Advances in technology have been crushing the cost of renewables. Strike prices for offshore wind farms have tumbled from £115 per megawatt hour to less than £60 over the past four years. Gas tends to fluctuate, but the outlook here too is rosy. New supplies are opening up, from US shale to liquefied natural gas from Australia. Then there’s the decline in electricity usage — consumption sliding by 8 per cent since 2010. Shouldn’t the overall trend in UK electricity costs be down?
Well, no actually. Or not, at least, if the latest cap set by the energy regulator Ofgem is anything to go by. Far from declining, the limit on the “dual fuel” bill per household (that’s gas and electricity) has just been raised by 10 per cent to £1,254 a year.
It is the latest in a line of semi-annual increases in a political mechanism that is designed — rather shamingly — to stop power utilities from gouging their most vulnerable customers. Somewhat belying its name, this “cap” has steadily risen, climbing by nearly a quarter from its lows in late 2016.
Why is this happening? Well, let’s start by deconstructing that cap a bit. About £521 relates to wholesale fuel costs, mainly gas. These move up and down and have recently been rising. Fair enough, you might say. The next big chunk is network charges, which is in effect the cost of operating all the wires that carry power from generator to consumer. Then we come to so-called “policy” costs, which account for £151 — or 12.5 per cent — of that £1,254 dual-fuel bill, or near 20 per cent if you strip out gas and just look at electricity. These are the consequence of the environmental policies the government has introduced to support decarbonisation, and are tacked stealthily on to customer bills.
They are much stickier. Many relate to contracts struck with low carbon energy generators stretching far into the future, which guarantee fixed sums indexed to inflation, or pay an increment over the prevailing wholesale price. What’s more they are still growing as a proportion of customer bills. In 2015, the environmental bill was just £91 per household, according to Ofgem data.
As a recent paper from the energy economist Dieter Helm points out, that upward march will continue as more low carbon capacity comes on at relatively high fixed prices in substitution for gas and coal baseload generation. True, the latest offshore wind contracts are actually slightly below current wholesale rates. But they aren’t due to come on stream until the mid 2020s. Meanwhile, earlier pricier cohorts of legacy deals still need to be paid.
There’s also the fact that the whole market has mutated. The government is increasingly the central buyer through state-backed contracts, a process that steadily ousts market-based competition. All this means prices are likely to ossify, or even go up.
High prices might be fine for those with cash and a big ecological conscience; the Tesla tendency, so to speak. But it’s not so great for those getting by on rather less. Note that the £1,254 cap represents about 10 per cent of the £12,000 of disposable income taken home by the poorest fifth of households in Britain. Add on another £400 a year for water and pretty quickly you have eaten nearly a sixth of your cash just to purchase the barest essentials of life.
These legacy costs may have been incurred in the necessary task of starting the switch away from fossil fuels. But few would argue that the experiment has been wildly cost-effective. The government has backed technological horses — with predictable results. Lobbyists have run riot.
The “gilets jaunes” movement in France shows that voters do not have unending reserves of patience for carbon taxation, especially when served up in this highly regressive form.
So what is the solution? It is not as if these legacy costs can simply be wished away. One way would be to socialise them. Mr Helm suggests putting them in a “legacy bank”, which would be financed out of general taxation. Such a move, he argues, would not only avoid distorting the market, it would allow “prices to fall and hence customers to benefit from the falling price of renewables and probably gas too”. The less well off would be less exposed to self-rationing. Meanwhile, the bill from the past would fall more proportionately on those with broader shoulders.
Wiping the slate would not itself solve the challenge of ensuring future decarbonisation took place at lowest cost. But it would at least mitigate the burden of past splurging.
That seems wiser than betting on the public’s concern about climate change, and hoping that it is matched by a willingness to pay whatever it takes.