Britain’s energy policy mess

Last week's government auction, in which power suppliers bid to feed energy into the grid at peak times, is fuelling a boom in dirty fuel. Why, and what can be done? Simon Wilson reports.

What's happened?

Last week, while global governments were finalising an agreement on cutting carbon emissions at the UN climate change talks in Paris, the UK held its annual "capacity market" auction, in which power suppliers bid for contracts to feed electricity into the national grid at times of peak demand. The capacity market mechanism the first in Europe is meant to ensure that backup power is always available when, for example, intermittent renewable energy sources fail to produce enough energy. The capacity market essentially pays suppliers to keep generators on standby, and is in effect the government's insurance policy against the long-predicted supply crunch in energy.

How did the auction go?

The auction of capacity contracts for 2019/2020 was completed at £18 per kilowatt, with the likes of Centrica, SSE and Drax awarded contracts for a total of 46.35 gigawatts (GW) of power-plant capacity. Crucially, the price agreed was below last year's £19.40, which means the UK's "insurance policy" will cost consumers less in the short run: the 2019/2020 standby capacity scheme will cost consumers £834m, according to government estimates, compared to £1bn for last year. But it also sends a worrying message to investors that building new (non-renewable) power plants in Britain is less lucrative than ever.

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Why does that matter?

Because the UK's capacity margin our spare power-generation capacity is tighter than ever, as polluting coal plants and uncompetitive gas-fired ones close, or cut output, "this auction does not solve the long-term problem in attracting new entrant large-scale gas plant to the market", says Phil Grant, of consultancy Baringa. Indeed, the auction awarded contracts to 1.9GW of power plants still to be built, compared to 2.6GW last year, underlining the less attractive conditions for new plants. And critics of the UK's energy strategy note the absurdity of a system that encourages the use of hugely polluting diesel engines to make up temporary supply shortages.

In what way is it absurd?

According to analyst Bernstein, around 1.1GW of capacity contracts went to diesel-fired plants. That's a small proportion of the overall capacity market, but it highlights, say critics, the contradictions inherent in our energy strategy. Diesel generators are well-suited to meeting temporary shortfalls. They can be installed fast and are transportable (they are typically built into shipping containers), and can reach full load very quickly (typically in about ten to 15 seconds from switching on).Yet they pour out carbon dioxide and toxic nitrogen dioxide. In other words, the UK is managing its energy supply issues in such a way that one of the most polluting forms of energy is also among its fastest growing all encouraged by multiple government subsidies.

What subsidies?

According to The Sunday Times, standby subsidies mean energy firms can get up to £83,000 a year for each two megawatt (MW) diesel generator they put on the grid, even if it's left off. When switched on, owners of so-called "diesel farms" earn up to £360 per megawatt-hour, nine times the normal rate, as they can charge premium rates in peak times. And under a Treasury "cashback" scheme, investors building diesel farms can claim 30% of the cost from taxpayers, plus exemption from capital-gains tax when the farms are sold. That might sound like an attractive investment, and indeed, The Sunday Times notes that around 95 firms have submitted more than 150 planning applications for new "diesel farms". And according to the Institute for Public Policy Research (IPPR) think tank, the subsidies and tax advantages mean diesel generator owners are raking in pre-tax profits of up to 23%. That "may be conservative, because many of the generators have been able to finance their projects through a tax relief scheme, which could increase returns by a further ten to 15 percentage points". High rewards but perhaps also high risk.

Why high risk?

The diesel mini-boom is highly exposed to any abrupt change in government policy. Also, critics argue, it's a glaring example of the mess into which UK energy policy has got itself (see box). Energy and climate change secretary Amber Rudd recently committed to phasing out coal power, yet the web of trading platforms, subsidies, levies and tax breaks that constitutes an energy "market" in the UK has thrown up a system that encourages a surge in generators running off high-polluting diesel. But it does nothing to foster new capacity in combined-cycle gas turbines, or even clean coal. Rather, where diesel contributes to a lower-than-expected clearing price in the capacity market as happened this month it actively discourages investment in (for example) new gas capacity, harming our long-term energy security.

How we're harming our energy security

Recent changes aimed at saving consumers money (the end of subsidies for onshore wind; cutting and restricting solar subsidies; an end to the climate change exemption on renewables; the removal of a £1bn fund for carbon capture and storage), clearly contradict the government's policy of sponsoring the surge in diesel, says the IPPR's Jimmy Aldridge. In other words, the government is creating incentives for "a form of generation that is penalised through another policy, the carbon price floor [and] the consumer pays for two separate policies that are working against each other".