Politicians are understandably fond of describing the cost-of-living crisis as “made in Russia”, after Vladimir Putin’s invasion of Ukraine sent global gas prices soaring. But this characterisation obscures the way in which the UK’s own energy system has amplified a specific commodity shock into a general economic crisis.
The government’s consumer energy price guarantee – extended for three months by this week’s Budget – provides welcome relief to households. Yet containing the spillovers from this shock requires eliminating at source – rather than simply subsidising – the wedge that lies between the squeezed budgets of energy consumers on the one hand and the exorbitant profits of generators on the other.
The UK’s domestic wholesale energy market is where the global spike in gas prices is transformed into higher electricity prices for customers. Every half hour, electricity generators submit bids to sell their energy to retail suppliers, forming a “merit order” from cheapest to steepest until demand is satisfied. The most expensive source needed to meet demand – the “marginal price” – then sets the price for the entire wholesale market. This is almost always gas, and means approximately 60 per cent of our energy consumption – the clean, low-cost portion – is penalised by the cost of the 40 per cent supplied by gas. So much for the “price signal” – which ought in principle to guide consumption and investment decisions according to real resource constraints.
The ramifications are as destabilising as they are unnecessary. High energy prices are not merely strangling household budgets but feeding broader inflation and jeopardising countless businesses (who consume nearly two-thirds of electricity). What little economic growth survives is then choked by central bankers desperate to signal the credibility of the commitment to restrain inflation on which their independence is founded. Politically, by obscuring the radically lower cost of renewable energy, the crisis has perversely aided the chorus of climate-sceptics presenting decarbonisation as core to the problem rather than to the solution.
Our energy system thus faces two urgent but conflicting priorities. Firstly, rapid investment to build out renewable energy in both proven and speculative technologies, to meet our climate goals and shunt expensive fossil fuels out of the pricing system. Secondly, the wholesale price of low-cost clean energy desperately needs to be decoupled from the price of gas.
Various energy policy organisations over the last eighteen months have addressed proposals towards the latter goal, each with their merits. In January the government implemented an energy generator levy of 45 per cent on “extraordinary profits” above a unit price threshold of £75 per MWh, the only policy implemented so far. Other proposals include persuading older renewable generators onto contracts for difference (CfDs), fixing energy prices at the level of the wholesale market; “splitting the market”, in which clean and dirty energy are divided into separate wholesale markets (the former subject to a price cap); and consolidating the energy retail market into a single buyer that dictates prices. But as long as the generators remain privately owned, the need to keep energy prices low will be in tension with our other imperative towards renewable investment. Low prices means low returns and low investor appetite.
There is one way to short-circuit this policy tradeoff: public ownership of clean energy generators selling at cost. Recent research by Common Wealth estimates that such a policy would have saved £20.8bn on wholesale energy purchases during 2022, more than any other proposal. That’s £252 per household on bills and a further £489 on inputs to other businesses. These estimates may be based on 2022 prices but they indicate huge savings as long as the crisis persists.
Moreover, with overwhelming agreement on the need for renewable investment (although less agreement on the means) and freedom from the discipline of capital markets, this option enables investment to continue, indeed accelerate, by diktat.
Public investment is cheaper than private. The state can issue bonds more cheaply, and need not extract dividends. Moreover, private investment is often secured at the cost of considerable state expenditure to de-risk returns via instruments such as CfDs (a net cumulative £5.9bn since 2016, and £7.9bn gross). Direct investment that brings assets onto the public balance sheet is therefore more fiscally sound from the perspective of net public worth. The construction supply chain would remain private, preserving the competitive dynamism currently driving down costs. Meanwhile, low energy costs in other industries will either boost margins, crowding in private investment, or support low consumer prices broadly.
Other countries recognise this and are renting our own natural resources back to us, with 40 per cent of our offshore wind capacity owned by foreign state-owned enterprises, like Denmark’s Orsted, Norway’s Equinor and Sweden’s Vattenfall. By my calculations, UK wholesale energy sales provided foreign governments with £1.3bn in 2022 (while Equinor’s shareholder payouts paid its government $1,075 for every Norwegian).
A rational energy policy is one that pools risk rather than amplifies it through fragmentation, that recognises that energy is a “systemically significant price” too important to be left to market volatility, and that does not hold our investment objectives ransom to the whims of risk-averse markets. Public ownership can manage exactly this. Our current Rube Goldberg machine of dysfunction – setting off chain reactions of immiseration – cannot.