Energy Bill

Viscount Hanworth Excerpts

Tuesday 18th June 2013 Lords Chamber

[Viscount Hanworth]

My Lords, this Energy Bill is the product of economic doctrines that have misled a generation of Conservative politicians and have penetrated deeply into the Civil Service. For a while, they also strongly affected the thinking of Labour politicians. The project of energy market reform, which the Bill promotes, is an ongoing attempt to subject the circumstances of energy production and supply to the nostrums of free market economics.

The project is being pursued in circumstances that have been strongly influenced by a previous ideologically motivated reform, namely the privatisation of the country’s electricity industry that occurred in the closing years of the Thatcher Administration. The doctrines in question derive from the ideology of neoclassical economics, which envisages a world composed of perfectly competitive agents operating in free markets, which are devoid of government interference and regulation and have been purged of state monopolies. In this world, efficient financial markets operate in such a way as to ensure that investment projects, with very different profiles of costs and benefits, can be placed on an equal footing. In effect, future costs and benefits are to be discounted by a factor that declines as one advances into the future and is directly related to the market rate of interest, which is the reward for lending money.

The resulting discount factor may be equated, in theory, to the marginal social rate of discount—if one is prepared to postulate such a thing—but some believers are keen to assert that there is no such thing as society. However, a basic proposition of the doctrine, which must surely be rejected in the context of a national energy policy, is that public investment can and ought to be evaluated according to the desiderata that govern private and commercial investment. By adhering to this proposition, one is bound to favour short-term commercial gain at the expense of long-term social benefit. The actual world is not the ideal world that neoclassical economics envisages—and it never will be—but the proponents of the ideology pay scant attention to realities. When the opportunity arises and whenever they are in a position to do so, they are liable to attempt to make the reality conform to their idealistic visions.

The free market ideology suffuses the Bill but, as time has passed, some of the more implausible aspects of its original design have been amended and obscured. I shall begin my critique by looking at its central concept, which is a contract for differences to be applied to the price of electricity. This terminology has been borrowed from financial markets, where a contract for differences is a financial derivative designed to indemnify the party who has purchased it against the effects of fluctuations in the price of a financial asset, measured as departures from a so-called strike price. The writer of the contract is described as the counterparty.

The Bill originally envisaged a multitude of counterparties, constituting a free market. In that case, the terms of the contracts for differences would be discovered or revealed by the market; and, given that markets are deemed to be efficient, it was imagined that this would create an optimal outcome. The idea has gone into abeyance. The critics have asserted that, in reality, such a market would be beset by risks of confusion and by dangers of default and bankruptcy. The outcome is that there will now be a single government-owned counterparty and that the terms of the contracts will be set through an administrative process.

However, it remains the Government’s intention that the strike price will eventually be set through a competitive free market process. An expectation of the designers of the Bill appears to have been that a competitive environment would generate a single strike price that would be applicable to all electricity generators, regardless of the technology. The beautiful idea here was that there would be no need for strategic decisions regarding the appropriate technology mix of our future power generation. This mix would be discovered by the market, as if by the operation of a hidden hand, and the outcome, according to the theory, would be an optimal one. In my opinion, this is an absurd idea. The costs and benefits of the various technologies in question have very different profiles through time. Notwithstanding the hypothesis of efficient markets, these incommensurable futures cannot be mediated solely by commercial and financial transactions. Instead, they should be determined in the light of some careful strategic planning. Indeed, the markets have no perception of the future, other than as an aggregate of the dim perceptions of the majority of their agents.

Gas-powered electricity generation has the shortest of the time horizons and, for that reason, it accords best with the short-term preferences of financial and commercial markets. Its capital costs are the lowest and its running costs are the highest. However, an imponderable aspect of this option is the future price of the fuel. There are some highly contradictory predictions of what will eventuate. There are anxieties about the security of supply given that, at present, the principal sources are in Russia and the Middle East. There is also an expectation of rapidly rising prices in the face of an increasing world demand. On the other hand, it is observed that gas prices in the US have been falling in consequence of fracking. The optimists imagine that an ample supply of shale gas can somehow be magicked out of the ground on which this nation stands to replace the depleted supplies of North Sea gas.

Those sceptical of the reality of climate change, who include the Chancellor of the Exchequer, also envisage the exploitation of Arctic oil and methane, the supplies of which are presently uncharted and undiscovered. For them, the discovery and exploitation of ample supplies of hydrocarbons is an exciting prospect. For the rest of us, who constitute the majority, this is a terrifying prospect.

The second technology to be reviewed is that of wind-powered electricity generation. Here, the capital costs are high, but the energy that drives the windmills is free. However, the power supply of windmills is intermittent and must be balanced by a compensatory supply, which is liable to be gas-powered. The intermittency implies that a very large renewables capacity is required to guarantee a minimum level of supply. The costs of wind-powered electricity cannot be assessed in isolation and the severity of the problem of intermittency will be a function of the proportion of electricity supplied, on average, by the windmills. To propose that mindless markets should be capable, on their own, of adjudicating these matters so as to determine the optimal proportion seems absurd.

The third technology that needs to be considered is nuclear power generation. Here, the capital costs come in large indivisible lumps and the stations are of such longevity that we should be considering 60 years of operation following a period of as long as 10 years for their planning, construction and commissioning. Once the nuclear power stations are in place, their operating costs are the lowest of all. The outstanding difficulty affecting a nuclear project is the size of the lumps of the capital costs. In one way or another, national Governments have hitherto been involved in the construction of every nuclear power station. For a variety of reasons, which are a mixture of ideological predispositions and budgetary restrictions, the present Government have resolved that the capital costs of nuclear power should be borne entirely by commercial suppliers. There are few suppliers willing to bear such costs, and the majority of those who originally expressed an interest have withdrawn.

We are left with one major potential contractor, which is a French nationalised industry in commercial disguise. This is EDF, or Électricité de France. It is an outstanding irony that their pursuit of a free market ideology has brought the Government face to face with a foreign state-owned monopolist. This supplier is expecting to assess the future costs and benefits according to the criteria of a short-term commercial investment appraisal that envisages a rate of return in double figures. In such an appraisal, the future benefits of a nuclear power station, which are delayed in time and subject to a heavy discount, must be weighed against the current up-front costs. In order that the benefits should outweigh the costs in such a calculation, an exorbitant rate of return is demanded. Moreover, this return is being demanded for an extended period. We believe that a contract for differences, designed to provide secure revenue, would be extended over 35 years. This would be a perilous commitment for any Government to make.

There is an obvious recourse that should be available to any Government who are not blinded by their ideology or hamstrung by their fiscal anxieties. It is that the Government should, at their own expense, commission the building of nuclear power stations which should then be owned by the nation. If need be, the stations could be leased out to commercial operators but, given their low operating costs, such arrangements would be a matter of minor detail. In assessing the benefits of nuclear power, a marginal rate of social discount should be used that is considerably below both the commercial rate of discount and the 10% that has been used by the Department of Energy and Climate Change in its calculations of the so-called comparative levelised costs of electricity generation.

I am an ardent protagonist of nuclear power generation and of the yet-to-be-realised superior nuclear technologies that would be available to us if we were actively to pursue their research and development, as the right reverend Prelate the Bishop of Hereford so eloquently enjoined us to do. Nevertheless, I have difficulty in evincing any enthusiasm for the way in which the Government are approaching our nuclear future and our energy future in general.