Why does the price of energy go up?

Energy prices increase on a daily basis. We have peak prices and off peak prices.

Energy prices increase on a seasonal basis. When its cold, prices go up.

Energy prices are also subject to long term shocks. E.g. Oil Crisis

Why is this?

Each day our demand changes, but the amount of energy available to us does not. So if we ask for lots more the price has to go up (p to p1 in above diagram). During seasons such as winter the energy companies have to forecast what to produce and again if winters are much worse, then price is the only tool that they have to compensate.

Energy companies are large and regulated in the UK. That said they are a classic Oligopoly structure. This means that as companies if they raise prices it is unlikely that everyone else in the industry will follow and raise theirs. If they cut prices then everyone will follow. We do not buy on energy quality. We have only one grid connection for electricity or for gas.

 In other words it is not in the interest of energy companies to compete on price. They tend to use complex tariffs and lots of advertising that are hard to understand.

In the UK we have been "lucky" as we have had cheap energy from the North Sea. This has given the UK cheap energy compared to Europe.

In the recent "end of term report" the coalition government outline that there are various new shocks that we as consumers are open to in the future:

• Coal fired power stations are to be taken offline as they emit lots of carbon (2016)
• Older Nuclear power stations are being decommissioned
• We have little or do not want large storage facilities for gas in the UK
• Our energy needs continue to grow (When we have a growing economy)
• Alternatives for purchasing Oil and gas supplies will be more limited in the future
• We have some tough carbon reduction targets to meet

In other words our demand may be quite predictable in the future, but supply is less certain. There is a danger that our supply will shift (supply to new supply as below) unless there is replacement investment in the present power stations with a considerable green tinge.

For consumers this will mean fluctuations between P2 and P3 rather than P and P1 on the graph above.

Estimates on the replacement capital needed are about £200bn. Investments in energy are very long term and very expensive. The case for (Energy companies) continuing as normal is quite strong. Indeed the now listed companies have to respond to the short term demands of the stock market and investors rather than the distant future.

Clearly this leaves consumers with some issues:

Fuel poverty. For the less well off fuel will become more expensive. The less well off may also have less well insulated or energy efficient houses.

Energy security. Everyone may become concerned that we do not have enough energy. Rather than prices going up "a bit" we may be subject to "a lot" due to market conditions.

Carbon targets. Love them or hate them, we have them. As individuals or organisations there will probably be penalties to ensure that we collectively meet the targets.

The solutions are a little less clear. Simply replacing existing power stations leaves the UK prone to the same shocks from energy supplies such as gas. It also does not solve the carbon problem. At the moment the proposals look something like:

1 Carbon Capture and Storage

This is a big hole where you "bury" your carbon. This will happen on new power stations. (My personal reaction is not good as I do not like burying problems - there are examples of explosions and it could mean a raft of disaster movies - seriously, it only builds up a problem for the future). This does not seem to be an immediate solution, but once the model has been proven the government will want retrofitting within 5 years. For more information see http://www.co2storage.org.uk/ . As this method will increase the cost of production the industry will need to be induced into doing this. This in turn will increase prices to consumers.

2 Nuclear Power

Nuclear power is carbon friendly. In the past the full cost of the power has not been past onto energy companies. Each year the tax payer spends an estimated £1.8bn cleaning up nuclear waste. If the full cost of nuclear power is taken into consideration it is "hard" to make the figures work (apparently!). The coalition government are split on this issue with the present minister being against nuclear unless it can be made to work on cost grounds. Bearing in mind nuclear power takes some time to build and not all the energy companies have made up their minds this may help reduce carbon emissions and add to electrical energy in the longer term future.

3 Use less energy

A simple policy in essence but harder in practice. There have been energy savings policies around for some time and they have limited effectiveness. EPC's to rate homes will be rolled out and loans to help upgrade homes with insulation are nothing new but are being given more marketing space by this government. Clearly as energy becomes more expensive it makes more sense to use more insulation. Government buildings are also being rated in a more stringent way. "the greenest government yet" is not hard. In the last 100 years we have only had Labour and Conservative governments (since 1916 and excluding the war), it is not a long list. However many of the buildings programmes of yesteryear did not have their eye on energy efficiency. It was more on cost of build.

Whilst new buildings will be more energy efficient. Today many government buildings programmes (e.g. schools) have been cut. Budgets have also been cut. Some energy efficiency measures do cost money - so councils up and down the land have issues. They cannot borrow, they have cuts and fines.

This policy may well cost more money than it first seems. There is a lot of campaigning needed, surveys, monitoring etc across millions of buildings. For the general public we have seen it all before. There have been insulation packages around for some years now. There has not been the uptake. Even from those households that could have got it for free. Will we listen this time?

4 Smart Meters

Smart meters have been talked about a lot. A cost to the energy companies, and they will have to be installed by 2020. More user friendly and accurate they will enable the consumer to see how much energy they are using. More information may mean better choices and a reduction in energy costs.

5 A green investment bank

Potentially confusing. An investment bank is normally found in the city and deals in finance for large companies. As such it supports (generally) low risk infrastructure or asset based investments rather than the research and development of new technology that venture capitalists support. Therefore it is logical that it will support wind power (if the figures add up). This bank is not a high street bank. Whilst it has been remitted to support loans to individuals to insulate their homes the bankers concerned have not really warmed to the idea. It is a "challenge". It also will not support renewable energy at the micro level  it is not what an investment bank does - however green it may become. The costs are estimated at £2bn to set up. They are hoping to divert funds from other places to do this. The initial spend is hoped to induce further capital spending (to meet the £200bn needed). I have no idea whether this will work. It is focussed on big infrastructure improvements for reducing carbon. Rumours of this plan being cut have surfaced. There will be a debate amongst the coalition in October. Should the money stay in its present use, fund debt, or be used in this way. Perhaps there is not a united front on this one.

6 Renewables Obligation

This is an obligation placed on electricity companies to use renewable sources to produce power. This targets carbon reduction. It also expands the supply chain to include fuels other than oil, coal and gas. It helps the business case for wind power, biomass power stations, or simply burning biomass in older power stations.

As with other policies this has been debated heavily. Debates are around efficiency rather than intent. In particular RO will help the wind farm development and biomass power plants.

Comment

Much of the strategy concerning energy is around grids and electricity. This is partly because electricity generation is not currently carbon friendly and partly as there have always been economies of scale in production.

Forward thinking economists acknowledge that power is both electricity and heat. As we move away from fossil fuels (including gas) - how do we heat our homes in the future? Projections indicate that oil will be phased out. Gas will be restricted to existing buildings. The National Grid believe that the gap will be largely met with a reduction in energy consumption. They believe there will be an increase in the use of electricity for heat. This was at the heart of the thinking in the Green Investment Bank proposals. Since then the government have committed to 12% of domestic heat being produced by micro renewables by 2020 clearly in conflict with their own "think tank". Another debate to be had?

7 Microgeneration

The cited difficulties with all micro generation are the following:

A high outlay followed by much cheaper low carbon heat and electricity
Attractive to middle classes if subsidised - so a tax on the poor
Complicated - how do we understand what we need?
Open to abuse by salesmen
Unregulated industry

MCS accreditation was introduced last year to improve the quality of service, products and installers. There is now a database of accredited products and installers of a variety of different renewable energies e.g. solar or biomass. This deals with much of the regulation and sales issues. The quality of the products, the procedures that all companies have to go through guarantee service to the customer but at a possibly higher price. The companies identify themselves with a logo and commit to a consumer based scheme which ensures that items are not miss-sold.

Adverts of Bristish Gas selling.... gas abound at the moment. There is very little advertising renewable items other than on the web and at "green" shows. Most companies selling biomass,for instance, are small. Companies selling air source heat pumps are larger e.g. Worcester Bosch leaving an imbalance between potential performance and advertising power.

The present government are consulting on the consulting on the consulting about how best to do this. The MCS accreditation is much of the answer. Providing advice in the same central place where there is already information on all the products and installers is logical. There has already been research completed on the support needed for the market called the Renewable Heat Incentive . The present position on this is

"This Government is fully committed to taking action on renewable heat; this is a crucial part of ensuring we meet our renewables targets, cutting carbon and ensuring energy security. The Government is considering responses to the Renewable Heat Incentive consultation and will set out detailed proposals on how to take forward action on renewable heat through the Spending Review."


Conclusion


There is not much clarity on energy when you read between the lines. There is very little actual progress with respect to energy security or carbon reduction. Some aspects can be achieved short term e.g. renewable energy is ready to go. Each heating season lost means targets will be more difficult to reach. Companies have geared up several times for false horizons and are now questioning the green credentials of this government. 


To quote Johnathon Porrit 


"Substantial reductions (of more than £30 million) in some of the grant schemes for renewable energy; the deferment until 2013 of the much-hyped ‘Pay-as-you-Save Green Deal’ for retrofitting existing housing; and Treasury gearing up to make it impossible for Mr Huhne to bring in the critically important Renewable Heat Initiative in April next year." means that much of the above will not happen quickly. Either large scale infrastructure improvements take a long time. Alternatively the small scale improvements at a home level are not popular with the city (or the treasury (or are they the same?)) in the same way that they were not a real winner with the unions (or Mr Darling). 


To answer the earlier question of "why do energy prices go up?". As it is our energy supply will shift to the left and our prices will go up. The government is not committed to developing the supply either through infrastructure improvements or renewables. Simple inactivity will push prices up.