With oil below $60 a barrel and energy consuming countries around the world, particularly those with an election on the horizon, looking forward to an unexpected economic boost and associated feel-good factor, attention has turned to what impact falling hydrocarbon prices will have on investments in renewable energy and the climate change agenda in general.
Will those wind and solar farms turn out to need even more subsidies than they were getting anyway in order to compete with cheaper hydrocarbons? Can we really continue to say that clean forms of power save us from an insecure and expensive future based on foreign oil, gas and coal? And will these new fangled forms of clean power station ever be competitive in a “market” which includes incumbent polluting forms of production?
Despite the reductions in cost seen in wind and especially solar power in recent years the answer to the above questions are: yes, no and no respectively.
Subsidy, of course, is a dirty word. It brings connotations of inefficiency, conspiracy, political preference and perhaps a throwback to the bad old days of the 1970s.
In power generation we subsidise the old and the new in some of the most convoluted ways. Since 2005, for instance, the European Union has had a trading scheme for carbon emissions. Bad for emitters such as coal and gas fired power stations you might think, as they have to pay a market price for the cost they impose on the planet.
Well, no. While at the margin the full cost of emissions was passed on to consumers, up to 2012, European power stations were given a proportion of their emission allowances free, meaning that the scheme set up to put a cost on emissions actually acted as a subsidy to those doing the emitting.
While the EU emissions trading scheme carries on, this free money to emitters largely stopped after 2012. So from early 2013 we have had outrage from conventional power producers at subsidies which the EU states give to renewable energy.
These renewable energy subsidies, conventional generators would have you believe, have ruined the free market for power and represent a costly political interference.
Yet in the UK there have been only two periods when power generation, or some large part of it, was not subsidised. The first was from the end of the regulated market in 1999 to the start of the emissions trading scheme in 2005. In that period many power generators including iconic ones like Drax and British Energy went bust. The latter needed to be nationalised.
The second is from the end of subsidies for fossil generators under the emissions trading scheme in 2012 to now.
This time the period without subsidy is already over in the UK. The coalition has spent its time in office reforming the power generation sector and hence the subsidy arrangements for both the old and the new. For the old (and some new) we have government awarded contracts for capacity which basically subsidise power stations for being around for when we need them.
If you are an investor in power you better make sure your portfolio is biased towards the form of generation in vogue for subsidies.The first set of awards were made just before Christmas and this helps appease those who lost their emission trading derived subsidies in 2012, as well as supporting the building of some new back-up power. For the new and clean, including new nuclear and renewable generation we have long-term subsidy contracts which guarantee the price for their output.
So here come the inconvenient realities of energy production.
First, all forms of it that make a return are subsidised. If you are an investor in power you better make sure your portfolio is biased towards the form of generation in vogue for subsidies.
Second, in order to ensure energy security, governments keep the power market in a state of constant oversupply. Markets in permanent oversupply, if they are competitive, tend to not remunerate players above their marginal cost and hence they don’t encourage investment. Therefore if we want to encourage investment in new, clean and replacement power stations before the old ones run out, and hence keep the lights on, then we will always need subsidies.
Third, while it is true that during the recent period of high oil and gas prices investment in clean energy has increased dramatically. It also turns out that when the oil and gas price are high people also invest heavily in new and innovative forms of hydrocarbon production. So while the predicted dwindling supply and the sky-rocketing future cost of hydrocarbons as an energy source have been a convenient rallying cries for the clean energy agenda for some time, as the recent drop in oil price shows, it is not an argument that can sustain it in the long-term.
Fracking shows that we are able to extract more than enough hydrocarbons out of the Earth’s crust to destroy ourselves through dangerous climate change. We cannot rely on the hydrocarbon age to end because we run out of hydrocarbons. An oversupply of cheap hydrocarbons as we decarbonise means continued protection, and hence subsidy for new clean and green power generators.
While subsidies have always been with us, there are alternatives. The recent UK government energy reforms involve, firstly, outlawing certain forms of new polluting power station and secondly taxing carbon emissions.
But we just haven’t been effective at pricing or taxing emissions in a way that provides a reliable return to investors and we aren’t getting better at it.
Subsidies will remain, and policymakers should ensure that these are focused, or re-focused, on the cleanest forms of energy. The job of the policymaker and investor in energy is to judge the absolute level of subsidy which is sustainable for the economy’s energy supply.
