Cost of carbon

1 September 2009


A recent study by Ernst & Young into the UK’s energy investment requirements to 2025 found that the recession-induced fall in demand had lowered the investment requirement by up £35 billion, but that £90 billion of investment needed to be made by 2015 to secure the government’s 2020 renewable energy targets – ie, the absolute level of investment has fallen but this needs to be brought forward if this reduced investment opportunity is to be fully realised.

The problem with implementing this investment scenario is that the UK is going through a period of political flux. By next June there will have been a general election and of the three possible outcomes – Labour win, Conservative win or a hung parliament – the least likely outcome is a Labour win that would provide some policy continuity.

Investors will have their personal political allegiances but what is more important to them is policy clarity and certainty. Currently, all investment has to satisfy the new planning regulations taking effect in the autumn, but within a year a new Conservative government could alter these investment parameters.

It is not just the potential changes to the planning regulations that need to be considered; there are also the investment incentives and limitations that will change if the colour of Britain’s political map changes to blue. For example, a Conservative government would introduce emission performance standard legislation that would prevent the construction of any coal-fired plant not fitted with carbon capture and storage (CCS) technology. It is also committed to introduce feed-in tariffs, which could potentially impact on the Renewable Obligation.

And it is not just political flux that will impact investment decision-making processes; there will also be a degree of economic flux. From an investment perspective the economic downturn is both a saint and sinner – a saint because it has reduced demand and thereby corresponding medium-term investment levels, and sinner because it has altered the risk-reward scenarios of investors firmly in favour of rewards with investors becoming more risk averse at a time when the market arguably needs more risk takers if a new robust green economy is to replace the damaged oil-based economy.

In publishing its UK Low Carbon Transition Plan ahead of the summer recess, the government claimed to have provided investors with a route map, with energy and climate change secretary Ed Miliband proclaiming: ‘Our plan will strengthen our energy security, it seeks to be fair to the most vulnerable, it seizes industrial opportunity and it rises to the moral challenge of climate change.’

Few can doubt Miliband’s assertion that the government is rising to the moral challenge of climate change, although some would argue the government has acted as a European laggard in this respect. But the energy secretary’s stated belief that his strategy will strengthen energy security is open to debate. Joining this debate was the Confederation of British Industry, which published a report, Decision Time, calling for a lower renewables share in order to realise a more balanced energy mix.

The CBI report should not be dismissed, and it is unfortunate that these views were not expressed earlier in the renewable consultation process. Ever since the government signed up to the EU 20% renewables by 2020 target Britain has risked compromising its security for sustainability, although somewhat fortuitously for the government the recession has deferred and destroyed demand on a scale sufficient to all but eliminate the supply risk caused by the closure of opted-out LCPD plant in 2015.

Based on the government’s own forecasts, coal’s generation share will fall from 32% to 22%, gas from 45% to 29% and nuclear from 13% to 8% by 2020 in order to accommodate a five-fold increase in renewables. With most of the new renewable capacity to be wind, this means that the share of guaranteed baseload plant will fall from 90% today to 60% in 2020 and the share of ‘clean’ baseload (ie nuclear) will almost halve. This does not inspire supply security confidence.

There is also a heavy cost associated with the government’s five-fold renewables increase, estimated at £100 billion or almost £10 bn per annum until 2020. But, according to the CBI, this investment would provide a higher share of low-carbon energy if the renewables target was scaled back to 25% and the regulatory frameworks for nuclear and carbon capture and storage were in place. Under the CBI approach Britain could derive 83% of its electricity from low carbon sources by 2020 compared to just 64% under the government’s renewable-driven approach. As such, not only would a more diverse supply market be more secure it would also be more sustainable at no additional cost.

Undeterred by the criticism, this particularly thick-skinned government announced European Investment Bank funding for small to medium sized onshore wind projects, which it said proved the intent in its low carbon plans, and it rejected fresh criticism from a loose business coalition, including the British Chambers of Commerce, that there were insufficient green investment incentives, pointing out that a more ‘robust’ carbon price will evolve in the third phase of the EU ETS.

The problem the government faces is that it is seemingly unable to convince risk-averse investors that its low carbon plan will provide sustainable returns. And without this necessary confidence it will likely struggle to develop the necessary energy infrastructure within the required timeframe.

Another problem faced, but that has yet to be adequately addressed, is the assertion that the government has created a non-level energy investment playing field that is too renewable/wind-centric. EDF Energy has called for financial support, ie subsidies, for its nuclear build programme, while the market also awaits the funding proposals for CCS, expected in the autumn.

Most, if not all, of the investment concerns could be alleviated with a low-carbon obligation to run alongside the Renewables Obligation or a feed-in tariff for nuclear and CCS-fitted fossil fuel plant. Such an obligation or tariff would provide some of the economic certainty that is missing from the government’s low carbon planning. If secured, the investment in Britain’s new low carbon energy infrastructure could provide the country with £10.5 bn of incremental economic benefit, according to the Ernst & Young study.

But there appears to be a gulf between the necessary medium-term investment and the promised economic benefits. And when business returns from its annual summer break the government has to fully address these investment concerns or risk Britain’s missing out on the full economic benefits of its carefully planned, but largely aspirational, low carbon future.




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