Creating energy system change and reducing consumer price: a short schematic

Background

1/ Much of the decent debate on the energy price crisis, including debate within Labour/left circles, has centered on whether the ‘big five’ energy retailers should be nationalized. However, as understanding has grown of the wider energy environment has grown [1], so too has the understanding that, while nationalization of these companies may be a good step [2] because profits may be socialized when some stability is returned, their nationalization will not of itself resolve the crisis of very high wholesale prices which result from the marginal pricing process whereby all prices paid by retailers are dictated by the most expensive energy source, gas.

2/ What has not happened yet to any great extent, at least from a Labour perspective, is an assessment of how the state (under a Labour government or under Labour-led pressure) might best intervene strategically (and within the confines of the law [3]), in the wider energy environment, and specifically at the other key three ‘points of transaction’ where the state does deals with non-state organizations (or in some cases such as offshore wind, with non-state organizations owned by other states).

3/ To date, the main idea that has been offered up is the idea that the country should invest as quickly as possible in renewable sources, so that the more expensive fossil fuels are no longer needed, and the marginal pricing issue resolves itself. This is not wrong, but there is a clear time lag before this becomes a reality, during which time fuel poverty can only be alleviated by state spending in the absence of other solutions (including better energy storage), and nor does it directly address the current pricing mechanism for organizations entering the renewables industry, which currently militates against investment (see below).

4/ More interestingly, and more immediately pertinent to this paper, is the idea that the stat should seek a ‘golden share’ in one or more fossil fuel extraction firms, such that it is able to exert some form of strategic direction on it/them and in a way which mitigates or removes the current differential between the marginal price they create and a more reasonable price paid by retailers. Economist James Meadway argues this from a socialist economics perspective, while journalist Paul Mason argues for it from a ‘national security’ perspective, for example, but both motivations (and of course they intertwine) lead to the same kind of concept: a multinational accepting control over the prices it offers at auction in one particular market in return for a large investment stake).

5/ At first sight, this seems unlikely to work; previous golden shares, such as that taken in British Aerospace, have come about at the point where the state were privatizing, but still had a say in what control it should have in future, but within the bounds of international law this is no longer the case. This should not mean, however, that the idea should be dismissed; the challenge is to find a way where it becomes advantageous to one or more multinationals to submit voluntarily to some form of domestic control, either formally via a golden share restructure of all or part (e.g. the North sea part of the business) or via less permanent but operationally robust agreements which replicate the effects of a golden share.

Core proposal

6/ Other than the price paid by the consumer to the energy retailers, and the now closely associated Ofgem price cap process [4], there are three key transaction points in the current energy system:

a) The half-hourly wholesale auction process between producers and retailers, dominated by the concept of marginal pricing, and whereby currently all prices paid by retail firms and passed on to consumers, are tied to the most expensive product, gas, because that is needed as the last part of the overall national energy ‘jigsaw’;

b) The capacity market process, introduced by the Energy Act 2013 [note here on politics of non-review], where contracts for the provision of additional fuel for the grid, or less use of grid capacity, at any point where normal capacity looks to be becoming insufficient, are agreed, either over a four year timeframe (T-4 auctions) or shorter (T-1 auctions);

c) The Contracts for Difference scheme, also introduced through the Energy Act 2013, which is intended to stimulate domestic investment in renewable energy by offering a guaranteed income at the contracting point ‘strike price’ in the event that prices falls (in line with a naïve supply-demand curve prediction), but which has In fact militated against investment via this route because renewable firms have to pay back the difference between strike price and current (high) wholesale price as part of the contract.

7/ Schematically, the way to bring down wholesale price is to engineer a position where fossil fuel extractors/producers are squeezed into a lower price at wholesale auction because the retailers, and the national grid operators, is able to fall back on the capacity markets to meet supply needs, having already agreed prices for these at the T-4 and T-1 auctions. This changes the whole raison d’être of the capacity market process, from one of making provision for System Stress Events to one that militates against higher prices. (This would, most likely. require a change in the rules that govern the capacity markets.)

8/ The logic from there is that the government could effectively use the capacity market process to set multinationals against each other (rather than against the government) as they seek to profit individually from what would of course be advantageous contracts, given the need to make proper long term contingency for supply in the context of (arguably) more frequent triggers of such contracts.

9/ If this logic works through, it could be that the government is then able to strike a preferential deal with one (North Sea) extractor, at the expense of others, in a way which starts to resemble a golden share i.e. ‘investing’ a contract price instead of taking shares, but with ancillary agreement about the multinational’s business behaviour both in terms of the wholesale market and support for the development of domestic renewables via joint ventures.

10/ Alongside this, and as another overdue change to the Coalition government’s underwhelming and under-reviewed [note] Energy Act 2013, there is sense in revising the Contracts for Difference scheme, originally designed to encourage renewables investment but now discriminating against renewable firms because they do not gain from higher wholesale prices. The revision, intended to supercharge the investment drive would make the strike price ‘one way’ — guaranteeing income as price falls (which over the longer term it will) but not penalizing while the wholesale price remains high. As an extension, a deal on co-investment from the preferred fossil fuel extractor might be worked into the quasi-golden share deal. Completing the loop back to the capacity markets, the government should also explore ways in which newer battery technology will enable renewable firms to store energy in ways which allow it to participate directly in capacity markets themselves, as well as opening the route further to a properly decentralized grid (and therefore a redefinition of what the ‘national grid’ actually is [5].

11/ Overall, then, the challenge is to intervene in two transaction points, in a way which impacts beneficially on the third (marginal price at wholesale auction), and uses state spending on adjusted, more generous contracts more strategically, both in terms of cost of living and net zero, than the state spending that will be needed in the short term.

Next steps

12/ As obvious first caveat, this paper offers a high level, lay person schematic of how progress might be made beyond a desirable but limited campaign for energy retailer nationalization, but with a view to the limitations on state power over multinational firms (and of course other humans-right abusing, fossil producer states). A first step will be a rigorous fact check, and a more detailed review of current legislative constraints, associated auction processes, and recent expert reviews.

13/ If the schematic stands up to this scrutiny, it may be appropriate to open up the idea to a wider, though potentially sympathetic audience e.g. at Labour conference in September. This might best be done with two elements of political narrative in mind:

a) Giving the Labour leadership a story about how, while its August announcements were rightly focused on the very short term need to provide households with at least some support by action on the price cap, work on a much more systemic solution has been going on (this may also open a route towards Gordon Brown’s apparent promotion of temporary nationalization); and

b) Stressing that the mess we are in now is result of both the of the Coalition government’s ‘ideological’ Energy Act 2013 provisions on the capacity markets (ch. 3) and Contracts for Difference ch. 2), and of a bone idle Johnson regime’s failure to meet its statutory obligations to present a review of that Act until May 2022, around three years later than required by section 66 of the Act itself.

14/ In terms of the latter, and the government action that did not place because of clear governance failure it may well be worth zoning in on the Five year Review of Capacity Markets, which was published to time in 2019, and which (at para. 16) contains what now seems like a key warning from experts, and recommendation for action:

“Whilst we recognise the importance of the CM, we understand that there is also room for improvement in the current design, to ensure it better meets its objectives. Responses to the CFE [consultation] focused in particular on the need to remove perceived market distortions that may impact auction competition and the need to adapt to future security of supply challenges (e.g. the changing nature of system stress events ….and also how the CM interacts with other electricity system requirements such as flexibility).”

15/ Finally, there is the question of what the new Prime Minister, presumably Liz Truss, will announce as soon as she takes office; most commentators seem to assume that it will be insubstantial, based on what has come to date, but as I have set out here, there is some evidence that in fact there will a big announcement on what likely chancellor Kwasi Kwarteng has called “supply issues”, specifically in respect of North Sea supplies. Labour needs to be ready for this if it is get any hearing for its own plans.

16/ Truss may, in fact, announce quite a dramatic state intervention, effectively forcing North Sea producers to reduce wholesale price, either using Section 2 of the Energy Act 1976, Section 22 of the Civil Contingencies Act 2004, or other emergency-focused legislation to do so.

17/ Interestingly, what she announces may be close to what the GMB union is now proposing (without reference to existing legislation): it wants effectively to remove the ability of the North Sea giants to sell to Europe (GMB suggests Ireland should be excepted as it has no other options for supply available, but for obvious reasons Truss might not be so understanding of Ireland’s needs). For myself, I am not as convinced as GMB seem to be that this is the best point of intervention, given the possible hostilities with ‘friendly’ states it would raise, but without removing the need for capacity market intervention. However, it would certainly be a bold step on Truss’s part, so Labour do need to prepare both a response to it and alternative plans.

Notes

[1] Arguably, the early media success of the anonymous Don’t Pay campaign, targeting the energy retailers as the key enemy, has served to obscure the bigger issues at stake. This is not to say that the Don’t pay campaign is unwise, as it has raised the potential for solidarity action, but a challenge will be to set out more complex proposals for systemic in a way which can also draw on the kind of support drawn in for the Direct Debit cancelling idea.

[2] Nationalization of the main energy retailers is not the mains subject of this short paper, but it is worth pointing to one possible downside of nationalization if undertaken in the absence of wider action designed to control wholesale price of the type schematized by this paper. This is that a single national purchaser of wholesale energy, which is bound to purchase in any event, may come to be an easier target for price-gouging than multiple firms. It is possible that this is a reason that Gordon Brown’s intervention in the Guardian, presumably agreed in advance with the Leader of the Opposition’s Office, mooted temporary nationalization.

[3] This paper makes no attempt to grapple with whether what is proposed around intervention in the capacity markets is within te bounds of the (neoliberal) Energy Charter Treaty, to which the UK is a signatory. This will obviously be a consideration, but so also may be the rising discontent with what is now largely seen as outdated international law in a time of climate catastrophe.

[4] It is obvious enough, but worth stressing that the Ofgem price cap was designed as a measure to guard against the ‘loyalty penaltyy’ i.e. to stop retailers nudging up prices for customers who do not shop around. It was not designed to cope with the rapid wholesale price increases, and it is hardly a surprise that it has not done so.

[5] The shift from a centralized to a decentralized grid, where the very definition of te grid is changed to incorporate energy flows that do not even touch the current national grid and in a way which opens up a whole different set of producer/consumer transactions to the ones identified in this short paper, can perhaps be most easily represented visually.

PC (26/08/22)

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Paul Cotterill

Secretary General, Habermasian Labour (UK). Indefatigably focused on the promotion of ethical discourse in the public sphere, except when there's cricket.