On Tuesday, Ed Miliband announced that a future Labour Government would cap energy prices for its first two years.
At first glance, this seems like a great idea. Many people have struggled because of the rising costs of gas and electricity over recent years and the cost of living is set to be a defining theme of the next general election.
Unfortunately, the attraction is only superficial. Britain is facing a looming energy crisis and this policy is likely to be a “sugar high” followed by a long and difficult comedown.
To set the scene: over the next decade, around 7GW of generating capacity will be lost as our aging nuclear power stations reach the end of their operating life. At the same time, because of the requirements of the Large Combustion Plant Directive, a further 12GW of coal-fired generating capacity must be mothballed.
Just replacing this capacity (without adding any new) is an unprecedented challenge. Ofgem have said that meeting this challenge (and the additional carbon reduction and renewables targets we have imposed upon ourselves) will require an investment of £200bn by 2020. The “cliff edge” effect we face is steeper than any other country in the western world
So just at the very moment we desperately need massive investment in energy, Ed Miliband has come up with a proposal which will have investors running for the hills.
Ed Miliband, of course, has never worked in a business so we should forgive his ignorance of how investment works.
When companies need to raise capital to buy machinery or buildings, they have to persuade investors to stump up the cash. The investor (whether it be a bank, hedge fund or individual) agrees to pay, but expects a “return” on their investment, whether that be in the form of interest on a loan, dividends or a higher share price.
When investors are being asked to lock up their cash for many years, they will demand a higher rate of return to compensate. If the company is to continue to give investors the return they are demanding it must remain broadly profitable throughout.
At the moment, average returns on investment in the industry are about 6%. If Labour feel that such returns are so high they can only have been produced by market failure, there are a whole bunch of other industries who should be worried that they could be next on the Price Controls list.
By banning companies from passing on their costs to consumers, Ed Miliband is making those companies extremely unattractive to investors – who are likely to hold off until these price controls have been abandoned. Just at the time our energy infrastructure is crying out for investment, it will be starved for the next four years.
If private investors will no longer touch the energy industry with a bargepole, there are two alternatives: blackouts and power cuts because of a shortage of generating capacity (which, incidentally happened when something similar was tried in California) or the Government has to step in to make up the difference.
If the Government steps in, that means that power stations will be competing for money from the same pool as that which is used to build our schools and hospitals. So in the end, the cost is likely to fall back on the taxpayer.
What Miliband is proposing is great politics but terrible Government.