Welcome news: a consensus is emerging around one way to attack energy costs – stop paying sky-high prices for electricity that is generated in the UK by firms whose costs are unaffected by soaring gas prices. We’re talking about nuclear power plants, windfarms, solar projects and biomass facilities, some of which are making fortunes thanks to the UK’s outdated wholesale energy pricing system.
The basic problem, revealed starkly by the crisis, is that electricity in the UK is tied to global gas prices. When the gas price spikes, as now, it has perverse consequences: a nuclear power station is paid as if its input costs had just risen fivefold, when they plainly haven’t. This “clearing price” setup was designed for another age – not one where nuclear and renewables together produce about 60% of electricity in the UK.
One idea to crack the problem in the short term (ie before the government settles on a method to decouple gas and electricity prices, which is the plan) was sketched out here on Tuesday. Academics at the UK Energy Research Centre (UKERC), followed by the consultancy Cornwall Insight, have been pushing the idea of shifting as many UK generators as possible onto contracts for difference, or CfDs.
Under CfDs, the problem of overpayments doesn’t arise: when wholesale prices are above a fixed “strike” price, the projects return cash to be recycled into lowering bills. But the CfD setup has been only been widely used since 2017. Before then, the main system for encouraging investment in renewables was renewable obligation certificates, or ROCs, which are still attached to 40% of UK electricity generation.
Such projects get the wholesale price plus, for instance, one ROC worth at least £50 per megawatt hour. The arrangement looked roughly fair when wholesale prices were £100 per megawatt hour, but, at £400-plus, somebody is raking in undeserved and unintended windfalls. If it’s not the owner, then it’s middlemen who bought the power via forward-selling arrangements.
Thus a switch to CfDs has right on its side. The chancellor, Nadhim Zahawi, said on Thursday that the government is looking at a voluntary shift to CfDs, albeit one that won’t be ready until next year in order to get around the forward-selling wrinkles. The lure to developers would be a 15-year contract that guarantees still-profitable terms when the current emergency has passed and (we hope) gas prices plunge. That sounds roughly like the original UKERC proposal from April. And Energy UK, the trade body, says the industry is backing the plan.
All that is welcome – it is movement in the right direction. But, before anyone gets the idea that salvation has arrived, two related points needed to be made. First, the obvious one: the savings may not be huge if ROC generators don’t all sign up for CfDs, or if the new contracts are too generous. Energy UK is projecting only £150-£250 for a typical household, albeit businesses would also benefit.
So the second issue is how robust the government wishes to be. A blistering letter in the Times this week from five former energy bosses, including former chiefs of Shell, National Grid and BG Group, backed a more radical idea to address the same core problem: just cap the prices of domestic electricity produced by non-gas generators.
The firms could still make returns “that reflect the investment risk”, but energy prices would be reduced at source. Yes, that idea indicates what could be possible with a bit of arm-twisting. An invitation to generators to enter a “voluntary” negotiation is far more likely to produce big savings if it is accompanied with the threat of a windfall tax.
The picture is riddled with politics, it should be said. A contract for 15 years is less appealing if your nuclear power station is due to close in five; and the 80% owner of the existing nuclear fleet is EDF, under the control of the French state. Therein lies an awkward negotiation, just as commercial terms for EDF-backed Sizewell C are on the table. And getting nuclear to sign up would be crucial to maximising savings – it is the big player.
But the bottom line here is that tackling prices in the wholesale generation market looks an open goal for an incoming prime minister. Some versions of the CfD suggest average household savings of £500-£600 would be possible with maximum corporate participation. But it would require an incoming PM to, first, recognise the problem; and, second, be willing to face down vested interests.
