7 June 2021

Britain can’t afford to sleepwalk back to central planning

By Adam Bell

Fourteen years. That’s how long the Government has to completely decarbonise the UK’s electricity supply if it is to meet the recommendation set by the Climate Change Committee, . Even getting close to that mark – which the Government will probably need to do to meet its Carbon Budgets – is a colossal undertaking. We’ll find out how it plans to do so later this year with the unveiling of the Net Zero Strategy.

There are three strategic approaches it might take. It can employ markets to invest in the right plant at the right time, it can attempt to pick the projects to build itself, or it can build first-of-a-kind plant to get key technologies off the starting blocks and then let the market figure out which to build more of. The latter is its ostensible strategy today, with pledges made in the Energy White Paper to deliver at least more large nuclear power plant, up to 40 gigawatts of offshore wind capacity by 2030, and a new carbon capture and storage-equipped gas plant by the middle of the decade. 

The problem is that once a Government starts interfering in the market it’s very difficult to stop – and nowhere is that more true than in energy. This is because any new infrastructure has a long lifespan and continues to affect the whole system long after the original imperative for its construction has been satisfied. If the Government wants to get to Net Zero without permanently distorting the market, it needs to set out its plans for an offramp from intervention now to avoid being accidentally locked into that role in the long term. The British state, after all, doesn’t have a great track record in picking winners.

A losing streak

In the early 60s, the Central Electricity Generation Board, the design and planning function for the nationalised electricity system, evaluated a number of competing bids for a new generation of nuclear power stations. In one corner were reactors using water as a coolant, which were a relatively established technology but had the misfortune to be established abroad, and in the other were British-designed Advanced Gas-cooled Reactors (AGRs). The CEGB found their preference for water-cooled reactors rapidly overridden by the government, who believed they could sell this new reactor technology overseas.

The AGRs were cooled using carbon dioxide and a key part of their economic case was that the reactor could maintain full output at all times, without having to be shut to refuel. This was an exciting proposition, marred only by the fact that it never worked in practice – the pressurised carbon dioxide caused the fuel rods to violently shake during refuelling. This significant blow did not prevent the Government building 14 of them, only to receive no foreign orders.

Mishaps in Market Design

Without a way out, the decision to invest in the AGRs continued to impact on policymaking well after their initial construction. In the late 80s, Britain stood on the cusp of privatising its electricity industry and needed to decide how to split up generation. Against the advice of its economists, who wanted greater competition, the government opted to split generation into two companies to ensure at least one could handle the nuclear fleet. But both refused to take on the AGRs – and certainly not the liabilities associated with older plants. Desperate to get the privatisation of the sector complete, the government opted to keep the nuclear plants in state hands.

Privatisation initially delivered rapid productivity benefits, as power station operators found themselves racing to beat the new daily price of the Electricity Pool into which they sold their power. However, power stations are notoriously unstealthy, and so each generation company knew where its competitor’s plants were and how they were likely to operate. This meant for any given day they could constrain the availability of their plants to create artificial scarcity and ensure that prices were as high as they could optimally be. The two new companies made a very significant amount of money. Consumers benefited rather less.

This was a clear failure of market design, and in the Utilities Act in 2000 it was swept away. But ever since then successive governments – without really meaning to – have awarded themselves ever greater powers to intervene – again, without an exit strategy. This has, of course, been in service of reducing carbon emissions from our electricity system, and the UK has been very successful at doing so. 

Rolling back the market

The Electricity Market Reform programme in the early 2010s put in place a regime to support low-carbon power that offered new nuclear plants and renewables a fixed price for their power, determined by auction for the latter. When the market was lower than this price, the generator would be topped up to meet it. The competitive element of this process has delivered tremendous reductions in the cost of renewables – especially offshore wind – but has done so at a price to the integrity of the market.

Under this scheme, renewables don’t charge their actual cost of production, which is primarily paying off the capital used to build them. Instead, they charge whatever will ensure someone will buy their electricity, as whatever that price is, it’ll be topped up to their contracted price. As more and more renewables enter the market, that charge gets lower and lower – especially given that most wind generators will be outputting at the same time when the wind blows. Indeed, there have been occasions when the price has gone negative. 

This means that if you want to build a new wind farm without benefitting from a government contract you’ll find yourself competing against other wind farms that can always undercut you. The contracts last 15 years, and wind farms generally last about 25 years, creating the real risk that a lot of wind farms under construction today will reach the end of their contract, find they can’t make any money and decide to shut down rather than incur maintenance costs. Estimates vary for when this impact on prices will become increasingly serious, but most point to some point in the mid 2030s – by which point the independent Climate Change Committee has recommended that all electricity should be carbon-free. In other words, clean power output could fall just at the point when we need it the most.

This won’t just affect wind farms – some of the plans for supporting new nuclear and new carbon capture-equipped power plants rest on similar contracts to those supporting wind, which will again impact on unsubsidised plants. By 2030, over half of all generation in the UK will enjoy insulation from the wholesale electricity market. 

Switching back on

Putting the public sector on the hook for new plant means bill payers will be paying for them even if they turn out to be bad bets. Market discipline is the best way to drive productivity and provide the best value, yet this government appears to be sleepwalking into the de facto removal of competition as a way of selecting which technologies to deploy. We will not be able to just turn the electricity market back on once we’ve built new kit. The biggest risk to delivering Net Zero is that costs to consumers get so high that popular support collapses – rebuilding the free market in electricity is the way to stop that happening.

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Adam Bell is Head of Policy at the strategy and advocacy firm Stonehaven.

Columns are the author's own opinion and do not necessarily reflect the views of CapX.