Energy policy should not be based on fantasy models of future energy prices

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The UK is “running out of money to pay for clean energy“, so the Guardian informs us today. There are supposedly a number of reasons for this. Installations of heavily subsidised solar panels on houses in sun drenched Hampshire are far ahead of where the government wants them to be, and the government might have screwed up by assuming new offshore wind farms would be less productive than they actually are. I’m still skeptical of the latter claim.

But the other reason, and an indisputable one, is that the government and everyone else was wrong about fossil fuel prices.

The basic problem is this. Government funds basically pay the difference between the price of renewables and the wholesale price of electricity. But if fossil fuels get cheaper the wholesale price also gets cheaper, and this results in more money having to be spent on renewables.

Bien pensant wisdom over the last few years was simple: the price of fossil fuels will just keep rising. Anyone who follows British energy debates is familiar with the following trope, “Renewables will protect us from rising gas prices”.

The thought that fossil fuel prices might end up falling didn’t appear to enter the heads of many politicians. It certainly didn’t enter the head of Ed Milliband. Milliband decided that a freeze on energy bills after 2015 would be a massive vote winner. It was, until energy prices stopped rising. Last week, British Gas announced a 5% reduction in gas bills. If Milliband had been elected British Gas may have had good business reasons to not make the reduction. After all, why should they pass on the reduction in wholesale gas prices to consumers if they would not be allowed to pass on the costs of a future increase in the wholesale prices? This ostensible vote winner for Labour turned into nothing in the end. And I don’t recall it appearing once in the election debates. (Declaration: I always vote Labour.)

Then of course we have oil prices. These were destined to keep rising. Here are official projections of future oil prices from the UK government’s Department of Energy and Climate Change. This forecast was published in October 2014, and they are Brent crude prices.

oil

As they do, DECC publishes three scenarios: Low, Central, and High. The truth is expected to lie between Low and High.

But it clearly did not. Oil prices are above $75/bbl throughout the next 20 years in all projections. Yet two days ago the Brent crude price was $56.70 a barrel. Anyone basing energy policy on the above forecasts will be in for disappointment. And you must ask why the Low prices are so high. Aren’t the civil servants at DECC aware that the recent fall in oil prices are something we should expect to happen, but not be able to predict when it will happen?

We are, as Vaclav Smil has rigorously documented, fairly hopeless at forecasting the future of energy.

This sadly does not stop us from listening to confident soothsaying. Experts and their computer models can tell us all kinds of nonsense. Take this random one I came across on Twitter:

Why should we take these things seriously? We barely understand the costs of things today. How much does a solar panel really cost given the bewildering array of subsidies, both overt and covert, that go towards their production and consumption? What is the real cost of fossil fuels given our species appears too incompetent to carry out a simple act of taxing them using the sky as a dump for carbon dioxide? What is the oil price given that OPEC can in the eyes of many rig the market?

We don’t understand prices today and we have a woeful understanding of what they will be in the future. Be wary of those who tell you otherwise.

Recommended reading

Future Babble by Dan Gardner is an excellent history of bad forecasting and the unwillingness of many experts to admit their forecasts were wrong.

14 thoughts on “Energy policy should not be based on fantasy models of future energy prices

    Sam taylor said:
    July 16, 2015 at 11:18 am

    “Aren’t the civil servants at DECC aware that the recent fall in oil prices are something we should expect to happen”

    This seems somewhat unfair to me. Precisely nobody called the price collapse, and it’s taken everyone from investmant banks to the big oil companies by shock (BP and Exxon are in deep, deep trouble if this price point persists). Inflation adjusted prices have averaged over $80 every syear since 2008, bar the the year of the financial crisis.

    And 15 years ago an oil price of $50 would have been thought of as sky high. Funny how quickly people’s baselines change.

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      Robert Wilson said:
      July 16, 2015 at 11:51 am

      I’m not criticizing them for not predicting the fall in oil price. I’m criticizing them for having a low scenario where all future prices are higher than the current price. Policymakers end up believing the future will be somewhere between the High and Low scenarios but it clearly isn’t.

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        Sam taylor said:
        July 16, 2015 at 12:30 pm

        Well a forecast for 10 years time with a high probability of being somewhat accurate would probably have a range of $40-$200, with lots of violent and random oscillations thrown in for good measure, but it’s hard to know how helpful such a forecast would be.

        Besides, the crash in price was something of a black swan, which are things that people love to rationalise after the fact. I don’t recall anyone criticising their projections back when they were released. Based on what they’ll have known at the time when putting the document together I don’t see how they could have reasonably concluded the oil price would average below $70 this year.

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        Robert Wilson said:
        July 16, 2015 at 12:34 pm

        Talk about not getting the point…..

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        Sam taylor said:
        July 16, 2015 at 12:56 pm

        Planning without a forecast is very difficult. Accurately forecasting the future is very difficult. How do you propose we get around this dilemma, then?

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        Robert Wilson said:
        July 16, 2015 at 1:03 pm

        A second world war general was once told that two week weather forecasts were completely unreliable. He responded by saying, “Of course I bloody know that, but I need the forecasts for planning”. You seem to share the general’s need to be comforted by fictions.

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        Sam taylor said:
        July 16, 2015 at 1:13 pm

        So I assume that when you leave the house you pack a bag containing clothing for every concievable weather condition?

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        Robert Wilson said:
        July 16, 2015 at 1:14 pm

        Once again, you are totally missing my point. And once again it wasn’t an overly subtle one.

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        Sam taylor said:
        July 16, 2015 at 1:28 pm

        No, I just think you’re making a terrible point, and that smug rejoinders don’t really help your cause all that much.

        I’ll restate my earlier question more simply, and perhaps you might consider engaging with it and not tediously massaging your ego.

        In matters of energy policy, or troop deployment, one must make decisions now for periods far in the future, and these decisions, once enacted, are difficult to reverse. One has finite resources, and must decide how best to deploy them. So, when making these decisions, one is implicity attempting to predict the future. This is why people make models to try and predict the future in the first place to help guide these decisions. So, what do you suggest we do instead? Roll a dice? Because from where I stand all you’re doing is post-hoc rationalisation with nothing constructive to add.

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        Robert Wilson said:
        July 16, 2015 at 1:32 pm

        If forecasts have been shown to be no better than a toss of a dice, then yes, let’s go with the toss of a dice or call upon the oracles.

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        Sam taylor said:
        July 16, 2015 at 1:54 pm

        Thank you.

        Though, I must say, if the best we can do with our forecasts is equivalent to rolling a dice, then I don’t think it’s worth getting all that worked up over, because the outcomes are no different either way. But if there’s a chance that our forecasts are even slightly better than random then it’s a win for us. Hence I fail to see the downside.

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    Striebs said:
    July 16, 2015 at 3:56 pm

    When the authorities make a mistake , they deny it .

    When market participants make a mistake , they have to correct it otherwise they go out of business .

    Ed’s proposal to freeze prices is just an example which shows that UK energy is not market driven but under centralised command and control .

    If they can’t forecast prices what makes them so certain in their ability to pick the winners ?

    Robert , do you see the December/2015 Paris talks setting a CO2 price which actually causes substitution of gas for coal ?

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      Robert Wilson said:
      July 16, 2015 at 3:59 pm

      What does your question have to do with the post?

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        Striebs said:
        July 16, 2015 at 5:22 pm

        The relevance of my question to the original post is that it asks whether international agreements are likely to change the fuel mix – which would strongly influence prices of different fuels going forward .

        Rather than assume you have little hope for the December/2015 Paris talks changing anything , I though I would ask you .

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