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21 September 2022

Truss joins Euro governments with a plan to halt gas price

All over Europe politicians are finally coming up with their policies which are designed to mitigate the huge increase in natural gas prices – not long term stuff about using less gas, but consumer price protection, to prevent a recession and a wages price spiral.

Last week we noted the European Commissioner Ursula von Der Leyen implementing a windfall tax on renewable energy companies, and this week in the UK new Prime Minister Liz Truss announced the UK strategy – an Energy Price Guarantee – part subsidy, part promise – funded no-one is quite sure how.

The precise technical details may still be obscured, but in every case, it the strategy is to allow the common wholesale energy auction to continue unaffected – but intercept the excessive amount of money that renewables are making.

Most energy people intuitively understand the problem – a reverse auction is used to set a striking price every half an hour, and the auction only ends when there is enough electricity to go around. Sometimes it takes in natural gas, which is now constrained by its incredibly high price – up 2000% over the past two years – and sometimes it doesn’t. When it does the price is off the charts and everyone in that auction round gets the same high price.

The gas companies have to pay an arm and a leg for the gas to deliver the electricity, but the renewable energy firms pay no extra, and all that increase in settlement costs goes straight into their coffers. This is also true for nuclear and hydro facilities.

If these firms did not have a windfall tax they would report massive profits, which were never anticipated by their investors. Taking those profits away effectively does them little harm – and offering them the chance to keep profits up to the point where prices would reasonably have been by now, should keep them perfectly happy.

The problem is how to get government hands on that money – through a taxation process or something else.

The problem once this is achieved is to limit the high prices to the amount of gas that is used in each grid. If it is 50% (the UK’s official rolling 12 month figure for fossil fuels is 44.3%), then that’s half the problem taken away.

Oxford academics pointed out to the government recently that it could use the Contracts for Difference (CfD) scheme that it has implemented since 2017 to subsidize renewables contracts. In essence it is a hedging mechanism – if an agreement is set at £50 per MWh, then when the wholesale price is £40 per MWh, the government subsidizes the renewable to the tune of £10 per MWh. When the wholesale price is £60, then the renewable takes £50 and pays the excess back to the government.

So in a situation where the energy price is more often close to £200 per MWh, any renewables firm with a £50 CfD deal, would pay most of it back to the government and never declare an indecent profit in the first place. The beauty of this idea is that the auction process will not be interfered with at all, as there are big fears of unintended consequences if there were any legal adjustments to how the auctions work.

One idea is to voluntarily offer new CfD contracts to old renewable installations whose deals are about to run out. By switching to a CfD, a pre-2017 solar installation would earn less immediately, but be extending its contract to a fresh end date, it would earn more over a longer time period.

By doing this in the background, the government may not indeed be borrowing £22 billion – instead it may well be break even on the deal, which is more or less exactly the same as the European Commission solution.

The idea for the UK government seems to be to push through something like this and to sort out the mess afterwards. And there is likely to be some mess. If this is available to everyone then companies like Drax, which burns wood (biomass) in a number of its power plants, imported from the US, might get an extended CfD, and continue to output CO2 forever – its subsidies were due to run out in 2028. The same is potentially true for nuclear plants also.

One of the worries we have about this at Rethink is that during 2018 the burning of gas represented some 39% of the UK’s electricity, it fell to 26% by last year, but somehow in 2022, the year to date figure is back up at 42.5%.

How could a diligent National Grid end up composing the electricity on the grid with 16% more gas than last year? Is there a conspiracy going on here? Or are things just getting back to normal after lockdown? Over the last month it has been as high as 54.2%.

The auction process is automated and real time, but can it be that gas is gaming the system to get significantly MORE of the UK’s electricity based on natural gas than ever before? It certainly seems to be the case. Why would gas generators do that?

Renewables such as solar and wind now comprise 28.6% in 2022 all told, and this is up around 3% on prior years – so the gas increase is not at the expense of renewables.

But renewables cannot take a full part in any auction. The National Grid places limits on how much solar energy can be traded on the system, to artificially ensure that its intermittency does not handicap the system. If there were more battery energy storage systems up and running – and there are around 9 GW of solar plus storage projects in Development – then solar could bid more for prime time slots. And yet the UK in particular is not awash with investors wanting to back these projects. They are all awaiting some spending signal from the National Grid on battery, to ensure those projects are profitable.

Right now every commentator is focused on how the new UK Prime Minister’s plans will affect consumers.  Her plan to prevent escalating energy prices takes the form of an Energy Price Guarantee which various estimates suggest will cost the UK treasury between £24 billion and £35 billion, for a two year period and they all believe it will massively increase UK debt.

The magic figure where Truss has drawn the line is capping energy prices at £2,500 a year for an average household. A year ago they were paying £1,200 and doomsayers were predicting prices as high as £6,000 by next April. There is utter confusion with UK consumer agencies protesting that the message is far from clear, with most people believing they can use as much gas to heat their homes as they like, and that their bills – electricity plus gas – are capped at £2,500 a year – which of course is not the case.

The mechanics of how the support is calculated is reliant on Government statements already made – there has been a £400 energy support payment to be made to every home, so that stays in place, the new pricing regime will take about £1,000 off energy prices for an average home and vulnerable households will get another £1,200 payment to cut electricity bills. The same reduced energy prices will apply to industry, but only for 6 months, with more industrial plans to follow.

As we have said, she appears to be doing is pretty much the same as every other country in Europe – attempting to intervene in the auction final outcome, without affecting its process.

But other statements – such as removing the ban on fracking – have also garnered UK headlines. What no-one seems to understand is that these statements have NOT led to accelerating plans for fracking in the UK. The rules Truss suggests is that this will only work in communities which want it.

Quite clearly any natural gas that comes out of fracking in the UK, will be sold on European gas trading hubs – not secured for use in the UK. Countries like Italy and German would out-spend the UK bidding for more replacement gas – so that the UK would get the earthquakes associated with the fracking, and US owned companies will get the profits, and Europe will get the gas.

However we should not worry overmuch at this. Unless there is a clear 10 year clear picture of natural gas opportunity, no-one is going to spend cash in setting up fracking in the UK. Essentially its first response was to ask the UK government for the ability to frack wherever it wants, regardless of what consumers say – a conservative UK prime minister is NOT going to give that kind of a guarantee, because its own membership is highly sensitive to anything happening in its back yard – something the wind industry learned to its chagrin in the past – so expect nothing much to happen here. US investors who lost their shirts on fracking over there, would be, we’re sure, keen to remind the UK that fracking is truly expensive.

This is much the same for expanded oil and gas drilling in the North Sea. Nothing can happen right away and it will take at least five years to bring fresh North Sea gas to market and by then the declining usage profile of natural gas will make investment highly suspect. The real headlines is to halt inflation in its tracks, and take the plaudits and move on.