Helm Review: “Cost of energy is too high; the market’s broken and can’t be fixed, so we need a new Energy Act based on a free-market model”

The expert Oxbridge author of the independent Review of the Cost of Energy – commissioned by the Brit-Govt – yesterday delivered a 220-page full free-market economic broadside assault on the energy generation, supply and distribution system in the UK.

 Prof. Dieter Helm’s report says that the current system is too confusing and too complex for either suppliers, consumers, and/or the state/ regulators to fully grasp, that the system is open to ‘political capture’ (management-speak for effective-lobbying) and is too difficult to fix.

He says markets work best within clear structures. They are the primary means to an end – ie, of providing the least-cost clean energy. The Report states equally bluntly;

 ‘The costs of energy are too high – and they should be going down.

 And it’s going to get worse, Helm warns, unless political action is taken to drastically overhaul the energy market.  Helm’s hard-hitting report says consumers continue to get a raw deal and recommends:

  •  The costs of nuclear power stations (including Hinkley atom plant) should be separately charged on consumer bills
  • The state (ie OFGEM) should set a standard default tariff for energy consumers against which all other gas and electricity providers would compete
  • Some parts of National Grid plc should be re-nationalised, and:
  • The break-up and re-formation of the present market-dominant Big Six energy providers.

So Helm has challenged the Brit-Govt to bring in a new Energy Act founded on clear free-market principles – coupled with dozens of specific policy and practice recommendations in his Cost of Energy Review t- o keep prices down for business and consumers alike.

His report sets out a long-term framework for the electricity industry which would provide a stable and least-cost way to achieve the twin goals of meeting the Climate Change Act (CCA) and security of supply.

The review comes at a time of considerable public debate and concern about the increases in energy bills to customers, and about the ability to pay and the impacts on industrial competitiveness.

However, in the current ‘phoney war’ over Brexit – where the UK and EU have not even started negotiations on trade terms, taxes, and tariffs – the Brit-Govt has neither the political will, the legislative time, the parliamentary strength in the Commons nor the intellectual strength to do anything with the Helm Report but to thank him for work and put it in a file marked ‘For the Next Government’.

Business and Energy Secretary Greg Clark said: “I am grateful to Professor Helm for his forensic examination. We will now carefully consider his findings.”

Helm’s report also comes at a time of huge technological opportunities and change on a scale not seen in electricity since the late-19th century, which offers considerable optimism about the speed of decarbonisation and about the process being less costly than many have feared.

He explained: “This task is urgent – not just because of the many failures of the current market – but also because of the pressing need to meet the new and exciting challenges ahead which will come with the digitalisation of the economy, electric transport, new storage, demand-side opportunities, and the development of decentralised energy systems.

 “This new world stands on their head the current assumptions on which the industry is structured.

 “The new world is likely to be more zero marginal cost and capacity-driven, rather than a marginal cost-driven wholesale energy market world; it will be dominated by a cornucopia of new data; and the old problems which have defined the industry structures – a lack of storage and passive demand – will gradually fade away.

 “This is a fundamental break with the past.

“Yet almost every measure on the long list of recommendations would have some party who would want to defend and protect it. The opposition to piecemeal reform is likely, therefore, to be tortuous, and this is why it is imperative to go back to first principles, which is what the long-term framework  energy market framework recommended in this Report does.

Helm Recommendations for a long term energy market framework

 A long-term framework starts with the key parameters:

 (i) rapid technological progress, including digitalisation, smart technologies, new storage options, an active demand side, and new materials and advances in basic science (especially for solar)

(ii) electrification of transport

(iii) the growth of zero marginal cost low-carbon generation and the decline of the wholesale market.

At the core of the long-term framework for the electricity industry lie three key design principles, all of which are violated by the current structures. These are: Simplification rather than ever-greater complexity;  the assignment of decisions to those best able to make them;  choosing market prices and auctions wherever possible; over-administered decision-making, and trying to pick winners.

 

Summarising the new energy market model

The merits of the new model are that it maximises the scope for auctions and competitive bidding; enables a fully private competitive market in back-up, storage and demand-side measures; and uses the market to identify the full and true costs of all the technologies, especially intermittent ones such as wind and solar power.

It opens up the decentralised market opportunities, gets rid of the licence distinctions between supply, distribution and generation at the regional level, and moves on from the periodic review regulatory model for DNOs.

 The new model is much simpler and it enables much of what OFGEM and BEIS currently do to be dismantled.

It is the model which meets the principles: it is simple; it places responsibility for costs on those who cause them; and it maximises the use of auctions and competitive processes <to put downward pressure on prices>

 Most importantly the new model goes with the flow of the big technological changes. It embeds storage, DSR and zero marginal costs, and maximises the chances that these great new opportunities will continue to drive down the cost of energy.

 

Helm’s Road Map: What to Do Now  

The report states; “This is a comprehensive package for the determination of the least-cost ways of achieving the climate change and security of supply objectives in the long run.

Most of the steps necessary to get from here to there can be put in place in the near term. Some of these measures will require legislation, notably changing the licences and creating the NSO and RSOs, and giving them statutory powers and duties.

 Many of the measures to get to the long-term framework do not require legislation, and where they do, they may not require a new Energy Act.

Government should start the preparatory processes now – and specifically prepare a white paper

The long-run destination is a competitive electricity market, with:

  •  A uniform carbon price and auctions determining investments on an EFP basis
  • Markets in storage; demand-side measures and back-up supplies;
  • A withering wholesale market with an NSO and RSOs ensuring the security of supply and opening up the networks to competition; and
  • A much-reduced role for regulators and the government.

 In addition to these road map measures <free-market first principles> to get from here to there, there are some immediate problems with the cost of energy identified above which need to be urgently addressed to provide some much-needed relief to households and industrial customers

Unless these measures are introduced, the widespread suspicion about energy prices and the conduct of the energy providers will continue to undermine trust, and thereby further exacerbate the costs of decarbonisation and erode the public’s willingness to pay for the necessary decarbonisation investments.

 The status quo is unstable, and on an increasingly inefficient pathway.

The Helm Report recommends that the Treasury, BEIS, Climate-Change Commission and OFGEM take the following immediate actions;

  • The creation of a ‘legacy bank’ for the out-of-the-market contracts for renewables and for nuclear – to be separated out from the industry costs and explicitly billed.
  •  Securitisation of the legacy bank contracts, to drive down the cost of capital and exemption of industry from the legacy costs.
  •  Detailing the capacity auction volumes necessary to address the coal and nuclear closures and uncertainty about Hinkley timings for the period through to 2030, and urgently contracting for the necessary capacity to overcome the coal closures  
  •  Setting out a road map to move to EFP auctions  
  •  OFGEM should consider options for addressing the outperformance of transmission and distribution within the current period

 

The publication of a default tariff for household electricity bills, based on the underlying costs, with published margins.

Households on the standard variable tariff have received a particularly bad deal as identified by the Competition Authority, and competition has worked to the benefit of switchers often at the expense of non-switchers.

Suppliers should not earn a significant margin on the large element of cost pass-through items.

There always is a default tariff, and the proforma structure of the tariff should be set out and all major suppliers should be required to offer it. The supply margin should be calculated on a common basis and published on the OFGEM website.

 

OFGEM should produce a league table of margins so customers can instantly identify the cheapest supplier for the default tariff.

Gas and electricity suppliers would remain free to offer any other tariff they wished. Competition and especially competitive entry will be greatly enhanced by this default tariff

 A gradual reduction in OFGEM’s activities as the NSO and RSOs are developed, and eventually considering the merger of OFGEM with other network regulators.

 

 National Grid plc functions should be re-nationalised

The NSO (national system operator) should be given explicit duties to ensure the security of supplies, both in generation through the capacity auctions and with regard to the transmission networks.

These duties should, where they apply and are relevant, be transferred out of National Grid. There will be an inevitable element of discretion in the public interest, which should not lie with a private company.

 The UK faces a cliff edge in capacity in the period through to 2025 as the coal power stations close, followed by the retirement of most of the existing nuclear capacity.

 

There are very real risks to security of supply, and a risk to the climate change agenda if, as a result, emergency measures are required to keep the coal stations available. 

 The government should set out what measures the system operator should take to mitigate the risks associated with the uncertainty of Hinkley starting to generate.

 

Government attempts to fix the system

 The Helm Report then excoriates governments – past and present –  for creating a detailed mass of market interventions which are ‘beyond the capacity of officials, regulators and companies to comprehend.’

He commented: “Complexity encourages lobbying by vested interests in each market intervention. Piecemeal reforms will almost certainly fail.

 “The current level of detailed, multiple, overlapping and costly interventions is the unintended consequence of a host of ad-hoc policy interventions <by government in the market>  including, but not limited to, EMR and the way it was implemented, as well as the addition of new objectives, and the general growth of regulation.

“These interventions keep on growing, as one measure is layered onto another, increasing costs and inefficiencies. The interventions have been wide open to pervasive lobbying and capture, and the result has been significantly higher costs.

 

 “The current framework is not fit for purpose. It is not stable: left alone it will get worse. The costs of energy are too high, and they should be going down.

 “Continuing down the current path will most likely result in ever-greater complexity and growing costs, independent of the changing technologies and cost structures identified in this review.

 “At some stage the results will be sufficiently bad to motivate reform, but the longer this is left the greater the impact on the cost of energy, and the more the decarbonisation process will be inhibited.

 “What is required, and what is set out in this review, is a radical simplification of energy policy, getting government back out of the detailed mass of interventions it has become entrenched in.

 “Government should stop ‘picking winners’ and engaging in detailed investment decisions.

 “Markets work best within clear structures. They are the primary means to an end – ie, of providing the least-cost clean energy.

 “Competitive auctions have already made a big difference to costs. They can achieve much more in the decentralised framework set out in this review.

 

“The costs of energy are too high, and they should be going down.

 ‘So the choice is stark: either carry on with the current energy policy framework and there will be increasing barriers to the penetration of the new technologies, and the incumbents will be able to thwart entry, OR or embrace a new long-term energy market framework.”

Read the full  220-page Cost of Energy Review herehttp://tinyurl.com/yck6jrah

 The Advisory Panel to the Cost of Energy Review comprised:

  • Richard Nourse (Managing Partner, Greencoat Capital LLP)
  • Laura Sandys (Chief Executive, Challenging Ideas)
  • Terry Scuoler CBE (Chief Executive, EEF: The Manufacturers’ Organisation)
  • Isobel Sheldon (Engineering & Technology Director, Johnson Matthey Battery Systems Automotive) Nick Winser CBE (Chairman, Energy Systems Catapult).

Helm added: “My intention has been to highlight what I regard as the failings of the current market framework and structures. The analyses and recommendations are mine alone.”

26 Oct 2017

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