The UK Energy Market

Growth of populations and expectations of rising living standards indicate that the use of energy in the currently developing world will pass and rapidly outstrip that of the industrial world of today. Source depletion and environmental impact will depend on the way the energy ratio of the rising economies develops. It will be strongly in the interests of the present industrial countries to assist the developing ones to move rapidly to the falling part of the energy ratio curve. Energy must be considered to be one of the basic human needs.

World history has shown that the purposeful use of energy resources has been the principal means of obtaining economic advancement and improvement in the quality of life. One of the changes that is hoped to be seen over the period in question must be the appearance of these benefits in areas where they have not yet arisen. Since the needs vary widely with location, it is appropriate to begin with a global viewpoint. This is necessary also because the main energy sources currently used are internationally traded commodities and the effects of their use are seen nowadays to have global dimensions.

The changing pattern of energy use in the UK shows that energy use in industry has fallen by half. Domestic uses continue to represent a very high proportion of the total – about 30 per cent – while that due to transport has doubled. The recent analysis by the Royal Commission on Environmental Pollution states plainly that the situation concerning transport in the UK is not sustainable. This is understandable when seen against projections by the Department of Transport, showing a further doubling of vehicle mileage within 35 years. It must be recognised that the availability of personal means of mobility has been immensely liberating, while the movement of goods, particularly foodstuffs, has contributed notably towards our quality of life.

Vehicle ownership in other countries has reached levels of nearly twice the UK per-head figure without reaching saturation. Problems of pollution, noise, congestion, road encroachment and others suggest that the pattern here will have to be different. One thing that makes forecasting unreliable is the infinite inventiveness and resourcefulness of people, which cannot be modelled. At a given point, we can only project potential solutions based on current knowledge, and not those that have yet to be conceived. No doubt, vehicles can become smaller and more fuel-efficient (The UK Energy Market Guide).

A growth in working, shopping and learning from home could produce a countervailing increase in the proportion of energy used in the domestic sector, which has remained high and steady among the changing energy patterns of recent decades. One estimate puts this rise at no more than 10 per cent (Energy in the UK Market Review). However, this is likely to be overtaken in any case by other developments in building energy control. Low-energy technologies for buildings, based on new understanding of insulation, ventilation, active and passive solar heating and daylighting, indicate that for the UK climate it should be possible to have comfortable habitation with virtually no conventional energy use at all.

This derives in part from significant development in advanced glazing systems; this will allow the controlled input of solar heat and daylight into buildings while offering the same resistance to outward heat loss at the surrounding walls and roofs. Other contributors will enlarge on our growing appetite for electricity in the home. Current developments point towards self-generation of electricity by the use of photovoltaic devices incorporated into wall and roof structures, capable of meeting most of the needs of the domestic sector.

It is frequently said that the UK lacks an energy policy. The implication is that there is a simple choice to be made between having one and not having one and, if there were to be an energy policy, the content would be obvious and have universal support. The assumption that market forces alone will lead to an optimum energy strategy for the UK has formed the basis of much Government thinking over the last decade and a half. In practice, it has been tempered by recognition of the need to consider environmental concerns and to give incentives to the use of non-fossil fuels in electricity generation. There has also continued to be some research and development funding.

The basic argument for relying on market forces to determine the energy mix in the UK is that the energy sector is extremely complex and previous attempts to devise national energy plans have been unsuccessful. It is asserted that, as with other sectors of the economy, competition will identify which energy industries are the ones favoured by society and therefore succeed. However, many of the important timescales in the energy sector are measured in decades, and to rely on market forces alone does not give sufficient weight to perceived longterm changes that are likely to occur on both a national and global scale.

The current review of nuclear policy provides a good example of this. It is clear that future pressurised water reactors (PWRs) such as Sizewell C could either be a very good or a very poor investment, depending on factors such as the future price and availability of natural gas and the possible introduction of a carbon tax. But these factors are outside the nuclear industry’s control, and the way they develop will not be known for a very long time; under these circumstances, it is unlikely that private industry would wish to risk its own money in building nuclear plant. Some Government intervention will be required.

Furthermore, it is clear from the privatisation of the electricity supply industry that the very form that it took has led to unfortunate, and probably unforeseen, consequences to the coal industry. Providing the conditions for market forces to operate freely and fairly is not as straightforward as it might, at first sight, appear.

There are firm arguments for the belief that privately owned companies operating in competitive markets, dependent upon the support of their customers, at risk of commercial failure rather than political censure, is the best way to ensure efficiency in production and the services that customers require. In this context privatisation, the creation of market structures that promote competition and the liberalisation of markets, would each appear to be a good thing. This revolution is spreading to utilities across the globe -from South America, across Europe and on to the East.

Does the establishment of a market and the appointment of a regulator signal the end of the Government’s role? In the report following the Coal Review, the DTI appeared to suggest that this might be the case-to the disappointment of the coal industry-a clear warning to those in the nuclear industry who hoped that the Government would find no alternative but to resume public investment in new nuclear power stations following the Nuclear Review (UK Energy Industry).

There are criticisms of the newly privatised markets-many of which relate to the transition arrangements that are ensuring that all parties have time to accommodate the massive changes that have to take place. In general, however, the architects of the new markets and their regulators seem pleased. There is some envy of the rewards flowing to shareholders and some executives, but precious little evidence that either the customers or the taxpayers have been disadvantaged relative to what might have been under continued public ownership.

However, there are areas of more widely shared concern. Many final customers do not have a choice of suppliers and the prospect of marketdriven price reductions. By and large, the main benefits to customers have resulted from regulatory intervention. Many observers of the electricity supply industry in England and Wales have been dismayed by the rapid replacement of perfectly serviceable coal-fired plant by gasfired CCGTs-with the consequent impact on the coal industry and rapid rundown of economically accessible reserves.

There has been a number of instances of regulatory interventions that have contributed to market instability. Even the understanding reached between OFFER, National Power and PowerGen, designed to cap prices and increase competition through the divestment of some 6 GW of fossil generation, has further destabilised the market-and the major costs of this intervention fell wide of their target. The resulting market uncertainty has merely reinforced short-termism in investment decisions in the electricity supply industry (ESI)-another area of widespread concern (Market research).

The evidence is convincing for the benefits of competitive markets. Nevertheless, the two competitive markets that the Government has created are behaving very differently for market structural reasons alone. They cannot both be right! If either has to be changed, it would seem reasonable to assume that this should be the responsibility of their creator, the Government.

With nuclear power still in Government ownership, decisions on its future remain entirely in the hands of Government. Nuclear Electric, the publicly owned nuclear generator, volunteered a solution by making early flotation its primary objective from the Nuclear Review-another decision for Government. There is no evidence yet that any renewable plant would be built without the benefit of generous support from the NFFO levy. This too remains dependent on the continued support of Government.

There seem to be three or even four good reasons why Government cannot simply rely on market forces. There are, in addition, the perceived risks of short-termism and all the external factors which are not reflected in the market place. Under today’s market conditions, investment decisions by the privatised and independent generators inevitably continue to favour gas-fired CCGT. After all, it is a characteristic of perfect competition, the declared goal of the present Director General of Electricity Supply, that each player moves quickly to emulate the market leader and both products and the means of production will tend to be undiversified. It is also the case that price competition leads to reduced profits and lower achieved rates of return.

With or without further intervention by the Regulator, it seems more likely that the diversification of corporate risk will be achieved in other markets or other products. Unless there is a new non-gas technology about to displace CCGTs, today’s undoubted diversity of electrical supply will be transient, and technologies with export potential-which Government would otherwise be pleased to encourage-will simply disappear from the UK scene. It seems reasonable to expect, within the decade, a further major shift to gas.

Of course, this is the second dash for gas. The first took place during the 1970s when natural gas replaced towns gas, coal and oil in domestic and commercial heating. Apart from transport, which is 99 per cent dependent upon petroleum products, there is the very real prospect of dependence on gas on both sides of the meter! In the short term this may confer major competitive advantages, but there is the likelihood that the only real switching opportunity for the domestic consumer may be changing from gas-fired to electrical heating-which of course is also dependent on gas. The prospect of such dependence on oil and gas may be seen to represent an unacceptable risk to the economy.

Gas may be better than coal, oil and orimulsion, but it is not the perfect fuel for protecting the environment and there is nothing in the marketplace to reflect the potential harm of climate change. Other externalities will similarly fail to be taken into account unless there is specific recognition of the costs and benefits in the rewards available in the market.

Governments surely have no option but to accept responsibility for the working of the market and the consequences of the decisions of the players which follow directly from their design of the market and its regulation. The creation of markets may achieve greater efficiency in the use of resources but not a perfect walk-away solution.

How should a Government intervene? The day’s winners will suggest ways that maintain or increase their competitive advantage. Others will seek overt support for their solution-in today’s terms translating to support for coal, nuclear and renewables. However, this route, even via a system of quotas, seemed not to the taste of the Conservative administration, and in any case it risks losing the benefits of competition and a return to central planning. The following alternative, and no easy solution, is presented for careful consideration. The Government should be helped to:

• Clearly define market outcomes that are undesirable. These will clearly include the failure to deliver competitively and predictably priced energy, failure to sustain acceptable levels of security, failure to achieve sustainability into the long term, failure to meet in full internal plant and fuel-cycle costs and failure to protect the environment from further harm.
• Reach an initial consensus on the risk and cost or value relating to each and the mechanisms for reflecting these in the market.
• Define the basis upon which the developing market will be measured in terms of the continuing risk of undesirable outcomes.
• Make clear the intention to review the market against these measures and to make further changes to externality costs or values or the mechanisms by which they are applied if it should prove necessary.

Above all, there should be as consistent a framework of policy and market regulation as possible. Only in this way will companies and their shareholders gain the confidence to engage in the long-term planning that the energy sector requires. One thing should be clear: if this cannot be achieved, there is perhaps no alternative but to reconsider more interventionist controls such as quota arrangements. If the lower-intervention solutions prove too hard, to do nothing is not an acceptable alternative.

Society needs electricity and its infrastructure for essential purposes. The more dominant use of electricity as the common energy currency for all forms of energy has many advantages in reduced infrastructure costs, flexibility of energy source and conversion, environmental pollution control and end-use technology, particularly for developing countries. Indeed, it may be the only way many developing countries can meet the demands of rapid population and energy growth and match their expectations for an increased share of the world’s prosperity. Society needs electricity for:

• lighting

• motive power

• water-including irrigation, pumping, purification and sanitation

• communications and information technology

• medical care

• improving the quality of life.

Although it is not always possible to differentiate clearly between supply of and demand for electricity, it is possible to think in at least conceptual terms of the ways in which electricity is used, and the sources of supply of that electricity. In the United Kingdom electricity is used for a great variety of purposes, which may be broadly categorised as domestic, industrial and agricultural.

Total electric consumption from all sources in England and Wales is shown in Table 1. Although there is significant year-to-year variation, there is little evidence of a systematic trend of increase. About a third is used for public electricity supply, by the electric companies; this includes both electricity used in homes and electricity supplied to a wide variety of commercial, business and public buildings. Figures for electricity put into public supply over ten years show an increase from 1991 to 2000, but only a 3 per cent increase within the last decade.

Troughs in total demand occurred in 2001, but overall demand continues to rise slowly, for both the UK as a whole and its constituent countries. The growth in demand for electricity supplies varies from company to company, being least in the areas served by the South West and Yorkshire companies, where rates are high and there have been strong public campaigns against charges. For unmetered supplies again variation exists, with North West, Southern, South West and Yorkshire not indicating consistent growth, unlike in the other areas (Winter Outlook for the UK Energy Market).

A very noticeable change currently in progress is the continuing growth of the human population. Universal global communications nowadays show to people everywhere what living standards can be like through economic advancement. It has been observed how the world-wide demand for energy will continue to grow as nations strive to achieve even minimum standards of living, let alone approach the levels of economic prosperity achieved in the developed world. The underlying link between access to energy and economic activity is fundamental to the World Energy Council’s analysis and beyond dispute.

It may be concluded that UK energy policy should continue to be largely determined by market forces but should also be tempered to take long-term, environmental, national self-sufficiency and UK employment factors into account. This policy will need to be fleshed out in some form of national plan, which would need to be reviewed from time to time as the future unfolds. It would be important that any changes should be of an evolutionary nature. Radical and sudden changes can easily result in destroying a UK industry which would be difficult, if not impossible, to start up again.

References

‘Energy in the UK Market Review’, Research and Markets. Available from: http://www.researchandmarkets.com/reports/3635/

‘Market research’, Research Connect. Available from: http://www.researchconnect.com/buyreport/report_6951.asp

‘The UK Energy Market Guide’, Energy for Business. Available from: http://www.ebusiness-energy.com/Your_Guide/YG_THEUKENERGYMARKETGUIDE_V1.shtml

 ‘UK Energy Industry’, Energylinx. Available from: http://www.energylinx.co.uk/uk_energy_industry.htm

‘UK Energy Review’, Energy Risk. Available from:  http://www.energyrisk.com/public/showPage.html?page=340874

 ‘Winter Outlook for the UK Energy Market’, Energy Business Review Online, Available from: http://www.energy-business-review.com/research.asp?guid=BFEN0177