Things not to do: Cap energy prices

In 1979 my colleague, Eamonn Butler, co-authored a book entitled "Forty Centuries of Wage and Price Controls."  The book showed that, throughout history, all attempt to fix prices by law had led to shortages, economic dislocation and black markets, and had ultimately collapsed. Throughout history, starting with the Babylonian emperor, Hammurabi, people have thought there was a fair and just price for things. Thomas Aquinas thought the same.

Politicians, including Richard Nixon and Edward Heath, have imposed price caps when people thought that businesses were profiteering unjustly when prices of scarce commodities rose. The problem is that price is a signal that responds to changes in supply and demand. When the price rises it tells consumers to use less of a product if they can, or to switch to cheaper alternatives. It similarly tells producers to step up production or to enter the market to take advantage of the increased price. In the absence of that signal those messages are not conveyed.

To impose prices by law is akin to blocking up a thermometer to stop it registering temperature. The heat pumping into a room will continue if nothing is done to stop it, despite the now-fixed reading on the thermometer.  In a similar way, prices fixed by law will do nothing to redress the imbalance between supply and demand that price changes indicate.

Energy prices have many components. They take account of the costs of extraction of the energy source, the costs of processing it, the costs of transporting it, and the costs of distributing it. They also factor in changes in the total demand for energy, something subject to short-term weather and seasonal changes and to long-term trends. Changes in any of these components can affect energy prices, some gradually, some sharply.

If energy prices are capped, energy companies will have less incentive to locate and extract new sources, and some potential sources will be unprofitable to develop at the capped prices. They will have less incentive to invest in new facilities and to invest in upgrading existing ones. The result will be energy shortages in the future. The politicians who enact energy price caps will be bidding for the support of today's consumers at the expense of tomorrow's ones. Pegged prices now will lead to blackouts in the future.

The way to put checks on price rises is to make it easier for new companies to enter the energy market to compete with existing ones, and for consumers to switch easily between suppliers. Competition and the fear of losing customers will restrain companies from raising prices without threatening the future supplies of energy that price caps will.