On 17 June 2019 our CEO Gareth Miller spoke on the panel at a joint event with law firm TLT on Clean Energy Growth. Many of the key themes set out by Gareth were echoed in this week’s Energy Spectrum, in which he discussed the government’s decision last week to legislate for a net zero carbon emissions target by 2050, and why there is now even greater expectation on government to ensure that policy decisions measure up to the new goal. Read Gareth’s thoughts below.
While this is an epoch defining development for the energy sector, all eyes will now turn to the hotly anticipated White Paper to determine whether policy can measure up to the new goal. We consider how the White Paper might unleash the power sector to achieve this end. We conclude that setting out a coherent vision, building coordinated action, and dealing openly with the realities of uncertain cost requirements and barriers to investment are good places to begin.
This train don’t stop here anymore
On 12 June the government announced that it would lay a statutory instrument to implement a target for the UK to achieve net zero emissions by 2050. The change will increase the 2050 emissions reduction target in the Climate Change Act 2008 from 80% to 100%. It also means that the UK is likely become the first G7 country to legislate for net zero emissions. BEIS Secretary Greg Clark, in introducing a debate on the amendment, told the Commons that the UK stood on the threshold of a new, fourth industrial revolution, punctuated by green growth and clean, renewable technologies. Clark cited that the offshore wind industry, leadership in green finance and research and development in electric vehicles would fuel the engines of this revolution. He also cited the Committee on Climate Change’s (CCC) advice to legislate for net zero (see ES664) including UK emissions from international air travel and shipping. He signalled that a further focus of policy could include looking at better use of land, technology and logistics for carbon sequestration, and supporting investment in areas such as carbon capture, usage and storage (CCUS), and in hydrogen and bioenergy.
With the long-term goal now significantly more ambitious, the focus now naturally turns to the energy White Paper, expected during this summer. There are heightened expectations that it will set out the big policy levers to commence the journey to net zero. Rightly so. BEIS is unlikely to have been taken by surprise by the need to accommodate net zero, knowing as it did that the CCC would be publishing its advice in May. Therefore, the White Paper has been prepared with this backdrop in mind. What can we expect? It is highly likely that the policy will be presented through the prism of the four principles that Clark set out in November 2018 (see Figure 1).
In light of a stretched department and the fast-moving political agenda, it is probably reasonable to expect the White Paper to favour a focus on “outcomes” over “means”, particularly on heat and transport where further consultative work is either already in progress or has been signalled. We will return to these two sectors in future Energy Perspectives. In the power sector, we should expect more detail, and there are a number of areas where it can step off on the right foot.
Don’t let the sun go down on me
For investors in low carbon power, the opportunity in a net zero transition is enormous and positions energy as one of the only sectors of the economy with huge capital demands. This is at a time when capital markets are very liquid, and investors are looking for places to put their money.
The CCC projects that to meet its “High Ambition” 2050 net zero scenario (see Figure 2), power generation volume will need to double. It sees the lion’s share of growth coming from renewables, but also with significant application of new nuclear, CCUS and bioenergy with carbon capture and storage (BECCs). In offshore wind alone, it implies growth to 75GW, compared to 8GW today. Staggeringly, in total, the GB generation market overall would need deliver new build capacity at a rate of 9-12GW per year.
All this is to be done when the established investment signals traditionally provided by support schemes funded through consumer bills have been radically cut back. At the moment, outside of the offshore wind and Hinkley Point C-led Contracts for Difference (CfD) scheme, low carbon developers are being asked to take risk on wholesale markets. There is a growing consensus that intermittent generators will be impacted by wholesale price volatility and cannibalisation – where periods of high-power production drive down prices for the renewables generators most likely to be producing then.
Many types of investors will be needed to deliver the required new capacity for net zero. The risk-averse of these like banks and pension funds will want project cashflows to be stabilised by contractual price fixing or floor prices. Expecting them to invest large sums of capital over long time periods on forecast power prices is unrealistic.
Power purchase agreements, co-location of batteries and renewables and portfolio models like virtual power plants will all deliver some price stabilisation. But, based on consultative and analytical work that we have undertaken, it is evident they are not scalable to deliver the capacity and output growth that net zero entails. The White Paper is therefore a timely opportunity for government to show it understands these investment and market realities.
It could do so by tabling sustainable models for smoothing out volatile cashflows from the wholesale markets for all technologies requiring long-term investment, not just those covered under the “less-established” or “first-of-a-kind” umbrella. This needn’t cost the consumer in the long run. With falling technology costs for renewable technologies, the setting of prices around which cashflows could be smoothed will be very low. The consumer could provide shorter term working capital support through floor or fixed prices, with any support provided repaid as wholesale prices trend above the level of stabilisation. Given the scale of net zero, whether consumers exclusively provide that underwriting on a volumetric basis is a question that also needs reconsidering.
Goodbye yellow brick road
The second challenge the White Paper could address is the vision for the low carbon power market in 2050. This entails a clear message about the ultimate system we wish to build and the different models we might want to use to deliver it. There are at least two decarbonisation models for the future on the table currently:
· through large, transmission connections of power from nuclear, gas CCUS, interconnectors and offshore wind, and
· the local delivery of a low carbon system through smaller scale renewables, storage and a much greater role for the demand side.
Establishing these as evolutionary phases rather than competing end-state models to achieve net zero is important. Both may need to co-exist periodically, with the policy balance and focus changing over time. But it is not clear what view the government takes on this at all.
Given what has been trailed thus far one can expect the White Paper to provide encouragement for new nuclear through some form of Regulated Asset Base model, and a CfD for CCUS. This should offer encouragement to investors in the large-scale model. On the other hand, investors and developers in decentralised markets are reeling from network charging reforms and the transition from guaranteed Feed-in Tariffs to the market vagaries of the Smart Export Guarantee. They will be hoping to see a White Paper vision that at least acknowledges they have a long-term role to play. Both sides are likely to be concerned about how resilient government commitment would be to maintaining support as political and economic priorities change. The danger is that BEIS working to the principles of “insurance” and “optionality” introduced by Clark in November 2018, ends up encouraging a hedging of bets by developers and investors of all sizes and stripes.
Candle in the wind
Thirdly, there should be a recognition of a need to better coordinate government and the regulator to achieve long-term policy goals. We anticipate parts of the White Paper to reference work on rationalising and making more agile code governance. But this should be supplemented by greater coherence at a strategic level too.
The pace, depth and impacts of the Targeted Charging Review (TCR), Significant Code Review (SCR) for network charges is a case in point. However much Ofgem thinks there is a case for pursuing changes that correct incentives, the combination of this review with wider changes that reduced value for decentralised, flexible and low carbon projects has been poorly received by small developers and investors in decentralised energy.
It is government’s role to set strategic policy direction and it does have powers under the Energy Act 2013 to bring coherence between policy and regulatory action. The Secretary of State is able to set out a Strategic Policy Statement (SPS); the particular policy outcomes to be achieved as a result; and the roles and responsibilities of those who are involved in implementation of that policy. The Act is clear that Ofgem must then have regard to the SPS when carrying out its regulatory functions.
In August 2014, the then government consulted on its first ever SPS, but despite concluding the consultation it was never enacted. A written answer to a Commons question by Labour MP Alan Whitehead said BEIS had confidence in Ofgem carrying out its duties and functions to deliver “a raft of policies on decarbonisation”. But net zero is a game changer and in light of the scale of coordination required to achieve it, the time of the SPS (or an equivalent) may well have come.
The fourth area is how the question of uncertain costs of this transition will be presented in the White Paper. In the Commons, Greg Clark was clear that one of the main reasons for moving to net zero was that the government believed it feasible that net zero can be met within the exact same cost envelope of 1% to 2% of GDP in 2050 as the 80% target when that was set.
The Treasury will now lead a review of the costs of decarbonisation, as recommended by the CCC. This will look at how costs will be shared across households, businesses and the public finances, and consider implications for UK competitiveness.
Consensus to proceed with net zero has been formed around today’s view of the future, but the truth is that projecting costs of the monumental transition to net zero based on many inter-dependent assumptions is always going to be fraught with risks and uncertainties. There is every prospect that much more money will need to be found to make the transition happen once we get into the detail of policy and real, operational data replaces assumptions.
How the White Paper positions government appetite to flex the public finances to meet higher than anticipated transition costs, should they arise, will send a strong signal about the seriousness of the net zero commitment. Without it, the commitment risks being seen as rhetoric.
The White Paper, following so closely as it does to the net zero commitment, is as significant as it is timely. It is the government’s first opportunity to lay out a clear vision for the power sector in light of the higher ambition, including how it wants to coordinate policy and regulation, how flexibly it approaches funding the costs of transition, and how it hopes to break down real investment barriers. Understandably, it cannot and will not provide the detailed answers. But it presents the opportunity to confound those who will accuse government of failing to back up long-term targets with an outline of the big levers it could pull to achieve them. Despite the broader political uncertainty, the imperatives of net zero means that this is an opportunity that cannot and should not be missed.