By Andy Mayer, Energy Analyst
“Wars are not paid for in wartime, the bill comes later” – attributed to Benjamin Franklin
Introduction
The start of hostilities with Iran has had an immediate impact on global oil and regional gas prices, most notably in Europe and Asia. Brent crude at the time of writing have risen 50% in a month and are above $105 a barrel. European and UK natural gas have doubled, or tripled versus the previous decade of mostly stable low prices. It has also impacted the cost of borrowing with UK yields on long-term bonds rising towards 5.5% above the ‘crisis’-level incurred during the 2022 ‘mini-budget’.
The situation is volatile, reacting to hourly headlines, particularly as they concern strikes on regional production facilities and Iranian aggression towards shipping in the Straits of Hormuz - a choke point for around 20% of global cargoes for both oil and gas. Iran says they will permit passage for Chinese and non-aligned states. But they continue to fire on ships, and may not be fully in control of decentralised drone and missile batteries. Whose range can extend up to 300km, exposing 1,000km of the sea route from the Gulf States to the Indian Ocean to potential attack. Shipping insurers and captains are reasonably nervous and cautious.
The US war aims meanwhile are unclear. If ‘regime change from the air’ is possible that is not yet evident on the ground. Iran have appointed the former Ayatollah’s son to the new top job, likely to signal continuity, and there is as yet no revolt by any branch of the army or a general uprising. If that doesn’t happen, the course of the conflict is unpredictable. A Kurdish insurgency could invoke a unifying response from the Shia Persian majority and Azeri Turk minority of which Khamenei was a member. Meanwhile US boots on the ground still seem unlikely. There is no border with Israel and Trump’s base is deeply hostile to ‘forever wars’. His domestic popularity is falling as prices rise at the pumps, which some have reported as “10 cents a day”.
It would then be reasonable for Western governments, particularly in Europe to plan, with cool heads, for a period of higher prices. The G7 considering the release of strategic reserves and securing new supplies from marginal exporters, particularly in Africa, may help, but many need to look closer to home at their own policy choices.
Where we are
The UK’s climate and energy policies for the last 25 years have left us almost uniquely exposed to this kind of crisis. Net zero policies prioritise decarbonisation over security of supply and affordability, and lead to ideological stances such as ignoring our own supplies of fossil fuels onshore (the fracking moratorium) and in the North Sea (crippled by a windfall tax, complexity and uncertainty).
The decision to ignore nuclear energy for 30 years, and then make it as expensive as possible with crazy safety standards and environmental rules was a boon to a growth in renewables, particularly offshore wind. But renewables require more land, more connections, balancing services and a duplicate grid of standby capacity given their unpredictable unreliability. That capacity at the moment is invariably gas. While most of the current wind fleet is rewarded by a ludicrous incentive scheme called the Renewables Obligation, which is linked to wholesale power prices, which tend to be set by gas, to which additional carbon taxes have been added.
That’s why going into this crisis we had some of the most expensive energy in the world, despite sitting on some of the largest reserves of fossil fuels in Europe.
Policy Options
In the short-term the only tools for respite available to the Government are removing policy costs and targeting support to avoid hardship.
In transport the Government can reduce fuel-duty (which is already too high compared to other implied carbon taxes), or remove VAT from duty (every 5p of duty is actually 6p of tax), or reduce VAT from 20% to the 5% applied to domestic energy bills, or scrap the biofuels mandate, a relic of policy ideas from 2008 that mandates blended fuel.
For energy-intensive industry (glass, ceramics, steel, chemicals etc.) the Government is considering a British Industrial Competitiveness Scheme (an extension of older policies) which may relieve around 500 firms from some policy costs and save them 25-30% on their bills. But this is redistribution of costs to other businesses and households not a real saving. This is hard to avoid, these policies fund things like wind subsidies and the capacity market, which implies addressing them properly will require wider reforms and may be subject to legal challenge.
Scrapping the North Sea windfall tax, or better scrapping both it and all the related complexity of allowances, special regulatory standards, and other taxes might have a medium-term impact in restoring investor confidence. It’s a similar story with fracking. It needs tax and regulatory equivalence to other extractive industries, not special treatment. All energy industries need more sensible planning and environmental rules, to avoid being tied up for years then overturned by manufactured claims of infringement of some mad law being interpreted by activist judges.
The Government’s preferred approach to helping households with rise in power and heating bills since 2019 is the energy price cap, which until 31 March 2024 could not rise above £2,500 per ‘typical household’ dual fuel bill. It means bills lag crisis events, regardless as to whether suppliers get hit with higher prices sooner. In 2022-23 this led to the bankruptcy of many retail energy companies, and it suppressed prices that otherwise would have risen to £4-5,000, around 3 times our current levels.
Like most price controls it’s a terrible idea that masks price signals, and encourages waste. In an energy crisis we want high prices to encourage less use, particularly for non-essential activities like heating swimming pools. Without preventing essential services, like the elderly staying warm in winter. We want those signals to get through to suppliers, so they invest in new sources of supply.
It is likely that the anticipated £100-150bn cost of the subsidy in 2022 is what triggered the market confidence event that exposed the LIBOR crisis and ended the 49-day premiership of Liz Truss. A smarter, cheaper approach would have been targeted welfare for relief of temporary hardship. At the time the administration claimed this would have taken too long. Presumably then, such a package is ready now, and if not, it would be wise to address that deficiency rather than repeat the error.
Without such distortions, in the long-term markets will adjust. Higher prices drive new investment in alternative supply and alternative energy, while dampening demand for non-essential energy use. For example, after the Iranian revolution in 1979, oil prices doubled, with higher prices persisting until the mid-1980s. But they did fall, and the shock precipitated new producers and industries, like Japanese car manufacturing, and early interest in the potential of renewables.
The cost of net zero and alternative paths
The central strategic question for UK energy policy is Net Zero. Predictably the latest crisis has restored the incentives for fans to claim it’s our insurance policy. But this claim is patently wrong when tested against the evidence of pre-crisis high prices, which in turn have been caused by Net Zero policies and failing (often wilfully) to understand that system costs matter more than marginal costs of production. Sunshine and gusts of air may be free, capturing them, connecting them, balancing them, storing them, offsetting their absence, and financing all of that, is not.
A simple change that would reflect reality is that all and any carbon targets are an aspiration, not legally binding. While the related premise of carbon budgeting, inferring the state central planning of the entire economy to meet them, needs to go. The goal of a sensible energy policy linked to a sensible growth policy is the delivery of secure, affordable, abundant energy, in that order, with low impact on the environment and climate a related benefit from innovation, not an end in itself. Higher growth is more likely to achieve decarbonisation than higher climate ambition that strangles growth.
Such a policy would be technology neutral, and encourage a market that rewarded ‘firm power’ delivery not infirm capacity idling on standby. Particularly if matched by regulatory reforms that prioritised fast delivery over the living standards of hypothetical spiders.
It’s likely on current options that this would mean newer nuclear power displacing most gas power and older renewables in the next two decades. But it’s uncertain, and dealing with that uncertainty efficiently is the major benefit of markets over Government plans.
Whether or not we use most of the oil and gas we sit on is not an argument against developing it. It’s either a genuine insurance policy against crisis events as it’s there and accessible. Or it’s a source of revenue from exports and taxes to develop the alternatives. Both improve our security of supply. Arguing conversely we can rely on any such global resources bar our own, as a Minister did this week, is irrational.
The future of new renewables should be one of subsidy-free market competition, which was always the goal of the support policies. They clearly have niche uses, and in sunny climes, or places with vast amounts of windswept land, exciting potential. If their costs genuinely fall, they will thrive. But the low carbon industrial complex the UK has created between Government, producers and lobbyists to hit capacity targets to the exclusion of the public and immiseration of the kingdom needs to go.
Conclusion
In brief if we want not just to survive the current crisis, but thrive the next time, we need a focus on growth, innovation, markets, and targeted support to alleviate the worst consequences for those most at risk. We need to use the resources we have to develop the future resources we need, and if successful export our success. Showing genuine leadership on the world stage through the example of our prosperity, rather than incurring derision for our self-imposed delusions and decline.