Wind power has surged ahead of water-generated electricity in Britain for the first time, new figures on the UK’s energy sources show. Government statistics released today show five percent of the country’s power came from renewable sources last year, up from 4.6 percent a year earlier. A 27 percent increase in installed wind power capacity was seen across the year, as momentum grows in the sector. Gas production was down for the seventh consecutive year, dropping 10 percent in 2007, with imports exceeding exports for the third year in a row. Overall power supply dropped by 1.1 percent to 402 TWh. This was the first year-on-year fall since 1997.

The recent announcements by British Gas and the French electricity utility EDF, that they plan to increase gas and electricity prices by a third and a fifth respectively, have major, and worrying, implications for those on the edge of fuel poverty. This comes on top of industry-wide increases at the start of the year. Even in the balmy heat of midsummer, people are understandably worrying about their energy bills. Average bills now sit well above the psychological barrier of £1000 per year. This in turn raises the question of whether the Government’s target of eradicating fuel poverty by 2016 is any longer credible, or even meaningful. There are currently 2.5 million households so defined. As domestic energy prices have shot up, so too have the questions about whether they are a fair representation any more of the actual cost of supplying domestic energy. Indeed, the current vogue for many who want to tackle the problems of fuel poverty is to point to the major energy producers as a source of economic “rent”, which can be used to cushion the impact on consumers. Many people feel instinctively that there is something wrong when companies – such as BP this week – are reporting exceptionally high profits at a time when people are struggling to afford their energy and fuel bills. There are demands for a windfall tax. But this largely misses the point. The headline profits usually relate to global operations, of which only a modest part is in the UK. Even if there were a large UK-based windfall tax, the same logic would apply to wheat farmers, who have also benefited from rising world prices. What is more, all these arguments for a windfall tax ignore the inconvenient truth that North Sea producers already face a windfall tax. I appreciate that this argument offers no solace to those facing soaring household energy bills. There is, however, a separate argument about the electricity and gas companies. These companies benefit from a windfall received from phase two of the Emissions Trading Scheme. During phase two of the scheme, the vast majority of permits to produce carbon dioxide have been given away free, and energy companies can decide to trade rather than use these permits.

The energy regulator Ofgem has calculated that the collective windfall of energy producers from the introduction of free ETS permits amounts to £9bn over the whole of phase two (five years). At least some of this money is fair game: there is a difference between profits made because of increasing demand and profits made because of a government giveaway.

Indeed, the Government (and the industry) has now accepted this argument in principle, and will auction permits in the future in a way that their scarcity value accrues to government rather than to the industry.

The industry argues that the current arrangements were entered into in good faith and that they should not be taxed retrospectively. But it is not unreasonable to expect it to shoulder more responsibility.

Indeed, there are other arguments for taking a tough approach. The competitive market which once existed in electricity generation has largely disappeared, with six major vertically-integrated companies dominating it. Moreover, the claim that consumers can shop around for good bargains is undermined by analysis from the University of East Anglia, which shows that a third of switchers actually make themselves worse off, and half of customers never switch. Overall, there is a strong case for a Competition Commission referral.

In the absence of such a – necessarily long – inquiry, various actions should be insisted upon, under the watchful eye of the energy regulator, to ensure that costs are not passed on to consumers.

The first is to improve energy efficiency. According to the Local Government Association, at least 12 million houses are currently inadequately insulated, costing households around £200 in lost energy. Some companies, under the Carbon Emission Reductions Target, already have a rolling programme to insulate people’s homes, but this needs to be scaled up hugely. A 10-year rolling programme of £500m could ensure that not only are all British homes adequately insulated, but that household carbon emissions are reduced by a fifth.

Secondly, the most vulnerable customers face disproportionately high bills from pre-payment meters. Ironically, despite the claims to offer a “social tariff”, major energy companies charge a negative social tariff. According to recent research commissioned for Energywatch, those on pre-payment meters can pay up to £142 more than people on direct debits on their combined gas and electricity bills. With around a quarter of poorer fuel customers on pre-payment meters, this has to be a priority.

Rolling out social tariffs to ensure that the 2.25 million people on pre-payment meters are not unfairly penalised would cost the energy companies in the region of £275m a year. Given the level of their ETS windfall, this does not seem an unreasonable obligation.

Finally, through the introduction of smart meters, which display consumption costs, Energywatch has shown energy usage can be reduced by between 3 and 15 per cent through changes in behaviour. With a 5 per cent reduction translating into a bill reduction of around £35, this can also help reduce fuel poverty. What is more, the introduction of smart meters that can be read remotely could also significantly benefit the energy companies.

The energy companies have so far led something of a charmed life, with a windfall from the ETC and a regulator who is reluctant to enforce the full rigours of competition rules. They would be well advised to be generous to their customers. Otherwise they may find themselves subject to enforced generosity.

Energy companies are raising gas and electricity prices again, meaning yet more misery for those struggling to pay their bills. Many pensioners face the prospect of spending about a quarter of their income on basic utility services – and that’s on top of the increasingly unaffordable council tax. While political tension in the Middle East and high demand in Asia
are clearly partly responsible for high wholesale energy prices, government policies, driven by an environmentalist agenda, are making a difficult situation far worse. An increasing share of bills is being used to subsidise uneconomic renewable energy, such as wind power. By 2010, the Government’s renewables obligation will add £1bn a year to electricity prices. Proposals by the European Commission to introduce legal targets for green energy are likely to lead to bill increases of 10-15 per cent by 2020. Extra expenditure will also be needed to integrate wind power into the national grid. The planned offshore locations tend to be distant from the existing network so new capacity will be required. This means that stretches of coastline are likely to be scarred by unsightly pylons, or that consumers will subsidise the costly process of burying power cables underground. A further problem is that wind power is highly unreliable. Extra capacity must, therefore, be provided in conventional power stations to maintain supplies on calm days. And there is more bad news. The decision to build a new generation of nuclear power stations will further increase prices. When capital costs are included, nuclear generation is significantly more expensive than coal-fired. Construction overruns, as well as largely unknown decommissioning and waste-disposal costs, could further inflate bills. If the consortia building the new stations go bust, the Government could end up finishing the job with taxpayers’ money. Britain’s previous nuclear programmes have been economically disastrous – development losses amount to at least £20bn, while decommissioning is likely to cost another £75bn. Yet caution has been thrown to the wind in an attempt to appease the global-warming lobby. Environmental policies have also raised the cost of fossil-fuel generation. Some coal-fired power stations, such as Drax, near Selby, have been fitted with expensive desulphurisation plants – costing up to £1bn each in current prices. Yet this equipment may actually speed up climate change, since sulphur dioxide emissions are thought to have a cooling effect on the atmosphere. The desulphurisation process also requires vast quantities of limestone, which has meant additional quarrying in the Peak District. These sulphur “scrubbers” were designed to reduce acid rain, but it is now clear that the scale of the problem was greatly exaggerated by a coalition of environmentalists and European bureaucrats. Acid rain from UK power stations had a positive fertilising effect on many soils and actually improved agricultural yields. The damage to trees was negligible. But electricity customers have ended up paying dearly for measures that, in reality, have had little impact. True to character, environmentalists are strongly opposing proposals to build a new coal-fired plant in Kingsnorth, Kent. Yet such new capacity is needed desperately to keep bills under control. Electricity from coal power stations is cheaper than gas or nuclear, while new technology means that new plants will be 20 per cent more efficient than existing ones and release far less carbon.

Energy security would also be enhanced. Major coal exporters include Australia and the US – stable countries that are unlikely to threaten Britain’s supplies. And the world won’t run out of coal in the near future – reserves will last for hundreds of years. There is, therefore, a strong economic and environmental case for building new coal-fired power stations. Yet despite huge benefits – cheaper electricity and lower emissions – none has been built in the last 20 years. Whether it made economic sense to “dash for gas” in the 1990s is a moot point, but gas has recently been in short supply, and the market has responded. A new pipeline has been built from Norway to Easington, in the East Riding, and import capacity for liquified gas has been increased at Milford Haven, in Wales. The energy companies should also be given similar flexibility to exploit new coal-powered electricity generation. But an increased level of regulation is likely to make such adaptation more difficult in the future. As politicians and bureaucrats attempt to control how our gas and electricity is supplied, there will be reduced scope for the innovation and entrepreneurship needed to combine lower prices with lower emissions. The recent policy record does not augur well for consumers. Government interventions in the energy sector have achieved very little in terms of improving the environment but have been highly successful at raising bills.

British Gas owner Centrica has announced it is to raise gas prices by 35% and electricity prices by 9%.

The UK’s biggest domestic energy supplier said that the price hikes would take place with immediate effect. It blamed “soaring wholesale energy prices”, but added that standard tariff prices would not rise again in 2008. The move comes just a few days after rival EDF Energy put up gas prices by 22% and electricity prices by 17%, with other firms expected to follow suit. Watchdog Energywatch said it believed the 35% gas bill rise was the biggest single increase in the price of a utility seen to date. Centrica said the average dual fuel bill for a British Gas customer would go up by 25% – putting the average household bill at about £1,250. This is the second increase this year, after a 15% rise in bills in January. “We very much regret that we have had to make this decision at a time when many household budgets are already under pressure,” said British Gas managing director Phil Bentley. “The simple fact though is that we have entered an era of unprecedented high world energy prices.” A report prepared for Centrica earlier this month warned that annual average gas bills could rise from £600 to more than £1,000 early in the next decade. Centrica said that wholesale gas prices in the coming winter would be up 89% on the previous winter. It added that the UK was suffering from diminishing gas reserves, and estimated that the UK would import 40% of its gas this year compared with 27% last year. The price of gas has risen in recent months as it is linked to the cost of oil, although oil prices have started to fall again in recent weeks. British Gas, which has 15.9 million customers, said its profits for the first half of the year were down by 69% to £166m.

EDF’s planned takeover of British Energy risks creating serious competition problems in the UK electricity market, rival companies and customers have warned. A deal that values British Energy’s equity at about £12.5bn ($24.8bn) could be announced this week. It is backed by the UK government, which controls 35 per cent of the company and wants to get the industry moving on building more nuclear power stations. But electricity companies and industrial users have called for radical changes to protect competitors and consumers. The business and enterprise select committee makes the same call on Monday in its report on energy markets. An EDF deal would mean “essentially handing the British nuclear industry to the French government”, says Dieter Helm, an energy expert at Oxford University. EDF would have a dominant position in running Britain’s existing nuclear power stations and in building more. Another French company, Areva, leads a consortium that this month won the contract to run the fuel reprocessing and fabrication operations at Sellafield, north-west England. Areva also supplies pressurised reactors that EDF plans to build in the UK. Both companies are controlled by the French state.

EDF and British Energy are discussing a plan to let the UK company’s shareholders benefit from any future improvement in its business, as a way of bridging the remaining gap between the two sides. Although they are close to a deal, and still hope agreement can be reached this week, there has been a difference on price, with EDF unwilling to accept the 750p-a-share or more value put on British Energy by its board and shareholders. A possible solution is a deferred payment paid to shareholders later if British Energy performs well. It could help the government, which owns 35 per cent of British Energy, avoid accusations of having sold its stake too cheaply, as in the case of Qinetiq, the defence technology company. “If the ambition was to create a privatised market where we have companies competing against each other, we have taken one step in a completely different direction,” Prof Helm says. British Energy plus EDF will have about 21 per cent of Britain’s power generation capacity but a higher share of output, because nuclear power stations are in use more often. A greater concern is the effect on competition in the wholesale market, where generators sell to suppliers. Keith Munday, commercial director of Bizzenergy, an independent supplier, calls the move “a very significant step in the wrong direction”. The wholesale electricity market “is profoundly illiquid”, he says. “It’s bad now and it’s going to get worse.” Concerns about liquidity in the wholesale power market have been rising in recent years. A growing proportion of generation capacity has been tied up in vertically integrated companies such as EDF, Centrica, and Scottish and Southern Energy, which both generate and sell their own electricity. Independent suppliers and some customers say it is too hard for entrants to break into generation or supply. As Britain’s biggest generator, with no supply business, British Energy has played a vital role in the wholesale market. If bought by EDF, it risks losing that role. “A takeover of British Energy by EDF would move a huge chunk of generation capacity into an integrated group,” says Graham Paul of Electricity4Business, another independent supplier serving small and medium businesses. “It will do damage to the liquidity of the already struggling wholesale market.” Dorothy Thompson, chief executive of Drax, the coal-fired power generator, warned recently that the lack of liquidity in the wholesale market was preventing independent companies investing in new power stations. “There is very,very little liquidity or trading ability three or four years out, which means that in the time frame that it takes to build one of these stations there really is almost no price signal to show you what would be the returns once you started operating,” she said. “At the moment, there are only three players of significant size who trade through the wholesale market for most of their output. And that is International Power, British Energy and ourselves,” she told Platts Power UK magazine. “The concern that I would have is if more capacity was to come out – particularly with the sale of British Energy – the market could actually become quite compressed in terms of liquidity. And it is liquidity that makes a market effective.”

The involvement of Centrica, which is in talks to take a stake of about 25 per cent in British Energy, may help the public image of EDF’s bid, by involving a UK company, but risks making the impact on competition even worse, by tying another integrated group into the alliance. The European Commission will look at the acquisition, but EDF believes Brussels will not put any obstacles in its path. Prof Helm says the Commission is likely to “take an essentially benign view” of the deal. Other industry experts think EDF will be asked to sell some power stations to strengthen competition. British Energy’s seven ageing gas-cooled reactors will be hard to sell, partly because of safety regulations, partly because no other European companies see them as attractive assets. But EDF has gas and coal-fired power stations, and is building another gas-fired plant, and could sell one or more of those. Ofgem, the UK energy regulator, is conducting its own review of gas and electricity markets, which is set to conclude in the autumn, and there is a strong expectation in the industry that it will call for a full Competition Commission investigation. If that inquiry is called, the effect of an EDF/British Energy deal is likely to be one of the central issues for it to address. If the deal goes ahead*, the prospect that the inquiry would recommend structural reforms of the market will be that much greater.

Intro: The impacts of the drive to cleaner fuels and the exhaustion of domestic gas supplies are already impacting on the UK Energy Market. Global Energy Advisory – a specialist energy think tank and advisory business – fear that UK businesses have not set energy strategies to avoid, at best, forthcoming higher prices, and at worst, frequent interruptions to power supplies.

EU renewable targets require that the UK uses renewable energy sources for 15% of total power, heat and transport needs by 2020. This will require around 30-40% of power generation to come from, most likely, wind power. Unfortunately, the wind doesn’t blow all the time, therefore generation from wind turbines can be “intermittent” at best. This will cause considerable engineering challenges at times of high or low wind to maintain adequate power supplies.

Global Energy Advisory also predicts that 13GW of new gas power stations will have to be built to replace predominately coal power stations that will close on New Years Eve 2015. These closures are due to another European Directive called the Large Combustion Plant Directive. With such fundamental changes necessary to the UK electricity generation infrastructure, it is far from certain that the required investment will be made in time to ensure that the lights will stay on. It is also highly likely that prices will continue to rise and not everyone will be able to afford the energy lifestyle that is enjoyed today.

Currently the UK power generation mix is roughly 40% gas, 40% coal, with the 20% balance from nuclear and a small amount of renewable generation. By 2018, Global Energy Advisory forecast that this could change to become approximately 60% gas, 20% coal 10% nuclear and the remaining 10% from renewable generation – short of the EU target. These dramatic changes will give power companies investment and logistical challenges, but more worryingly, it will lead the UK to further increase it’s reliance on gas imports which, by 2017, are predicted to be 76%.

So where does this gas come from?

Last year 67% of the UK’s gas, 67bcm, came from the North Sea, but this source is depleting and this year will account for only 62% of total consumption. Norway is an important gas supplier to the UK, but there is also heavy reliance, with some concern, on gas flows from Europe and from Liquid Natural Gas (LNG) sources. Although the UK has invested in pipelines and LNG terminals, these are often unutilized as the gas does not flow on to UK shores. Last year the Grain LNG terminal was only utilized 17% of the time and the BBL gas pipeline with the Netherlands only 40%.

So where is the gas going to?

Some countries, such as Japan, rely heavily on LNG as a vital source of energy and are prepared to outbid other countries to secure tanker supplies. Soaring costs have stopped new LNG production projects and the International Energy Agency (IEA) predicts current delays could lead to a short fall in global LNG supply as soon as 2012. Worryingly, the IEA has also turned its global gas focus to security of supply. The agency describes gas as “vulnerable and expensive” and notes that the world does not have a “strategic store” of gas with the only global surplus existing in the LNG cargoes that transcend the globe: put very bluntly unlike oil, gas security of supply is inadequate and impossible to accumulate. The IEA also say that there is gas energy security only until 2015, by which time, Global Energy Advisory expects 30% of UK gas supplies to be LNG.

How Bad Can it Get?

The current European energy policy and the increasing dependence on foreign gas have put UK businesses and households at unprecedented risk. Factories and businesses will have to adopt energy risk management practices and find new ways of working if production and commercial operations are not to be impacted. Market reaction to the recent high energy prices has been to reduce costs and many firms are already shedding jobs.

But then what? Businesses particularly need to consider their energy future carefully and review or set a sustainable energy strategy which identifies, and aims to avoid, the numerous energy pitfalls that lie ahead. As seasoned energy market and risk professionals, Global Energy Advisory can assist firms in this important task.

France’s EDF and Britain’s nuclear generator, British Energy, are understood to have reached agreement in principle on the terms of an agreed bid. Although work on an offer is continuing, the French company is understood to be keen to finalise a deal next week, ahead of publication of its latest figures on Friday. The offer is expected to be pitched at around 775p a share, which would value British Energy, in which the UK government has a 35% stake, at some £12.4bn. EDF is in negotiations with Centrica, the parent company of British Gas, about the possibility of the UK company taking a minority stake, thought to be around 25%, in British Energy after a successful EDF offer. Centrica is keen to increase its own electricity generating capacity and to be part of the building of new nuclear capacity while its inclusion in a deal might help to offset any criticism that a key British asset was being sold to a state-owned French company. Last night none of the companies was prepared to comment. On Thursday, British Energy said it was in advanced discussions with another company, though it did not name its suitor, pushing its shares up 6%. On Friday British Energy shares were slightly lower on the day at 726.5p, well below the expected price, suggesting there may still be concerns about a last minute hitch. Setting a valuation on British Energy has proved tricky for the negotiators. The company was pushed into the bid spotlight when the government gave the green light for a new generation of nuclear power generators at the beginning of the year. British Energy has eight nuclear power stations as well as a coal-fired station, and its existing atomic sites were immediately seen as the most likely places to build new capacity. That has given the company a hard-to-value combination of existing non-fossil fuel generation, at a time of rising electricity prices, and the future value of the sites as places to build new generation nuclear plants. A number of European energy companies, including Spain’s Iberdrola and RWE from Germany, are understood to have looked at British Energy. EDF has already said it would be keen to be involved in the construction of a number of new nuclear plants in the UK. The success or otherwise of Britain’s nuclear build programme is seen as having an important bearing on such development in other countries, in Europe and elsewhere. In the UK, the government is keen to promote nuclear power as part of a portfolio of energy sources, including gas, coal and renewables, in order to increase security of supply and reduce the impact of rising fossil fuel prices on Britain’s energy bills. EDF has already had a bid of more than 680p rebuffed but even a significantly higher offer may not be seen as enough by some investors. “Based on $100 a barrel oil until 2012 and $70 a barrel thereafter, we value British Energy’s existing assets at 760p [a share],” Evolution analyst Lakis Athanasiou said. He added that though an offer of about 775p would be a good one for the existing assets, it “does not include any price for new nuclear”. EDF’s acquisition of British Energy would also raise competition issues. British Energy is the largest of the so-called merchant generators in the UK — electricity producers which sell their output into the wholesale market and do not have a retail customer base. On the other hand, EDF has its own generating capacity, amounting to slightly over 7%, as well as more than five million residential and small business customers. Other merchant generators are concerned that allowing EDF to acquire British Energy would increase the amount of UK electricity capacity held by vertically integrated companies.