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To Subsidise Or Not To Subsidise Energy?

In the last couple of weeks as temperatures have dipped below 10C, energy has been a hot topic.

Last week, SSE announced rises of 8.2% for domestic energy consumers, Ed Miliband promised to freeze energy prices for homes and businesses if he is elected in 2015, and amid fears that consumers will bear the brunt of the cost, the government has been wrangling over where subsidies should be made.

Economist Lisa Waters looks at where these subsidies are being focused and asks whether the government are making the right decisions and in doing so weighs up the impact of these decisions on cost and security of supply.

There is often comment on the subsidies given to renewable energy sources, notably the cost and operation of wind farms. However, the nature of this intermittent generation source, irrelevant of peoples’ support for it, does indeed create an issue: What you build as back up. Just like keeping a torch for a power cut, you may not use it much, but it is good to know where it is, and it’s good to know its batteries are working.

However, the Government has now decided it will not subsidise gas storage. Energy Minister, Michael Fallon, said the Government did not believe that a subsidy to build a new facility provided value for money for customers. But, if you look past the press release to the analysis done for the Government by Redpoint (a Specialist Energy Consultancy), you could draw a different conclusion. In fact, as a customer one may ask if you could subsidise storage over other energy supplies what would you choose?

Redpoint considered a range of different options to determine the costs and benefits of pursuing three different types of interventions; two around giving obligations to provide and book storage; and one to provide support to a new facility.

How could new storage bring benefit to the energy market?

Firstly having a big seasonal storage facility, which is filled in summer with the intent to empty in winter, reduces the gas price volatility, or at least reduces winter peaks. Without the comfort of such storage, suppliers manage volatility by adding a risk premium to customers’ contracts.

Secondly it ensures that at times of supply problems, customers are likely to have access to secure supplies, helping us all stay warm.

Finally, in a world of wind generation, it also adds to security for gas-fired generators who will fill the gap when there is no wind, and thus keeps the lights on.

What is interesting for customers is that support for a new storage facility could, according to Redpoint’s analysis, deliver benefits of between £660m and £986m over the period 2020-2030. So why would the Government not wish to subsidise storage given these compelling numbers yet continues to subsidise renewables, and to negotiate support for new nuclear?

Redpoint’s analysis simply does not correspond with the Michael Fallon press release which stated that the decision not to intervene would save customers around £750m over 10 years. While the Government may not wish to support storage, it is unwise to simply ignore some of the findings in the Redpoint report, which suggest that a Supported Storage Intervention can deliver significant benefits. The benefits are dependent upon the rate of return assumed, however, it would be reasonable to suggest that a rate of return at closer to 8% rather than 13% would still be attractive to storage developers.

Heading into elections energy policy will start to come under scrutiny. For many businesses, less subsidies on renewable power, and thus lower electricity bills, replaced with subsidy for gas storage back-up, may well look significantly more attractive.

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