Myth busting – sifting energy facts from wishful thinking

In the furore about the rise of energy costs, several factors have been cited as contributing to escalating prices. David Cox, managing director of the Gas Forum, untangles the truth from the myths in the government’s argument for committing a minimum £38bn to subsidise energy genera-tion over the next eight years.1

Following the tariff increases announced by all of the Big Six energy companies in late 2013, the UK energy market has come under intense scrutiny – from both the media and poli-ticians on all sides of the House. Receiving much less atten-tion was the deal agreed between the British government and EDF to underpin the construction of the Hinkley Point C nuclear power plant, which will receive subsidies until 2058. Ed Davey sold the deal to the British public on the basis that it will contribute to UK targets for carbon reduction and per-haps more importantly given the recent debate on energy price rises, that it will insulate UK customers from the highly volatile gas prices associated with increased reliance on im-ported gas supplies.

It is the second point that we think is worthy of further scru-tiny, given it is frequently used to justify the restructuring of the UK energy market and defend increases to the subsidy burden, which will be borne by UK consumers. With contin-ued concern about energy costs, we believe that consumers need to properly understand where their money is going and to what end.

The simple facts are that the UK is legally committed to meet a number of emissions targets and the energy industry is being incentivized to deliver an energy supply mix, which in theory will meet these targets. The incentives take the form of subsidies which are being targeted at particular forms of low carbon technology, notably wind and nuclear, which as of 2013 could deliver a generation portfolio that gives us a fighting chance of achieving the required 34% emission re-ductions by 2020 and 80% reduction by 2050. However what seems to have been lost in the debate is that the cost of sup-porting these technologies is, and increasingly will, be borne by consumers. Additionally the justification for this strategy is nebulous – focused primarily on the potential savings of following this approach. As usual the truth is far more com-plicated than this.

Assertion 1 – green energy subsidies will reduce costs for consumers over the long term

In March 2013, DECC published its report on the estimated impacts of energy and climate change policies on energy prices and bills. The headline message was that “the Gov-ernment’s policies mean that household bills will be on aver-age 11%, or £166, lower in 2020 than if we just sat on our hands and did nothing.”

Research by the Tax Payers’ Alliance in October 2013 sug-gests that total support for renewable energy through the main subsidy scheme (the Renewables Obligation and Feed in Tariffs with Contracts for Difference) will rise from around £1.99 billion in 2012-13 to over £5.32 billion in 2018-19 as more capacity is added to the network and over the six year period, the total subsidy will be £21.9 billion with wind farms accounting for the majority. Onshore wind will receive a guaranteed electricity price double the typical wholesale price and offshore wind will receive triple the typical whole-sale price. The subsidy caps, which do not include all subsi-dies, such as the Renewable Heat Incentive (RHI), are de-tailed in the table below.

Upper limits to electricity policy levies, 2011/12 prices (excludes the RHI)

Source: Levy Control Framework Update, DECC, June 2013

The original premise behind Government subsidies was that they were supposed to reduce costs by creating economies of scale and driving technological innovation but many types of renewable energy still require very similar levels of subsi-dy despite years of support. The announcement that high subsidies will continue for the foreseeable future suggests that this strategy has failed and the consumer energy price debate patently demonstrates that subsidies have failed to deliver reductions in cost.

Assertion 2 – future energy prices can be estimated with certainty

In order to arrive at its 11% estimate, for it is only an esti-

2015/16 2016/17 2017/18 2018/19 2019/20 2020/21

£4.30bn £4.90bn £5.60bn £6.45bn £7.00bn £7.60bn

1 The reality is that subsidies will continue for many years beyond 2020/21, for example the nuclear subsidy to EDF will run until 2058

mate and one accompanied by raft of assumptions, DECC’s central premise was that gas prices would reach 72p/therm by 2020 (at 2012 prices). This may or may not be correct – it would be impossible to model estimated impacts without taking a view on longer term gas and carbon prices so the government could be correct that they will continue to rise.

Paradoxically in another decision document published in September 2013, outlining government’s reasons for not intervening in (potentially subsidizing) UK based gas storage, which could smooth volatility and price spikes, DECC de-clined to predict future gas prices arguing “If we exclude the modelled effects on gas price levels and volatility (which, are inherently challenging to estimate and are subject to wide bands of uncertainty) and consider only the direct benefits in terms of avoided costs of disruption against the cost of build-ing the storage, the costs outweigh the benefits in all cases”.

We find it interesting that there are times when the Govern-ment recognises the perils of estimating future gas prices to inform policy but then justifies the merits of doing so when the aim is to validate policy. The fact is that there are many inputs into future energy prices which mean they cannot be predicted with any certainty.

Assertion 3 – gas prices will only continue to rise

It has become routine for many to claim that energy prices, including that of gas, will continue to rise. This is often based on the blind assumption that recent trends will contin-ue, which has little to do with a deeper understanding of the global supply/demand balance. We are told fossil fuel re-sources are finite and demand is rising but we are also told that we cannot afford to actually use the fossil fuels (without carbon capture and storage) as to do so will result in disas-trous climate change.

The facts are that we have ample supplies of gas, with more discovered continually – both conventional and unconven-tional. We have seen sharp gas price reductions in the US and this could be replicated elsewhere. In our view, it is just as likely for gas prices to stabilise or even fall over the medi-um and longer term.

Fact 1 – the biggest energy savings come from product effi-ciency measures

According to the DECC ‘impacts’ report, the biggest single impact on average energy costs is delivered by EU policy, in particular its products policy2. For consumers this means that energy-efficient appliances, such as white goods, are deliver-ing the biggest contribution to lower bills. Ironically, of the estimated £166 annual saving generated by the deployment of various climate change policies in 2020, DECC attributes £158 (95%) to the impact of the EU products policy. Other notable contributions come from Boiler Regulations and The Carbon Emissions Reduction Target (CERT), Community Ener-gy Savings Programme (CESP) and Energy Efficiency Commit-ments (EEC)

Fact 2 – using less energy reduces both costs and carbon

As argued by many and apparently substantiated by the gov-ernment’s own analysis, the most effective way to bring down energy costs is to invest in the demand side, through improvements in efficiency, insulation and information. Re-

ducing energy usage and increasing efficiency has the double benefit of reducing emissions and bills for consumers.

The Gas Forum wholeheartedly supports this practical ap-proach to optimizing our use of energy and supports the continuation of subsidies to achieve this aim. We know that huge savings can be achieved by effective targeting of de-mand side policies. We also know that simply replacing ex-isting coal and oil generation plant with CCGT will lead to immediate reductions in carbon emissions. Investing in inno-vation to improve the efficiency of future plants to generate more power from less energy will cost less per kilowatt and produce less carbon.

It is uncertain whether the UK will meet its 2020 renewables target let alone the 80% reduction in emissions by 2050. However the legal obligation to reduce carbon emissions and the use of industry incentives to achieve this is profoundly different to the rationale that is being communicated to con-sumers – that green energy subsidies will produce energy savings for consumers in the long term.

We remain to be convinced that the UK has chosen the most cost effective route to our low carbon future. Insufficient evidence has been presented to the industry and consumers as to the full costs of the chosen carbon reduction strategy. We know that the contracts being entered into, and their associated subsidies, with low-carbon generation technolo-gies will last for a minimum of 15 years. We don’t know is what gas prices will look like in the future – certainly DECC does not seem clear and perhaps more importantly, we don’t know what new technological innovation could be just round the corner. We believe that there is a real danger of the UK locking itself into an inefficient process based on spe-cific renewable technologies and an electrical generation system built around suspect, and unproven, selection of ‘winners’.

There are clear shorter term wins in terms of energy efficien-cy measures and greater concentration of CCGT, which will buy us time to allow for more efficient, effective and cheaper low carbon technologies to be developed. Importantly, re-search into proving carbon capture and storage should also be accelerated as it could provide a cheaper way of reducing our carbon dioxide emissions and provide a secure energy system.

2 Policy concerned with improving the environmental performance in the manufacture, use and disposal of products.

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