By Dr. Pierre Noël
(This post is based on a talk I gave to a side event of the 2012 Conservative party conference in Birmingham organised by Policy Exchange on the theme: 'Low-Carbon and Lower Bills - Can the Circle be Squared?'.)
DECC v Treasury: two visions of electricity supply decarbonisation
The current debate on the future role of gas is much more than just that. It may signal the beginning of the end of the current UK policy strategy on energy and climate change.
The consultation document prepared by the Department of Energy and Climate Change (DECC) and Treasury ahead of the forthcoming Gas Generation Strategy shows that there is a conflict, at the heart of government, not about the role of gas but about the fundamental approach to decarbonising energy.
On the one hand, DECC wants to explore the implications for the gas market of large scale deployment of wind generation. There are indeed tricky issues about the interactions between renewables and natural gas that need to be better understood. For example: what are the consequences of intermittent power generation on the level and - crucially - the profile of gas demand? And also: how to make sure that the gas plants needed to make for the unreliability of wind get built, or stay on the system as their profitability is destroyed by the very renewables they are supposed to complement? In summary, DECC wants to understand better what its policy strategy, including the large-scale deployment of wind through fixed-price contracts, means for natural gas.
On the other hand, the Treasury is asking (implicitly in the consultation document but more explicitly elsewhere, including in George Osborne's speeches) a fundamentally different question, which is: could the displacement of coal by natural gas in power generation, helped by the carbon price floor, reduce emissions at a much lower cost per ton of CO2 than long-term fixed-price contracts for nuclear and offshore wind?
I believe that the Osborne alternative is a fundamental challenge to the UK Climate Change Committee advice to DECC, which is reflected in the Electricity Market Reform (EMR) and supposed to be endorsed in the forthcoming Energy Bill. Indeed, the Treasury approach is incompatible with the strategy of nearly total decarbonisation of the power sector by 2030 as an enabler for 80%+ decarbonisation of the economy by 2050.
This interpretation of two conflicting approaches to decarbonisation within government is consistent with the Treasury's unwillingness to be counterparty to the long-term contracts for difference under the EMR and their even refusing to appear before the House Committee on Energy and Climate Change.
It was bound to happen
This debate, happening as it is within government, is not conducive to the policy visibility that investors call for. However, the row over the potential cost of the current UK policy strategy was bound to happen.
The British strategy on energy and climate change consists of the long-term target enacted by the Climate Change Act and the UK Climate Change Committee (CCC) recommendations about how to achieve it. The CCC advised that electricity supply be decarbonised fully by 2030 so that heat and transport could then be decarbonised through electrification. The EMR, which is supposed to become law through the forthcoming Energy Bill, is an essential part of implementing this strategy.
This policy strategy commits the country to decarbonising electricity generation:
- to a very ambitious level
- following a pre-defined trajectory of emissions reduction over a relatively short period of time
- using a limited and pre-defined portfolio of technologies
- therefore, at any cost (hence the surprising situation where DECC seems to be hoping that gas will be expensive so that EMR is cheaper)
- irrespective of what other countries do or do not do
- via central planning rather than decentralised choices co-ordinated by the price mechanism.
This strategy ignores many fundamental uncertainties, shifting significant economic risks onto the British economy. Its political sustainability was therefore always questionable. The long recession, the government's own reports on the cost of implementing it and the prospects for an era of abundant internationally traded natural gas, only accelerated the moment of truth.
Towards a politically sustainable approach
So far energy bills have risen mainly because of commodity prices, not climate policy. But everybody understands - if only by reading DECC and Ofgem's reports - that the real costs are ahead of us and will indeed be large. The government implicitly asks the public to trust that the international climate change negotiation will indeed deliver a meaningful agreement; that the cost of low-carbon technologies will fall significantly; and that fossil fuels, especially natural gas, will be expensive for decades to come. Under these conditions the cost of the policy strategy looks manageable. However Copenhagen and its aftermath revealed that delivering an international climate agreement is an uphill battle and the unconventional hydrocarbon revolution dramatically changed the prospects for fossil fuels.
Uncertainty is the crucial issue. A politically sustainable approach has to acknowledge what we don't know and cannot know, in particular:
- Whether there will be any meaningful international agreement on climate change;
- What the absolute cost of decarbonisation is and what the 'cost curve' looks like (if we did 60% by 2050 instead of 80%, would it be 25% cheaper or 75% cheaper?) and how this curve could evolve over time;
- What the relative costs of existing technologies are - let alone future ones.
- Several implications follow:
- The eventual level of national emissions reduction should not be legislated;
- Costs have to be revealed, not assumed;
- We must incentivise other countries to act, not give them a free ride.
The way to reveal relative decarbonisation costs - not only between technologies but also sectors of the economy and the supply and demand sides) is to tax carbon emissions. Any other solution assumes that we know the answer. The way to increase our chances that new, cheaper technologies emerge is by investing in research and development (R&D). The way to incentivise others to act is by committing to certain levels of carbon prices and R&D budgets if and when other major economies commits to do the same (conditional commitments).
Under the current strategy the UK economy is asked to bear the risk of deep decarbonisation being much more costly than some currently might think or hope for. It is also asked to bear the risk of the world failing to act collectively in a meaningful way. Finally, it would bear the risk of ministers and civil servants picking the wrong technologies at the wrong time, under heavy lobbying from industry. A strategy based on conditional carbon price targets and R&D budgets would eliminate or significantly reduce these risks.
The current debate over the future role of gas in the UK power sector is about much more than natural gas, shale or not shale. The Chancellor's challenge to the EMR probably signals the beginning of a significant energy policy adjustment. It might be a messy process but the current energy policy strategy is not politically sustainable because it is too risky economically.
Ministers cannot defend the current approach by less-than-rigorous cost-benefit analysis and plainly misleading statements about the security risks associated with gas imports and the job creation potential of green technologies. The political choice is between the following alternatives:
- Either government fully acknowledges the risks of the current strategy and presents them as the unavoidable counterparty to leading by example in the fight against global carbon emissions;
- Or it shifts strategies and goes for the cheapest carbon emission reductions first while keeping the option open to increase its effort over time as part of an international agreement.
If the latter happens it would benefit natural gas. But it is about much more than natural gas.
Dr Noël is a Senior Research Associate and Director of Energy Policy Forum at the University of Cambridge.
Join Noël and four other world experts at Intelligence Squared's 'A Natural Gas Revolution: Hot Air or Dose of Sanity. An Evening of Debate', at One Birdcage Walk, London on 18th October. The event is part of the Switched On series of live debates and discussions in partnership with Shell.