The problem is essentially this. The price of fossil fuels, which in the UK still account for around 55pc of electricity generation, is determined by the usual rules of supply and demand. If supply is restricted, the price rockets. Yet in virtually all other forms of electricity generation, be it wind, solar, hydro or nuclear, operational costs are essentially fixed, and in the case of renewables, close to zero once capital costs are met. In any case, they are completely unaffected by changes in the cost of fossil fuels. Unlike gas, the energy source is free.
Theoretically, then, this generating capacity – around 45pc of the total as things stand – should provide a strong counter weight to the soaring cost of gas fired generation. Only it doesn’t. Instead, the wholesale price of electricity, wherever it may come from, is dictated by the marginal cost of the most costly producer – which has lately been gas fired generation. Decoupling these prices has to be a first order priority for the new Prime Minister, but it’s tricky because it is bound to involve overruling many current contacts.
So be it. Needs must. As things stand, wind, solar and nuclear have become major beneficiaries of Putin’s war alongside suppliers of gas, generating returns beyond the dreams of avarice, and way in advance of anything ever imagined. Windfalls of such magnitude are unprecedented and unacceptable.
The last contract price for offshore wind, for instance, was £48 per megawatt hour. Wholesale gas currently sells at nearly ten times that amount. In any case, most non-fossil fuel forms of electricity generation is both fixed and lower cost. But it is having no effect on the price of electricity.
The trouble is that for the bulk of installed renewable capacity, the old “Renewable Obligation Certificates” (ROC) regime still determines the prices that can be charged. In order to get the renewables sector going, the Government agreed to big green subsidies. Providers can then charge whatever they can get in the market on top. At the moment, that price is hugely elevated. The same applies to legacy nuclear capacity.
That regime has since been replaced by “contract for differences”, where a fixed price is set which is established via an auction. If the market price falls below the strike price, the difference is made up by consumers. But if the price rises above, the producer pays back to consumers.
Government officials reckon that in current circumstances, with market prices so high, contracts for difference (CfDs) are already knocking £20 off the average bill, a small amount in the context of the punishing size of overall bills, but not to be sneezed at. Even Hinkley Point looks cheap at today’s prices, with a contract for difference strike price of £93.5 per megawatt hour in 2012 prices.
Eventually, all the old ROC sources of energy supply will be moved onto the CfD regime, but it will take time for those contracts to expire. Analysis by Adair Turner, chair of the Energy Transition Commission, finds that it won’t be until 2030 that all the old contracts have expired. The Government hopes to persuade suppliers voluntarily to move onto the new CfD regime ahead of time. Good luck with that, and in any case, it would take many months, even years, to negotiate such a change. The need is now.
Law of contract should never be breached lightly. Trust in the courts to enforce it is partly what makes Britain an attractive place to invest. But millions of households are threatened with penury; the wider economy and the public finances meanwhile face ruin. This is a war, and in a war, normal rules do not apply.
There is an equally strong case, it seems to me, for capping the price of North Sea gas, where the same egregious levels of profit are being made. The alternative is a windfall profits tax to pay for handouts, as proposed by the Labour Party, but this would be complex to administer fairly and wide open to avoidance.
Capping the price is the more direct and effective approach. Again, it would involve riding roughshod over existing contracts. Domestic producers would also have to be in effect barred from selling their gas overseas at higher prices. Radical stuff, but there are no good alternatives that I can see.
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