Column: UK energy fragility exposed by soaring global gas prices: Kemp


A warning label can be seen on the front of a gas meter at a home in Manchester, Britain on September 18, 2021. REUTERS / Phil Noble

LONDON, Sept. 22 (Reuters) – Like most other energy crises, Britain’s electricity and gas crisis has a short-term trigger (a sudden surge in international gas prices), but issues under -jacents she exposed have been accumulating for years.

Britain’s choices regarding energy market design, price controls, gas-fired power generation, charges and billing reflected the balance of political power and lobbying from corporate groups. interest, whether deliberate or unconscious.

Policymakers have wanted national gas and electricity supplies to be reliable and affordable while reducing emissions, but a surge in global gas prices has exposed the tensions between these targets.

Wholesale gas and electricity prices have reached record highs, but regulated invoice prices paid by customers have lagged behind, leading to insolvencies among small energy retailers.

Gas prices in the spot market have increased 400% over the past year, while electricity prices have increased 250%, but customer bills have increased by less than 10%, although that further significant increases be expected from October and March.

In practice, the contract prices paid for most gas and electricity are generally much lower than the spot market, which only manages a small amount of imbalances between expected and actual consumption.

And wholesale gas and electricity costs only accounted for 35% of the average customer bill in 2020, with the remainder attributable to transmission and distribution costs, operating costs, environmental and social obligations and taxes.

Retail prices therefore do not need to rise as much as wholesale prices, but tripling or quadrupling wholesale prices while bills are barely increasing has put unsustainable pressure on retail margins.

SMALL RETAILERS

Even before the latest wholesale cost shock, retail margins were very low or slightly negative, according to data compiled by the UK energy regulator (https://tmsnrt.rs/39qcCuD).

The average retail supply margin among the largest incumbent suppliers was negative in 2020, according to figures from the Office of Gas and Electricity Markets.

In practice, most of the large incumbent suppliers also have gas production, power generation and wholesale activities, where the margins are much higher.

Production, trade and retail are managed as integrated businesses, with retail clients offering guaranteed consumption / drawdown and an integrated short position to trade.

Integrated suppliers are naturally covered – losses on the retail side due to higher prices are offset by increased profits from production and trade.

In recent years, however, the government and regulator have encouraged a large number of small, non-integrated retailers to enter the market to increase choice and competition.

The stated objective was to improve the functioning of the market by increasing diversity, promoting innovation, improving customer service and keeping margins low.

Small retailers have received various benefits, including exemptions from certain social and environmental costs, in order to stimulate market entry and competition.

But their retail-only activities are not naturally hedged and they are exposed to rising wholesale purchase prices unless they cover all of their expected and realized supply volumes in the broader market.

Many turned out to be undercover and the exceptional surge in gas and electricity prices led to an unsustainable squeeze of margins, leading to bankruptcies.

DESIGN DEFECTS

Britain’s energy crisis was sparked by the global rise in gas prices, but it also exposed flaws in the country’s approach to managing gas and electricity supply.

The inherent tensions and contradictions between affordability, security, and emissions were hidden while gas prices were low, but soaring international gas prices pushed the conflict’s goals to light.

Competition in the retail sector has been more apparent than real because residential gas and electricity services are essentially homogeneous. Most of the competition has simply been the customer churn.

Competition has involved arbitrage of regulatory costs and price discrimination between different customer groups, for example by reducing tariffs for new customers to the detriment of long-standing customers.

By focusing on fostering competition, policymakers failed to ensure that small, non-integrated gas and electricity suppliers were properly managing their price risks and pursuing sustainable business models.

At the same time, Britain has become abnormally dependent on gas, which accounted for 36% of primary energy consumption in 2019, compared to 28% on average for the OECD (“World Energy Statistical Review », BP, 2021).

Gas is the main heating fuel used in almost 80% of homes. It also accounted for the largest share of electricity production (41%), ahead of renewables (37%) and nuclear (17%) in 2019.

Britain has made faster progress than other advanced economies in phasing out the burning of coal for electricity, but has become heavily dependent on gas as the main and sole source of flexible production.

However, Britain depended on imports for almost 60% of all gas consumed in 2019 and 2020, according to government data (“Digest of UK Energy Statistics”, BEIS, 2021).

The result is that almost all of the country’s residential energy system depends on imported gas, which in turn depends on international pipeline gas prices and in particular LNG.

DOMESTIC INVOICES

In an effort to defuse political pressure on rising gas and electricity bills and respond to accusations of profit, the government and regulator have introduced increasingly tighter controls on retail prices.

Residential gas and electricity prices have major social, economic and political implications, so they are exceptionally sensitive for policy makers.

In 2019/20, the poorest households in the lowest income decile spent nearly three times as much on gas and electricity than those in the highest decile as a proportion of their total spending.

Gas and electricity bills represented 7.5% and 7.3% of all household spending in the bottom two deciles, against 3.1% and 2.7% for households in the top two deciles.

Rising gas and electricity prices will therefore affect households in the bottom half of the income distribution much more than those in the top half, exacerbating poverty and reducing spending on other goods and services.

Escalating gas and electricity prices come at a delicate time, as the economy still recovers from the coronavirus recession and a series of other changes to the jobs tax and benefits social welfare will hit the poorest households harder.

CHARGES ON INVOICE

On utility bills, the biggest contributor to the price paid is the wholesale cost of energy, accounting for 35% of the bill, but until recently it was down, by 3.7% on average per year between 2009 and 2020.

The second contributor is the cost of the transmission and distribution network, which represented 25% of the bill and increased on average by 1.2% per year between 2013 and 2020.

The third item is social and environmental obligations, which have increased at an average annual rate of 7.6% and now represent 15% of the total bill.

Policymakers have found that all kinds of social and environmental goals can be paid for by additions to customer invoices, where the costs are much less visible than if they had to be paid by general taxation.

The temptation to shift policy costs onto invoices has been particularly strong in times of declining wholesale prices, as the impact on final invoices has been masked.

The result is that the average paid 410 pounds to cover wholesale gas and electricity costs in 2020 (up from 621 pounds in 2009), but the other charges on the bill increased to 774 pounds (down from 474 pounds) .

Political support for low-income and indebted households as well as support for the growth of renewable energy production were charged directly to the bills.

In principle, this makes sense since service users have to pay the associated costs. In practice, gas and electricity expenses are proportionately so much higher among the poorest households that the tariffs have been regressive.

Editing by Barbara Lewis

Our Standards: Thomson Reuters Trust Principles.

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