EU: Energy Governance (EUC Report)

Viscount Hanworth Excerpts

Monday 13th June 2016 Lords Chamber

[Viscount Hanworth (Lab)]

My Lords, several reports of the European Union sub-committees of the House of Lords have been scheduled for debate prior to the crucial date of 23 June, when the referendum will be held to determine whether Britain has a future as a member of the European Union. It might seem that such reports would become irrelevant if our membership of the Union were to cease. Indeed, the very existence of the European Union Committee would be in doubt. However, it is a misapprehension to imagine that, in that event, the committee’s reports would become irrelevant. In any circumstances, we shall be tied to Europe, and the needs and problems to which the reports draw attention will be only exacerbated if we leave the European Union.

The need to which the report on energy governance draws attention is for an orderly and integrated system of energy supply throughout the European Union that transcends national boundaries. The three aims are to achieve carbon reduction in line with agreed commitments, to ensure security of supplies, and to achieve efficiency and affordability. The European Union imports 53% of its energy supplies. For their imports of gas, the member states depend heavily on a single supplier, which is Russia.

There are mounting anxieties over the security of supplies. There is a growing dependency on renewable resources for generating electricity, and these can be intermittent and unreliable. These problems can be addressed and partly overcome by enhancing the interconnectedness of the network of supply. The intermittency of the electricity generated by wind and solar power can be mitigated if the network of interconnections is wide enough to comprise regions of greatly differing climatic and meteorological conditions.

Britain faces the same problems as many of the other nations of the Union. After spending most of the previous 25 years as a net exporter of energy, the UK became a net importer in 2004. The gap between imports and exports has increased since then, and it looks set to continue to increase in future. Our imports of energy now amount to 40% of our consumption. The narrowing margin in our capacity to meet the demand for electricity is compelling us to seek external supplies via enhanced connections with neighbouring countries.

The need for concerted action across the European Union to deal with the problems of energy supply is increasing at a time when its ability to act in concert is in doubt. Thus, whereas the European Commission is keen to declare common objectives, it is hesitating to define the means by which they can be achieved.

The tendency is well illustrated by the programme for carbon reduction. In 2007, the leaders of the European Union agreed climate and energy targets for the year 2020. These included a 20% cut in greenhouse gas emissions relative to 1990 levels. The Commission mandated a 20% provision of energy from renewable sources and a 20% improvement in energy efficiency. Targets were declared for individual member states. In 2014, the European Commission adopted targets for 2030 that included a 40% reduction in greenhouse emissions relative to 1990 levels, a 27% target for renewable energy and an energy efficiency target of 27%. However, no targets were declared for individual member states, for fear of their being resisted.

Such apparent weakness of purpose has led, in some quarters, to the disparagement of the European Union. However, in an alternative perception, it highlights the need for concerted action. The need to act in concert is evident in view of the threat to supplies of gas. Russia, which is the principal supplier of gas to the European Union, is inclined to use its position as a means of achieving its political aims. The Russian intentions have become clear recently in connection to the Nord Stream 2 project, which proposes to link Germany directly to Russia via a gas pipeline under the Baltic Sea. This would bypass Ukraine, thereby denying it the tariffs for transporting the gas, as well as threatening its own gas supplies.

It is rumoured that the five western companies co-investing in Nord Stream 2 have been told by Gazprom, the Russian state energy company, that, as a condition for participating in the project, they must cease to receive gas supplies via Ukraine. The project has been heavily criticised by central and eastern European nations that are dependent on Russian supplies that come via Ukraine and that are fearful of Russian aggression. The European Commission had reacted by proposing that mutually supportive groups of member nations should be established with the aim of pooling and protecting their supplies of gas.

It is notable that the former Soviet Baltic states of Lithuania, Latvia and Estonia are pressing for the creation of a single gas market with no internal borders. They have grave anxieties concerning Russian intentions. However, Latvia, the gas supplies of which remain in the hands of Gazprom, has rejected the opportunity to import gas from Lithuania, and Estonia is pursuing its own projects, including co-operation with Finland. This makes regional co-operation difficult, and it is incumbent upon the European Union to try to amend this situation.

The project for unifying the European energy market is beset by political, technical and economic difficulties. The economic difficulties concern the design of an integrated market and the raising of the necessary funds for establishing or enhancing the interconnections, and for enhancing other aspects of supply.

The Union has adopted many of the nostrums of the neoclassical economists who inspired the Conservative Governments of Margaret Thatcher, and which also prevail among the Conservatives at present. The document declaring the framework strategy of the European Commission for a resilient energy union makes it clear that the Commission expects the necessary investment funds to be provided by private enterprise. It declares that a centralised, supply-side approach is an outdated business model, and it evinces the belief that private firms in competition can be relied upon to cope with the complexities of an integrated market.

To some degree, interconnectedness can be seen as a public good; the public in question being the people within the realms of the interconnected nations that form the European Union. Since public benefits would not be included in their cost-benefit analysis, there is a risk that private investors will underinvest relative to the size of the investment that would maximise the public good. In view of the differing interests of groups in different member states, there is a need for an overarching policy negotiated at European Union level.

The belief of the economics pundits, who tend to be neoclassical economists and free marketeers, is that the appropriate outcomes can be engineered by establishing incentives for private investors. I have a different opinion. To expect to achieve the optimal outcome in a hands-off manner strikes me as foolishly optimistic. Not only must one identify the appropriate outcome but, in order to fashion the incentives, one must make an accurate assessment of the likely responses of private investors. There is a strong possibility that the incentives will be misjudged.

We had a recent experience of this in connection with the energy market reforms of the present UK Government, which are intended to be mediated by so-called contracts for difference. A similar “cap and floor” regime has been proposed by Ofgem for mediating the returns to private investment projects, aimed at enhancing the UK’s connections to the electricity supplies of Norway, Denmark, France, Belgium and Ireland. The regime sets a maximum and a minimum amount of revenue to be derived by the interconnector, and it proposes to add to or subtract from their actual revenues according to their shortfall or their excess.

In the UK, the policy of placing investments in power generation entirely in the hands of willing commercial providers has been a disaster. The willing providers of the next generation of nuclear power stations have not been readily forthcoming. We will have to rely on French and Chinese nationalised corporations to undertake the task of building our nuclear power stations, at an exorbitant cost. At present, their commitment to this task is in doubt. I wish to argue in favour of initiatives for which the finance has been provided by central government, and in which the Government, supported by expert opinion, have the oversight of the associated technologies.

The incentive to rely on the private funding of infrastructure projects has been to remove the costs from the Government’s budget and to prevent them impacting on the levels of the Government’s deficit. A fallacy of this approach is to imagine that the discount rate by which the present value of future costs and benefits is calculated, and on which the rewards of the private investors are based, can or ought to be the rate that applies to commercial investment projects. That rate, according to the Government’s methodology of levelised costs, is at an exorbitant 10%, which is appropriate only to high commercial risks. Investment in national infrastructure is not associated with commercial risks, and the risks that there are should be borne by the Government.

This is recognised in the advice that is embedded in the so-called Treasury Green Book for the appraisal and evaluation of investment projects by central government. There, we find that the discount rate for social investment is deemed to be 3.5% per annum. This is a high figure when compared with the current prime lending rate of 1.5%, which is the average rate of interest charged on loans by major commercial banks to private individuals and companies. The consequence of funding energy infrastructure projects in the manner of the UK Government is that the deferred benefits of the projects will accrue largely to private enterprise, when they ought to accrue to the public good.

The European Commission has adopted similar nostrums to those of the present UK Government. However, whereas the Commission is in a position to promulgate an agreed agenda, it is not and never has been in a position to dictate how it might be fulfilled. The documents of the Commission openly concede this point. It behoves us at present to recognise this truth and to gainsay those critics who suggest that our membership of the European Union in some way diminishes our national sovereignty. We are free to make our own decisions on how to reach common objectives. Our membership of the Union can only empower us.