The cracks in UK energy policy are widening17 Oct, 2011
Government and investor hesitation
The last few weeks have seen evidence of both government and investor hesitation in delivering on the UK government’s decarbonisation agenda:
- The Chancellor George Osborne publicly announced his concern over the threat that decarbonisation poses to UK competitiveness
- The Prime Minister’s senior energy adviser warned that the cost of low carbon policy support would be much higher than Department of Energy and Climate Change (DECC) analysis suggests
- Scottish Power appears to be on the verge of withdrawing from investment in the UK’s primary CCS demonstration project at Longannet after a disagreement with DECC over funding
- Two of the UK’s three nuclear new build consortiums appear to be under strain as RWE reconsiders its involvement and SSE withdraws altogether.
Behind the government’s hesitation is a growing ideological conflict between members of the Conservative party and their more environmentally progressive coalition partner the Liberal Democrats. This conflict is mirrored to some extent in the relationship between the Treasury, which is managing the UK’s austerity drive and DECC, which has primary responsibility for delivering the government’s decarbonisation agenda. These conflicts are undermining the consistency and credibility of the UK’s energy policy, particularly in relation to reform of the electricity market. In turn, policy uncertainty is increasingly fuelling investor hesitation in committing capital to the UK energy market.
The policy cracks are widening
“I want a Conservative Treasury to lead the development of the low carbon economy and finance a green recovery.” George Osborne, Nov 2009
‘We are not going to save the planet by putting our country out of business. We’re going to cut out carbon emissions no slower but also no faster than our fellow countries in Europe’. George Osborne, Oct 2011
George Osborne’s recent comments reflect an increase in intensity of the ongoing conflict between the Treasury, lead by a Conservative Chancellor (George Osborne), and DECC, lead by a Liberal Democrat Secretary (Chris Huhne). This is in principle an ideological clash of ‘economy’ versus ‘environment’. But it has very practical implications for the funding of the government’s decarbonisation agenda.
Osborne has never been a strong advocate of carbon targets, but his latest comments show he has publicly reversed his view on the potential growth benefits of transition to a low carbon economy. This is important, given the UK government is confronted by the increasing threat of a new recession. A weak economy adds to the intensity of the conflict between the Treasury’s austerity drive and DECC’s policy support for low carbon technology. DECC’s rather unconvincing argument that decarbonisation will have little impact on energy prices or the consumer’s wallet has done little to defuse this conflict.
The risk to electricity market investment
The credibility of the government’s commitment to a decarbonisation agenda has important implications for the UK electricity market. The decarbonisation agenda has been the foundation for the development of DECC’s recently announced Electricity Market Reform (EMR) policy framework. Uncertainty around the EMR policy threatens UK security of supply as we set out here, even if the government’s commitment to decarbonisation is taken at face value. But if internal government conflict undermines the credibility of low carbon policy support, there is a risk that investor confidence in the UK electricity market will collapse altogether.
One of the principle weaknesses with the EMR policy framework is that it appears to hand DECC a toolkit of policy measures with which to influence capacity outcomes. Understandably, investors are nervous about committing capital, at least until the government provides more detail on EMR policy implementation.
Another weakness is that the policy measures themselves are not set in stone. For example, the Treasury-administered Carbon Floor Price looks to be increasingly vulnerable. The Floor Price has been strongly criticised for directly undermining the EU ETS and was designed with the rather naive view of facilitating competition between new nuclear build consortiums. In practical terms it would not be difficult for this government or a subsequent one to remove this policy measure. Given the implications of the Floor Price on investor returns, the uncertainty around this is a substantial hurdle for infrastructure project investors to overcome before committing capital.
If the UK government is to rely on private capital to deliver the enormous electricity infrastructure investment required this decade, it can not afford indecisive policy. Decarbonisation of the power sector by 2050 requires a credible and consistent policy framework to support all options (renewables, nuclear, CCS, demand side response and energy efficiency). Policy also needs to recognise the requirement for system flexibility and the role that thermal generation, particularly gas-fired capacity, will need to play in the transition to decarbonisation. The government’s EMR policy falls a long way short of this and the credibility of this policy is being undermined by internal conflict within the government. As a result, the UK electricity market is increasingly vulnerable to a loss of investor confidence, threatening the orderly operation of the market and security of supply.