The Blog

More Market, Less Border Will Jolt the Energy Sector

The lesson of this revolution is one that we have seen repeated time and again: market economies need good regulation and, with this in place, they generate benefits, efficiencies and opportunities, many of which are often unforeseen.

Reading news headlines over the past months one cannot fail to notice the prominence of energy.

Energy has dominated the political debates in country after country - whether it is the reaction to the "all of the above" energy strategy advocated by President Obama in his recent State of the Union speech, proposals for price freezes in the United Kingdom, the new paradigm for the treatment of renewables in Spain, or the future of nuclear power in Japan. The energy sector is often, rightly, characterised by massive, long-term capital investments and heavy regulation, but for a sector with such inertia it has a remarkable ability to make headlines and prompt rapid decisions and revisions, which may be reversed in a minute.

Over the past 12 months the EBRD has reflected on the complexities of the global energy sector, in the context of revising our Energy Strategy. We are just one of many commentators on, and participants in, the sector. However, our mandate and business model give us some insights, drawn from our experience working with governments, regulators, and public and private companies across 34 very different countries: some small, some very large; some major energy exporters, others entirely dependent on imports; some isolated energy islands, others major transit countries or closely interconnected with their neighbours; some with energy sectors under state control or ownership, others where the private sector is dominant. What have we learnt from this very wide range of experience?

Most notable is the dislocation in energy markets that comes from a failure to bring into a coherent framework the competing aspirations for the energy sector. Consumers want affordable, reliable energy. At the same time, societies want an energy sector that is environmentally sustainable and will meet global emissions reduction goals.

These aims are often in tension, if not in conflict. Regulation that aims to promote one goal may have unexpected, or even counter-productive effects. This tension is exacerbated when, as in Europe now, demand has fallen rapidly, while long-lived infrastructure remains in operation. An example of these problems is the current interaction of the European Union's policy to promote renewables with the EU's climate policy: as renewable energy generation has increased dramatically, so carbon prices have fallen to levels that do not sustain low-carbon investment.

Similarly, gas-fired generators are being mothballed because of reduced running hours, and coal-fired generation is increasing due to the impact of yet another unexpected "revolution", the one concerning shale gas in the USA.

This tension is not easy to resolve, of course. There are no panaceas: delivering a sustainable, fit-for-purpose energy sector in the next decade will require many different interventions, a diverse range of energy sources and a sustained, continuous evolution in regulation. Drawing on the EBRD's experience, this article argues for two basic principles that are neglected in the current structure of the global energy sector.

The first principle is the importance of the private sector, as a source of both capital and technical innovation. The EBRD's mandate is to promote market economies and private and entrepreneurial initiative, not as ends in themselves but because they lead to better outcomes for societies. We have seen the advantages of this approach in many countries - that private investors, when properly regulated, deliver public services with great imagination and efficiency.

But the best example comes from the United States: the unconventional oil and gas revolution, that has turned on their head assumptions about US import dependency, global gas availability and US industrial competitiveness. This revolution is, of course, partly driven by the US geological endowment, but it is also the outcome of a market-based economy. A diverse ecology of companies included entrepreneurial risk-takers willing to employ old techniques in new ways, while liberalised prices provided the incentive for new investment and open access to transmission networks, allowing investors to monetise newly exploited reserves.

The lesson of this revolution is one that we have seen repeated time and again: market economies need good regulation and, with this in place, they generate benefits, efficiencies and opportunities, many of which are often unforeseen.

The second principle is the importance of interconnection; of developing an energy sector that is integrated across borders. Energy is not distributed or consumed uniformly across countries or regions - the supply of, and demand for, different sources of energy are distributed in different locations.

Energy is also a business that often operates on a very large scale. Consequently, there are many benefits of greater integration: increasing energy security though access to more sources of energy, increased efficiency through economies of scale and more diverse providers of energy services, and increasing renewable energy penetration through connecting location-specific renewables to demand and facilitating the balancing and back-up that renewables require.

However, we are a long way from a fully integrated energy sector, even in the European Union. Too many countries are still, in some respects, energy islands. For example, the electricity connection between France and Spain is less than 1,500 MW - the size of one power plant - while the western Balkans remains without meaningful access to natural gas.

The source of this lack of integration is again deep-seated tensions inherent in the sector. Liberalisation brings the benefits of efficiency and innovation, described above, but it also brings volatile and unpredictable prices, which in turn make investments in long-term, capital-intensive network infrastructure very challenging.

The other dimension to this problem is the political economy challenge of making regulation both certain and democratically accountable. Investors need to have confidence that a regulatory regime will allow long-term cost recovery, but ultimately all regulation is vulnerable to changing political and popular moods.

This is a call to policy-makers and regulators to do two things: first, to continue to have confidence in the private sector and create an environment where various businesses have the incentive to innovate technologically and as a result can deliver new energy in new ways; second, to find new regulatory models that give reassurance to those businesses and particularly support the networks through which this innovation can flow and achieve scale.

These may be models that use long-term contractual commitments, such as the investment contracts that the UK government has adopted, or they may have a greater reliance on supranational regulation, mediated through entities such as the European Agency for the Cooperation of Energy Regulators.

Policy and regulatory innovations are key to a thriving and sustainable energy sector. Certainly there will be difficulties in making a new paradigm acceptable to all parties. But the benefits that it would bring in the long period outpace the shocks that may be felt in the short term.

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