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Overspends on electricity subsidies highlight the need to manage uncertainty

Failure to manage the uncertain costs of low-carbon electricity subsidies could lead to an overspend

The Department for Energy & Climate Change’s (DECC) failure to manage the uncertain costs of low-carbon electricity subsidies could lead to an overspend of nearly £1bn. Oliver Ilott sets out the wider lessons for government.

In some cases, uncertainty is unavoidable. In 2011, government decided to forecast and cap its spending on subsidies for low-carbon electricity (payments to wind farms, solar panels, etc). It knew that this process would inevitably involve managing big unknowns: windier conditions would mean more payments to wind farms, while some subsidies were linked to the market price for electricity and so were bound to fluctuate. But while the uncertainty was unavoidable, they must have judged that it was manageable. Today’s National Audit Office (NAO) report shows that government failed to manage it.

A key requirement in managing uncertainty is to constantly refresh your forecasts, making sure that the analysis on which you base your decisions is informed by the most up to date information. For this reason, the Office for Budget Responsibility updates its fiscal forecasts twice a year, to allow the Chancellor to adjust his plans in the Budget and the Autumn Statement.

The Government had already experienced the implications of getting energy pricing wrong – when the fall in the cost of solar technologies meant that it was providing a very high return to those who could afford to install panels – at  the cost of the general electricity consumer. Eventually it took much political flak for reining the scheme in.

Earlier on it had been hit in the opposite direction – when its assumption that falling energy prices would allow it to meet its fuel poverty targets faltered in the face of energy price rises in the mid-2000s.

So when government tried to cap electricity subsidies, there was no excuse for failing to institute a process for updating its analysis. Between 2013 and 2015, government did not attempt to refresh its understanding of the underlying costs of the technologies it was subsidising. As prices fell, the Government kept on signing contracts based on those stale forecasts – at a cost to consumers of £615m of subsidy. By the time the government reviewed its subsidies in June 2015, it discovered that it was actually on course to breach the cap for 2020-21 by £1.5bn (the breach is now forecast to be £0.9bn).

In part, the Government failed to refresh its forecasts, because those who should have been driving this work went AWOL. The ‘Levy Control Board’, established to provide joint HM Treasury/DECC oversight of the subsidies, stopped meeting after November 2013. By the time it met again in July 2015, it found that the cap on subsidies was due to be breached. As the NAO note, there was no one in government asking the question ‘what if the forecasts or key assumptions are wrong?’

One potential explanation for this is that managing uncertainty simply wasn’t prioritised within DECC. An internal review in May 2015 concluded that part of the reason for its weakness in collecting market data was that officials were preoccupied with other tasks, namely with implementing the Government’s high profile ‘Electricity Market Reform’ package.

The NAO report does note that DECC (now merged into the new Department for Business, Energy & Industry Strategy) has since overhauled its processes for managing the uncertainty around low-carbon subsidies. Responsibility for analysis has been split from responsibility for policy, improving the scrutiny of forecasting assumptions. The Levy Control Board now meets once a quarter. The report notes that DECC benefitted from a broader trend of improved commercial capability across Whitehall.

In 2013 the former Treasury Permanent Secretary made a number of recommendations about improving the use of analytic models – including forecasting models – in government. It makes only passing mention of the need to regularly update assumptions to make sure they take account of the most recent information. That needs to be added to the list.

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