UK Energy Policy - Far-Sighted or Misguided?

UK Energy Policy - Far-Sighted or Misguided?

25th June 2014

The 2008 Energy Act re-calibrated UK energy policy from cost and security of supply priorities toward a low-carbon future by re-configuring the electricity generating infrastructure.  However, it is only recently that the full cost implications of this far-reaching policy change are becoming apparent.  In essence, low-carbon electricity supplies are only sustainable economically through a complex architecture of subsidies which impose minimum prices for renewable and nuclear-sourced energy that could increase overall electricity prices by up to 75% in real terms over the next 11 years.  Viewed from this perspective, it is clear that UK government policy is a key driver in electricity pricing and will become more so in the coming decade. Guest author Barry Aling presents an opinion on current policy and its implications from the perspective of ensuring UK industrial competitiveness and minimizing future energy costs.

Laudable goals for a meaningful reduction in the environmental impact of UK power generation would be worthwhile if such policies were adhered to on a level playing field i.e by the entire global community as, arguably, such a scenario would offer the prospect of the more extreme climatic predictions from the Intergovernmental Panel on Climate Change (IPCC) being averted. But for all the good intentions of the UK government and their European partners, such an outcome appears little more than a pipedream. Put simply, efforts by the UK to “go green” will make a negligible difference to global carbon emissions, risk widespread fuel poverty for millions of individuals and raise significant cost burdens for the country’s industrial and commercial sector, with inevitable consequences for employment. It is time for politicians of all hues to come clean with the public and lay out the true facts:

Figure 1

Figure 1. The UK's changing electricity supply by fuel type

The Global Picture

  • China has added an estimated 580GW of coal-fired electricity generating plant in the last 10 years, equal to c. 10% of global capacity and more than 7 times total UK capacity.

  • Proposals for construction of additional coal-fired plants in China and India exceed 1000GW, equal to Europe’s entire installed capacity.

  • China, US and India consumed 70% of the world’s coal and emitted 17 billion tonnes of CO2 in 2012, equal to 50% of global emissions or 34 times the equivalent UK figure.

  • Global CO2 emissions have risen more than 40% since 1990. See Figure 2.

  • Replacement of the world’s coal-fired power stations with combined cycle gas turbine plant would reduce global carbon emissions by 17%[1].

  • Potential global gas reserves of 1000tcm equate to more than 250 years of current demand.  If all coal-fired generating plant were converted to natural gas, the additional 1.9tcm required annually would still leave potential reserves equal to 190 years demand.

  • Dramatic growth of global gas reserves, notably in North America and the Caspian region, offers the prospect of lower international gas prices in the coming decade

Figure 2. Global CO2 emissions

Figure 2. Global CO2 emissions

The National Picture

  • The UK Government is committed to derive at least 36% of national electricity requirements from renewables, mainly wind, by 2020, compared with 12% in 2012.  

  • Load factors for renewables in electricity generation of between 25 – 35%, vs. 66% for conventional fuels, render renewables unreliable for base-load power needs and necessitate the retention of spare fossil fuel capacity, the cost of which is not computed by the DECC in its cost comparisons.

  • EU decarbonisation policies will require the shutdown of 14% of the country’s fossil fuel generating capacity by 2015 and decommissioning of older nuclear plants will require closure of a further 11% of UK capacity by 2025.

  • Plant closures will result in what OFGEM’s chief executive describes as an “uncomfortably tight” 4% reserve generation capacity margin between 2015-17.

  • The UK’s current energy policy ignores potentially significant reserves of domestic gas which may be recoverable through hydraulic fracturing

  • Minimum guaranteed prices for wind and geothermal of up to £140/ MWh in 2018/19 are more than three times the current wholesale electricity price.

  • Minimum guaranteed prices for supplies from the new 3.3GW Hinkley Point nuclear plant have been fixed at nearly twice current wholesale price and a further 12.4GW of capacity is in the planning stage.

  • Minimum price levels for renewables and nuclear, equal to between two to three times current wholesale prices, will apply to more than 50% of UK generating capacity by 2025, effectively locking in an overall price increase of up to 75% over the next 11 years. 

 Figure 3

Figure 3. UK electricity supply

UK Energy Policy – Renewables, renewables, renewables

UK energy policy is anchored to EU-mandated targets to source no less than 15% of member states’ national energy requirements from renewables by 2020 and 27% by 2030, with the electricity sector as the focal point for this policy. The opportunity to re-configure the UK’s power generation sector is provided by the combination of scheduled nuclear plant closures and retirement of carbon-intensive coal-fired facilities and the decision was taken in 2007 to replace this capacity with a source mix of next-generation nuclear power and renewables, notably wind power.

From its inception, it has been clear that the low-carbon policy re-set was unachievable at current wholesale prices. UK electricity prices are established through an open market auction between generators and suppliers with high seasonal and daytime volatility. Within the last year, peak winter demand in November saw prices as high as £52/MWh while recent low-season prices have been averaging less than £40/MWh as shown in Figure 4. By way of comparison, minimum guaranteed prices for offshore wind have been set by the UK Government at £140/MWh for 2018/19 and for EDF’s new Hinkley Point nuclear supply at £89.50/MWh.

Figure 4. Spot wholesale prices for UK electricity June 2013 - May 2014

Figure 4. Spot wholesale prices for UK electricity June 2013 - May 2014

Figures published by the Department of Energy and Climate Change (DECC) show that the so-called levelised[2] costs for various power technologies as of 2013 are as follows, based on “central” assumptions:

Energy Cost Comparisons
Table 1. DECC Estimates of Levelised Costs for Various Power Technologies
Costs (£/MWh) Front-end & fixed Fuel/Operating Carbon Tax Decommissioning Total
Gas (CCGT) 13 49 18 0 80
Nuclear 82 8 0 2 90
Offshore Wind 116 1 0 0 117
Onshore Wind (1mw-5mw) 121 0 0 0 121
Solar 158 0 0 0 158
Hydro (16mw) 128 6 0 0 134

   

 

 

 

 

 

 

 

 

 

N.B. DECC estimates that the average levelised cost for various “ clean coal” technologies is £135/ MWh for plant commissioned in 2025.  No figures are given for existing coal-fired technology as these do not meet EU standards for carbon emissions.

Although the DECC figures show a clear economic advantage in using natural gas for power generation, the true scale of the differentials is masked by the inclusion of carbon taxes and comparatively high feedstock costs. Most countries, including USA and China do not impose national carbon taxes and their inclusion in the DECC analysis, which adds more than 20% to the levelised cost of gas, significantly distorts a true comparison and burdens domestic and industrial UK electricity consumers with an economic disadvantage.

Equally, fuel costs for gas-fired plant in the DECC model make up more than 60% of total costs, based on a 2015 price of US$ 11.86/mcf and while this figure is not unreasonable in relation to current traded prices for gas in the European region, there is evidence to suggest that large volume imports of gas may be available in the coming years at a lower level. The recent Sino-Russian gas contract, comprising the delivery of 38bcm per annum for 30 years, is reported to be priced at c. $10/ mcf or 15% below the DECC price and this single contract would provide sufficient gas to allow replacement of the UK’s entire coal-fired generating capacity[3] at prices far below anything achievable with renewable energy.

UK policy is predicated on an energy supply matrix from nuclear and renewables of 32% in 2013/14, rising to 44% in 2018/19 and above 50% by the mid-2020’s and with guaranteed prices for this supply estimated at a blended level of c. £120/ MWh or three times the current wholesale price, the prospect of large and recurrent electricity price rises is inevitable. Against these facts, it is difficult to rationalise the recently-stated warning from the International Energy Agency who argue that an investment “blitz” in renewables is needed to avert widespread blackouts by 2035. Given the poor load factors inherent in renewables and the additional stand-by costs needed, precisely the opposite view may be more appropriate, namely that a slavish pursuit of carbon-free energy in ignorance of economics could paralyse in investment in new plant and result in supply interruptions on an unthinkable scale. 

Notably, the UK is not alone in its political support for green policies that appear to contradict economic logic.  IHS pointed to similar concerns in respect of German energy policy in a recent paper [4], warning that the "Energiewende" policy of promoting low-carbon energy carried serious competitive risks and should be replaced by intensive development of domestic shale gas.  As Johannes Teyssen (CEO of E.ON) said at an industry conference earlier this month: "10 years ago, renewables were in an immature state and needed to be nurtured.  Today, they are the biggest animal in the zoo and if you continue to treat them as imbeciles and feed them baby nutrition, you will just get a sick big cat". 

Looking beyond Europe, comparisons with other major economies that have pursued development of renewables is instructive. Contrast the UK approach with the US model, where the construction of gas-fired plant, fed by abundant supplies of shale gas, currently priced at less than half the UK equivalent level, will raise the gas market share from 30% to 35% over the next 25 years, ensuring that US consumers and industry enjoy highly competitive electricity pricing for decades to come (see Figure 5) and helping the US economy to embark on a process of "re-industrialisation”. Although the Federal Government promoted the development of a nascent wind power sector through subsidies, US wind capacity has now reached a level at which such special treatment is no longer considered affordable or fair and it is highly likely that further growth in wind capacity will now be constrained by poor economics.  

Figure 5. Electricity generation by fuel, 1990-2040

Figure 5. Electricity generation by fuel, 1990-2040

A Policy Re-think? – it is not too late

The ideals enshrined in UK energy policy, based on the goal of developing sustainability in resource use, are indeed praiseworthy and may become a model for human society in the latter half of the 21st century. However, the costs associated with a headlong rush for renewable energy appear likely to place the UK (and its European partners) at a significant economic disadvantage to the major developing economies, whose social priorities place the elevation of living standards above the environment. In these circumstances, the UK should consider a two-stage approach in which its carbon footprint is lowered by the replacement of coal-fired plant with natural gas, resourced at least in part by aggressive development of domestic shale gas and pending a more radical shift towards renewables on a 50-70 year time-scale rather than the present 20-year crash programme. The reality is that UK policy towards wind power has no economic basis for the foreseeable future and should be subject to urgent review. 

 

[1] US EIA data: 7.86mcf/1000KWh; global coal-fired electricity production - c. 8550 bln KWh; CO2 emissions from bituminous coal – 93.3kilos/ MMBTu; natural gas – 53.1kilos/MMBTu

[2] Defined as the total costs, including planning, construction, operating & decommissioning, averaged over the life of the facility and expressed in £/ MWh of electricity generated.

[3] Coal-fired generated 143 TWh in 2012 (DECC); 1 TWh uses 7.87 bcf gas (EIA); 143 TWh = 32 bcm

[4] IHS Online Pressroom, 27.2.14

Authors

UK Energy Policy - Far-Sighted or Misguided?

Barry Aling

Director, City of London Investment Group PLC

Barry Aling is a former Director of Gaffney Cline & Associates and continues to write for GCA on a number of topics including the geopolitics of energy.

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