FIT for nothing

Second in the list of this week's lousy initiatives* announced by the Government is the micro-generation Feed-In Tariff (FIT), or "clean-energy cashback" scheme. The micro-gen FIT is a scheme to pay significant amounts of money, over and above its value to consumers, for every unit of electricity generated by renewable generators upto 5 mega-watts (MW) in scale.

You may feel that 5 mega-watts doesn't sound very "micro", and indeed it is enough to supply the needs of several thousand houses, but let's not carp. That is hardly the main issue.

Now, I have to declare an interest. Our company may benefit from this initiative. So I would like to thank all of you for your generosity - your extraordinary, overwhelming generosity. But you can afford it, can't you? It's not like we're all strapped for cash or anything...

Don't take my word for it. The Government has detailed exactly how generous you are being.  According to their Impact Assessment (IA) of this initiative, it will cost...

£8.6 billion (bn).

But you can't just look at the costs. You have to weigh the benefits against it. And those come to the princely sum of...

£420 million (m).

That's right. According to the Government, it is worth spending £8.6bn in order to make carbon savings of £420m. 

Let's just remind ourselves what the carbon price is supposed to represent. The carbon price is supposed to be the Net Present Value of the future damage that is predicted to result from current emissions of carbon dioxide (per unit of emission). If a measure to reduce greenhouse-gas emissions costs more than the carbon-price, that means that the damage to our economy (people, environment, etc.) from implementing that measure is greater than the damage to the future economy (people, environment, etc.) from not implementing the measure. In other words, if an abatement measure costs more than the price of carbon, it would be better for the environment and for future generations not to take that measure and use the savings to increase our wealth so that we are better able to deal with the challenges later on.

This one isn't even close. And the Government knows it. According to the Minister (Lord Hunt):

I am satisfied that, given the available evidence, it [the IA] represents a reasonable view of the likely costs, benefits and impact of the leading options.

Nevertheless, Lord Hunt believes the scheme is worth it (in his introduction to the Government's response to the consultation):

I am confident that these measures will mean that small is not only beautiful but also worthwhile.

Putting 20 times as much in as you get out is a new definition of "worthwhile".

Perhaps, you may be thinking, this is justified to kick-start the market - "pump-priming", as politicians like to refer to throwing your money at their pet-projects on the promise that it will be worth it in the never-never.

If so, I hope you are patient. This pump takes a lot of priming. Those costs are the cumulative totals for the scheme between now and 2030. In 2020 alone, it will cost more (£570m) than the total value of carbon predicted to be saved by the scheme between now and 2030. If you are still priming a pump 20 years after you started, it would probably have been better never to have started in the first place.

To be fair, that does also put the costs into perspective. That £8.6bn (and £420m) is over 20 years. So it's "only" going to cost us £430m a year on average. Of course, the other side of that equation is that we are only going to gain carbon-savings of £21m a year on average. But at least it won't weigh as heavily on our household budgets as you might have thought that cumulative total implied. In fact, the Government calculate that the scheme will add "only" £8.60 a year to household energy bills (£430m across 25 million households is double that, but I guess they're allocating half the cost to industry and other consumers). This government has other, more expensive Easter Eggs to leave behind for their successors. I'll be coming on to one in a later post. (Does that tell us anything about their chances and desire to win the coming election?)

£8.60 per household per year may not sound like much, but let's be clear what you are getting. You are getting a gnat's fart of electricity and carbon-savings. Deployed almost any other way, including leaving it in people's pockets to choose how to spend, it could have paid for a lot more.

And, like subsidy for the fine arts, it's a lovely transfer from the less well-off to the better-off. The Government estimate that this will pay for around 750,000 renewable installations. That will be in homes and organisations with the capital to invest the thousands of pounds that even these puny installations will cost. That's roughly 2% of households and organisations, much of which will be in the top 2% by wealth, while the cost is spread over 100% of energy consumers, rich and poor. And doubtless the public sector will be in amongst that 2%, spending your money to invest in token green boondoggles in order to exploit a subsidy that you are also paying for.

You won't even be getting the best 750,000 installations of this technology that your money could have paid for. Because the system is constructed to reward technologies according to their (badly generalised) "need" rather than the value they provide, the less effective a technology is, the more money it receives. This naturally means that we will get more of the ineffective options than would have been the case if they had all been valued equally according to the amount of renewable power they provided, and less of the effective options.

So, if you have a wind scheme of over 1.5 MW or a hydro scheme of over 2 MW, which could be expected to contribute a material amount of power at relatively low cost, you will get little more than you would have got under the existing scheme (the Renewables Obligation), but with a little more security. But if you put in a wind-turbine of 1.49 MW, you will get twice as much as you would have previously, and if you put in a hydro scheme of 1.99 MW, you will get two-and-a-half times as much. I guess we won't be seeing many 2 MW wind turbines or 2.5 MW hydro schemes, even where the resource justifies them and where they would offer a better return on investment, if the incentive weren't skewed to smaller, less efficient units.

That's just the start of it. The subsidy keeps ratcheting up as technologies get smaller and less economic. The smallest hydro schemes (< 15 kW) get nearly four-and-a-half times as much as the larger hydro schemes. The smallest wind schemes (< 1.5 kW, like the one that David Cameron has on his roof) get over seven-and-a-half times as much as the larger schemes, even though these roof-top schemes are generally hopelessly inefficient, because a rooftop isn't the place to get good clean wind, and many of them aren't just on any old rooftop, but on urban or suburban rooftops in less-windy parts of the country.

The treatment of wind and hydro is almost sane compared to the treatment of photovoltaics (PV) and small, gas-fired CHP (micro-CHP). Even the largest PV scheme gets six-and-a-half times as much as the largest wind and hydro schemes, and for a longer period of time. And the small PV schemes - the ones most likely to fit on your roof - get over nine times as much. They will contribute almost nothing (in terms of electricity and carbon), use up significant resources in their production, cost a fortune to install (that could have been spent on better things), and for that, the Government (i.e. you) will pay hundreds of pounds over-and-above the value of the electricity produced. This will be some of the most expensive carbon saved in the world.

But at least it's better than subsidising the continued emission of carbon. Micro-CHP will get more than twice as much as large wind and hydro, in order to encourage the continued use of gas in our houses (as though that needed any encouragement). The VILE companies, who see great potential for this technology to persuade governments that something is being done while making almost no difference to their net revenues, fossil-fuel dependence and carbon emissions (they'll sell a little more gas and a little less electricity) have done a good job in peddling misinformation about the potential contribution of this technology. All the political parties back it, and even intelligent, independent-minded MPs like David Davis have been taken in. The technology works by passing the heat from a gas flame through a (small and inefficient) Stirling engine before passing the residual heat through heat-exchangers as in a normal gas boiler. If modern gas boilers are around 90% efficient, micro-CHP boilers may be around 80% heat-efficient and 10% electricity-efficient. This is, undeniably, a gain in efficiency, because the electricity that would otherwise have been generated if it hadn't come from the CHP unit would have been produced at under 40% electrical-efficiency on average. So the loss in heat-efficiency is more than compensated for by the effective gain in electrical-efficiency.But it's a tiny amount. You can't do much better than this without breaking the laws of thermodynamics. To supply 8 units of heat from a condensing gas boiler and 1 unit of heat from the grid would take a little over 11 units of fossil fuel. To supply 8 units of heat and 1 unit of electricity from a micro-CHP unitwould take around 10 units of fossil fuel. We have reduced our fossil-fuel consumption by around 10% (increased it in the house, but reduced it by more at the power station). And we have given a strong incentive to continue using the other 90%. And this is to be treated as of greater value in displacing fossil fuels than larger anaerobic digestion, wind and hydro schemes? In practice, it is a monster subsidy (in terms of value per unit of fossil-fuel displaced or carbon avoided) to the VILE companies to help maintain their business models against the threat of alternative technologies from which they can benefit less.

The only saving grace is that the number of micro-CHP units to be supported has been capped at 30,000 installations of less than 2 kW, so the subsidised contribution from this technology, and the cost to consumers, will be constrained. Per unit, the subsidies for PV and micro-CHP are on a par for gross wastefulness, but in aggregate, the subsidies for the renewable technologies are the ones that will cause the pain to energy-consumers.

Needless to say, all the main political parties are fully behind this particularly-wasteful set of magic bullets.

* First was the announcement of new civil powers for the Environment Agency.



Tim Worstall also addressed this issue, in his usual acute way, on his Adam Smith Institute blog. I have to say, I think he's being too generous, though I realise that may well be the intention (to offer the fewest hostages to subjective opinion). It seems to me pretty clear that revenue support is a lousy way to encourage R&D, if that is really the intention (even if we accept the idea that governments know which immature technologies should be supported and have an appropriate role in providing that support, which I don't).

And does every country have to do its own R&D, as though starting from nothing? Or should we be able to treat a technology as pretty mature if it has enjoyed massive subsidy over many years in one or more of our neighbours and partners (e.g. Germany and Spain, in the case of PV)? The primary purpose of the FIT seems clearly to be, not R&D support to drive the technologies down the learning curve, but to subsidise the development of an industry and deliver quantities of different technologies at different scales, as calculated by the Government's crystal ball to be the ideal amounts. And as Tim says, that is a truly dumb idea.

Isn't this missing a point about scarcity of supply in the future. To reduce our national exposure to imported energy (primary fuels and electricity) shouldn't we be encouraging these types of smaller installations now? If we're out of electricity from coal and gas and the lights start going off in 2025 doesn't having a headstart in installing a wide variety of smaller scale generation technologies look like a good idea despite this high cost. If generation from renewables were cheaper than from fossil fuels or the price of fossil fuel generation including ROC impacts - we wouldn't be in the mess in the first place - but it's not, so we need to pay for it.

James, Thanks for visiting and commenting.

I am inclined to agree with you about the risk of resource depletion for our energy security. But even so, there are (at least) two arguments why it does not follow that something like the FiT is justified.

The purist argument would acknowledge that, though you and I have good reasons to be afraid of this eventuality, we do not have perfect knowledge and neither do governments. If we manage our economy by encouraging certain solutions that those with imperfect knowledge assume to be the best solutions, we will sometimes get lucky (when our assumptions are right), but when we are wrong, we will have no way of discovering that we are wrong (because governments will have deterred the alternatives through their interventions). Markets reflect the balance of opinion of many people with many different pieces of and perspectives on the available information, and can accommodate minority as well as majority views. When the majority are right, the market will deliver the same outcome as a state-mandated solution, without the bureaucracy and with greater competition. When the majority are wrong, in a market system, there will be competing alternative perspectives and solutions that will prosper and displace the mistaken approach of the majority. It's not that one approach (state-mandated or market solution) is necessarily intrinsically more right than the other in individual cases, but that one is more robust and responsive to evidence of error, so ends up being more right in the long-run as circumstances change and economies correct.

In this case, the market price and investment decisions reflect the balance of opinion that these risks are not imminent, or at least not sufficiently expensive sufficiently soon to justify more expensive solutions. If the majority are wrong, you and I can become more successful by investing against the consensus and reaping the profits when the market is shocked by interruptions. But we have no right to have our assumptions forced on other people, and if we try to do so, we are probably demonstrating our lack of confidence in our judgment, which is a good sign that we shouldn't be listened to.

But let's say that I accept that energy-security is one of the limited number of areas where it is appropriate for governments to intervene. There is still a pragmatic argument against doing so via something like the FiT. Amongst the many types of scarce resources (which is the basis of economics), scarce capital is a very important one. We can expand our money supply artificially, but we cannot expand our wealth other than through real economic growth. It is vital, therefore, to use our wealth or capital as efficiently as possible to conserve and expand it. If we use it for one purpose, it is not available to be used for another (regardless of what the easy-money majority might like to think). In this case, if we put £8.6bn into micro-generation, that is £8.6bn that is not available to be invested in alternative solutions to reduce our dependence on fossil fuels. If that £8.6bn could have displaced twice, or three times or (as is the case with some of these micro-technologies) ten times as much fossil fuel if invested in other technologies or scales of projects, it is madness to waste it on the micro-scale technology. That is exactly the situation we find ourselves in, and not just with the FiT, but with banded ROCs, and a multitude of other interventions.

The only efficient way to deal with this is to put a rational price on the externalities and discover what are the most efficient responses (including adaptation as well as mitigation).

If we are worried about the external cost of the risk of damage from anthropogenic global warming, we should institute a mechanism that helps us to discover the price at which we achieve the most efficient balance between mitigative and adaptive responses to the risk. I produced a paper some time ago about how we should do that.

If we are worried about the external cost of the risk of damage from having underestimated the impact on our energy security of dependence on fossil fuels as our native production depletes, we have probably misunderstood the concept of "externality", but if we persuade ourselves that this is a real externality, we should institute a fossil-fuel levy to internalize the underestimated cost of continued dependence.

In so far as micro-generation is competitive with other options under appropriate carbon- and fossil-fuel- levies (and no other interventions on account of these externalities), then it is appropriate to install them. It may be that prices would fall and these technologies would become competitive with alternatives for a much larger share of our energy supplies than the 2% of electricity provided for under the FiT. The state-mandated solution can be as bad for the technologies it "favours" by placing artificial constraints, as it can be good for them by boosting uncompetitive options. The extent of the learning curve is an appropriate risk for entrepreneurs to take into account, and something that governments are endlessly hopeless at predicting, and harmful when they try. If the potential efficiencies are genuine, businesses should invest in the technologies now even if they are not economic, so long as they can reap the rewards of what nowadays might be called "excess profits" if they manage to drive down costs to competitive levels. If businesses won't do that and want governments (i.e. taxpayers) instead to shoulder the risk and reward, it is a fair indication that the claimed efficiencies are exaggerated, or at least not as certain as claimed.

There is no economic justification for the levels of targeted support provided by the FiT - neither on account of climate-change and energy-security risks, nor as a means of providing support for R&D/scaling. Even George Monbiot, who is a passionate green and far from a market fundamentalist (or even enthusiast), has understood this. As I have just been saying to some Tories, it is extraordinary that their leadership is so economically-illiterate that they have managed to place themselves to the left of someone like George, in their desire to throw even more money at micro-generation than our hapless Labour government. Just as with the recent vote on Emissions Performance Standards for new power stations, the political debate on this issue is between Dumb and Dumber, with absolutely no connection with reality.