Clean and Secure Energy Obligation?

Some friends of mine in the energy sector have been excited by a new report by Dan Lewis on Securing Our Energy Future. This report does indeed make some excellent criticisms of current energy policy, but I'm afraid it does not follow (as they seem to have assumed, perhaps from too quick a reading) that the author's recommendations are of equal merit, nor even that the analysis is balanced or complete. Unfortunately, it is tarnished by Dan's obsession with certain electricity technologies.

The day that Dan treats the three main energy uses (electricity, heat and transport) with the equal weight that they occupy in our energy systems and recognizes their close inter-dependence (particularly between heat and electricity, but also with transport now that electric transport looks an increasing prospect) is the day that his views will deserve serious consideration. Unfortunately, that day has not dawned, as the following section from his introduction makes clear:

-"And whilst energy use can be broadly divided up into heating and cooling, transport fuel and electricity, historically and today, energy policy has really always been understood to be about the UK's electricity supply. That then will be the focus of this report."-

Really? You mean, because governments have always been blinkered and stupid, that is a sound basis to continue to be blinkered and stupid?

Remember, electricity accounts for only one-third of our primary energy consumption and around 20% of our final consumption. Twice as much gas goes to the production of heat as to the production of electricity, so a 10% reduction in our use of gas for heating would have the same effect as a 20% reduction in our use of gas for electricity (or, to look at it another way, enable the continued and increased use of ultra-efficient CCGTs to produce our electricity without increasing our dependence on imported gas).

Dan's failure to notice the relative significance of gas in the heat and electricity markets may account for his mystification at government claims that the UK will reduce its consumption of gas by 30% by 2020. They may well be wrong, but it has little to do with false assumptions about the role of gas in our electricity supplies and much more to do with assumptions of reduced heat consumption due to efficiency improvements.

Besides this myopia, the other big problem with the report is that Dan's skills at prescription do not match his skills at diagnosis. Many of his criticisms of current policy are well-made, but unfortunately his analysis of some of the alternatives, and his proposed solution do not match his analysis of the current failings.

For example, his analysis and dismissal of energy-efficiency (apparently treating it as a policy solution rather than the response to incentives that it actually is) and carbon tax is superficial, partial and uninformed. On energy-efficiency, he rightly points to the Rebound Effect, but  misses the simple and critical point. If you try to deliver energy-efficiency by supply-push, you will have exactly the Rebound Effect he describes, because the consumer is made better off and will probably spend their savings on goods that consume energy, as he says. If you deliver it by demand-pull by making energy more expensive, you won't get the Rebound Effect, because the energy savings are balanced by the increased energy costs.

It's not rocket science - even mainstream, mathematical economists are aware of this, which is why so many of them support carbon tax as the efficient way to reduce our fossil-fuel consumption. Actually, it would probably be better to call it a fossil-fuel tax, and the critical point, as made by Greg Mankiw and others, is that we can expect to pay it whether or not our government introduces it. It's either going to go to Vladimir Putin and King Abdullah, or it's going to go to the Exchequer. Not a difficult choice.

Once you realise this, the objection that a carbon tax needs to be agreed internationally is much diminished. And that is a key plank of Dan's case against a carbon tax - a case that relies (in the full three paragraphs that he gives it) on the arguments of two people who were heavily invested in an alternative approach (carbon trading), with which Dan rightly also disagrees.

Perhaps partly due to the source of and self-interest embedded in these arguments, they are not as strong as Dan likes to think:

-"Thus far the evidence is that governments around the world have found it very difficult to bring in carbon taxes".-

Really? So Sweden hasn't hit 40% renewable energy (not just electricity) through a pricing policy that is largely based on carbon- and fossil-fuel taxes?

As for his other arguments against carbon tax, and his own proposal, they betray an unsurprising ignorance (given Dan's lack of commercial experience on the side of the fence that has to create the return on investment, rather than on the side that provides some of the funds and takes the lowest-risk cut of any return that the customer can achieve) of the effect on investment of sovereign risk. Dan wants a mechanism to be flexible - capable of being changed at short notice by the politicians if they judge that it is "wrong". At a philosophical and economic level, concepts of "right" and "wrong" prices or levels or outcomes calculated by central government reveal a naivety about the extent of the uncertainty surrounding our knowledge of the issues, and the paucity of the information and tools available to government. (This is not ameliorated by his earlier assumption that governments cannot accurately calculate the right levels of a carbon tax but can calculate the impacts and desirable contributions of technologies.) And at a practical and commercial level, if Dan is as worried about security as he claims to be (and I'm sure he is), the last thing he should be proposing is a mechanism that can be changed at short notice on politicians' whims to tune it to their latest political priorities, obsessions of the media, and arguments of various rent-seekers.

We already face perpetual and almost unbearable sovereign risk in the current structure. It is this risk that makes investment (which is vital to security and prosperity) very difficult. At the least, it drives up the rate of return that is required (which may go some way to explain why our foreign-owned VILE companies would rather invest in the rather more stable policy environments of their native France or Germany). In practice, given the length of time over which energy investments have to be recouped, it can be hard to calculate a viable rate of return that would insulate against the sovereign risk in a country where governments of all flavours are addicted to continuous policy tweaks in pursuit of micro-management of the economy and the incentives. Consequently, some may choose not to invest at all, particularly if the prospects of achieving a decent return to compensate for the risk look remote. Hence the situation in which we find ourselves, with even the Government's advisers warning of the likelihood of blackouts within a few years. And Dan's answer to this is to replace many of the mechanisms that create this sovereign risk with a mechanism in which technologies may be included or excluded on annual review by three senior ministers of government! I'm a businessman, get me out of here.

The VILE companies may feel differently about this, because one of the features of politically-adaptable mechanisms is that they can work in your favour if you have enough access to and influence over the politicians. Rent-seeking - that is the other major objection to Dan's "Clean and Secure Energy Obligation". Rent-seeking can be achieved by negative as well as positive means. As much can be gained by persuading government to disadvantage the choices of your competitors as by persuading them to favour your own choices. Those of us without access to government (and no government can provide equal access to large and small petitioners, nor can industry bodies accurately represent the divergent interests of their members) will be in continuous fear that some privileged rent-seeker (pressure groups and other lobbyists, as well as businesses) will persuade the government that the technology in which we had chosen to invest had disadvantages that required it to be marked down, if not excluded completely. And in practice, even those with access to government live in fear that one of their competitors will get better access or be more persuasive, and suffer from the effect of that which they seek to promote in the mistaken belief that it is in their interest (see the VILE companies' devotion to the EU-ETS as a classic example).

It is beginning to be recognized (by many, if not, unfortunately, by our political leaders) that our politicians would benefit from substantial real-world experience outside politics before entering parliament. The same, it seems, should go for those who seek to influence their policies. Dan's attempt is clearly well-meaning and addresses many real problems. And I am sure he is sincere in his classical-liberalism. But he still wants a system that is managed by ministers to produce the optimal result that it is assumed they are equipped to divine. That is the product of a view of the economy that sees it more as a vehicle steered by a lever-pulling, all-knowing captain and his crew, than as a means of coordinating activity amongst many independent actors who each possess a small proportion of our dispersed knowledge.