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Energy Subsidies

    • Energy policy has been driven by offering generous incentives to investors.
    • The energy market has been made increasingly complex by attempts to solve policy failures.
    • Rather than creating a sound energy grid, subsidies have created growing costs for consumers.

    One of the most controversial aspects of climate policy has been the use of producer subsidies to drive the decarbonisation of the UK’s power sector. Much of this part of the green agenda has been motivated by the belief that policy can in turn drive investment and innovation. Discussions in Parliament about the reform of the UK’s energy market in the 2010s, for example, were concerned with ensuring that policy creates “investor confidence”. At a renewable energy industry association event in 2010, Secretary of State for Energy and Climate Change, Chris Huhne MP, told attendees that the government would “continue to provide clear signals to the market through the Renewables Obligation and Feed-in Tariffs’. Once given a financial foundation secured in policy, politicians believed, renewable energy developers would find ways to produce energy more cheaply. Furthermore, the country would become a world leader in innovation. But how many of these hopes have been realised?

    Three main subsidy policies demonstrate the problem with this approach.

    The Renewables Obligation (RO) is a subsidy policy that gives green energy generators installed between 2002 and 2017 a number of certificates (ROCs) per megawatt hour (MWh) of power generated, depending on the type of technology (e.g. onshore wind or solar). Suppliers of power were required to obtain an increasing proportion of power from renewable generators, which were proven by the ROCs. Suppliers who failed to provide sufficient ROCs were punished by extra fees, or they could buy surplus ROCs from other generators. Subsidies are equivalent to the value of the ROCs, paid by suppliers, and set by the government on an annual basis.  In 2007, Ofgem produced an analysis that found the scheme was ‘a very costly way of achieving’ renewable energy growth, highlighting its failures.

    The Feed-in Tariffs scheme (FiT) gave subsidies to small renewable energy installations up to 5MW, for example to owners of domestic rooftop solar panels and anaerobic digestors on farms, installed between 2010 and 2019. Owners, or licensees, were paid according to the technology and size of their installation, and the amount produced and fed into the grid, by their local supplier. This was an extremely expensive scheme, which paid owners of domestic solar PV installations 43.3p/kWh – approximately 8.5 times the average wholesale market price for electricity in 2011. Though they seemingly helped to drive demand for domestic installations, these prices were unsustainable, and the FiT rates were dropped over subsequent years. A 2016 industry news site reported a third of jobs in the solar sector were lost as a result of the cuts. And in 2018, a Renewable Energy Association analysis found that ‘Over 40% of UK solar installers are considering leaving the industry entirely’. The scheme was closed to new installations in 2019.

    Contracts for Difference (CfDs) were implemented by the 2013 Energy Act. Under this scheme, generators place bids with the regulator – a ‘Strike Price’, which is an offer to provide power at that price. If the price of electricity exceeds the bid price, then the generator will return the difference. This scheme, which became active in 2017, at first seemed to have significantly reduced the cost of renewable energy. However, as is described in the section on Consumer rationing and dynamic pricing, the bids offered by renewable energy developers have not been met, and no power has been delivered to the market at these low prices. This is because, though the scheme is called ‘Contracts for Difference’, in reality, there is no obligation for generators to take up the option of selling electricity at the seemingly agreed price, as would normally be understood by the term “contact”. This has had the effect of increasing the price still further, and influencing the government’s decisions about which technologies to deploy. And despite now being five years old, the CfD scheme has produced no benefit to the consumer.

    Using data from the UK Office for Budget Responsibility in early 2022, Net Zero Watch showed that RO, ROCs and FiTs payments and environmental levies cost the UK economy over £11 billion a year. Additionally, balancing payments, made necessary to stabilise the grid, cost a further £4 billion. What this succession of failed subsidy policies demonstrate is a problem that runs throughout green policymaking: the objective of decarbonising the power sector has been put before a technical understanding of how this can be achieved, how much it would cost, and whether the public agreed with the principles and priorities underpinning this shift in experimental policymaking and objectives. Instead, it was presupposed that ‘sending signals to the market’ would foster innovation and lower costs, and that the public would agree. All of these assumptions have been proven wrong.

    In order to mitigate some of this criticism, green campaigners and significant global political agencies have argued that hydrocarbon energy producers have been the beneficiaries of substantial subsidies. However, two false claims lie at the centre of these claims.

    First, attempts to calculate subsidies to hydrocarbon energy producers have falsely claimed that a reduced rate of VAT on domestic energy is equivalent to a ‘subsidy’. This is false, not least because the lower rate of VAT (5 per cent in the UK) applies equally to electricity produced from renewables as from gas, and is a putative benefit to the consumer, not the producer. But moreover, a lower rate of VAT than is applied, for example, to consumer items (20 per cent) is not a ‘subsidy’ at all, as it involves no transfer of money to the consumer. Different rates of VAT apply to different products and services, as itemised by the government. They are just different rates of tax, not a ‘subsidy’ in any ordinary understanding.

    Second, some have attempted to claim that the putative damage caused by climate change is a subsidy, since in general society has to pay the consequences of, for example, damage caused by extreme weather. At best this is a confusion of ‘subsidy’ with the economic concept of ‘externality’. An externality is a cost that is not included in the price of a product. For example, a bar that opens in a residential street may reduce the peace of the neighbourhood, causing nearby properties to lose value and the residents’ enjoyment to be reduced. As the section on the social cost of carbon shows, however, calculating the cost of climate change is extremely difficult and good arguments exist that there is no evidence that climate change has had a detectable influence on any economic metric or measurement of human welfare. These claims should therefore be regarded as being likely driven by ideological and subjective reasoning.

    Large subsidies have been necessary to make green energy possible, because they are unable to compete with conventional energy production technically or economically. Weather-dependent energy is non-dispatchable, meaning it cannot be guaranteed to be there when it is required, and no economic storage technology yet exists. This has caused immense distortions in the energy market and led to a loss of reliable capacity and worse, as the entire continent of Europe is now experiencing.