over the last couple of decades, the support level has been less generous, with consequently less capacity to show for it. But today, most of the private investment action is in renewables.
Summary
I am worried about Labour’s plans to re-nationalise the energy industry. The costs are undeniably large, while the benefits are very uncertain to say the least. Labour’s approach is ideological and, it would appear, somewhat blind to evidence.
We can, and should, encourage new renewables and further decarbonisation. Some of this will be through local community energy schemes. But they should work in harmony, not discord, with our national energy system.
It is important not to be dogmatic. Public ownership, in some times and contexts, may work better than private ownership, and vice versa. In the case of Britain, and electricity, privatisation appears to have worked relatively well – if one’s criteria are costs to consumers, security of supply, and decarbonisation.
Let’s not rip up what we have. The country has more pressing priorities.