Saturday, September 06, 2008

The bigger scandal

It comes to something when this blog feels impelled to hand out plaudits to the left-wing Guardian but it deserves some applause for its front page story today which headlines: "Revealed: Brown's £1bn power windfall".

This lifts the lid on the bizarre, arcane and thoroughly disreputable financial arrangements for funding the government's obsession with wind energy – but only in part. More detail comes with a dense comment piece by Oliver Tickell which helps to explain what is going on.

As to the headline issue, the paper is offering us a "scandal" (which has been picked up by other newspapers), to the effect that the government is creaming off payments made to renewable energy providers (mainly wind farms) and absorbing them into the general tax fund. So far, it has taken £585m, another £218m is up for grabs and there is potentially another £200 million available, making up the £1bn which gives the story its headline.

How we get there, however, is a study in complexity which most papers do not even attempt to explain, not least because of that very complexity.

Where is starts, though, is in the dim and distant past when, under the Electricity Act 1989, the government of the day (which, as I recall, happened to be Conservative) imposed a levy on all consumer electricity bills known as the Non-fossil fuel obligation (NFFO). This came at the time of electricity privatisation and was then intended to provide a (highly controversial) subsidy to the nuclear sector.

The basis of this scheme was that it guaranteed a fixed price for electricity supplied by qualifying generators, then above the market rate, to ensure that they could continue in business. The electricity from these generators was taken up by a newly formed quango – the Non-Fossil Purchasing Agency (NFPA) - which sold it on the market for what it could get, making a loss in the process.

This scheme was then extended to include renewables as a measure to kick-start that sector – and the nuclear subsidy was dropped. The NFPA then offered the likes of wind farm operators 15-year electricity supply contracts at a fixed price, to give them guaranteed returns on their investments.

Because, for some time, the actual price paid to the operators was above the market price of electricity, the difference was financed from the fund built up from the NFFO levy – which ran at a loss. But, with regulatory changes and the increasing price of electricity, the NFPA started getting more for the electricity than it had paid for it. Since the NFFO levy was not reduced, the fund thus moved into surplus. It is this surplus which is being creamed off by the government.

However, it has to be stressed that this is a legacy scheme. The last contracts issued under these arrangements will expire in 2018 and the surplus will disappear, reducing over time as contacts come to term.

In the meantime, the NFFO system has been replaced by a new funding scheme, the Renewables Obligation (RO), which works on a completely different basis. The operators are able to sell their electricity on the open market and also get a top-up from the RO levy, based on the amount of money collected, which is handed pro-rata, according to the amount of power produced. Thus, a producer which, say, delivered ten percent of the total renewable energy produced in any given year, would cream off ten percent of the fund.

Going back to the headline issue, the point here is that, had the current arrangements prevailed, the surplus money would not have gone to the government. Instead, it would have been paid out to the existing renewables operators, adding to their already considerable profits. Either way, the electricity consumer would have been stiffed. I am not going to shed any tears about the government getting the money instead of the subsidy wind farmers.

Of course, the levy could have been reduced, but that is not the name of the game. In that sense, it is the levy – the structure of which, we must remind ourselves, was created by the Conservatives – which became a "stealth tax". But then, in the nature of this levy, it was always set to become so in the event that electricity prices increased.

It is deliciously ironic, therefore, that The Guardian should quote Charles Hendry, the Conservative shadow energy minister, accusing the government of using the scheme as a "stealth tax", warning that it would further damage public confidence in environmental measures.

Given that this is a legacy scheme, though, there is a different lesson to be drawn from the affair – one which Tickell does bring out in his piece. It points up the huge profits being made by the renewables industry under the current RO scheme. These, as we pointed out last month are set to cost the consumer as much as £6 billion a year by 2020, offering a staggering £155 billion to operators over the expected life-times of their projects.

This makes the current, time-limited windfall of £1 billion that the government will accumulate mere chicken-feed. The far greater scandal is in the current RO scheme which is a total mess – something which Tickell readily acknowledges. It is distorting investment decisions and driving the industry into making the wrong energy choices, increasing our reliance on gas and making us much more vulnerable to an unstable global energy market.

When it comes to The Guardian, therefore, we can only offer it one cheer for its story. It lifts the lid on a small scandal but has not begun to address the bigger picture – a far bigger scandal which, in the fullness of time is going to create the "perfect storm" of higher energy prices and shortages of supply.

One of these days, the media may begin to address this issue – but don't hold your breath. As for the opposition politicians, it looks like that, by the time they climb down out of la la land, it will be too late. The lights will already be out.