By Richard Tol, University of Sussex
Winter is coming. And the UK has a real chance of brownouts or even blackouts from lack of power. The long predicted capacity crunch in electric power generation is likely to hit us earlier than expected after the fires in Didcot, Ironbridge and Ferrybridge power stations, and the discovery of cracks at Hartlepool and Heysham nuclear plants. But there are structural problems in both senses of the word and a serious and powerful regulator needs to unpick a policy tangle if we are to make sure the nation’s TVs stay on for the Queen’s Christmas speech.
Capacity was always going to fall short in the winters of 2016 to 2020, for the reasons given below. Some have blamed climate policy for this, as policy makers put carbon dioxide emissions ahead of more prosaic concerns, like keeping the lights on.
But policies designed to reduce acidification of soil and water are more important. The UK has run out of exemptions under the Large Combustion Plants Directive, which aims to control acid rain. This means Britain’s old coal-fired power plants have to close because they emit too much sulphur and too many particulates. Using CO2 scrubbing technology to clean up old power plants makes no economic sense, so the plants will be shut down or mothballed.
A strange business
So, because fears of acid rain grabbed policy makers’ attention in the 1970s and 1980s, we will see blackouts in the 2010s. Indeed, regulation moves slowly and power plants last for decades.
This has been hard to grasp for the average politician focused on the next election. Although the current capacity crunch has long been foreseen, nothing was done about it. Again, the reasons lie in the remote past.
Electricity is a strange business. Compare it to peanut butter. The demand for peanut butter equals its supply, but only roughly. We store some in our fridges, some on supermarket shelves and in warehouses. That is fine. Electricity, however, cannot be stored. Supply must meet demand at every moment. This means that the electricity market has to be much more tightly regulated.
Demand for electricity typically peaks a few days before Christmas, between 5pm and 7pm, because it is cold and dark, there are Christmas parties taking place everywhere, and people are working overtime before the holidays. Some power plants operate only a few hours per year in order to meet that extraordinary demand – but they still need to be maintained throughout the year.
Power plants break down all the time. To make sure demand is met, there are also a few power plants running in reserve. Typically, these plants are superfluous. They do not sell electricity. But they need be paid for their effort nonetheless. Electricity markets therefore must have some system of cross-subsidies to reward providers of all this peak and reserve capacity.
When the UK power market was liberalised, the first regulator designed a market, centred on long-term bilateral contracts, that worked well in theory. It did not work so well in practice. Utilities have been “sweating”, or overusing, their assets: make money; don’t invest; let old plants crumble. This is a short-sighted strategy.
Politicians have only recently realised that blackouts may hit the country while they are in office. The focus has been on the retail side. But the market is dominated by a few large sellers. Jean Tirole won the Nobel Prize for showing just how counterintuitive and counterproductive regulation of oligopolies can be.
The Labour government decreed that all clients should be treated the same. Companies promptly withdrew offers for new customers. Fewer customers decided to switch supplier. The average price of electricity went up.
On the supply side, dithering over market reform and frequent changes in direction in climate policy have left investors nervous. A power plant lasts for 50 years. The details of future policies and regulations determine whether this investment returns a profit or not. When he was minister for energy, Ed Miliband announced that ten new nuclear power plants will be operational in 2020. We may have one by 2030. A senior energy executive once lamented to me that Venezuela has a more dependable and credible energy policy than the UK.
Fortunately, the European Union has decreed that the power market be reformed. It will be based on the Scandinavian model, which does not work so well in theory but has proven to be pretty robust in practice. The Scandinavian model relies on both spot markets and day-ahead markets for electricity, as well as auctions for reserve and peak capacity.
The energy regulator has to become more like the Bank of England. Mark Carney is a household name and an internationally respected banker. But who has heard of his energy counterpart, Dermot Nolan? Ofgem employs many capable people, including its chief executive, but does not have the stature and independence necessary to stand up to the political whims of the day. Energy is one of those sectors where politicians should strike the balance between potentially conflicting goals – affordable, reliable, clean energy – but technocrats are best placed to fill in the details.
For now, we should pray for a mild winter and stock up on candles and firewood. We should also argue hard in Brussels for one final exemption to keep our old coal-fired power plants running for a few more years.
Richard Tol makes his money teaching economics at the University of Sussex and the Vrije Universiteit Amsterdam. He receives research funding from 7th Framework Programme of CEC DG Research & Innovation. He is an independent adviser to a wide range of organisations, including the governments of Germany, Ireland, the Netherlands and the USA, multilateral organisations (e.g., European Commission, World Bank), investment banks, energy companies (both renewable and fossil), engineering companies, political parties across the spectrum (from Freedom Party to Greens), activist groups (e.g., both pro- and anti-wind power), charities (e.g., the Global Warming Policy Foundation) and academic organisations (e.g., Royal Irish Academy, Global Trade Analysis Project). He is a Member of the Academia Europaea, a Fellow of the Tinbergen Institute, and a Fellow of CESifo.