Energy, Environment and Sustainability Group
The UK government has announced their intention to release a draft bill aimed at introducing tariff controls within the UK energy market. By the time you read this, the extent of the proposed interventions will probably be known.
The proposals may simply be symbolic, or indeed a substantive intervention in the energy market. Whatever the proposed changes, governments of all persuasions should exercise some caution to ensure they do not result in unwelcome and sometimes unforeseen side-effects. As is so often the case, we can often learn lessons from history or from other countries when seeking to formulate new energy policies.
In respect of energy tariff controls, much can be learned from the experiences of South Africa. Tracing its roots back to 1923, Eskom today claims to generate approximately 95% of the electricity used in South Africa. They operate 23 power stations with a total nominal capacity of 42GW, comprising c36GW of coal fired stations, 1.8GW of nuclear power and 2.4GW of gas-fired plant. Escom also operates over 368,000 km of power lines and the associated substations.
Like many UK utilities, Eskom has needed to invest heavily in aging infrastructure. Its required investment is greatly increased by the pressing need to supply electricity to a greater percentage of all South Africans in order to raise their living standards. In the early 21st century, Eskom repeatedly warned the South African government that significant investments would be required to ensure that the lights remained on. Despite these warnings, the government adopted a policy which suppressed power prices. At the time, it was understandably focussed on the need for all South Africans to access affordable power, whilst also supporting economic growth through the provision of cheap power to industry. Over a period of years, the South African power reserve margin fell from roughly 25% at the turn of the century to some 5% only eight years later.
Finally in January 2008, the warnings became a reality; South Africa entered a period of rolling blackouts due to a shortage of supply. The resultant load shedding left millions of homes without electricity, whilst some of the world’s largest gold and platinum mines were closed. As tourists were trapped in cable cars half way up Table Mountain, it seemed that no part of the economy would be untouched. The South African government called the problem a national emergency and there was talk of electricity rationing.
Following the calamity in South Africa’s power supply industry, the South African government and the regulator (NERSA) permitted supply prices to rise in order to attract investment into the sector. Electricity price rises in the four years following 2008 were between 25% to 30% per annum, and significant rises continued for many years afterwards. It is now widely acknowledged in South Africa that Eskom’s warnings should have been heeded and that the wrong interventions can do long term damage to the economic wellbeing of a country.
Coming forward in time, in 2016 the UK produced 24.6% of its electricity from renewable sources1. This represents a dramatic increase in the deployment of biomass, wind and solar PV technologies and demonstrates how government policy can encourage enormous investment in the energy sector. Notwithstanding the impressive growth in renewable power generation, little has been done to decarbonise heat and transport. Indeed, when one looks at the UK's total energy consumption, only 8.9% was sourced from renewable technologies during 20161. Clearly much remains to be done to meet our Paris climate commitments; this will require a concerted effort on the part of utilities, scheme developers and the investors who will finance our transition to a low carbon future.
In the coming decades the UK will need to invest heavily in an extensive portfolio of distributed generation assets, together with the replacement of an ageing nuclear fleet with new schemes such as the contentious Hinkley Point development. Just like South Africa, the UK has witnessed a dramatic reduction in its supply reserve, resulting in the requirement to invest in grid based storage schemes to support peak shaving and frequency response etc.
Whilst limited in its application, the implementation of contracts for difference (CFD) will help to provide some investors with price certainty when building new generating assets. The introduction of the capacity market has also helped to reward investors for maintaining sufficient generating capacity. However some investors will remain wary of unexpected changes in policy and the uncertainty that may be associated with some market interventions. Some may fear that we are at the top of a slippery political slope, and this may impact potential long term investment decisions.
Introducing tariff controls within energy markets does not come without risks, and governments need to be cognisant of all stakeholders’ concerns when formulating new policy. The experience in South Africa provided several lessons that we may wish to reflect upon:
- Firstly, ignoring the early warnings from industry experts and a failure to address a steadily decreasing reserve margin ultimately proved to be detrimental to consumers and to the economy in South Africa’s case.
- Secondly, against a backdrop of suppressed power prices, many independent power producers (IPPs) would not invest in building new generation projects in response to the evolving South African energy crisis. Investment in energy efficiency schemes was also limited, as payback periods were extended by low power prices.
- Thirdly, after suppressing prices for many years, the resulting annual price increases were substantial and very difficult for both consumers and business to accommodate.
Fossil fuels have allowed us to benefit from millions of years of stored energy; we have become very accustomed to the low prices associated with these fuel sources. Whilst protecting the fuel poor, it is perhaps time that we acknowledged that the transition to a smart grid, low carbon generation and sustainable transport will cost more than we have become used to. Perhaps it is time to be honest about the cost of this transition and to set out a visionary plan to invest in the change and the new jobs that will be created.
Reference 1: Digest of UK Energy Statistics (DUKES) 2016
The Author
Ernie Shelton, has over twenty five years’ experience delivering strategic projects and advisory services for EMEA based corporations and has worked with the nuclear, oil and gas, and renewable energy sectors. He currently delivers impartial support services for corporations, investors and developers who are working to reduce greenhouse gas emissions.)