Sunday , August 14 2022
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Days of reckoning

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Here’s something which will likely be universally unpopular:  The government shouldn’t do anything to subsidise energy prices.  I say this in the face of a £700 or so increase on annual bills announced today.  And this is just the beginning, because, as Nils Pratley at the Guardian points out, when the price cap is raised again in October, it will add a further £300 to bills – just in time for next winter.

To be clear, I am not arguing that millions of households should be left to choose between heat and food; I am merely pointing out that there are better and more effective ways of alleviating poverty than bailing out a private energy industry which is the victim of its own past follies.  Rather, I agree with Torsten Bell from the Resolution Foundation, who told this morning’s Today programme that the best way of addressing poverty is through increases in the benefits system.  Restoring and adding to the £20 a week cut from Universal Credit and the triple lock on pensions would be by far the most effective way of alleviating fuel poverty.

The energy side of the crisis, however, requires sweeping restructuring which goes well beyond anything the government or the opposition are currently prepared to countenance – not least because the economic models they operate on are so out of step with the real world that they fail even to understand the problem, still less offer a workable solution.

Why the energy cap failed

The state-imposed energy cap, which is the focus of establishment media attention today, was always the wrong solution to the wrong problem.  As I explained four and a half years ago:

“The energy cap will end up upsetting everyone and solving nothing.  This is because, while the failed quasi-market arrangements are an irritant, they are not the true cause of the problem.  The same arrangements were in place prior to 2008; when complaints about overcharging and switching supplier were limited to the affluent classes.  It isn’t the system that has changed; it is the broader operating environment.

“The harsh reality is this: the cost of energy is rising remorselessly.  The cheap North Sea gas, on which Britain built the current energy infrastructure, is gone.  In its place are increasingly expensive gas imports – something that the eye-wateringly expensive fracking of UK shale deposits is not going to change (assuming there is any gas to recover).  Renewables only appear cheap because of the sleight of hand of measuring cost per Kw/h at the point of generation (rather than the point of use).  None of the infrastructure and balancing costs are included, nor are the inefficiencies and relatively low (25-30 years) lifespans of renewables factored into comparisons with coal, gas and nuclear plants (that last for 50 or 60 years).  Nevertheless, with fossil fuel availability falling, and nuclear having a few popularity problems of its own, renewables are going to become the greater part of our energy mix whether we can afford it or not.

“Here’s where government price caps fall down.  One way or another, the energy infrastructure has to be built and maintained.  Indeed, if you want the additional energy required for a growing economy, you need to build a lot more energy capacity.  Someone has to pay for that.  And if we are sticking with the current quasi-market arrangement, that someone is investors.  And nothing drives private investors away from a business faster than state-imposed price caps.

“The other side of our predicament is that as access to cheap energy goes away, so productivity (which is merely the use of technology to harness and focus increasing amounts of energy) falls like a stone.  The result is that it becomes increasingly difficult to maintain profits in the hi-tech manufacturing sectors that ultimately shore up the value of the Pound.  Instead, more and more of us are funnelled into low-paid/low-profit, and usually highly manual sectors of the economy; with employers using devices like gig-working and zero-hours contracts to hang onto their profits.

“The solution to this is to find a new source of cheap energy.  The problem – which is why this is a predicament – is there is no such cheap energy.  So we are stuck with rising energy prices – which filter through into inflation in general – even as wages fall across the economy.  And there is no way out.”

Bad economics

What is happening with energy is an overdue reckoning for our blind faith in an economic doctrine which has hardly anything in common with the real world.  Moreover, alternative and contrarian economic theories have been systematically and wilfully excluded from the mainstream.  But the predicament we now find ourselves in reveals three fundamental flaws in mainstream economic thought which are coming back to bite us.

The first of these is the belief in “infinite substitutability.”  This is a core idea within conventional economics, which argues that if any external input to the economy is in short supply or ceases to exist entirely, rising prices will result in alternatives being used.  And as these alternatives gain critical mass, their price will fall accordingly.  Thus, any supply-side – aka cost-push – price increases are always temporary.  The problem with this article of faith is that there is no “external.”  And in a closed system containing finite resources, some shortages cannot be dealt with… no matter how much money you are prepared to offer:

Economic theories written at a time when the Earth’s population was less than two billion, and when most of the world’s countries remained to be developed, it was possible to treat energy as infinite.  But as we approach eight billion souls whose governments are determined to catch up with western living standards which already exceed the planet’s carrying capacity, the realities of finite resources – and, indeed, the planet’s ability to cope with our waste – are increasingly visible.

The second flaw is the belief that energy is just another cheap economic input.  Until recently, petrol and diesel cost less per litre than coke cola.  But this is only because we pay the amount that it costs to produce rather than the massive value that we derive from it.  As an illustration, imagine that you had to push your car seven miles along a road.  How long might that take you?  A few days?  Maybe a week?  Maybe longer?  A litre of petrol will move you and your car that same seven miles in just seven minutes… that’s a measure of the value we derive from a fuel that, even now, costs less than £1.50.

Nothing that happens in the economy happens without the expenditure of energy, and all energy comes at an energy cost.  Even a weak source, such as using sails or blades to capture and concentrate diffuse wind energy comes at a huge cost in constructing, transporting, deploying and maintaining the energy-harvesting device.  Even weaker energy sources, such as animal or human labour power come with the additional costs of housing, clothing and feeding.  And the extraction of strong, fossil fuel energy sources come at an eye-watering energy cost in drilling, refining and transportation.  Nevertheless, because of the energy value derived from coal, gas and – especially – oil, the energy used to obtain energy is worth it.

The vast complexity of the modern, global economy – including the obscene levels of inequality which allow a handful of godzillionaires to own as much nominal wealth as the entire bottom half of the human population, only exist because of the explosion of value released in the consumption of fossil fuels.

The third flaw, is found in the “Phillips Curve” – the belief that inflation and unemployment have a stable and inverse relationship.  As often happens in economics, this idea is used to justify policies which favour the wealthy at the expense of the poor, as in practice it justifies the creation of mass unemployment – via interest rate rises, tax increases and public spending cuts – in order to stabilise prices.  It should go without saying that cost-push price increases resulting from global energy shortages and disrupted supply chains have absolutely nothing to do with the level of unemployment in the UK.  This though, is unlikely to prevent governments and central banks from seeking to generate unemployment in order to dampen demand sufficiently for prices to come down once more.

This appeared to work in the early 1980s, when massive increases in interest rates and the curbing of currency printing caused the loss of five million jobs in the course of just two years in the UK.  Inflation came down, and the economy had turned the corner by the end of the decade.  But it was the development of new oil and gas deposits in the North Sea, Alaska and the Gulf of Mexico which was responsible for pulling the economy out of the doldrums – and had we not sacrificed our manufacturing base on the alter of a previously untested economic doctrine, we might have been better placed to benefit from the debt-based boom when it finally arrived.

As the exergy available to us declines, it is technological complexity – particularly in areas of the economy which generate valueless activity – rather than employment which will have to go away.  Indeed, this process had already begun in the aftermath of the 2008 crash, but will accelerate considerably now that the value we can generate is falling fast.

Inflicting further unemployment at this stage not only weakens the economy at a time when we need to invest our remaining energy and resources into making it resilient, it also risks political unrest on a scale not seen since the first half of the twentieth century.  As I have said on many occasions, if you think Brexit and Donald Trump were bad, you are really not going to like what comes next.

Fake solutions

The current, knee-jerk response from the government and the Bank of England makes all three of these errors.  The £200 “discount” – in reality a deferred payment – from 2022 energy bills is based on the assumption of infinite substitutability.  Since prices are high now, clever people somewhere else will either figure out a way of getting new supplies of cheap gas (which don’t exist in the real world) or they will come up with an alternative (such as hydrogen which, in the real world, is an expensive derivative of the gas it is supposed to replace).

The more likely outcome is that the price of gas – particularly in autumn and winter – will continue to increase so that the £50 instalments to repay the £200 loan will have to be added to even higher gas prices… in which case it would be better to bite the bullet and pay the £200 – or more realistically, to find ways of cutting £200 worth of energy use – immediately.

The decision by the Bank of England to raise interest rates, ostensibly to combat inflation, is intended to generate sufficient unemployment to overcome the current high level of vacancies (mostly in London) which it assumes are driving up wages.  But none of the conditions that created the wage-price spiral of the 1970s – strong trade unions, generous social security safety nets, regulated national economies, etc. – is present today.  Moreover, the central bank ignores the impact that high and rising energy prices are already having on the wider economy.  Nor is this solely about gas and electricity.  While the establishment media has been distracted by the Downing Street Christmas parties, the price of Brent Crude – the international oil price – has risen to around £90 per barrel.  The International Energy Agency has revised down its prediction of global oil reserves – we have a similar supply shortage to gas – and several investment banks are advising that the price of oil will go up to at least £100 per barrel this year, while some speculators are betting on a rise to $200 per barrel in the near future.

It is not just that oil – and the fuels and products derived from it – are going to be more expensive, but that every good and service which depends upon those fuels and products in its production, transportation, supply and maintenance is also going to cost more.  The Bank of England assumption is that those cost increases will be passed on to consumers as price rises, and that these will be affordable because wages will rise accordingly.  It follows that wages must be held down, and so the cost of money – the base interest rate – must rise to force workers to settle for less or face redundancy.

In the real world – where the stock and bond markets that the central bank has kept artificially inflated are vulnerable to a sudden deflationary collapse – the rising cost of energy – which is essential to every process in the economy – will have a far more deflationary impact than the puny rate rises that can be implemented without triggering another 2008-style debt default crisis.  In any case, it makes no sense having the central bank attempt to remove currency from circulation at the same time as the Chancellor is throwing money around like a drunken sailor.  Either choose inflation or deflation, because you can’t have both.

What might we do?

The current crisis is not some temporary post-pandemic blip, it is the latest stage in an “energy death spiral” which has been gathering pace for more than a decade:

  • Energy costs rise as a result of rebuilding and expanding the infrastructure and because fuel costs are rising
  • Energy companies increase prices accordingly
  • Businesses and affluent consumers take advantage of green energy subsidies to move some of their consumption off-grid
  • Poorer customers and cash-strapped businesses cut their energy consumption
  • The cost of operating, maintaining and expanding the grid infrastructure falls on fewer customers, causing a loss of critical mass
  • Energy companies increase prices again…

So it goes on, until the loss of critical mass – too few customers having to pay for too big a share of the system costs – that the system begins to implode.  Energy companies go bust and the remaining companies fall back on the state to fund their losses through some combination of tax relief, grants and subsidies (including additional support to customers).

When the death spiral was solely a consequence of expensive attempts to modify the system to accommodate non-renewable renewable energy-harvesting technologies (NRREHTs) at the same time that millions of customers were suffering falling real wages and austerity cuts, relatively cheap fuel could mitigate the problem.  But now it is the fuel itself which is adding to the cost pressures; causing millions more households and businesses to seek ways of lowering their consumption.  And if, as seems likely, fuel costs continue to rise, we will eventually lose one of the big, vertically integrated energy companies.  After which, the entire system faces collapse.

In large part, of course, responsibility for the predicament rests with governments of all colours and creeds over the past three decades.  Quick-fixes based on political expediency prevented serious long-term planning for the day when North Sea oil and gas production peaked – 1999 as it turned out.  And even when, in 2005, the UK became a net importer of oil and gas – coincidentally the year global conventional oil production peaked – governments refused to even acknowledge that Britain faced a looming energy crunch that it was ill-equipped to deal with.  Magic thinking took the place of strategic planning, with the result that we are – and will become ever more – dependent upon imported gas to keep our economy running and our households from shivering in the dark.

In 2017, the then new Business Secretary Greg Clarke attempted a review of the energy system with a view to upgrading it to cope with the decline from the North Sea – which had fallen by 60 percent from its 1999 peak.  His reviewer, Dieter Helm produced a highly critical report, which came to some unpleasant conclusions:

“It is not particularly difficult to set out what an efficient energy system might look like which meets the twin objectives of the climate change targets and security of supply. There would, however, remain a binding constraint: the willingness and ability to pay for it. There have to be sufficient resources available, and there has in a democracy to be a majority who are both willing to pay and willing to force the population as a whole to pay. This constraint featured prominently in the last three general elections, and it has not gone away.” (my emphasis)

Helm – a NRREHTs advocate – called for root and branch reform to undo the damage done to the energy sector by thirty years of political quick-fixes:

“As a consequence of Electricity Market Reform (EMR), the government now determines the level and mix of generation to a degree not witnessed since these were determined by the nationalised industries – notably the Central Electricity Generating Board (CEGB). Investment decision-making has been effectively quasi-renationalised. This is a direct consequence of EMR. The government, not the customer, has become the client.”

Helm’s solution was a far more privatised and de-regulated market in which the true cost of energy generation would be made transparent by insisting that energy companies provide firm 24/7/365 electricity with the costs of intermittency built-in:

“This would be a radical change, but it would have many advantages. These include:

  • establishing via the market the full costs of subsidies;
  • incentivising the secondary markets in flexibility, back-up supplies, storage, and other ways to manage the intermittency as part of the broader energy-only wholesale market;
  • cutting away the ‘picking winners’ elements and associated lobbying and capture;
  • radically reducing and simplifying the multiple policy interventions and regulations.”

This was far too rich for a government that was buckling under the strain of Brexit, and was under pressure to hold down energy prices – which is why we got another political quick-fix in the shape of the energy price cap.  In any case, our dependence upon expensive imported gas to balance the intermittency of too large a deployment of wind turbines, while no realistic alternative back-up has been invented, is a major cause of the current electricity price increases.

It would have been far better to grasp the nettle of energy sector reform in the years before the foreseeable crisis arrived.  Instead, we are going to have to reform the system even as it is falling apart.  For now, of course, we will be offered more political quick-fixes such as Rishi Sunak’s deferred payments and council tax rebates.  But ultimately, we will need to simplify the system if we are to keep the lights on and the economy running.  And, for better or worse, the simplest way of embarking on that process is to re-nationalise energy rather than throw good money after bad bailing out energy companies which are doomed to bankruptcy anyway.  As I argued when the energy cap was implemented:

“Without a cheap energy, our fate is ultimately sealed.  However, there is a means of delaying the spiral of decline.  This is to accept that the quasi-market experiment has failed.  The energy companies themselves claim they are caught in a “death spiral.”  Now – while we still have room for manoeuvre – is the time to give them a mercy bullet.

“Because of the graft in the system (in which customers are forced to subsidise investors, and the true cost of various forms of generation are hidden) we desperately need to bring everything back under one roof.  Whether this is done as an entirely public enterprise (recreating the old Central Electricity Generating Board) or as some kind of public/private partnership is of lesser importance.  What matters is that cost is made transparent and investment decisions are rational.  Because if – as seems to be the case – renewables like wind and solar can only operate with gas, coal and nuclear baseload, or hugely expensive storage, then we all need to know that and to make our decisions accordingly.  In an energy-scarce environment, we must get the best possible energy return on investment.”

It goes without saying that we have as much chance getting a Tory government to re-nationalise energy as we have getting electricity from a wind turbine when the wind isn’t blowing.  And sadly, the opposition Labour Party is too timid to consider anything more radical than a cut in VAT and a one-off tax – which will be avoided – on energy company profits…

Which is why – among other things – I bought myself an Arctic-rated sleeping bag last autumn – I advise you all to do likewise.

As you made it to the end…

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