British energy - the return of the state?

Matt Rooney unpicks the thorny issue of government getting involved in the energy market

The UK government is rumoured to be ready to take a £5bn stake in the proposed new nuclear power plant in Wylfa. Department of Business Energy and Industrial Strategy (BEIS) Secretary of State, Greg Clark has suggested that this would be a one-off, but direct government investment in electricity generation would be a huge U-turn after decades of aversion to such state intervention. Why would the government take such a step? And more generally, what are the principles which should determine the level of government involvement in the energy market?

The main argument for direct state investment in electricity generation is the government's ability to reduce costs through much lower borrowing rates than those available to private companies. This will generally reduce the cost of electricity for any technology, but it has a greater effect when the upfront costs are high, the running costs are low and the asset has a long lifetime. Ticking all these boxes will be the likes of large nuclear, hydroelectricity, and yes, tidal lagoons. All of these technologies will generate electricity for many decades, but typically private companies do not make decisions on these timescales. With a supposed 120-year lifetime, tidal lagoons are the type of energy projects that would be more suitable as a government investment in the nation's long-term interest than as a wholly private sector endeavour. 

The Hendry Review of the Swansea Bay Tidal Lagoon project recommended that the government greenlight the project citing mostly industrial strategy reasons - this was to be a 'pathfinder' project that would lead to cost reductions in future projects. However there would also be further local benefits to the region, such as employment, research and development opportunities, but also economic gains from resulting tourism and recreational activities for Swansea. This is why the Welsh government was reportedly willing to step in with financing for the project.

However, the primary aim of UK energy policy for over a decade has been to provide secure, low carbon and affordable electricity for the people of the United Kingdom and the ideal process for doing so is thought to a technology neutral competitive auction. Designing a competitive auction between different low carbon technologies with very different characteristics is already a challenge, so adding in spill-over benefits to the mix would complicate matters further.

There are potential pitfalls for governments attempting to pick winners in the energy market. Politicians are generally not very good at deciding the best technologies to invest in ­- a legitimate concern. Also, once a government creates an industry, it creates a lobby and the more entrenched and large it becomes the harder it will be to let it fail should it become unproductive and costly to the taxpayer and consumer. Government involvement puts more onus on politicians to 'do something' to protect people's jobs and livelihoods and they are all too often happy to oblige.

There is also a disparity in resources between large, well established industries and disruptive technologies that makes it harder for the challengers to find space in crowded market. Larger companies will have greater resources with which to lobby government ministers to choose and promote their technologies, and politicians will want the government to fund projects that will provide benefits to their constituents, helping to secure re-election. In the USA, this is referred to as 'pork-barrel politics', where historically State Senators have had considerable power to direct federal funds, paid for by all US taxpayers, to projects that will largely benefit just their own states. In the UK, the power of MPs is not as great, but a talented politician with a well-organised local campaign can still generate considerable pressure on the government to back their pet project.

Even the potential government investment in the Horizon nuclear power plant, given how the UK energy market is currently structured, could create conflicts of interest. The government would be an investor in the project and therefore logically looking to generate as high a return as possible, but the justification for state financing in the first place is to lower the cost to consumers. Ministers will have simultaneous incentives to desire both a high and low strike price for the electricity generated by the plant. 

The case for state involvement in some new energy projects is more straightforward. Technologies that involve the management of long-term liabilities necessitate government involvement, most notably carbon capture and storage (CCS) and nuclear power being an obvious candidate. Although the latest scientific evidence suggest that the risk of stored carbon dioxide leaking from geological repositories in negligible, this is still a long-term liability that goes beyond a feasible timescale of a private business. It is also the case that the responsibility for long term management of nuclear waste will have to fall on the State.

Carbon capture and storage (CCS) is widely recognised as a crucial technology required decarbonise our energy system and strong government involvement will be required. Government investment in carbon capture and storage infrastructure is not necessarily the state trying to pick winners. CCS is not one technology, but a range of various different ways of reducing emission from processes that produce carbon dioxide. Companies will be competing with each other to best technologies that could become the industry norm, but in order to create a market in CCS, the government needs to provide the enabling infrastructure.

Where the difficulty arises in this case is in the approach to choosing which region will host the first demos. Already Scotland, Teesside, Yorkshire and the north west of England are all vying to host Britain's first CCS hub.

State involvement in the energy sector is not going away any time soon. The best we can do is introduce competition where possible and where not have processes in place to ensure government investments are transparent and the case for making them is strong.