Concerns that the strike prices in the upcoming CFD auction round could be too low to be deliverable have been raised as more details of the scheme have emerged. Back in May 2022, our chief executive Gareth Miller discussed why such fears may have some grounding.
Last week I was on a great panel for Mott Macdonald and the Energy Industry Council on UK security of supply. Amidst discussions on skills, technology choices, market structures and fuel mixes, my main theme was that costs in the energy sector are generally rising, and I don’t just mean the obvious issue of gas and rising wholesale prices, although this is something we expect to see continue. More concerning is that the picture on wider costs also looks challenging.
- Non-wholesale – policy and network – costs are steadily rising, to a peak mid-decade by our forecasts, before layering on expected charges for new nuclear, hydrogen and carbon capture usage and storage. There could well also be a whole array of as yet unquantifiable costs that will likely flow from further action on heat and transport decarbonisation as the decade unfolds.
- Supply chains are under pressure from rising material costs, with (for example) wind turbine suppliers bemoaning margin pressure and warning that something needs to give. This was echoed earlier this year by then Siemens Gamesa chief executive, Andreas Nauen, who said that the company had been hit by a “perfect storm” of spiralling materials and freight costs, along with frequent transportation issues, with Nauen adding “we have components where delivery times have been increased from five weeks to nearly 50 weeks”. The paradigm of ever-decreasing renewables auction prices cannot be banked on, or if they do continue to fall then the risk of fragility in supply chains may well rise. Either way, an upward adjustment feels likely.
- Add in the rising costs of credit from interest rate rises feeding through to underlying capital across the financing markets and noting how pivotal financing costs are going to be given the investment challenge, then that’s non-trivial. Some of these are medium-term, others may relent, but all are issues given the need to carry public confidence. It is dangerous to simply assume continued funding for the array of technologies required to achieve security without rethinking who pays what, how much and when.
My argument was that whilst government and private capital are vital, in truth the ultimate source of money in the energy sector comes from consumers. Policy incentives that allow investment to be raised and repaid, and the system costs of managing and maintaining the network, are set confidently on the assumption of recovery from bills.
But what happens if larger proportions of consumers than before either can’t pay, or won’t pay? I used to think that was an interesting thought experiment, but an unlikely scenario. Now the risk has increased. Uswitch have said that the amount of money that households owe their energy supplier has doubled in the past year to £1bn, with 23% now in debt to their supplier. And if we head into recession, is it really credible to maintain an ever-increasing cash call on ever-tightening business and household budgets? This would be the first recession of the net zero age, but it is unlikely to be the last, which is a reflection of economic cycles rather than cause and effect. It brings into sharp focus the ability to maintain financing energy transformation during periods of general hardship.
The Default Tariff Cap doesn’t solve the issue, whether 3 months or 6 months. Temporary interventions designed to smooth out or cap costs, as we have seen previously, ultimately spread liabilities but do not remove them, as we have seen with the COVID-era loan schemes to defer electricity balancing costs. We thought those costs were exceptional at the time, but they now look like the new normal. Balancing costs in 2020-21 totalled £1.8bn, with a further £21.4mn deferred into the 2021-22 charging year. However, balancing costs continued to rise significantly in 2021-22, totalling £3.1bn, before the inclusion of the deferred costs from 2020-21, with a further £43.9mn of costs deferred to the 2022-23 charging year.
What all this points to for me is that yes, we need to explore the relative merits of all technologies and business models to deliver the flexibility and strategic resilience to ensure low carbon energy security. And yes, so long as we recognise the need to maintain investor confidence, we need to think about further network infrastructure solutions as well as questions of market design to remove inefficiencies, and create proper incentives and unnecessary costs. And of course, we need to think about unlocking new investment in transport, heat and the broader economy.
But nothing happens without the continued, sustainable flow of cash around the system, whatever technical or market solutions we choose overlay. And if we don’t resolve the issue of public expectation of lower energy costs with the reality of rising bills then there is a crisis likely to occur somewhere down the line, and not just this winter. Talk of GDP neutrality/benefit of net zero by 2050, or net zero being “cheaper than the counter-factual” is fine, but isn’t constructive to families struggling now, or indeed at various intervals as we move from the current system to the low carbon system we do desperately need to make real. This is unlikely the last time that energy costs will be front and centre of economic and political agendas given the scale of the ambition and the likelihood of ups and downs in the fortunes of the broader economy that will occur over the next few decades.
So, the most pressing issue – as others have alluded to – is addressing the issue of higher costs, transparently with the public, and then working hard to develop a sustainable funding model that moves us away from layering new costs uniformly into price cap formula-driven bills, and which can prevail regardless of whether we are at the peaks or troughs of economic cycles. We need a big focus on the model of funding the costs of energy and the costs of transition, and we need it soon. The Treasury needs to look again at its Net Zero Review of costs and this time takes its responsibilities much more seriously.
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