Pragmatism, partnership, and people

In this piece, we take stock on where we now stand after a tumultuous period for the energy markets since Autumn 2021. But beginning, we want to give voice to the sadness our team feels at the terrible human impact arising out the conflict in Ukraine. This clearly is of much greater importance than the energy market effects we spend time as a business analysing. We offer comment on energy market impacts as one would expect us to, but always our thoughts and prayers are with those so badly affected by these terrible events.

Back in September 2021 we wrote a piece entitled “The stakes are higher than they seem”. We focussed on the rising costs of energy and argued that the government needed to map out the contagion of rising energy costs into the economy, and then try to put firebreaks in to ring fence the economic impacts. And in January 2022 we followed this up with more of a prospectus on the best way to re-think the market for an environment where it was clear, even prior to the commencement of the tragic conflict between Russia and Ukraine, that current market design and approaches to balancing energy security, markets, and decarbonisation were creaking somewhat “Wake up call”

In this latter piece, we set out an outline plan to restructure our net zero energy system with a need for a re-evaluation of electricity market design. We also argued that the government should produce a specific strategy for transition away from gas, including displacing imported gas by looking at indigenous sources for the same declining trajectory of gas consumption to net zero. And we put accelerating actions on energy efficiency and the demand side, at the very centre of the proposals. We also talked about the need for clarity on how policies will be sustainably funded, and we noted the limitation of recovery of investment (and wider) costs in the energy transition through energy bills if the intention is to do so fairly and sustainably.

Fast forward to March and I am afraid to say that many of these issues and questions have remained unaddressed. Meanwhile, the conflagration of energy cost inflation, fanned by the terrible human tragedy of a European armed conflict, has already overrun the wider economy and households. Significant financial costs are now guaranteed to flow through into the macro-economic picture and impacting real people and real businesses.

We now await a meaningful plan to deal with the transitionary pathway to a gas future that is compatible with net zero and secure and affordable, as signposted by Boris Johnson at his press conference on Monday 7 March and expected to be published imminently. The fundamental difference between now and the turn of the year is that this is being prepared at a time when gas costs have surged to even higher record levels. Whilst volumes continue to flow, market prices are responding to (variously) the risk of sanctions on energy imports from Russia, or possibly Russia reducing supply, or physical interruption to supplies in pipeline gas through Ukraine arising from the conflict.  

Gas costs have hit extraordinary levels this week, off a long lead in of higher than average costs for months. We need only take our own modelled projections of where the default tariff cap might be heading in October 2022 to understand just how much financial pressure this will place on households in the UK. The rebate scheme that the government introduced to address potential increases in the default tariff cap was, we argued, unlikely to be sufficient at the time, and certainly requires revisiting now. Meanwhile businesses will already be feeling the impact of increases in their energy bills, in both gas and power, which show no sign of abating. Recovery of the costs of previous energy supplier failures and heightened costs of balancing the electricity system only add to the upward pressure on energy costs.

The present situation also means that the environment in which decisions on energy policy are now being made is highly pressured and substantially more complex than before. Today, making energy policy is no longer just about the comparatively straightforward tension of the “trilemma”. It is now tied up inexorably with the geopolitical and economic strategic objectives of Europe as a whole. Energy security has rarely been so profoundly interlocked with issues of values, and national and international security.

But it is also true that energy policy now may also be less encumbered by the normal constraints and barriers that tend to apply to it, as actors recognise the requirement to enact change swiftly and to finance change more robustly if necessary. With this potential comes an immense responsibility to ensure that there is a balance between the pragmatism that the current geopolitical situation demands, and a resolute commitment to delivering net zero and an affordable, secure energy future that long term subsequent generations will no doubt expect.

The pillars we constructed in “Wake up call” still hold true as the foundations of a long-term energy strategy. But in the short term there are some urgent and new areas for us to consider as we face into the emergency unfolding around us. In proposing these we assume that the risks of disrupted gas supply from Russia, and thus consequential continued high price impacts on GB gas prices remain a real and present danger:

People: One of the biggest levers available to us to reduce exposure to gas, even in advance of energy efficiency measures or boiler replacement, is demand reduction. To say consumers can play a role is in no way to diminish the role of energy companies and governments too, it is instead a recognition that some consumers also have agency. Actions such as turning down thermostats by a degree or two or reducing the flow temperature of boilers to improve efficiency. Some suppliers have stepped up to the plate with a public information campaign on this, including highlighting consumers who may be better advised not to participate given their situation. But government could also play a key role in driving behaviour change. If there is one lesson to take away from Covid, it is that the public will radically change behaviour if they see clear benefits to them and their communities, and if it is clear who the target audience is such an appeal is being made to.

Partnership: In addition to reconsidering the balance between domestic and imported gas, we should be exploring a coordinated strategy with our interconnected neighbours on LNG procurement. This could factor in the realities of our shared gas infrastructure in terms of terminals, storage and transit, accounting for how we overcome likely bottlenecks in all parts of this value chain and investing in possible new capacity where time allows. We should also consider how we – as a trading and transit hub for gas – could use some more gas storage to cement our own resilience to short term stresses and play a better role in helping our international partners as a result. This won’t result in gas prices reverting to prior levels necessarily, but it will ensure much greater cross border efficiency in a world where east-to-west gas flows are not guaranteed or desirable.

Pragmatism: It has been somewhat disheartening to see the continuation of entrenched debates between technology proponents from all sides in the energy community, despite events that should be promoting partnership and cooperation. Of course, where there are low-cost and low carbon solutions (like merchant onshore wind and solar) that can be accelerated to reduce our dependence on fossil fuels even further in the near term then we should take them, noting that a place-based rather than one-size fits all approach is likely to be necessary given our geography and energy system. And where appropriate we should also seek to remove or reduce unnecessary friction to their delivery. But in truth, as we face into the next few winters there will need to be realism and flexibility in thinking. It serves nobody if we see underserved electricity or skyrocketing power prices creating hardship and misery that could have been avoided. Not only might this be inequitable, but it may also foment opposition to new policy in general. We cannot change reality and create platforms in 6 months that take 5 years or more of solid development to deliver, and it is unlikely that decisions on nuclear plant made on safety grounds would be reversed even in these trying times. So, we also need to make best use of what we have. As an example, consideration of if, how and when remaining coal stations could be used to provide additional reserve next winter is a question that should not be off limits.

Paying: Expensive bills for households and businesses have spill over effects for the economy more generally. The budget presents a great opportunity for HM Treasury to develop and then share measures for increased support where it is most needed. For households, there were myriad options discussed at the time of the rebate introduction, and proposals from key stakeholders were rich and well thought through on welfare, tax, and use of existing schemes. It feels like some targeted and more extensive action here could follow quite quickly given that backdrop. For energy intensive businesses there is also now going to be an intensifying level of concern. Support that allows for economically viable demand side flexibility could allow for a good balance between reducing consumption without risking the future of factories, plants, and jobs in the medium to long term.

In each case, we may need clear off ramps and triggers for ending these “emergency measures” so that they don’t become long-standing features of the market and end up slowing the implementation of (or indeed becoming) the longer-term strategy. 

We said in September that the stakes were incredibly high. They have increased immeasurably since, and now play out on a grander European scale than we originally envisaged. But so has the impetus, latitude, and potential to find solutions to the challenges of making a successful net zero transition happen.  The magnitude of the current crisis should focus minds on removing limiting factors and unnecessary barriers, drive unity rather than division, and open up thinking. The progress towards net zero to date, through our success in decarbonising power, has already contributed to our ability to reduce our dependence on fossil fuels, but a reliance on gas as a flexibility source will persist for years to come even under the most optimistic scenarios. We need to be creative and pragmatic about what the current emergency means for the mix of solutions that need to be leveraged to achieve net zero over time. Different technologies, approaches and sources of production and consumption may wax and wane over time, or by region. That is fine so long as we continue moving forwards, sustainably, and with popular support to the net zero destination. And on this latter point of sustainability, we are long overdue explaining to citizens the profile of the cost and benefits of the transition over time and arriving at truly equitable ways of distributing these across society and the economy.

In a way, these characteristics were always going to be vital components to achieving our energy policy objectives. The current crisis has just clarified the required actions and underlined the necessity of taking them.