Should Europe cap energy prices? Who finally pays?

The issue of energy prices has risen to the top of the political agenda in many European countries as a new round of increases in retail gas and electricity prices gets underway this autumn. Can price controls stem the rise?

SHOULD EUROPE CAP ENERGY PRICES?

European consumers face inflationbusting increases in energy prices of up to 10 per cent this winter as energy suppliers hike prices, citing higher wholesale prices and network costs. With much of Europe still in recession and other countries just embarking on a fragile recovery, the cost of power and gas has become a big issue.

Politicians from across the continent and the political spectrum have responded with pledges to tackle ever rising prices. Much discussion has focused on price controls, which even a few years ago were unthinkable given the emphasis on market liberalisation and increased competition to deliver lower prices.

But the official line from the EU is that competition coupled with increased integration of national markets can still deliver.

Lithuanian President Dalia Grybauskaite vowed to take action as the country took over the six-month rotating presidency of the EU for the first time on 1 July. Grybauskaite said rising energy prices were hindering the continent’s economic recovery. She blamed this on growing reliance on imported natural gas, especially from Russia, because EU countries had been too slow to invest in liquefied natural gas (LNG) infrastructure that would allow them to diversify their supplies.

Nor has Europe moved fast enough to develop shale gas, whose development in the US has given rise to an abundant new energy resource, transforming the sector.

Addressing a conference on completing the EU’s internal energy market in Vilnius on 4 November, Grybauskaite urged the EU to invest in infrastructure and indigenous energy.

“Reasonably priced energy is demanded by our businesses. Rational use of energy can free funds which can contribute to our economic recovery,” she said.

“More than ever, if we want to be less dependent on external suppliers, we should also invest in local options such as renewables, as well as in energy efficiency,” she added.

During Lithuania’s EU presidency, she urged European countries to kickstart new infrastructure investments and to embrace shale gas – gas found in tight geological formations whose extraction requires the use of water for hydraulic fracturing. But several European countries, including Bulgaria, France and the Netherlands, have banned shale gas drilling while others like Romania and Sweden have abandoned shale gas exploration projects on environmental grounds or because suitable sites were not available.

Grybauskaite said Lithuania would push ahead with shale gas exploration plans despite fierce local opposition in order to diversify its energy sources – like its neighbours, Estonia and Latvia, the Baltic state is entirely dependent on imported gas from Russia. And she said Europe should benefit from US shale gas in the form of LNG exports.

But the US is still several years way from exporting any of its shale gas, and LNG prices, in the meantime, remain stubbornly high because of high demand in Asia – especially post-Fukushima Japan. Some LNG terminals are lying idle as LNG is too expensive to displace pipeline gas.

Putting the lid on prices

But even in the UK, where shale gas exploration is underway and LNG imports are already a fact of life, energy prices have continued to march upwards, prompting the leader of the opposition Labour Party, Ed Milliband, to promise to freeze energy prices for 20 months from 2017 should his party win the next election in 2015. He said a Labour government would use the time to reform the energy sector, including splitting up the ‘big six’ suppliers and replacing energy regulator Ofgem with a stronger regulator.

His pledge comes against a backdrop of inflation-busting price hikes for customers not on fixed-price deals. Four of the big six

Prelude FLNG Gas & Power LNG Tanker

Bonny Island Terminal Liquefied Natural Gas Ship

have already hiked prices. German owned RWE Npower is putting power and gas prices up by an average of 9.3 per cent and 11.1 per cent respectively from December 1. Centrica, which owns the UK’s biggest energy supplier British Gas, will raise prices by 9.2 per cent on average from November 23, while SSE said it would hike prices by an average of 8.2 per cent from November 15. Spanish-owned Scottish Power is to hike prices by an average of 8.6 per cent on 6 December. The other two, EDF and E.ON, are expected to announce similar increases this winter.

As in other countries, utilities say they have to put up prices to pass on higher wholesale energy costs and the cost of meeting environmental and social obligations. RWE Npower chief executive Paul Massara said that only 16 per cent of the costs faced by energy suppliers are under their control and warned that price controls would not work.

“It doesn’t cut the growing costs of supplying energy. Imposing price controls discourages investment, increases uncertainty and ultimately leads to higher prices,” Massara said.

Centrica shares this view. “If prices were to be controlled against a background of rising costs it would simply not be economically viable for Centrica, or indeed any other energy supplier, to continue to operate and far less to meet the sizeable investment challenge that the industry is facing,” British Gas’ owner said in September.

Who pays the price?

Any move to introduce new price controls would be at odds with European Union energy policy, which puts the emphasis on liberalisation and competition to bring prices down. Indeed EU leaders have agreed in principle to end all regulated prices by next year, which is the deadline to complete the EU’s single energy market.

The European Commission found last year that two thirds of EU countries were still regulating energy prices in some form. And European energy regulators group CEER concluded in May that the use of regulated prices was hindering the development of the free market.

But prior experience of price caps shows this merely moves the cost burden from the consumer to the taxpayer, who are in essence the same. When Spain embarked on the liberalisation in the late 1990s and early 2000s, the government decided that it would give customers a choice of switching suppliers with the hope of getting a better

deal on a new market-based tariff, or sticking with the security of regulated tariffs for an interim period.

It was betting on competition bringing lower prices. But Spain’s move to a liberalised power market coincided with the beginning of a long rally in oil prices that saw the oil price more than triple over the course of a decade. This is significant for the power sector because Spain’s gas imports, increasingly used for power generation, are priced using a formula that indexes them to oil. This is the case in most European countries.

The gap between the artificially low regulated price and the market price continued to widen with the effect that it was in consumers’ interest to stay on regulated prices rather than move to market rates. The country’s utilities protested that they could not fund vital investments in new infrastructure, power generation capacity (including a booming renewables sector) with their meagre earnings from regulated tariffs.

The government stepped in to compensate them, as a temporary measure until market prices fell below regulated tariffs. But this never happened. What began as a relatively small gap of a few hundred million euros in 2000 was supposed to be clawed back through higher transmission tariffs, but the deficit has now ballooned to a staggering €30 billion according to the latest estimates.

The tariff deficit has become a major headache for Spain as it grapples with austerity measures to pay off its huge public sector debts. Other countries, including Portugal and Italy, have faced similar challenges as a result of price controls.

Are ‘green’ costs to blame?

But if policy makers are to resist the temptation of direct intervention in the energy market, what can they do to stem the tide of rising energy costs? Some utilities point the finger at the politicians themselves, blaming them for mandatory targets for renewable energy and energy efficiency investments, especially for low-income consumers. But even according to their own estimates, ‘green levie’ and social costs only make up a fraction of total utility bills.

And investments in indigenous renewable energy sources like wind power are intended, in part, to cut dependence on imported fossil fuels, whose inflated costs utilities cite as a justification for hiking retail prices. While renewable energy typically has high initial capital costs, running costs are minimal. Policy frameworks could be adjusted to ensure that renewable generators do not receive excessive compensation once they have paid down those capital costs, but the cost of existing renewable capacity has already been borne.

And as renewable technologies mature, those capital costs should fall. However, recent action by the European Commission to protect Europe’s solar energy manufacturers in the face of aggressive competition from ‘cheap’ Chinese imports could result in higher costs. In June the EC imposed provisional anti-dumping duties on Chinese solar panels and components, upholding a complaint from European manufacturers that Chinese producers were selling solar cells into Europe at below-cost prices.

European solar generators face higher costs as a result and that in turn could mean more price hikes are in store. n

Large-scale LNG plant