Electricity Market (EAC Report)

Lord Burns Excerpts

Monday 17th July 2017 Lords Chamber

[Lord Burns (CB)]

My Lords, I also thank the noble Lord, Lord Hollick, for his outstanding period of service as chairman of the Economic Affairs Committee. He had a happy knack of being able to take on timely subjects for investigation and completing reports that are relevant and make an important contribution to policy debates. That is a great ability. This report certainly falls into the category of relevance.

I was pleased to be part of the inquiry. It is not a subject that I have had much to do with in recent years, but I learned a great deal in the process. For many years, I have been puzzled by a number of things. Why was it that industry, particularly the large users of electricity, was being so vocal about the prices it was being charged relative to competitor countries? I really wondered whether that could be true. Similarly, there were extraordinary concerns about rising prices to retail users that became an election issue. How could we suddenly find ourselves in an election where issues of price capping should become a significant question? How is it that we came to be paying all this money for Hinkley Point when it is shrouded in so much uncertainty? Why has it become so difficult for any outsiders—I count myself as an outsider—remotely to understand the mechanisms of the present system for electricity supply, particularly with regard to competition? That was my starting point. As I read the report again over the weekend, I found that it went some way to help us understand these developments.

As the noble Lord, Lord Hollick, set out in his introduction, at the outset there are two important milestones. The first is the remarkable 1982 energy policy introduced by the noble Lord, Lord Lawson, when he was the Energy Secretary—during the very brief period in the 1980s when I was not working for him—and the second is the early 2000s when the policy evolved to include concerns about climate change and capacity margins as the older power stations came to the end of their life. It is important to note that the report does not question the need to reduce emissions and to ensure a sufficient level of excess capacity; rather what it does quite effectively is to question whether that needed to involve as much government intervention as has taken place and whether that intervention could have been done in a more effective way, with less distortion.

The fundamental question is whether the recent policy has delivered an answer to the trilemma, as it has come to be known, of security, affordability and emissions control. As the debate has developed today, we can see that the scorecard is pretty uneven. We have ended up in a situation where we still have a rather slim capacity margin. We are told that this has been handled well in the short term but that there are still questions about the longer term. There is some acceptance that capacity auctions mark a step forward, but the report makes clear the danger that it is biased towards solutions which can be brought forward quickly rather than solutions for the longer term.

As we have also heard, average domestic bills have risen sharply, mainly because of the international prices of fossil fuels but also because of the cost of low-carbon policies. In total, UK prices have risen faster than they have in other EU countries. The committee is worried that the costs of low-carbon policies are not transparent and difficult to scrutinise. The position is even more striking with regard to industrial energy prices when compared with other EU countries. We received a lot of evidence about the extent to which these were moving industrial activity from Britain to other countries, and again the issue of transparency was raised strongly by the right reverend Prelate, and rightly so. On compensation schemes, in terms of how the trilemma is working it is important that there should be complete transparency about costs and on giving priority to certain objectives.

In fact, the reality is that the present approach can be summarised as follows: ensuring that security of supply is a political necessity, that decarbonisation has been determined by legislation, and that affordability is the residual which is determined by the costs of the first two.

The committee spent a lot of time trying to understand how it might be possible to restore a greater degree of competition. As has been mentioned, we concluded that we had to move away from the idea of the trilemma and place security of supply firmly at the top of the priorities. Once that has been done, the next question to arise is that of the correct balance between decarbonisation and affordability. For myself, I am persuaded that having decarbonisation as a statutory target is a severe complication in the balancing process, in particular as it is tested by the five-year objectives of decarbonisation which are also prescribed. Even more important is the fact that these objectives do not take account of the targets reached in other competitor economies, and so it is by this route that we end up in a remarkable situation where we have higher electricity prices for high electricity-using industries than elsewhere and an incentive for them to move some of their output overseas. As the noble Lord, Lord Forsyth, mentioned earlier, the consequence is that we have been more successful in decarbonising production than in decarbonising consumption. By exporting some of our carbon, we flatter ourselves about the progress that we have made at the expense, of course, of the industries involved in the UK. Again, the committee argued that there should be much more transparency about what is happening in this area. The report acknowledges that some offsetting compensatory measures have been taken, but with them we see even greater complexity in understanding just what the costs involved are.

It is a similar position with retail consumer prices, which are no longer as low as they were compared with other countries. As a result, we have seen a lot of dissatisfaction and loss of trust between customers and suppliers. Some talk about excess profits and politicians are tempted to reach for price controls, which might reduce competition if some potential participants withdraw. The evidence for neither conclusion is robust and is no substitute for well-thought out regulation of prices by a strong and effective regulator.

Undue complexity is often the consequence of poorly chosen objectives and a reliance on short-term responses rather than a carefully designed long-term response. Complexity and uncertainty are not cost-free. As pointed out by our witnesses, the energy market is a delicate combination of public policy and private money; investors do not appreciate uncertainty and their presence in this market is essential.

Like the noble Lord, Lord Turnbull, I am persuaded that we must try harder to keep our ambitions for decarbonisation more closely in line with achievements in other countries. There is little to be said for being out of step. To achieve this, the committee was agreed that the Government should be prepared to use their powers to vary the pace of emission reductions in electricity supply and not be bound by a strict programme regardless of what is happening elsewhere.

Following the noble Baroness, Lady Bowles, I want to finish with a few words about competition and switching. Not surprisingly, in the search for more competition, attention has landed on encouraging switching by consumers as a way of increasing competition in electricity supply. I have no issue with this as far as it applies to consumer pressure on firms to offer better standard rate tariffs than other suppliers. However, there is a real trap if all that happens is that new and potentially switching customers are offered better deals than existing customers, and that such better terms last for only a relatively short time. It would not be unusual if those short-term switching incentives were funded by the subsequent inertia of those same customers, but it can also be the case that existing customers contribute to restoring margins. Alert customers have to switch again to maintain their advantage and go through the process regularly. It produces behaviours and responses that have plagued financial services, and its use carries some responsibility for the deterioration in the relationship between providers and customers in that sector. As special “teaser” deals often expire after one or two years, customers are forced into making an annual selection of the best provider. This is not a good way of encouraging trust and respect with suppliers. Rather than benefiting all customers, it can become little more than an exercise in cross-subsidy between switchers and non-switchers which damages the reputation of providers, particularly with their loyal customers.

I struggle to see how this behaviour can be in the interest of those who do not participate in switching and, if anything, it is likely to damage their interests. I emphasise that this is not an attack on switching, which is a critical aspect of competition between suppliers, but on this particular type of short-term pressure to switch. With financial services, I came to the view that the real benefit of competition comes where switchers not only help themselves but help the community at large to get better terms. Switching as we have it with some utilities often gives more of the appearance than the reality of competition. The only successful long-term switching policy is when the benefits go to loyal customers rather than to short-term switchers and where the deal is as straightforward as possible.

Real competition is where suppliers compete on grounds of efficiency and service, and not by putting one type of customer in competition with another. I hope that, as a result of the pressures that we have spoken about this evening, we will not end up believing that the type of switching now encouraged is somehow the solution to this problem.