What the U.K. and Texas Energy Crises Have in Common

(Bloomberg Opinion) -- Back in February, thousands of Texans faced astronomical power bills in the aftermath of a sudden winter freeze. They had signed up with Griddy Energy LLC, a power provider that passed on wholesale rates directly to customers. These are often cheaper than traditional residential utility rates. Except in an emergency. Beneath the recriminations was a straightforward truth: Those unfortunate customers had been briefly exposed to the unvarnished, parabolic price of energy in a supply crunch.

Energy is life, yet we tend to have a shaky grip on what it actually costs. More important, the whole concept of energy’s “cost” is often distorted or incomplete.

While I can attest the U.K. is different from Texas in several important respects, its current predicament offers some similarities. It, too, is something of an energy island, especially after a recent fire knocked out a cross-Channel cable to France. The U.K. also has a competitive energy market and a laissez faire approach to certain critical infrastructure.

Just as Texas’ unwillingness to impose stringent weatherization on its gas network was exposed by the February freeze, so the U.K.’s lack of adequate gas storage and reliance on the kindness of neighbors is biting it now. Like Griddy, undercapitalized U.K. energy suppliers are going bankrupt. And just as Texas stepped in to shield Griddy’s customers, the U.K. government has various thumbs on the energy scale, such as price caps and, potentially, backstop loans to suppliers.

To some extent, this is all to be expected. Energy has always been too important to be left wholly to the tender mercies of the market. Utilities are designed to socialize costs. Even Texas’ energy-only power market sets (very high) wholesale price caps.

The added twist is something that has tended not to be priced into energy at all or not very well: climate change. Decarbonizing energy comes with costs, of course, but also benefits, such as the reduced risk of unnatural disasters. Yet we are conditioned to think of this as all pain and no gain. Even Bill Gates calls the extra spending on carbon-free things a “green premium.” Why not instead say fuels like coal trade at a “dirty discount?” To be fair, Gates acknowledges the role of unpriced externalities. Still, the nomenclature, implying decarbonization is a nice-to-have, speaks volumes.

It matters because, as happened in Texas and California, Europe’s energy crisis fuels opposition to decarbonization. There is an inherent tension at play between political term limits of just a few years versus regulatory and investment decisions that play out over decades (not to mention climate’s geological clock). We risk returning to the comforts of our old energy paradigm just for a quiet life.

Yet this old paradigm locks in an unquiet future. Dispatachable energy sources, such as natural gas, still come with supply risks, unless you think geopolitics and competition for cargoes no longer matter. At the same time, this isn’t to say we merely need more ambitious green targets. All these crises show that a transition is exactly that: an indeterminate period where we depend on, broadly speaking, two types of system, with all the friction that entails and where the tolerance for error is vanishingly small.

Rather, it comes back to reforming our old friends: pricing, incentives and penalties.

When faced with acute energy crises, governments are usually powerless to immediately raise supply, so their first instinct is often to cap prices by fiat. Philip Verleger, a U.S. economist with long experience of energy crises, argues they should look instead to our recent experience with another crisis: the pandemic. Rather than broad suppression of higher prices, which encourage conservation, use the state’s ample fiscal powers to reimburse those least able to afford higher bills. The point is to buffer the economy from a temporary shock without abandoning the imperative of decarbonization. 

The structure of energy pricing must also change. There is a long tradition of politicians tinkering with power bills and leaving (inadequate) balance sheets to take the strain of unfettered energy prices. The U.K.’s price caps echo regulatory mistakes made in California’s energy crisis some two decades ago.

Sticking with California, another problem is that piling ever more policy objectives into rates tends to result in higher bills and debatable benefits. As Severin Borenstein and others at UC Berkeley’s Energy Institute at Haas argue, this is regressive in a state where that’s a four-letter word and also rather blunts a primary tool for combating climate change, wider electrification (see this, this and this). Some costs, such as for wildfire mitigation or solar subsidies, are perhaps more suited to general taxation, where they can be better matched with incomes.

The U.K. has the same issue. Some 15% of the average combined gas-and-power bill now consists of a raft of environmental and social levies. Yet that figure is just 2.5% for a standalone gas bill but more than 25% for power — exactly the opposite signal needed. 

Griddy’s flaw wasn’t so much that its promise of cheap power also exposed customers to fluctuating energy prices, which are a fact of life. Instead, it threw the burden of hedging systemic risk best borne by the crowd onto the individual.

Rather than smother prices, we should enhance them and use broader fiscal measures where necessary to foster change and curb shocks. That means pricing in the climate and security burdens of fossil fuels while also rewarding reliability and conservation of all stripes. Tradeoffs are unavoidable; the U.K., just like California and Texas, relies on gas for critical functions until breakthroughs in storage and other technologies are ready for primetime. “Affordable” energy — a term so abused it should come with a health warning — isn’t actually that if we can’t depend on it or it threatens our collective future.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Liam Denning is a Bloomberg Opinion columnist covering energy, mining and commodities. He previously was editor of the Wall Street Journal's Heard on the Street column and wrote for the Financial Times' Lex column. He was also an investment banker.

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