Why governments' attempts to pick winners produce more losers than winners.
I was contacted recently by someone who was studying the renewable heat sector. They asked:
We read your blog on Picking Losers and I guess the question is, given that DUKES Table 7.6 gives the existing renewable heat total for 2009 as 966 ktoe, is it that some of the categories that DUKES has as renewable heat, are rejected by DECC as not renewable heat in the 2020 sense?
For example, DUKES lists the technology break down as below.
Solar thermal 69.5
Municipal Waste combustion 31.3
Biomass - landfill gas 13.6
Biomass - sewage sludge 67.9
Biomass - wood domestic 375.2
Biomass - wood industrial 164.6
Biomass - animal biomass 40.3
Biomass - plant 203
As you note in your blog this total is something like 450 ktoe more than the NREAP states for 2010. Is it possible that they decided that there was double counting with electricity or that some of these are not really renewable?
I thought my reply might be of interest to others besides the original questioner, so I have decided to post it here:
Imagine you are a politician, elevated after the recent election from shadow to head of a department. You have quite a bit of experience shadowing your department, but to be fair, you haven't had access to all the information and resources that ministers have. You find, on taking charge of your department, that the timetable for some issues is outside your control (e.g. where actions are required by European law). You will have to set out at least a holding position earlier than you would like. It's a pity to be rushed, but you were going to have to rely on your civil servants for much of the detailed drafting anyway, and they have years of experience and a draft close to completion, almost ready for you to sign off. Maybe you are worried a little that the draft may not fully reflect the changes of philosophy and policy that you hope to introduce, but with the addition of some judicious conditionals (i.e. weasel words), you can at least put out something internally consistent and coherent, which avoids commitment to any specific courses of action that you don't want to commit to. At the very least, you and your civil servants should be able to avoid the most egregious mistakes with a little, basic maths and the benefit of your combined years of experience, right? It may not be exactly what you want, but at least it will add up.
Apparently not, if you are Chris Huhne or a civil servant at the Department for Energy and Climate Change (DECC). They have just released the National Renewable Energy Action Plan, which they had to release by June 30 under the EU's Renewables Directive. And it doesn't tally, on even the most basic sanity checks, with the data for the current renewables position.
Second in the list of this week's lousy initiatives* announced by the Government is the micro-generation Feed-In Tariff (FIT), or "clean-energy cashback" scheme. The micro-gen FIT is a scheme to pay significant amounts of money, over and above its value to consumers, for every unit of electricity generated by renewable generators upto 5 mega-watts (MW) in scale.
You may feel that 5 mega-watts doesn't sound very "micro", and indeed it is enough to supply the needs of several thousand houses, but let's not carp. That is hardly the main issue.
Now, I have to declare an interest. Our company may benefit from this initiative. So I would like to thank all of you for your generosity - your extraordinary, overwhelming generosity. But you can afford it, can't you? It's not like we're all strapped for cash or anything...
Don't take my word for it. The Government has detailed exactly how generous you are being. According to their Impact Assessment (IA) of this initiative, it will cost...
£8.6 billion (bn).
But you can't just look at the costs. You have to weigh the benefits against it. And those come to the princely sum of...
£420 million (m).
That's right. According to the Government, it is worth spending £8.6bn in order to make carbon savings of £420m.
Some friends of mine in the energy sector have been excited by a new report by Dan Lewis on Securing Our Energy Future. This report does indeed make some excellent criticisms of current energy policy, but I'm afraid it does not follow (as they seem to have assumed, perhaps from too quick a reading) that the author's recommendations are of equal merit, nor even that the analysis is balanced or complete. Unfortunately, it is tarnished by Dan's obsession with certain electricity technologies.
The day that Dan treats the three main energy uses (electricity, heat and transport) with the equal weight that they occupy in our energy systems and recognizes their close inter-dependence (particularly between heat and electricity, but also with transport now that electric transport looks an increasing prospect) is the day that his views will deserve serious consideration. Unfortunately, that day has not dawned, as the following section from his introduction makes clear:
"And whilst energy use can be broadly divided up into heating and cooling, transport fuel and electricity, historically and today, energy policy has really always been understood to be about the UK's electricity supply. That then will be the focus of this report."
Really? You mean, because governments have always been blinkered and stupid, that is a sound basis to continue to be blinkered and stupid?
These programmes¹ are examples, like the EU-ETS, where government intervention hands commercial advantage to the VILE (Vertically-Integrated Large Energy) companies, to little beneficial effect.
The VILE companies point to the fact that demand for domestic energy has fallen in the last couple of years, as evidence for their success. I have argued this was largely a response to price increases, increasing disparities between costs-of-living and disposable income, and warmer winters (until last year), and not the effect of their energy-efficiency programs. In my opinion, the timing demonstrates the point. EEC was introduced in 2002, and Warm Front in 2000, but domestic energy demand carried on rising until 2005², which coincidentally was when global wholesale gas prices spiked (consumers did not feel the full effect until Winter 06/07, but there was already concern and initial increases in 2005).
It is difficult to prove the relative significance of different factors on this basis. The VILE companies can argue that it would take time for the modifications funded by EEC and Warm Front to accumulate and their effect to be felt. But a small news item in last week's New Statesman offers a pretty clear way to assess which was the more significant factor. If efficiency improvements were the main factor, so the elderly and underprivileged (the main targets of these programs) could maintain a decent temperature whilst consuming less energy, you would expect excess winter deaths to fall. If the price rise was the main factor, so people were choosing to heat their houses less because of the cost, you would expect excess winter deaths to rise.
According to the New Statesman, "excess winter deaths rose by 49 per cent in England and Wales last year in comparison with the year before." The information appears to have come from a page on the National Statistics website.
I have a post on the effect of the Government's plans to increase by a huge amount our use of intermittent wind power on future prices and availability of electricity on the Institute of Economic Affairs blog.
The Government and the opposition parties believe that climate-change and energy policy should revolve around identifying the technical solutions and their potential, calculating what each of them needs to encourage their deployment, and implementing mechanisms that provide just the "right" level of support for those solutions. They do not believe that, to whatever extent Anthropogenic Global Warming is a reality, emissions of greenhouse gases are an externality whose impact (and therefore social cost) is the same however and wherever they are emitted, and that the most efficient way to encourage less to be emitted is to apply that social cost to those emissions regardless of provenance.
Our politicos' assumptions of omniscience and omipotence tend to be undermined by reality. When it comes down to the reality of providing just the "right" level of support, they are amazed to learn (if they ever do) how many variables have to be taken into account, and how often it turns out that the information they were working on was wrong or has changed. Policy-making becomes a process of arbitrarily picking those variables that you will take into account (and about which you hope it is safe to generalize) and those variables that you will ignore and expect those who are disadvantaged just to suck it up, and then regularly changing them in ways that are unpredictable to investors. Such policies thereby achieve the brilliant combination of being altogether too changeable and complex (by taking account of too many variables) and yet partial and insufficiently reflective of the real-world (by ignoring so many inconveniences).
The recent banding of the Renewables Obligation (RO) was one such case, piling further complexity, irrationality and partiality onto many existing layers of partiality, irrationality and complexity. Now we have another case looming. A banded RO might be complex, irrational and partial, but it wasn't complex, partial and irrational enough for the politicians and civil servants. Some variables, particularly scale, weren't sufficiently covered. So they are bringing in a micro-generation Feed-in Tariff (micro-gen FiT), to support similar (though not identical) technologies to the RO, supposedly at a smaller scale, though the upper size threshold for the micro-gen FiT encompasses a large number of the projects currently included in the RO. They are also introducing, at more leisurely pace, a Renewable Heat Incentive (RHI), which will probably work in a similar way to the micro-gen FiT, but in the heat rather than electricity sector, and without (probably) the upper size limit.
The micro-gen FiT will provide a value beyond the ordinary electricity price, for each unit of electricity produced by an eligible micro-generation installation. It will be tailored supposedly to provide the "right" level of support for each technology. But that isn't specific enough, because the economics of a 5 kW micro-gen unit are very different to the economics of a 5 MW "micro-gen" unit (the upper threshold for eligibility, thanks to some strange definition of "micro" for public-choice and rent-seeking reasons) of the same technology. So the Government declared their intention to "band" the micro-gen FiT (and the RHI) not just by technology, but by scale too (and they were also considering banding by type of consumer, but hopefully have abandoned that option).
We know what the effect of banding by scale is. People make all sorts of irrational decisions about the type and size of plant, in order to achieve the maximum level of support under the bands. So, with the proviso that the whole approach is wrong but recognizing that something rubbish was inevitable and trying to minimize the damage, I came up with a suggestion for how they could achieve the same benefits that they wanted to achieve with banding without the harmful effects of banding. The suggestion was to "front-load" the mechanism, so projects would get a higher price for their first X MWh, and then a lower price thereafter. Large projects would get through X in a couple of months and would have to rely on the lower price for most of their lifespan, making the mechanism fairly similar to an unbureaucratic grant for them. Small projects would take years to get through X, and would therefore receive a higher level of support for a longer part of their lifespan. Medium-sized projects would fall in between, in terms of the effect of the front-loading. There were many advantages to this approach, but most importantly, there was no size threshold, so there was no disincentive to install simply the most appropriately-sized unit and technology for the circumstances.
To its credit, the industry broadly adopted and supported this idea, and extended it from the RHI (for which I had suggested it) to the micro-gen FiT. To rather less credit, but typically for a committee camel, the industry decided that they could improve the concept by making it more complicated, which was the form in which it was promoted to the government. Still, their bastardized version was a lot better than the Government's idea of banding by scale. Amazingly, for anyone with any experience of "consultation" in recent years, there were even some signs that the Government was giving the concept some serious thought.
We still wait for details of the RHI, but the Government has recently provided more detail on how it sees the micro-gen FiT being implemented. And guess what? Front-loading is out, and they are sticking with banding by scale.
We have to assume that this irrationality will apply in due course to the RHI as well. And I have some first-hand experience of the effect of that assumption.
As I have mentioned too often in recent posts, our company supplies wood pellets. I therefore have a stronger-than-average interest in installing a pellet-boiler for my home. As it happens, the cluster of three houses where I live make a particularly suitable opportunity for a micro-district-heating scheme powered by a shared pellet boiler.
We got quotes from a number of suppliers. They sized the project variously at between 60 and 80 kW. The prices unfortunately were all too high to be justifiable by the fuel-cost savings to be made, even though we were displacing the most expensive fossil fuel (LPG) and would have taken a longer-term view than most customers (given the commercial interest). The reasons why the capital costs are too high (and significantly higher than in other countries) is another story, also related to the effect of government intervention.
But sticking to the case in point, the main reason why the value did not justify the investment was the absence of any carbon value. Indeed, the low rate of VAT on domestic fossil fuels effectively creates a negative carbon cost, as those fossil fuels are cheaper than they would be if they were simply treated as any other product in the market. But after extraordinarily-prolonged cases of first myopia and then prevarication, something is on its way: the RHI. Doesn't that make the difference and justify the investment?
For instance, what if (as is not unlikely, but not predictable) they make 50 kW a threshold between one band and another? And what if the level of support for boilers below that size is double the level of support for boilers above that size? How much of a plonker would I look if I now installed a 60 kW boiler? In those circumstances, I will obviously want a 50 kW boiler, and find ways to eke it out (larger buffer tank, or top-up from another heat-source). Or if I really want more than 50 kW, maybe I will divide the project and install two 35 kW boilers, attributing each nominally to a different property to be able to claim the higher rate on each, even though that is a dreadfully economically-inefficient solution compared to one 70 kW boiler. But what if I try to hedge my bets by going for one of these options, and then find that they have set the thresholds at 30 or 100 kW? Sizing sub-optimally is then money down the drain.
Clearly, I can't invest now, precisely because of the thing that is supposed to encourage this market. And whenever I do, I will not necessarily be installing the most suitable setup for the location, but the most suitable setup for the perverse incentives. A government proposal aiming to put right their failure over many years to treat heat equally to other forms of energy has, in practice, created the opposite effect for the foreseeable future. And all because they are so ill-educated in economics and deluded about the quality of their information and competence that they can't just do the simple and right thing: front-loading at the least, or better still scrap most of the existing and proposed mechanisms, replace them with a carbon tax, and let the market figure out where and how carbon can best be saved at less cost than the social cost of the emissions.
According to the Guardian:
"The government will today demonstrate its willingness to exert influence over Royal Bank of Scotland and Lloyds Banking Group by announcing £1bn of lending to wind farm developers whose schemes have been becalmed by a lack of cash... The £1bn cash arranged by the government is part of the additional £4bn of EIB lending to support UK energy projects announced in the spring budget."
This brings together several threads I have been following recently: the Government's coopting of EIB funds for their political objectives, the hype, ignorance and political-preference surrounding wind power, the resurgence of "industrial policy", delusional confidence in some quarters about the returns from and security of investments in "green technologies", and the disaster for the effective operation of markets that was the bale-out and nationalization of our most incompetent financial institutions.
Why should the banks prefer one technology over another? Presumably, they should look critically at the business models for projects of all kinds that fall within the EIB's objectives, and disburse the money on the basis of the credibility and suitability of the proposal, not simply on the basis that it uses a technology that the Government seems determined to favour almost to the exclusion of other, often more practical, alternatives.
It's utterly corrupt and stupid. And the Tories and LibDems wouldn't do much different, also having been blinkered by VILE-company rent-seeking.
This is our money they're burning, and our freedom they are destroying. How long before we can have a political option that takes government out of where it doesn't belong? Or (as some people whose political judgment I respect have depressingly concluded) is it hopeless? Must we resign ourselves to continuous decline into a patronage state, where success is achieved not by anticipating correctly and providing efficiently what people need and want, but by influencing governments to implement policy in your favour?
Who will speak for those of us who are aware of the lessons of history and know what that latter world brings? How do we fight it?
UPDATE: By coincidence, I was sent a link today to an article on EIB funds being used to bale out a bankrupt project for a Belgian offshore wind-farm. Financial services are only going to get more politicized and corrupt in the current climate.
According to David Kidney, Energy Minister with responsibility for fuel poverty, the Government has "spent £20 billion helping people in fuel poverty since the year 2000" (it's near the end of the interview).
At 3.5 million, the number of homes in "fuel poverty" in 2006 was significantly higher than it was in 2000 (see graph from DEFRA's UK Fuel Poverty Strategy 6th Annual Report 2008), and that was before prices went really high.
Is it possible that the Government's strategy is not working? Have we wasted a colossal amount of money trying to encourage improvements to energy-efficiency and usage whilst keeping domestic energy prices as cheap as possible? Is fuel poverty a bogus concept that gets in the way of rational energy policy?
Or is £20 billion to make things worse a good return on investment (to use the Government's favourite word for spending)?
Here's a graph from the Renewable Energy Strategy, of a type that the Government has been growing increasingly fond, as it steps up the complexity of its efforts to calculate outcomes and costs of support policies:
The first and most important point is that it is remarkable how precisely the Government believes it is possible to predict the costs of achieving the 2020 target. But let's nevertheless play the game of pretending that these figures are worth applying some critical thought to.
It is amazing how much the marginal resource costs of various technologies within the three sectors cluster together. One would have thought that one of the fundamental features of marginal costs is that they vary across the piece, and don't proceed in a few large steps. For example, it seems that there are no opportunites for renewable heat that incur marginal resource costs of between £15/MWh (the second, dark-blue block) and £70/MWh (the eighth, mustard-yellow block).
Perhaps I am holding them to too high a standard, and the mustard-yellow block is (for example) intended to contain all potential renewable-heat projects with marginal resource costs between £15 and £70/MWh. But in that case, why does the chart distinguish consecutive blocks of transport energy with marginal-resource costs of £20, £35 and £40/MWh (approximately, see the third, fourth and fifth blocks in the graph)? Couldn't they all have been lumped together like the 10% (mustard-yellow) heat block, or the 24% (sixth, salmon-coloured) electricity block? And doesn't this contradict Government policy on support mechanisms, which tries to tailor the support-level to ensure that projects all get only just enough to make them viable (projects of each technology being consistent in cost and the Government's knowledge perfect).
The Government intends to rely on renewable electricity to meet the largest part of its renewable-energy targets, and for wind and other intermittent generators to supply most of that renewable electricity. To be precise, they have produced the following graph (p.44) indicating what they think the capacity of the various renewable-generation technologies will be in 2020 compared to last year:
Of this, output from the wind (onshore and offshore), some of the wave and tidal, and most of the small-scale projects will be inconsistent and unpredictable at more than short timescales. That makes up around 32 GW of the capacity envisaged for 2020.
Here is a graph of how our demand for power has varied over the past week, from National Grid's realtime data-display facility:
The vertical scale is in megawatts (MW, of which there are 1000 to a gigawatt, GW). As you can see, the peak demand last Sunday was around 34 GW, and demand at night-time is under 30 GW. So, even if we hypothetically switch everything else off (the nuclear, gas and coal-fired power stations, and the more reliable renewables like bioenergy and hydro), on a windy summer night we may be producing more power than the total demand in the country. And this is only a hypothetical, because much of that alternative capacity cannot just be run up or down to suit the weather patterns.
Conversely, under an anti-cyclonic system in winter, we may have minimal wind output (5% of capacity across the country) and demand of 58 GW or more. The unavailability of around 30 GW from intermittent renewables will not be helpful. The other technologies will want and need to charge very high prices at this time, as they will have to recover their capital and fixed operating costs over fewer periods when they can export, as they will be displaced by wind (etc) for a fair amount of the time.
But this is not good enough for the Government. It is altogether too unambitious. From p.41 of the Renewable Energy Strategy:
"In particular, in the case of offshore wind, our ambitions are for much greater levels of deployment than shown in Chart 2.3. Discussions with the offshore wind industry suggest that far higher levels may indeed be possible. Estimates of what is achievable are nearer to 20 GW and the Strategic Environmental Assessment recently undertaken for offshore energy indicates that a further 25 GW is feasible by 2020, in addition to that already deployed. In all cases, the estimated contributions for each technology in this lead scenario are in no sense an upper limit on our ambitions."
Note 30: "The figure of 25 GW relates to new capacity (on top of existing plans for 8 GW from previous leasing Rounds) in the UK Renewable Energy Zone and the territorial waters of England and Wales, in water depths of up to 60m. The Scottish Executive is in the process of assessing the potential for an additional 6.4 GW in Scottish territorial waters, which is subject to a separate SEA."
So that's 8 GW from previous rounds, plus 25 GW of new capacity around England and Wales, plus 6.4 GW around Scotland, plus the 14 GW of onshore wind already assumed and around 5 GW of other intermittent projects. That's 58.4 GW - coincidentally almost exactly the same as the highest level of demand achieved in any half-hour period so far this year. So 99.9% of the time, on a windy day under an "ambitious" scenario for the Government where all this capacity is developed, we would be producing more power than we could use, even if we shut down all other technologies. And for a good part of the year, there would be a risk of producing more than twice as much as we could use.
But that's just a detail. Governments can't let details get in the way of their ambitions.
"Every tax ought to be so contrived as both to take out and to keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury of the state", The Wealth of Nations, Book V Ch.II Part II