It is a sad fact that the UK’s industry electricity prices are amongst the highest in developed economies – higher than in the EU and around four times the prices in the US. The result is that UK energy-intensive industries are uncompetitive. Other things being equal, no companies are flocking to the UK to gain access to the promised low energy prices, which were to be the result of switching from fossil fuels to renewables. On the contrary, what is left of UK energy-intensive industries are going for the exit. Grangemouth and Port Talbot are the latest in a long line, including the chemicals industry and the fertiliser industry. The car industry is back to its 1950s’ volume.
Not all of this is, of course, the fault of energy prices. BREXIT has accelerated the exit and reduced the attractiveness for inward investment. Higher labour costs, exacerbated in the Autumn 2024 Budget, and low productivity hardly help, and corporation tax increases, as well as increases in capital gains taxes, add to the competitive disadvantages.
All this has one happy consequence for Ed Miliband, Secretary of State for Energy and Climate Change, that UK territorial carbon emissions fall as the remaining energy-intensive industries fall, paralleling the falls in the industrial demand for energy. This allows the government to point to the fall in the carbon emissions against GDP.
Sadly, this is all smoke and mirrors. By switching from home production to imports, our territorial carbon emissions fall, but not, of course, the emissions of the stuff we import instead. The negative impact on global warming is highlighted by switching Grangemouth production to becoming an import terminal instead.
Part of the problem is that the sprint to net zero is increasing the relative cost of UK electricity. Far from being “nine times cheaper than fossil fuels” as Miliband would have us believe, the UK, along with Germany and its Energiewende, have put us in the leaderboard for the highest energy costs.
Contrast all this with the US. In Miliband’s world, energy-intensive businesses should be deserting the US in droves, burdened with the higher and volatile costs of fossil fuels, to get access to all those cheaper wind farms and solar panels in the UK. The US should be the global loser, and the UK the global winner, as well as global leader on climate change. In fact, the UK is only a “leader” in mitigating territorial emissions, but not in mitigating climate change. It is importing its carbon, and causing higher emissions elsewhere. The government recognises some of this in its carbon consumption estimates, though it is so badly measured as to give the impression that progress is being made here too.
The truth is that the US is streets ahead when it comes to energy costs. Being the largest producer of oil in the world and having abundant and cheap gas give it a huge competitive advantage. It has so much gas that it was even able to bail Europe out when the Russian gas supplies were cut. Contrast that with the UK, which prefers to import its gas in LNG (liquefied natural gas) form and by pipeline from Norway, whilst cutting off its own future sources of supplies in the North Sea.
How to get out of this mess? The starting point is not the one that the government and the industrial lobbies go for. It is not to tinker with the industrial costs of energy. What is needed is to turn the situation on its head. What is needed is an international competitive price of energy, and especially of electricity.
Start with the competitive energy price
How might this be achieved? The same way as it was under the “bad old days” of the Central Electricity Generating Board (CEGB). Start with the price that would be competitive. How it was done in the UK (and in France) pre-privatisation was to charge industry the long-run marginal costs of energy. What industry was not charged was the full fixed and sunk costs of the capacity. Under the old Bulk Supply Tariff, there was an energy price and a capacity cost, to which was added, where appropriate, the transmission and distribution costs. Industry paid the first energy element, covering its variable costs, and it made some contribution to the capacity and network costs, howbeit a small one.
How could this be a sensible economic approach? Because everyone was better off with industry, as long as it made a small contribution to the capacity and network costs. Think of the scenario where it is charged the full costs. Imagine that this is uncompetitive, and the industry closes down as a result. Is everyone better or worse off? They are worse off, since industry no longer contributes to the capacity and network costs – nor, indeed, to the wider economy.
In economics theory, this is just the Ramsey pricing principle applied to energy. Ramsey answers the question: what is the most efficient way to recover the fixed and sunk costs? The answer Ramsey gives is: the inverse to the demand for electricity. Energy-intensive industries are very demand-elastic: if they are not competitive, they go out of business, losing market share to rivals and exiting the market. Charge them the marginal costs and a little of the fixed and sunk costs, and recover the costs from the demand-inelastic customers – the broader customer base.
This is how it was done from the late 1940s until privatisation. Privatisation eliminated the preferential treatment of demand-elastic, energy-intensive industries. They were pulverised by the sharp recession in 1980–81, when the new monetary policies of the incoming government led to a reduction in UK manufacturing output of around 25%. As a Private Eye cover at the time of privatisation put it: “Higher prices mean cheaper electricity for all.” What really happened was that the law of one price was applied, industry lost its preferential marginal prices, and much of it went to the wall.
That is what continues today – except it is worse. With more and more renewables, the share of fixed costs increases. Renewables are almost all capital costs, with near-zero marginal costs. They are like water pipes and classic utilities. The gap between the marginal and the full costs is even greater. Under the CEGB approach, the result would have been a great benefit to energy-intensive industries. Under the current approach, there is no preferential treatment on the basis of the elasticity of demand. The paradoxical result is that, as industry retreats, there is a small base for recovering all these fixed capital costs, with the result that the rest of the customers have to pay all of the remaining costs, without the support of industry.
What to do?
If we start with the competitive price for large industrial users, then industry costs would fall very sharply. Better still, since the marginal cost of wind and solar is close to zero, it would actually be true that the UK could be a really cost-competitive location. This way, the UK would be able not only to retain steel and fertiliser and petrochemical industries (assuming that the government stopped increasing the cost of labour and, through unfunded spending, raising the cost of capital), but also to attract new investment into the economy. Territorial carbon emissions would go up, but most likely the global carbon footprint would go down.
This would be implemented by thinking about the costs and pricing of electricity through the Bulk Supply Tariff lens once again. There would be an energy price and a capacity price (the cost of equivalent firm power). There would also be a transmission cost and a network cost. So far, so simple.
The next step is to differentiate the charging between industry and consumers. This is more difficult. Why? Because in a liberalised market, why would a supplier charge less to one class of customer when it can get more money by charging the full price to others. This is how the liberalisation that accompanied privatisation undermined the differential pricing to industry (and the cross-subsidies to the regions too).
But it is not as difficult as it seems. Why? Because the government is the central buyer for almost all electricity generated. All the renewables and the nuclear are now contracted to government, not to customers. Some of the gas isn’t, but it is only a matter of time before there will have to be a strategic gas reserve, contracted through the government again.
If the government is the central buyer, it can be the central seller. De facto, it already is. Hence it can operate a modern form of the Bulk Supply Tariff.
The consequences
Doing what is proposed above is good economics (it is efficient) and it is good for the climate. Not doing the above means that what is left of energy-intensive industries in the UK is effectively finished. The last of the petrochemical and other chemical industries will mostly close; the car industry will further contract, and nothing will be left of the steel industry. Worse, all the ambitions for the UK to become a “world leader” in AI and data and quantum computing will be in jeopardy. These new tech industries are the great energy-intensive industries of the future. A data centre is basically a giant electricity consumer. Its data is, in practice, electricity. If the government thinks that these industries will all be coming here for the cheap renewable electricity, think again if these renewables are priced on a common basis to all customers. Data centres need 24/7 electricity – firm not intermittent power – and they need global, competitively priced, electricity.
Time for the UK government to get real – real about just how costly the net zero sprint is already becoming, and real about making sure that energy-intensive industry is cost-competitive globally. That means competitive pricing to the energy-intensive industries also means higher prices to consumers who will have to bear more of the fixed and sunk costs. The government has to realise that, unless it moves back to the world of the Bulk Supply Tariff cost allocations, consumers will eventually pay even more, because there will not be the industry to share at least some of the costs. Real, too, in that imports will go up and the UK’s carbon footprint will go up. We will all be poorer. We already are.
