What is happening with UK energy policy?

Following the election in 2010, Chris Huhne, newly installed as Secretary of State for Energy and Climate Change, promised that the Government had ‘a reform [agenda] that [would] reshape the market more fundamentally than at any time since the eighties’.

It is possible to argue that some of the changes introduced as part of his Electricity Market Reform process were indeed very significant – most notably, a feed-in-tariff to support new nuclear generation. However, whatever changes the previous Government managed to introduce, pale into insignificance compared with those already delivered in the first six months of the new administration. Through a series of incremental changes, and without any policy fanfare, the entire direction of UK energy policy has been turned on its head.

The most common question that I am asked at the moment, particularly when travelling around Europe, is ‘what is happening with UK energy policy?’ This reflects the realisation that something significant is going on but an inability to understand exactly what it is or, more importantly, why it is happening.

The essence of energy policy lies in making choices on behalf of consumers (current and future) that they are not well-placed to make themselves. In particular, this involves ensuring that sufficient resources are available to meet future demand and that the right technology mix is in place to decarbonise the system at least cost. The choice of technologies to meet these goals is the core of any energy policy. Whilst some might argue that it is possible to ‘let the market decide’ energy mix through technology neutral auctions and carbon prices, evidence has repeatedly shown that this unachievable. The cost structures vary so significantly that any auction will inevitably favour one choice against another. Note the design contortions in the current capacity mechanism, involving 15 year, 3 year and 1 year options, introduced in a vain attempt to equalise incentives for life-extension of existing assets versus the construction of new ones. Also, it goes without saying that no single tender process could create a level playing field for nuclear, carbon capture and storage and offshore wind. Finally, carbon prices would have to reach and sustain extremely high levels before investors could be persuaded to part with the funds needed to finance new assets that relied on continued high carbon prices.

Until such time as there is a demand side of the market that is able to adjust consumption in response to price, and high carbon resources are no longer a feasible investment option, then Governments must continue to make broad technology choices. This is why the policy adopted by the current Government is so radical. The policy to deploy a range of renewable resources and invest in reducing demand – a policy that had been pursued with increasing intensity for more than a decade – has been stopped and replaced by one that seems focused on creating a secure market opportunity for new gas-fired power plant and promoting a new fleet of nuclear power plant, coupled with technology innovations, as the primary means to achieve decarbonisation goals.

An old set of technology choices has been replaced by a new set of technology choices without any explanation as to why this change is a more effective way to meet long term energy policy goals. Perhaps even more worrying is the suggestion that somehow high level policy objectives have changed and security of supply has been given greater importance than decarbonisation which has, in turn, been demoted to a ‘nice to have’ status. This is despite the fact that current legislation – the Climate Change Act – is specifically designed to prevent this from happening.

So why does all this matter? Isn’t it the right of any Government to have new ideas and priorities? The problem lies in the fact that for any policy to succeed, it must lead to a significant flow of investment to fund the required infrastructure. Investors have always worried about the propensity for Governments to change their minds and, more importantly, not to worry about the collateral damage that might be caused to their investments. One of the big failing with the previous administration’s electricity market reform process was that it was not underpinned by a clear and compelling narrative as to why the particular choices that were being made represented the best value way to meet long term policy objectives. This meant that any potential savings achieved by lowering financing costs through introducing new market mechanisms were more than offset by an increased perception of policy risk as investors worried about the sustainability of the measures being introduced.

The current market abounds with stories of impaired investments and angry investors. Unfortunately for the Government, it is largely the same investors who must be persuaded to part with funds to support the new policy agenda. Putting aside the emotional hurdle of being ‘one bitten twice shy’, hard-nosed investors will want a clear and compelling story as to why this new policy is sustainable, not just over the duration of this parliament, but throughout the lifetime of the assets in question. It is inconceivable that investors will make major bets of the basis that decarbonisation might not matter in 10 years. Throughout the world, investment committees are re-evaluating the risks of stranded carbon-intensive assets. This is not only because of a belief that the global community will hold good on its promise to keep temperature increases within a 2°C limit but because the industrial landscape is shifting – and fast. Dramatic reductions in the costs of renewable technologies and a potential revolution in the way energy is consumed create an existential threat to old industry structures and technologies.

Policy choices are ultimately based on beliefs about the future. If the Government is to have a hope of succeeding with its policy reset then it must clearly articulate these beliefs and hope that the story is sufficiently compelling to an increasingly sceptical investment community. It appears likely that upcoming debates about the 5th Carbon Budget will shine a light on the new policy that the Government might find rather uncomfortable.