Energy subsidies threaten Britain’s economic future

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Recent weeks have seen the publication of the UK Energy Bill and Gas Strategy.

The first is intended to encourage investment in energy generation by offering a guaranteed energy price. The second promises that gas-fired power plants will supply much of this capacity. But imported gas does not address the need for energy security. The Government has also announced its backing including likely tax breaks for locally-produced shale gas.

Such tax breaks fit into a long history of government support for the energy industry. Hydrocarbon energy has been by far the greatest winner. And, in spite of the stated attempt to wean ourselves off fossil fuels, these industry windfalls are getting bigger.

The International Energy Agency (IEA) last month reported a 30pc annual increase in global subsidies to consumers of fossil fuels. Over the same period, carbon emissions rose by one gigaton. In the words of the IEA, this constitutes “an unsustainable energy path”.

Increasing subsidies contradicts 2009 statements from both the OECD and the G20 committing to in the words of the latter “rationalise and phase out over the medium term inefficient fossil fuel subsidies that encourage wasteful consumption”. Such support also distorts the relative cost of renewable energy which is itself in receipt of $88bn (£55bn) of government subsidies globally.

Many governments’ stated goals of increasing energy sustainability and reducing emissions might be accelerated by establishing a level playing field for different energy technologies.

Definitions of what constitutes a subsidy are fraught and often partisan, with many claiming in contradiction to the OECD’s definition that tax breaks should not be included.

Further complexities arise by including producer subsidies alongside consumer subsidies. Producer subsidies are aimed at making a country’s energy more affordable globally. Consumer subsidies are aimed at making energy more affordable to domestic users.

But there are four main drivers that make change inevitable.

First (OTC BB: FSTC.OB - news) , the economic direction of travel makes these transfers unsustainable. The Energy Bill offers financial support that is intended to be phased out as new generation comes online yet such closed-end support is only possible where the affordability gap is narrowing, as it is with renewables.

Subsidising energy plants which are exposed to global and likely upward volatility in fuel costs invites a widening cost gap. This issue is most dramatically illustrated by Mexico’s petroleum price-stabilisation fund which, through being pegged to international oil prices, jumped to $18bn or 1.61pc of the country’s GDP in 2008.

Second is pressure on public finances. For this reason, India recently took the brave step of removing some diesel subsidies, leading to a 14pc price increase and a more than 50pc reduction in month-on-month consumption growth.

Reforming consumer supports is politically difficult. Much of the recent growth in subsidies observed by the IEA came from consumer subsidies by new regimes in the Middle East.

And reforming producer subsidies is, in the words of the OECD, “not easy... due to the vested interests of those that benefit from them and the limited available data”.

However, more transparency is being delivered by projects.

Energy (NYSEArca: JJE - news) is also one of the least trusted sectors. It will not be able to escape the movement towards better governance and social accountability which has already swept through many other sectors.

Third, energy users will increasingly demand the opportunity to allocate their own capital rather than allowing governments to reallocate it for them.

Energy efficiency and locally owned renewables both of which featured in the Energy Bill are two main areas that will benefit.

This is timely as the IEA has called energy efficiency the “epic failure” of policy making. It has suggested that growth of energy demand could be halved solely by using technologies that pay for themselves in four to five years.

In terms of locally owned renewable generation, 13pc of German companies own generating equipment and a further 16pc plan to. Many UK supermarkets are now following suit.

How can governments continue to tax those companies’ efficiency gains to prop up a centralised energy system? Instead, they should cut down on both subsidies and tax bills to free up value for companies to make their own energy decisions.

Some already choose the greater upfront cost of local generation in return for energy independence in the future as, increasingly, does the US military.

Fourth, is better understanding of the way different risks are connected. This is leading to the cost of “externalities” increasingly being accounted for at source.

For fossil-fuel subsidies, these external costs are emissions, pollution, oil spills, corruption, energy insecurity, political risk, and additional pressure on water resources (a specific concern of the IEA).

The total cost of fossil-fuel subsidies is therefore higher than the financial cost. And the relative cost of renewable-energy subsidies which bring fewer externalities and cover a narrowing affordability gap is lower. I hope the current window in UK policy-making addresses these inescapable issues.

Ben Goldsmith is a partner at Wheb Partners, which invests in energy efficient technology