Wrangling within the UK’s coalition government over how to decarbonise the electricity sector as part of the draft energy bill has paralysed investment decisions and resulted in a mixed message about the future of the country’s power system.
On 25 July Energy and Climate Change Secretary Ed Davey told Parliament that gas will continue to play an important part in the energy mix well into and beyond 2030.
Clarifying the point, the Department of energy and climate change (DECC) released a statement the same day saying that it did not expect the role of gas to be restricted to only providing back up for renewables.
Proposed subsidies for renewables in general (and wind generation in particular) coupled with proposed aggressive decarbonisation targets in the government’s draft energy bill have raised concerns in the gas sector that gas-fired generation would become commercially unviable.
Bolstering the government’s attempt to convince investors Britain still has a credible gas strategy, the Treasury announced on 25 July new tax support for North Sea gas in the form of a £500m (€638m) field allowance for large shallow-water gas fields.
It seems likely the positive announcements for investors in the UK’s gas sector are linked to a compromise by the Treasury over its demand for deep cuts in subsidies for onshore wind farms. These will now only see a 10% reduction in subsidies (previously the Treasury was seeking a 25% cut in subsidies).
It is not clear whether this more modest cut will maintain support at a high enough level for new investment, particularly given this is due to be reviewed in 2013.
Worryingly, the UK is no closer to having a stable long-term energy and climate policy, nor will it while the debate is not framed correctly.
If the government is really serious about reducing the UK’s carbon footprint while keeping bills down then it is going about it completely the wrong way.
Instead of encouraging investment in hugely expensive onshore and even more expensive offshore wind generation, it should be looking to switch away from burning coal and replacing it with gas-fired generation as soon as possible.
If the carbon pricing mechanism was fixed, politicians wouldn’t even have to make the politically difficult decision to do this themselves because the market would do it for them, as producers would be forced to switch off coal-fired plant.
Gas-fired plant has half the emissions of coal-fired, and a switch to it could be achieved at virtually no additional cost to consumers or to industry.
Such a switch would provide a brief but important transition period to allow time for technologies in renewables and even carbon capture and storage to catch up.
Coal-fired power generation currently represents around 30% of the UK energy mix, but this can rise to 50% at peak times during the winter.
Building hugely expensive wind projects won’t even offset emissions from dirty coal-fired plant, but they will increase the cost paid by consumers for electricity.
Gas is the best compromise way forward that still maintains security of supply, and the draft energy bill needs to reflect this when it goes back to Parliament in the autumn.
The draft energy bill, published on 22 May, represents a tremendous setback for proponents of market deregulation and competition. The bill is the government’s response to the country’s need to address two issues. First is that of supply security. The UK faces a growing reliance on energy imports – particularly natural gas – used to generate electricity, and needs to replace one-fifth of its electricity generation capacity over the coming decade.
Second, the draft bill’s electricity market reform proposals attempt to put Britain on the road to achieving its aggressive plan to decarbonise its economy while ensuring that the cost of energy bills is kept in check.
The draft attempts to do so by encouraging investment in nuclear and renewables power generation at the expense of gas-fired generation. Unfortunately, in its current form, the draft would fail to deliver what the country needs. Politicians and the general media are quick to play the security-of-supply card, and this publication has made the case many times that an increased reliance on gas imports is not a supply security concern per se.
The UK’s need to replace one-fifth of its generation capacity is a big problem. The government estimates it will need to attract £110bn (€137bn) over the next decade to meet electricity demand, while meeting its ambitious carbon-reduction targets. Yet the draft bill lacks the crucial detail required to make investment decisions.
The government says it will introduce a feed-in tariff (FIT) based on contracts for difference (CfD) for low-carbon power generation in 2014. Operators would receive a payment from a contractual counterparty if wholesale electricity prices fall below the strike price, but would have to refund the difference if prices exceed the strike price. However, the draft bill fails to clarify how exactly prices will be determined, and how frequently they will be reviewed.
Irrespective, governments can quickly U-turn on policies. In 2011, Germany chose to shut down its nuclear power stations, while the UK introduced a subsidy cut of up to 50% for solar projects.
Unfortunately, nuclear and offshore wind farms – the two types of generation most favoured under the draft energy bill – require huge upfront costs that take years to recoup, and would be the first to suffer any later U-turns in policy by successive governments.
Conversely, the set-up costs of gas-fired generation are small, with the bulk of the generation cost linked to the fuel itself. Current estimates puts the cost of offshore wind at two to three times that of gas-fired generation.
The government also makes the case that introducing long-term contracts for low-carbon generation will reduce consumers’ exposure to generation fuel price volatility, and assumes that the price of gas is set to rise much higher.
But this is a big assumption, and a misleading one. Retail energy prices are notoriously slow to respond to a downturn in wholesale energy prices. And while the wholesale gas price is volatile, it sits far below the long-term oil-indexed gas contracts that supply much of continental Europe.
With the US set to become a huge gas exporter and the more distant promise of a shale gas boom in Europe, a future high gas price is by no means certain. The reality is that CfD contracts represent an overly complex way of delivering much-needed investment. To address these issues, the government should stop interfering and instead strengthen the market.