Heads you pay today. Tails you pay tomorrow.

Paying for the current energy crisis, and getting customers engaged in net zero.

Is a windfall tax ever justified??If it is, now may be a good time to consider it.

I’ve spent a long time wondering about whether to post this or not.?Its something that really concerns me, yet is contra to the pervasive energy narrative, and to be honest against my free market mindset.?Interested in thoughts and perspectives for or against this - its not something I have seen reflected elsewhere.

In a world where end customers are seeing bills doubling (or more) in the space of a few months, and at the opposite end of the market generators and producers are seeing record (and more than likely unexpected) incomes; it seems that we should be seeking alternatives to simply spreading the pain of costs to something more to share the benefits of the investment we have collectively made to back renewable generation.

Paying for the energy crisis

The current high energy costs have to be paid in one form or other; a free global market will always serve the highest paying accessible hub, so the UK needs to pay a sufficiently high price to attract energy flow and keep the gas coming – the question then is: how things are ultimately paid for – over what period and by whom.?The excess bill this winter will run to billions of pounds above what is priced in or can be recovered from end users.

In the first instance, energy suppliers will pay to secure product for their customers; but cannot pass the costs to domestic end users due to the price cap in force forcing them to sell at a significant loss – this has sent some suppliers to the wall, and others may yet succumb.?Business Suppliers are also paying, and can theoretically recover costs under their contracts, but may be struggling to hedge at what customers consider a reasonable price, or a price that they can afford. Where poor hedging choices have been made, these should be for the account of the supplier, but where market conditions create extreme exposures who should pay?

Ultimately, in a free market the end user should pay – after all it is them that has used the energy; but when the market price has spiked to such an extreme level is that reasonable in a market with such high levels of government intervention, and where some parties have received what can only be described as windfall profits from the current circumstances.

Available methods to finance the costs

There have been several methods of recovery discussed in the media, and none actually solve the problem of the cost of energy, they simply smear the costs over longer periods to make it more manageable.

1) A loan to suppliers

This will keep suppliers solvent, although whatever the terms of the loan, suppliers will end up repaying the capital and interest back.?The only source of income is end users, so costs will be smeared over a long period.

2) VAT relief

This could allow customers to pay less in the short term, although unless bills rise by the same amount as the reduction in VAT there is no recouping of stranded energy costs associated with the crisis.

3) Green Levy relief

As with VAT, this only solves the problem if end user bills remain at the same level to allow suppliers to cover stranded energy costs.?Generators may be asked to forgo income, but the agreements under which they operate are rightly legally robust (which was part of the way they were developed by government) so legal action would likely follow.

A salutary lesson is what happened in Spain in the 2008/9 financial crisis.?The government of the day revoked renewable payments, leading to the death of new investment for a long period of time.?This isn’t something that is to the benefit of any individual in the push to manage climate change.

What about alternatives, and sharing the cost/benefit that an integrated and financially entwined market could deliver?

Where is the windfall?

Delivery of net zero will require development of new and innovative technology above what would have been delivered via the markets alone, so the acceptance of costs for societal benefit makes rational sense.?However, the market circumstances this year have demonstrated the inequity in the subsidy structures in place, and the scale of risk being held by end customers – something that I think has now reached breaking point.

As energy prices have continued upwards the rewards earned by generators, producers and storage operators have also increased.?In a world of pure merchant risk, enjoying the rewards associated with success are the result of taking a large exposure and it paying off (something I am fundamentally in favour of); however in a world where the capital risks have been broadly underwritten by end users through subsidies this seems less reasonable to me.

Some high level numbers (these are educated estimates rather than the result of detailed study)…

According to many publications the costs of solar are below ?￡50/MWh -?making it considerably cheaper than other sources of generation on this basis.

A 1 MW solar generator would expect to produce roughly 1 GWh/year.

Current market prices could see a 1 year PPA price of over ￡175/MWh

This creates a profit of over?￡100k /MW for generation in the current market.

In the context of customers; and assuming the generator is being underwritten by the RO or SSFiT (CfD is different as it creates a cash-flow rather than absolute issue) this notional 1MW solar farm would produce enough energy to power 350 average size households. ?Each of these households is going to pay a cost of over ￡400/customer/year at this market value above the asset financing costs; despite having underwritten the costs of the assets through subsidy payments when energy prices were lower; rather than experiencing cheaper prices.

The market circumstances in 2021 have laid many things bare that were otherwise invisible to most, this seems to me like the most critical to resolve to retain long term buy-in to delivering net zero.

Can a windfall tax be justified?

Climate change is impacting us all, we all need to take action; but the mechanisms for delivering it need to be equitable across the whole value chain.?How can customers be expected to remain on board with the changes needed when the only things they see are the costs, whilst the benefits are taken elsewhere.

As a believer in free markets, and having watched the merchant generation fleet all but disappear, I don’t see customers bearing the full cost as being a fair outcome, and am for the first time in my life thinking a windfall tax may be appropriate to share the impacts of the current market conditions.?

Previous windfall taxes have been based on a certain political belief, now there may actually be an economic one that makes sense. ?Although its clearly something that would be complex to enact, it could pay for the costs of the crisis rather than smearing them – and demonstrate the value of switching to renewables to end users.