The Price Is Wrong

29/11/2013 at 5:20 pm

When it comes to UK energy supply, this seems to be one thing on which most of our politicians can agree. Ever since Ed Miliband made his commitment to freeze household energy bills two months ago the issue has remained topical to one degree or another. The government’s response to this challenge has been to fob it off with talk of competition, suggest that people wear jumpers, approach the industry with plans for its own price freeze (or possibly not), and most recently to trumpet a reduction in inflationary green levies to be announced in next week’s Autumn Statement.

For while the politics of this issue has been by turns fascinating, brazen and depressing, the inflationary impact of green policy is undeniable. This is quite difficult to quantify, however, since energy policy in the post-Climate Change Act (CCA) world is bogglingly complex. The current estimated impact on bills is of the order of 4%, attributed as follows:

  1. To the Renewables Obligation, which is set to rise sharply;
  2. To feed-in tariffs, currently co-existing with the Renewables Obligation but which are planned to supersede it, and to rise sharply both during and after the overlap period;
  3. To new boy the Carbon Price Floor, which operates by tacking a Carbon Price Support rate to the existing Climate Change Levy in certain cases, and is expected to rise sharply;
  4. To the rollout of “smart meters“, which will enable energy providers to charge more highly for consumption at times of peak demand, thus incentivizing people to change their ways (and as a byproduct, make it much easier to disconnect the supply to customers).

As well as noting that this low-seeming figure of 4% arose ultimately from zero – and is projected to rise sharply, in line with the requirements of the CCA – we should also note that there are costs which are not picked up by these quasi-transparent figures. For example, there might well be man hours associated with having to negotiate the various areas of 21st-century energy policy. And while some generating costs associated with the CCA are (probably, and for now) not figured on household bills – such as Carbon Capture and Storage – others, such as “biomass co-firing“, probably eventually sometimes are. Oh, and there are always new costs to consider of course, such as the subsidy for new nuclear.

Even what is measurable has already added billions to household costs, is forecast to add tens of billions more in coming decades, and might continue right up until we arrive at the CCA goal of an 80% carbon emissions reduction by 2050.

Back to data, markets, and cleaner information.

The Fuel & Light sub index of the RPI has been rising at an average rate of over 7% over the last five years. By October this component had gone up more over the previous twelve months than any of the other fifteen sub indices except Clothing & Footwear and Seasonal Food.

Some of this will be due to currency movements and some to energy prices. Using the near month ICE Natural Gas Future, the gas price is up by 7.7% over the past year – and some in government have pinned the blame for higher bills on this. Yet the sterling price of oil is 1.4% lower, and the Bloomberg composite price of ARA (Amsterdam, Rotterdam, Antwerp) Steam Coal in sterling has fallen by more than 13%. To attribute all of the inflation to the price of gas is therefore incorrect. (In fact it might also be pointed out in this context that shutting down coal generation on environmental grounds has not been helping.)

The government has a choice: to continue the commitment to inflate energy prices, however marginally, as a matter of policy; or to change policy in an attempt to ease concerns over inflation.

The situation is highly reminiscent of the VAT hikes of 2010 and 2011, which pushed real wages down and the UK household sector back into recession. There is no benefit to this. (Regular readers will know that the “inflation kills debt overhangs” thesis is addled and lazy.) Price inflation is inimical to growth and further impoverishes the poorest.

Which brings us to the Bank of England.

This blog has been scathing about the Bank’s record of forecasting inflation and keeping it contained. Now the Old Lady deserves to be partly exonerated when troublesome price behaviour comes about as a result of government rather than monetary intervention. But to salvage credibility as an inflation fighter – especially as growth returns to a world not used to problem prices – it would not do for her to stand completely idle.

Now for the really exciting news.

Only yesterday, the Governor of the Bank of England announced that he was taking action to rein in some of the recently observed surge in house prices. After all, while a lodestone of the British economy, higher house prices are themselves inflationary.

It is too early to say whether or not this makes Mark Carney more of a hawk than his immediate predecessor. But it does at least suggest a preparedness to take responsibility for price behaviour.

The Bank was careful to distance its manoeuvre from the government’s recently ignited Help to Buy mortgage guarantee scheme, but the coincidence is noteworthy – and has been widely noted, with several reports carrying Mr Carney’s correct assertion that he cannot “veto” the programme to stave off a housing bubble.

The Bank could, however, put up interest rates. And that might well have a dampening, if not deleterious effect on the housing market.

Early signs from the new Governor were not encouraging. Nor would it help those threatened by higher prices for energy – a price inelastic good if ever there was one – to add higher mortgage payments to their burden. But if our government has any intelligence, it will connect the Bank’s move on housing to the current debate on energy, and act accordingly.

With lower price pressure from the fiscal as well as monetary side the outlook for the UK’s economy could just get a little brighter.

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