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£32 billion? That'll do nicely

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The future for UK energy may be smart technology, but the economics behind that decision are decidedly unsmart. Or possibly very very cunning, depending on whether or not you credit the beancounters at Ofgem with a degree of subtlety.

On the surface, this week’s story (pdf) on Ofgems smart grid plan was straightforward: in order to cover the infrastructure investment of £32bn that will be needed by 2020, consumers will pay an average of £6 per year extra for their energy (split evenly between gas and electricity).

This bland assurance hides the fact that the actual average increase, by 2020, in respect of infrastructure investment alone – not taking account of inflation or other factors such as hikes in raw fuel costs - will be £80 per household.

It also conceals the suspicion that, on figures provided by Ofgem itself, the energy companies will eventually be quids in. Against a proposed investment requirement of £32bn, they are actually proposing to raise £40bn from consumers and a comparable figure from business and commerce – or in other words, up to two-and-a-half times what they actually need to pay for network improvements.

Such investment cannot be raised within the current pricing framework, which allows energy companies to increase prices relative to inflation. Ofgem’s announcement therefore served both to highlight the scale of investment required and to herald the launch of a new pricing structure which will allow energy companies to raise funds that are specifically needed for infrastructure building.

No one is denying that such investment is needed. The UK’s energy supply infrastructure needs serious upgrading for a number of reasons, from energy security, through to carbon emissions reduction under the Kyoto agreement – and existing forecasts have come up with figures of at least £200bn for the task.

It is not surprising, therefore, that the energy industry needs to raise more cash. What is dubious is the way in which Ofgem have massaged this demand down to the innocuous-sounding "£6 a year".

Of course, what they mean is "£6 a year a year": it is a rate – not an increase. Applying that rate over a 10-year period, the average household will be paying some £60 a year extra at the end of the period compared to what it paid at the start. Or, to put it another way, it will hand over £330 more than it would have handed over had prices not increased.

This additional demand comes on top of an announcement last year of an extra "£6.5 billion investment proposal for 2010-2015", which "will deliver new and renewed regional networks" – all at the bargain cost of "£4 a year on average" on domestic electricity bills. Again, they really mean "£4 a year a year" – meaning another £20 a year on the average bill by 2015.

But hang on: even the £6 increase, over the 26 million household base that Ofgem uses for its calculations, only gives £8.6bn from consumers over the next decade.

At this point the discussion moves into surreal territory, as Ofgem explained to us that although £32bn is needed over the next decade, they would be raising the money from consumers over a longer period, approximating to the real life of the asset, which might be 20 to 30 years.

Aha! So bills will be going down after 2020? Because if the £60 a year increase (by 2020) is maintained, the energy industry will collect a further £31.2bn between 2020 and 2040.

Not exactly. A spokesman for Ofgem tells us that they "haven’t looked at what happens after the next decade".

Nonetheless, they "stand by" all their calculations.

If they genuinely haven’t looked at what happens after 2020, then that raises some serious question marks: that is so unlikely – so irresponsible, even – that the only alternative conclusion is that they are looking to raise far more than claimed, but spinning the news so that it looks less.

On the figures provided, Ofgem will be raising almost £40bn from consumers over the lifetime of their new infrastructure. Depending on whether they raise an additional £16bn from business (half of the stated total), or £40bn (matching the take from consumers), that means they will be raising somewhere between £56bn and £80bn to pay for a £32bn asset.

Nice investment if you can get it. ®

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