Analysis – UK energy market mired in new policy uncertainty

Uncertainty is now the only certainty in the UK energy market after the opposition Labour party said it will freeze retail energy prices between May 2015 and January 2017 if it wins the next general election.

Labour’s move piles yet another layer of policy risk on to power utilities that are already struggling with the complexities of existing electricity market reform (EMR), the biggest redesign of the wholesale electricity market since Labour launched new trading arrangements (Neta) in 2001. Labour’s announcement underscores the UK’s position as a leader in the new wave of energy market intervention in the EU.

Final investment decisions on new generation now look unlikely ahead of the general election in May 2015 and beyond as investors will wonder what the next seismic shift in policy could be. The incumbent coalition government said blackouts could result but Labour denied its strategy could hit investment in generation or stunt the growth of renewables. In the wholesale market, forward prices for the proposed retail-freeze period showed little reaction today. But there will be pressure on some suppliers to lock in prices and reduce exposure to the potential disconnect between wholesale and retail prices, with speculative buying interest also possible.

The proposed price freeze would also call into question the viability of the EMR project, given the additional layer of risk it would put on suppliers exposed to elements of the projects such as contracts for difference to support nuclear and renewable generation. One analyst described the energy bill backing EMR as “dead on arrival” after Labour’s announcement.

The attraction of the UK market for integrated utilities is surely at its lowest for more than a decade. Labour said the price freeze could cost energy supplies £4.5bn. Shareholder pressure on continental giants such as Eon and RWE to reallocate resources and capital elsewhere is likely to grow, although the attraction of emerging markets as an alternative to mediocre demand growth prospects in Europe has dimmed in recent months. Labour’s plan, which aims to tackle energy affordability rather than EMR’s goal of achieving lower carbon and security of supply, looks capable of extending an investment hiatus triggered by uncertainty over EMR.

Among the big six suppliers in the UK, Centrica, which is structurally short of power, has given the strongest response to Labour’s plan, saying the cost of disconnecting wholesale and retail prices, albeit temporarily, would make its business non-viable. UK policy measures have hurt business models before. Neta triggered a halving of wholesale prices, bankrupting nuclear generator British Energy which had by then disposed of its retail arm and therefore lacked a natural hedge. The European unit of US utility TXU was another casualty of Neta. It was forced to exit the UK market after locking in power supplies at higher prices and then being left by its parent company without sufficient credit to negotiate better deals.

Legal challenges to Labour’s plan could follow. The EU has battled to rid some national markets of regulating end-user prices for years. But regulated prices remain in France and southern and eastern Europe. The European Commission accepts that end-user price regulation can be justified on an exceptional basis provided that strict conditions are met, it says in a paper on household energy tariffs. “Regulated end-user prices are compatible with the internal market legislation if the measure is adopted in the general economic interest, is in compliance with the principle of proportionality, is clearly defined, transparent, non-discriminatory and verifiable, and guarantees equality of access for EU energy companies to national consumers.”