PÖYRY POINT OF VIEW ARTICLE / 4 Oct 2013
European Energy Markets: Price freeze, trust and political capital
The UK’s Labour Party has proposed to freeze retail energy prices for 20 months should they win the 2015 election. This type of pronouncement and the uncertainty that it brings threatens to unpick the fabric of the electricity industry, and damage our ability to achieve renewables and decarbonisation targets.
There is a proper role for controlling prices in electricity retail markets. Competition will benefit consumers only if certain preconditions are met. Customers must have good information on competing tariffs and must face (or perceive) low costs to switch supplier. Economies of scale and barriers to entry (including ‘brand power’) need to be eroded. These are all legitimate targets of market intervention and education campaigns aimed at boosting the power of competition, and price regulation can properly remain in place until competition takes hold.
However, the form of price intervention is delicate, and clumsy treatment erodes the trust which allows investment to take place. The accepted form of price regulation is through an independent (non-political) regulator, which is isolated from the short term needs of populist democracy. This isolation is necessary because the electricity industry relies on long term investments, and a continual short-term approach would prove costly in the long term. The proper process for price regulation requires the companies to be treated fairly, including a well-researched understanding of the base cost of electricity supply, and safety valves in case of unexpected events.
Investment is a long term issue and political interference damages its prospects. If the politicians have any desire to improve the workings of the electricity system and to deliver decarbonisation while keeping down the costs to consumers, they should work to correct the flaws, help to build up the mutual trust which is required between voters, governments, electricity companies and their financiers, rather than selling this ‘trust capital’ for short term gain. This ‘family silver’ is being sold far too cheaply.
The need for trust has never been higher. Europe’s political classes continually repeat their ambitions to decarbonise the economy and the power sector, but the poorly coordinated and costly subsidy regimes that have delivered these aims so far have cost untold €billions. We are now close to the point where market regimes should take over from the centrally planned renewable roll-out. However, the atmosphere of mistrust which is being perpetuated by recent political pronouncements undermines the future balance between voters, government, the electricity industry and the finance world which funds the necessary investment and permits a shift to decarbonisation. Even the introduction of smart meters, which brings scrutiny of customers’ behaviour and an attempt to ‘nudge’ consumption patterns, requires confidence that the changes are for the benefit of customers not the companies. And without such confidence the cost of the meters will be simply lost.
A virtuous circle of trust would operate as follows:
Electricity companies set prices competitively, and customers (voters) believe that the electricity industry treats them fairly
Governments set long-term arrangements (e.g. a carbon market) to decarbonise the economy, and explain the future costs honestly to voters in a way that they accept
Customers (voters) accept the cost of decarbonisation and give (long term) political support which enable the governments to commit to long term stable regimes (beyond the term of a single electoral cycle)
The financial world attaches a low (regulatory) risk premium to power sector investments and the electricity industry can make investment at reasonable cost
The current vicious circle operates more like this:
Governments use electricity companies as scapegoats to divert attention from austerity measures, and gloss over the true causes of electricity price rises (which include the cost of previous government decisions)
Electricity companies are characterised as a soft target for windfall taxes, arbitrary price limits, etc. as a means of gathering populist support, and this risk remains live over successive electoral cycles
The electricity industry is perceived to have a high regulatory risk by the financial community and investment becomes difficult and/or costly without direct project-specific support
Market-based arrangements to support decarbonisation cannot be made credible as there is no political mandate, and the centrally-planned world of subsidies remains the norm
The energy companies are not paragons of virtue and some mud has stuck, through misselling and poor customer service. However, the core accusations of collusion and price manipulation towards customers are merely assertions and have not been shown to have substance, despite several investigations.