Wednesday, September 25, 2013

The patent absurdity of Miliband's energy policy

It is difficult to comprehend the economic illiteracy behind Ed Miliband's announced plans to freeze the prices charged by energy companies for a full twenty months. Okay, it's actually quite easy to comprehend the plans when you allow for the fact that politicians are constantly playing such games at the expense of the public - you know, the masses they are supposed to serve. It's damn scary either way.

In a nutshell, Labour's idea is that since around 2010 the big six energy companies skimmed some £3.9bn from customers in artificially high charges and now its time payback time, with about £4.5bn planned in the claw-back. In addition, Labour are looking at breaking up the energy companies on the basis that the current structure is anti-competitive. Here are some of my quick thoughts:

  • The implication is that over the past few years Ofgem has got the completely wrong picture of the sector and Labour somehow know better than the regulator. I'll have to put my hand up here as somebody who works for one of the big six but I also don't see how it's all that anti-competitive, it at all. If it is, it's probably only at the margins, although I really don't have the information to make a confident judgement call here. I think the bigger issue is that customers are sticky, a bit like they are with banks, but they do have the freedom to shop around and switching is pretty easy these days.
  • A large portion of the rise in energy bills has been due to the governments various green tariffs and such like. Okay, these were enacted by the conservatives but I doubt Labour would be opposed to them.
  • Price freeze controls have been proven through history to cause large scale disruptions and distortions. We see this distortion in rent controlled apartments from Manhattan to Prague, in the long queues at petrol stations the world over whenever governments introduce price caps (e.g. in the US during the OPEC crisis) and in the empty shelves of the stores in times of rationing. The simple economics of it is that when a price is frozen at a low level, there is no equilibrium in the market - the quantity of goods demanded rises due to the lower price while the quantity of goods willing to be supplied at this low price reduces. End result: a shortage. The shortage can lead or reductions on quality, or in the case of price caps in the Californian power market, black-outs.
  • Note, the UK is a country with a severe power generation capacity problem around the corner and there were already pressing concerns of the lights going or, or at least flickering, before Labour's announcement. Capping prices may provide a short-term hit for voters but the impact on investment signals is such that any serious investment plans in the UK's energy infrastructure will surely be called into question by the big six. The end result could be even higher prices and more black-outs.
  • Of the big six energy companies, two are listed in the UK. These are Centrica and SSE. Today, their share prices fell over 5% are the market digested the implications of Labour's proposals. This translated to a combined total of £1.9bn wiped off the market capitalisation of just two of the big six. So already the public (ultimately, shares are held by the public through pension funds and other investment funds) are down at least £1.9bn. Good work Labour, good work indeed. 
  • If price caps are so patently absurd, then why are they being pursued? It's good vote-grabbing politics because the impact is clearly evident for a large group of people, while the distortionary losses that are already being felt (even though Labour isn't even in power!) are far less transparent. Indeed, with anti-market sentiment running so high right now (the press is littered with news of banks and brokers being fined for malpractice), the public appetite for payback must be at a peak. 
  • If the above point is not true then we are in an even worse situation because it means the current Labour doesn't get basic GCSE level economics and is genuinely misguided in its thinking.
  • Before you mark me as talking my book, note that I applauded the government's decision not to subsidise UK gas storage projects even though it will be to my direct detriment.


Lee said...

I don't think that the French owners of EDF will be wanting to subsidise British energy consumers for 20 months.

Ijaz said...

It is difficult to know how to begin with such an economically illiterate policy. A few observations from me:

- Ofgem has conducted numerous reviews of the wholesale and retail markets and not found a 'smoking gun' which would needed to justify such a major intervention in the energy market.
- Margins are not much higher than in other sectors such as supermarkets, telecoms, water etc.
- How will such a policy be enforced? What is to stop firms from pushing up prices ahead of the freeze and again after the freeze.
- Not sure if Labour has heard of what happened in California in 2001 when retail prices were frozen which wholesale prices were not - the outcome was entirely predictable.
- A large proportion of the rising prices is due to environmental costs. If fuel poverty is such an issue why not take these out of bills and fund renewables through general taxation?

The list goes on. This really is a very stupid policy economically and perhaps even politically once people understand what the implications are.