CC (2013) – Freezing Energy Prices

Another post I wrote for the Conservative Companion, this on on the topic of Ed Miliband’s much maligned Energy Price Freeze. One of the few articles I’ve written that actually looks at policy.

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After 3 years of opposition and nothing but opposition, the Labour party has used conference season 2013 to announce numerous new policies and items on which they hope to legislate. These policies may be new but each one bares the hallmark of the Labour party. They are policies designed to attract votes to Labour, no matter what the cost to communities, families or individuals. Grant Shapps MP described the policies as encouraging “more spending, more borrowing and more debt – exactly what got us into a mess in the first place”. One such policy is a promise to force energy companies to freeze electricity and gas prices for 20 months from the election in 2015.

There are, as one would expect, numerous areas of rational concern with simply freezing prices for an extended period of time. Namely that it could result in increased prices in the short term (before implementation of the policy), a lack of investment and research in the medium term and the mixed consequences of both looking towards the long term. Other concerns include the affect the freeze would have on the value of company shares and the overall effect of the policy could have on employment and the economy.

Reducing the consumers cost of living is the aim of the policy, but whilst a freeze would stabilize the consumers energy bill energy’s costs would still be going up for the companies involved. Increased costs, price of gas etc. that would normally be transferred onto the consumer would instead have to be absorbed by the energy companies themselves for almost two years. The companies know this and sensible providers looking to reduce the effects the freeze had on their companies could increase their prices pre-election. Ed Milliband has said that he would not tolerate such a move but quite what he could do about it is open for debate. Simply put the policy could have the unintended consequence of raising energy prices almost as much as would occur anyway. It can’t be guaranteed either that companies would then reduce prices if Labour were kept out of office or dropped the policy in government. Certainly large price increases would occur after the end of the policy. A good example of this is after price controls were dropped in California energy bills soared by 800%.

As I just mentioned companies’ profits will reduce throughout the time the policy is in force. This means that as the freeze continues companies will have fewer and fewer profits to use to both their and our advantage.  As with many companies the greater portion of profits are re-invested in the company in the form of research and development. Green energy research is the most important area of investment for energy companies and the energy market as a whole. However, as profits are reduced companies will be more interested in making investments that have an immediate benefit for the company. Green energy is a long term investment that would suffer as companies started to struggle and economise. Similarly, energy infrastructure in Britain requires updating and cash strapped energy firms will have neither the will nor the way finance this. Reduced funding for green energy research will result in a much slower development of vital new sources and types of energy.

Many green energy sources, such a solar, are currently grossly underdeveloped and horrendously inefficient; this results in a greater dependency on foreign gas and oil imports as demand increases and our own native fossil resources are depleted. Increased dependency on foreign imports is the largest contributor to price hikes in the UK. Whilst the UK does have the lowest energy costs in the EU we also have the fastest rising prices. The head of utilities research at Liberum Capital, Peter Atherton, said: “We assume that Labour could not be so staggeringly naive/stupid/misinformed as to believe that an arbitrary price cap is compatible with the threefold increase in investment required from next year to hit the renewable target.”. Essentially reduced profits could reduce investment in research which would increase costs in the future.

In many cases the government takes more in VAT than the company does in profit.

 With reduced profits and slower development the energy sector would become far less appealing to investors which would damage the British economy. The markets registered the immediate response to the policy and gave us a taste of what we could experience in the event of a labour victory and with the implementation of the policy. Centrica had £950 million wiped off its value alone and SEE saw share prices drop by 5.4%. Centrica has 3,000,000 private investors; every single one stands to lose out. Similarly pension funds invest heavily in energy and a sharp decrease in the value of energy companies would have a severe effect on current pensioners and those saving up.

Crossbench Peer, Lord Jones warns the policy would reduce Britain’s standing abroad by sending and anti-business message, resulting in less foreign investment in the economy as a whole. “The sheer damage it [a price freeze] will do to the economy does not bear thinking about”. It is clear to Lord Jones that the policy could not only affect the energy sector but realistically result in damage to the economy to the extent that it would affect employment and the stability of businesses dependent of outside investment.

The policy makes no mention of LPG or Oil and it is fair to assume that Milliband does not intend to include them in his freeze. This means that rural communities will once again be ignored by a government because their way of doing things (not piping gas) remains delightfully incompatible with urban culture.

Whilst there are a number of very good arguments against the freeze there are also some very silly ones and it is only fair that they are mentioned. First and foremost is the threat that some companies would leave the UK, an idea that has been floated by energy firms. The point made was that if they are unable to make any profit then they would see no reason to stay in the UK. This would be believable if the freeze was an open ended policy, instead it will end after 20 months. They know that the UK market is a lucrative one and they would not wish to remove themselves from it. There is the small chance of a company going bust because it can no longer make any profits but it is unreasonable to think that that would leave of their own accord.

 

Ofgem predicts fracking could reduce gas prices by 2-4%.

Now it isn’t all doom and gloom, at least not for David Cameron and the Conservatives anyway. The policy wants to make the Conservatives out as the millionaire baddies standing up for profiteering big business. However, the policy is flimsy and collapses with only the slightest examination, providing an opportunity. It puts clear water between the Conservatives and Labour, and gives the Conservatives another example of the latter’s economic illiteracy as long as the right message can be presented to the electorate.

It is in the end a policy designed to attract votes and relies on the electorate not realising the pitfalls of the idea before the next election. It demonstrates an extreme lack of foresight. It will result in higher bills in the long run due to less research and infrastructure development, share prices will be hit which will affect millions and the message it sends internationally could cause wide spread economic bother. It is more debatable but it is entirely likely that it will result in increased energy prices even before the freeze is implemented.  It is not the solution to our energy costs and should not be treated as such by anybody. The Conservatives many not be claiming that they have an alternative solution to energy costs but that is because there are no easy or simple options. The long term solution is the development of realistic and cost effective renewable sources of energy as well as the exploitation of shale gas reserves. Effective quick fix solutions do not exist in the energy market. Don’t let Labour tell you otherwise.

 

 

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