"To meet targets, Britain has to build wind farms, no matter what the consequences for security and price"
Energy crises are often triggered by surprises—from the Arab oil embargo in the early 1970s to more recently the Fukushima disaster. Britain’s energy crisis is, however, unlikely to be a surprise. It has been coming for a long time, masked by the economic recession, and seriously exacerbated by a combination of fundamental misunderstandings about markets and market design, poor regulation, an enormous bet on marginal and expensive technologies, and a stubbornness in the face of mounting concerns.
The facts are widely known and not much in dispute. Many of Britain’s power stations are old, built against the assumptions of the very different energy world of the 1960s and 1970s, when Britain was relatively energy intensive. All our coal stations are pre-1980, and the first and second generations of nuclear power stations are coming to the end of their lives, if not already shut down. The renewables have made little contribution so far, and they are intermittent, so until mass storage comes along, they do not remove the need for conventional generation. More renewables means a higher total capacity is needed on the system, since when the wind doesn’t blow something else has to generate the electricity.
It does not take a genius to work out that as the old stations close, and little else is added, eventually the gap between supply and demand will close up, with nasty consequences for prices. Even the regulator, Ofgem, appears to have finally realised this.
Unfortunately, the incumbent companies have little incentive to come to the rescue. Higher prices mean higher profits. In most markets, high profits attract entrants. Investment by the private sector is, however, a voluntary activity, as the government is discovering. In energy, that investment takes time. Security of supply is a system problem, and not necessarily a problem for the incumbents. For them, it is better if nobody invests, giving them much higher returns on their existing power stations. After a decade of unprecedented mergers and acquisitions—coupled with a good dose of financial engineering—most of the big players are in poor shape to do much investing anyway. Bashing the companies might make good politics, but it makes lousy economics.
If these facts are well known, how did the politicians and the regulators at Ofgem let it happen? Or, perhaps more accurately, how did they create the conditions for the coming crisis? Ofgem led the way by forcing through a set of ill-conceived market reforms at the end of the 1990s. Ofgem made the economic mistake of thinking that the electricity market would automatically guarantee security of supply, voluntarily creating the necessary excess supply margin of capacity to absorb demand shocks, and all without being paid for directly.
From Margaret Beckett to Ed Miliband, Chris Huhne and now Ed Davey, a succession of politicians made things much worse with a deeply flawed underlying narrative and set of assumptions about future energy markets. The main components were: a conviction that oil and gas prices would go ever upwards as a result of “peak oil” and “peak gas” (the theory that fossil fuels are finite, so supply will inevitably decline, causing prices to rise); a belief that if only enough subsidy from customers was spent on the current generation of renewables they would become cost competitive, and make a difference to global warming; and a naivety about the relationship between energy efficiency and energy demand. From these beliefs followed the prediction early on in this government’s life that the current policies would lower total customers’ bills by 2020.
The story that knits these assumptions together runs roughly as follows. Ministers after the last election “knew” that the oil price would increase sharply, and that gas prices would remain linked to oil and would be volatile. (No mention was made of the volatility caused by wind). It was therefore only a matter of time before they surpassed the costs of wind and rooftop solar. All we had to do was build lots of wind farms and install the current solar technology and all would be well—reinforced by a good dose of energy efficiency and perhaps some new nuclear power stations. Indeed, the argument ran that if there was an error it was not pushing on much faster in this decade with more current renewables.
In this fantasy world, pity the poor Americans. They would be lumbered with all these incredibly expensive fossil fuels whilst Britain would bask in the warm glow of cheaper wind farms. Energy intensive industries would presumably flock to Britain’s safe haven of cheap energy, outcompeting the US. America as a result would be an economic basket case, stuck with its dependency on oil and gas, and its energy companies would be lumbered with stranded fossil fuel assets. It would also, on this view, suffer from the lack of all the new green jobs and world-beating renewables industries that Britain would have developed.
You might think that as the evidence mounted there might be a pause for reflection. But not so. As the evidence has mounted, as the US marched on towards energy independence, lots of new jobs were created in the new shale oil and gas industries in the US, and energy intensive industries began “re-shoring” to the US from China and elsewhere, so campaigners intensified their efforts to kill off gas in Britain. Their argument is that to build more gas power stations now would be to lock Britain into a high-carbon world going forward. The hardliners simply want most new gas power stations banned—and, above all, shale gas banned.
The carbon and methane consequences of gas are serious, but the campaigners are wrong about the role of gas in the transition to a low-carbon world. Globally, the alternative to gas in the next decade is not wind farms but coal. Wind is a low density intermittent energy source. There is not enough land and shallow water to build sufficient wind farms to make much difference to global warming. Across Europe, new coal power stations are being built—notably in Germany, based on very dirty lignite, itself subsidised. Existing coal stations are working hard, driving up emissions too. Gas has half the carbon emissions of coal, and as the US has demonstrated, switching to gas is driving down carbon emissions there, whilst coal is driving them up across Europe.
In the wider world—which is what matters for global warming—coal is being added in frightening amounts. Between now and 2020, China and India may add between 400 and 600GWs of new coal, even if the Chinese do all the environmental things they say they will in their 12th Five-Year Plan. To deny that gas has a transitionary role to play in halting this dash for coal is to condemn the world to temperature increases well beyond the aspirational limit of two degrees. As I argue in my book, The Carbon Crunch, a more sensible and balanced way forward is to build some current renewables, put a big effort into the more promising future renewables and use gas as a transitional fuel instead of coal—more like the American approach, and less like the European.
In the meantime, it is worth diverting just one or two of the tens of billions going into offshore wind into Carbon Capture and Storage (CCS). The North Sea is one of the best places in the world to try out this technology—shallow, with depleted gas fields and pipelines already in place. It might not work, but then again it might, and if it did it would provide another transitionary lifeline.
For Britain, new coal investments are at least limited by the emissions standards. Here it is less a question of coal versus gas, but rather gas or nothing much else—at least in this decade—unless the government gets a derogation from the EU Large Combustion Plant Directive limiting non-carbon emissions from existing power stations, and is allowed to keep running old, dirty coal power stations.
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The department of energy and climate change (DECC) is confident that, notwithstanding current policies, the bills are going to come down because they assume that measures to increase energy efficiency will drive down demand far enough to offset the higher unit prices. This confidence is based upon two assumptions: first, that there are lots and lots of energy efficiency opportunities that are already profitable and, second, that higher energy efficiency will drive down the demand for energy. DECC believes that its flagship Green Deal will see a transformation of the housing stock, and that there will be little or no rebound—the spending of the energy savings on yet more energy for things like air conditioning. The hype around the Green Deal already looks embarrassingly overdone, and since energy efficiency (a good thing) reduces the cost of energy, economics suggests that overall energy demand will go up, not down, as it has for the last 200 years. It is high prices, not energy efficiency, which reduces demand. Energy efficiency and energy demand are two different things.
Customers already struggle to pay. By 2015, possibly a quarter of all households will be spending more than 10 per cent of their total income on domestic energy bills, of which already over 10 per cent is made up of various policy levies.
A much-ignored golden rule of energy policy is that the customers actually have to be able to pay. It is hard to avoid the conclusion that the wall of costs coming from current policies is unsustainable, but surprisingly few draw the corollary—that it will not be sustained.
Add all this together and the outline of an energy crisis is pretty clear. Britain may of course get “lucky” in energy terms as it has since 2008. The economic crisis may continue, GDP may fall, and hence energy demand may stay subdued. But that is a poor bet and anyway in such a depressed situation the bills issue would probably be overwhelming. Recovery and a lower exchange rate mean a gradual rebalancing—more manufacturing means more energy demand, and economic growth drives consumption.
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So what is to be done? Having dug a very big hole, the first step is to stop digging. Unfortunately there are two separate but related reasons to doubt that the spades are about to be put away soon: the EU renewables directive and the energy bill.
The renewables directive requires that Britain generates at least 15 per cent of its total energy from renewables (as defined by the EU) by 2020, and since we cannot do much about transport and other main uses of energy in the short run, this means that a massive 30 per cent of Britain’s electricity will have to come from renewables if this target is to be met. Given the target date is so short term, we can only meet it by building a lot more wind farms, fitting more solar panels, and burning more biomass—whatever the security and price consequences. With the current electricity price at around £50 per megawatt hour, onshore wind costs around £100 MWh (not including the full system costs of its intermittency), offshore wind about £160 MWh (again not including the full system costs) and the early subsidies paid for by customers for rooftop solar anything up to £240 MWh—even if the target could be met, it is probably unaffordable.
The energy bill before parliament is about to make things worse. It is extraordinarily complex given that the challenges are pretty simple. It layers more and more instruments and interventions on top of the current morass of detail. Just to understand the interventions is beyond most in DECC. Every technology has its special subsidies, and DECC is about to embark on yet more picking of “winners.” The unintended consequences of the overlaps and interactions of the interventions are unlikely to be trivial.
It is not too late to radically simplify the energy bill. What is needed is sufficient investment in power stations to provide roughly a 20 per cent capacity margin, to insure us against shocks and keep a lid on prices. The government needs to recognise that this excess capacity will not be produced by the market. It needs to fix the margin, and then auction the slots to meet it. These auctions need also to meet the carbon budgets and the decarbonisation trajectory. Such an approach is of course anathema to many of the current recipients of subsidies. Imagine asking offshore wind to bid against other technologies to meet the carbon target—to reveal their true costs and have them tested by the market. Ministers probably would not like this either. Imagine revealing through the bids the extraordinary subsidies they have been handing out to the “winners” they have picked.
Added to this setting of the margin requirement and the capacity auctions, other decisions need to be made quickly. The nuclear saga cannot go on. For 12 years governments have decided that they don’t want nuclear, and then that they do, that nuclear needs no public subsidy and then that it does, and that a waste solution should be found first, and then that it is not urgent. The current approach to nuclear is a close replica of that of the late 1970s. The plan is to try out a number of different technologies and providers and see if they work. So Hitachi is pitched against EDF, with Westinghouse in the background. It is time to recognise that nuclear is a political technology that requires a long-term political consensus and a national industrial policy for its supply chain. Either do it properly or don’t do it—but the middle way looks at best very expensive.
Government also needs to decide what it is going to do about the most expensive renewables. Offshore wind in particular has inherent cost characteristics that are going to be very hard to shift. Many European countries have just pushed the biomass button, whatever its environmental merits. Some 50 per cent of all the qualifying renewables in Europe will be biomass. The obvious solution is to seriously try to renegotiate the renewables directive’s targets, timetables and what counts within its definitions. To date there is no evidence any minister has tried. Given the underlying rationale has long gone, that is where DECC should be targeting their efforts. It is worth bearing in mind, too, that should the Conservatives win the next election, the energy crisis is scheduled to happen in the middle of a promised EU referendum campaign. The risk of prices shooting up because of very inefficient directives is not going to make the case for staying in the EU any more persuasive.
Beyond the details of the peculiarly British energy crisis, it is time for Europe to raise its game. The 2008 EU climate change package has not made much difference to global warming and is driving up European energy costs, while the EU emissions trading scheme is close to collapse. After the 2014 European elections, with a new Commission, there will be a good opportunity for a rethink in the face of rampant US energy competitiveness.
It would be nice to think that ministers in Britain will take that opportunity to radically simplify energy policy. Sadly history suggests that they will continue to pile one layer of interventions upon another until the system collapses. Energy policy tends to get reformed after a crisis, not before. That date is fast approaching. As the government ploughs on with the energy bill, others will prepare for another energy review immediately after the election in 2015.
