Clarity vital in energy debate

As the political debate on energy rumbles on at Westminster, energy price inflation continues apace along with an outbreak of conflation. Not Mr Cameron’s unparliamentarily repost to Mr Milliband but the mixing of issues that any debate on energy seems to default to: energy security, carbon emissions and, of course, the rapidly approaching risk of brown outs and blackouts.

Too often in debate the issues and arguments are intertwined so that direct links are made between different aspects such as prices and the consequences such as blackouts. For the interested listener it can appear confusing but to the casual listener the message is often misleading. Prices, energy security, carbon emissions and the electricity crunch are all connected and all contribute to the rise in energy costs, but it is worth considering them individually.

Firstly, energy security has become a more important issue over the last few years as production from the North Sea has declined and the UK has become a net importer of energy after 25 years of exporting. The UK is now at the mercy of the international markets, which are themselves susceptible to the global political environment. It is interesting to note that the biggest rises in energy costs occurred in 2006 and 2009 with year on year increases of 25% and 18%. Given that the wholesale cost makes up more than 60% of the cost of electricity and that the principle energy source is gas, the 240% rise over the last decade has been a major contributor.

A combination of EU Directives and a lack of investment in new plant has led to the risk of blackouts increasing to a predicted one in 12 year risk in 2015

Secondly, the UK’s 2050 commitment to an 80% cut in emissions means it must develop a new energy infrastructure. This needs investment to reduce demand, to expand low carbon generation and to develop a smarter distribution system to cope with the intermittent nature of renewables.  The cost of this has been feeding through into bills. Whilst relatively small in absolute terms the cost of feed-in tariff payments are illustrative of some of the cost pressures that have been built into the system. For those who installed photovoltaics before March 2012 the strike price for the power generated is close to £450/MWhr which is index linked and tax free. This is great for the owners of PV but being paid for by other consumers. A typical consumer price for electricity is £140/MWhr. Incidentally the strike price for electricity from the new nuclear at Hinkley Point is set at £92.5/MWhr. So unless the Government decides otherwise there are more costs to come and price rises are inevitable.

Thirdly, and perhaps most alarming of all, is the rapidly approaching electricity crunch. A combination of EU directives, a low global coal price, and a lack of investment in new plant has led to the risk of blackouts increasing from the one in 3300 year risk of 2011/12 to a predicted one in 12 in 2015. My guess is that the current administration will have taken sufficient action by the time the risk is at its highest that the UK household consumer will avoid the trauma of widespread rolling blackouts. However this will achieved at a price, by paying generators to keep their mothballed or standby generation capacity in a state of readiness in order to respond at short notice to a potential blackout. How the UK ended up in such a perilous situation is for another day but the net result is ultimately more cost to the consumer.

So what is driving energy costs? The answer is a combination of greater exposure to the global market in an energy hungry world, increasing green and social levies and a need to invest heavily in a new low carbon infrastructure. However the common thread is the decade of dithering and indecision that has stored up the troubles that the UK is paying for.

Nick Cullen is a partner at Hoare Lea