Subsidy madness

The essence of this post previously appeared as a thread on X. It did rather well, so here is a long-form write up.

During the communist era, the Polish government decided to deal with a shortage of windows – or, more precisely, a shortage of glass with which to fill them – by setting manufacturers a target. For every tonne of glass they produced above the target, there would be rich rewards.

The result was not what the commissars expected. The supply of windows remained broadly unchanged, but the glass they held was much thicker than before. Indeed, it became so thick that it was barely possible to see through it.

Realising their mistake, a new target was set, this time based on the area of glass delivered, with the inevitable result that thenceforwards the glass in new Polish windows was paper thin and broke at the slightest touch.

Tales of useless products in command economies are legion, but it is not just the quality of goods that falls short; the quantities are also likely to be wrong too – with bureaucrats delivering vast overproduction of some goods and failing to deliver an adequate supply of many others. The Soviet Union was the largest manufacturer of shoes in the world, but most remained unsold, and were usually poorly made too. Russians would queue for days to get hold of good quality Western alternatives.

The tale of the Polish windows demonstrates one of the fundamental difficulties of running a command economy. If it is impossible to formulate a target to manage delivery of something as simple as window glass, what chance is there of doing so for more subtle consumer choices, such as shoes, or for more complex goods or services?

We are about to find out. Although we do not live in a command economy, our electricity system is now so distorted by government dictat that it has more in common with a central planning than a free market. We are already starting to see the kind of problems the Poles and the Russians knew all too well in the 1970s and 1980s.

For example, government targets for deployment of renewables mean that overproduction of electricity is now rising alarmingly, a major headache for the system, which will collapse if supply doesn’t exactly equal demand at all times. Grid managers are left with no choice but to pay generators to switch off.

Like the bureaucrats in charge of Polish glassmaking, Whitehall has tried to address the problem by tweaking the rules. They recently decreed that that future windfarms will no longer get subsidies in times of oversupply.

The problem is that, for windfarm developers, subsidies are the whole point. As the investment guru Warren Buffett once explained, “We get a [tax] credit if we build a lot of wind farms. That's the only reason build them.” Many windfarms get more than half of their income from subsidy. Selling electricity is something of an afterthought.

But not entirely an afterthought. Many windfarms presell their entire output, but they receive a subsidy equal to the difference between market prices and the fixed “strike price” they have agreed with the Government. What they actually sell the power for is not part of the equation. That means that if market prices are just above zero, windfarms get nearly all of the fixed “strike price” they have agreed with the government, plus whatever they have presold the power for in practice. They double their money!

Because of this, the new subsidy regime creates an extraordinary incentive for windfarms. If market prices are a penny below zero, they receive no subsidy at all. If prices are tuppence higher, at a penny per megawatt hour, they can get a financial bonanza. For a large windfarm, hundreds of thousands of pounds per hour are at stake. The incentive to manipulate prices will therefore be irresistible.

But how can a windfarm operator (or its in-house energy trading firm) nudge the market price to just above zero? They have to buy up the surplus electricity, of course, but then they have do something – anything – with it. One obvious way is to store it for later use – batteries and hydrogen are often proposed, as well as apparently crazy schemes to raise and lower large weights down abandoned mine shafts.

There is no doubt that the renewables industry is keen on storage. In the last twelve months, we have had reports from the House of Lords Science and Technology Committee and a joint effort from the Royal Society and the Royal Academy of Engineering urging the government to remove barriers to these technologies; the House of Lords paper was even subtitled Get on with it. However, the revelation that half of the team that led the Royal Society/Royal Academy study had close links to a hydrogen company called Ceres Power did rather suggest that it was less than objective, as did the revelation that Baroness Brown, who headed the House of Lords inquiry, was a paid director of the same firm. Worse still, Brown is also a director of windfarm developer Orsted, which is currently planning two vast windfarms, Hornsea 3 and 4, both of which will both fall foul of the new subsidy regime. No doubt the £200,000 per hour these sites might lose at times of market oversupply will have weighed heavily on her mind when coming up with the title for her report.

The renewables industry undoubtedly sees storage as part of the solution, but it is unlikely to be the whole answer because batteries and hydrogen are expensive. For example, a battery big enough to store a few hours of Hornsea 3 and 4’s output would run to billions of pounds. Capital on the scale required is probably not readily available.

What is really needed is a way to get rid of vast quantities of electricity at very low capital cost. One possibility would be to obtain some large open tanks of water and equip them with heating elements. Raising the water to boiling point and evaporating it away would neatly dispose of the surplus power at low cost, thus securing the vital windfarm subsidies.

It is possible that such an approach would be too embarrassing to deploy in practice, but with such incentives on offer, human ingenuity is surely equal to the task of finding a more palatable alternative. Hauling weights up and down mineshafts would be equally futile, but at least would dispose of surplus power at low cost while maintaining the pretence of doing something useful with it.

It would be madness either way, of course. But as the tales of the Polish glassmakers and the Russian shoemakers make clear, madness is what you get with central planning.