How to avert the policy crisis

The liberalisation of Europe’s energy markets has brought systemic instability, to the point of threatening security of supply, says Christophe Brognaux. He suggests three ways to improve things.

Some 20 years after the liberalisation of Europe’s energy markets, we’re almost back to where we started.

In Germany, 65 per cent of energy production is re-regulated, and permission from the government is needed to close a (loss-­making) power plant. In other European energy markets, we see a similar pattern, with almost every type of power generation subject to some kind of financial meddling. The meddling can take the form of specific taxes or subsidies, but the upshot is the same: we’re quite far from a free market for energy. One of the reasons is – ironically – liberalisation itself, and the European focus on competition for the sake of competition.

In the first decade of the liberalisation of the market, from 1998 until 2008, energy policy in most member states focused on liberalisation, competition and CO2 reduction.

In the second phase (2008 to 2015), we saw an acceleration in the promotion of renewables, and nuclear exits announced in countries such as Germany and Belgium. Increasingly during this phase, other policy priorities crept in. Among them: efforts to keep retail energy prices low or stable, some noises about energy independence here and there, and of course an increasing nimby attitude towards building new power generation or power networks.

Some of these priorities are conflicting and even mutually exclusive. And almost invariably, they are increasing the cost for the overall system. The simplest illustration is renewables.

Member states wanted to promote renewables, so they subsidised renewable energy through attractive feed-in tariffs (FITs). This renewable energy pushed out the more expensive power that was generated in gas-powered plants, and eventually caused them to be taken out of service because they became unprofitable.

Unfortunately, on days without sun or wind, we still need gas-powered plants. So to avoid blackouts, on top of the cost of ­subsidising the renewables, we now have to subsidise gas-powered plants too.

The conclusion is that 20 years of ‘free’ energy markets have brought us systemic instability in energy markets across Europe, to the point of threatening security of supply. System costs are generally up, and all the ad hoc policies do nothing to attract investors.

The energy market in Europe is, in a word, a mess. Is there a way out of this shambles? I think there is, if we do three things.

1. Politicians should develop a systemic view on energy

Politicians fail to see the interdependencies in the energy system. By trying to solve one problem in the system, they create problems elsewhere in the system.

The UK is now subsidising diesel generators, the most polluting kind of power generation, worse even than coal. The subsidy is part of the capacity market, which is the response to the low profitability of conventional power generation, which was a consequence of trying to promote renewables. To sum up, the UK is supporting the most polluting form of power generation as a result of the way it has set up its policy to promote clean energy.

2. Policymakers should be transparent about the societal choices embedded in their energy policy

In the current energy policies around Europe, politicians are making societal choices, without being explicit about them. Do policy­makers want CO2 reduction? Price stability? Nuclear exit? Affordability? Industrial competitiveness?

It’s impossible to have all of these as a priority, and they should have the courage to acknowledge that. Also, politicians shy away from stating a simple observation: that a lot of energy policy choices will lead or are ­leading to escalating system costs.

China approached this differently. Several years ago it decided economic development was the main priority. It needed lots of energy for that, fast, and the only option to get there was coal. Chinese decision makers knew that this wasn’t the most ecologically responsible choice. But they made the choice and decided not to think about cleaner energy until after China had realised its goals for economic growth.

3. Stop focusing on competition for its own sake and choose some priorities

Finally, we have to pick one or two priorities to build a policy around. Currently this isn’t possible, partly because European regulators focused on ensuring competition in the energy sector for the sake of competition. Even if we manage to generate power in a decentralised way very fast, we will still need big collective power generation assets for many decades. To get any investment in these, governments will need to de-risk it.

A mechanism that works well to ensure investment in centralised power generation is a power purchasing agreement (PPA). PPAs allow governments to create a consistent policy and choose the kind of plants that will supplement renewable power, while putting different bidders in competition for the project. The problem here is that Europe deemed these PPAs illegal because “they hurt (short-term) competition”.

We are prioritising competition over cheap – or even clean – energy, it seems. Or are we? Because some member states created FITs, guaranteed rates for certain forms of (mostly renewable) power generation over 15 to 25 years. What is a FIT, if not a PPA?

The British, who were at the forefront of liberalisation, are also the first to set up a new PPA for a large non-renewable capacity: Hinkley Point C. Only they don’t call it a PPA – that would be illegal. So they call it a contract for difference. In Europe, it would seem that some forms of PPA are okay and some aren’t, depending on what you call them and how well you can sell the arrangement to the competition authorities.

Meanwhile, we are hobbling from one miniature energy crisis to the next. This is a farce, and the policymakers in the EU would do well to work out a system-wide policy logic. Energy is too important for the kind of improvisation we have seen over the past decade.

Christophe Brognaux, senior partner and managing director, The Boston ­Consulting Group