Energy Futures Network Paper No. 13

The first 100 days of Conservative energy policy

Dieter Helm Professor of Energy Policy University of Oxford

20th August 2015

Amber Rudd, the Secretary of State for Energy and Climate Change, has had a very busy start. She has ended new subsidies for onshore wind, reined back the Green Deal, removed the exemption from tax for renewables, ended the zero- carbon homes plan, removed guaranteed subsidy for biomass, borne down on solar PV subsidies, speeded up the rules on fracking planning process, and at the same time fully come in behind the Paris climate negotiations and the UK’s commitment to tackling carbon emissions.

For some in the green lobby, this smacks at best of inconsistency and at worst it is disingenuous – saying one thing, and doing another. Unsurprising Renewables UK, the powerful and vocal lobby group, has screamed about the scale back of the subsidies its members have to date so effectively campaigned for. It claimed that Rudd’s commitment to tacking climate change was “like saying you want to win the Tour de France on a bike without wheels”.

So what can we learn from the first 100 days of Conservative energy policy? Does it add up to a coherent framework, or is it just ad hoc and made up as the new government has been going along?

The case for the initial changes

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The Conservatives inherited a mess, partly of their own making during the Coalition. Energy policy has for almost a decade been dominated by the framework laid down by Ed Milliband in 2008, and faithfully followed through by Chris Huhne and Ed Davey – what might be called MHD.

In this world, the dash-for-renewables was expected to meet all the objectives of energy policy simultaneously. It would decarbonise, increase security and make Britain a world competitive leader. This miracle would mean that customers’ bills would be lower (by 8%) by 2020 than they would have been without the MHD framework. Britain would have world beating new renewables industries, and British industry would have access to comparatively cheap electricity (compared with the expensive fossil fuels the Americans were apparently addicted to).

If it all sounds fanciful today, after the collapse of coal, oil and now even gas prices, this is little consolation. The damage has already been done: customers are committed to years of levies to pay for some of the most expensive technologies. It is not as bad as in Germany, where customers must pay around €20 billion per annum, but it is more than voters seem willing to carry on underwriting. Worse still, it does not do the carbon job, and it does not enhance security.

On carbon, the problem is global warming, not British warming, and hence what matters is carbon consumption, not carbon production. Ever-higher prices and taxes reduce the carbon-intensive production of Britain, but not the carbon- intensity of the shopping basket. There are much better, much cheaper ways of decarbonising much faster – as set out in The Carbon Crunch1. As to security, the current renewables have undermined the economics of gas, and choked off new investments in CCGTs – so much so, that a capacity mechanism has been required, in the face of an almost zero capacity margin.

1 Helm, D. (2015), The Carbon Crunch – Revised and Updated, London, Yale University Press.

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The result of MHD has been more costly, and less secure energy, taking the most expensive route to decarbonisation when there are much better alternatives.

In the first 100 days, some of the scaffolding of the MHD approach has been taken down. The Green Deal was overhyped by Chris Huhne – there were going to be 250,000 new jobs as the housing stock was transformed on a street-by- street basis. An army of assessors and government-approved contractors were going to facilitate this, backed up by loans tied to the house rather than the individual. It was claimed that the opportunities were enormous, since people were apparently neglecting to take pick up all the £20 notes lying in the street (the Net Present Values (NPVs) of energy efficiency measures were argued to be extremely large). All they needed was access to loans.

It was largely nonsense and, as ever, the public could see through it – even if one or two of the big energy companies supported it. Very few thought the Green Deal was a good deal, and on almost any reckoning it has been a flop. Amber Rudd has rightly pulled the plug. The challenge now is to come up with something that actually works. The good news is that almost anything would be better.

Next comes the withdrawal of subsidies from onshore wind. This brought howls of protest, but is merely the implementation of what was supposed to happen under MHD. Since Milliband, Huhne and Davy all knew that fossil fuel prices were going to continue going up (and all paid at least lip service to the concept of “peak oil”) and since they also knew that gas prices were going to be very volatile, the mature renewables technologies would be cost competitive by 2020 or before. Better to get out of fossil fuels now, they thought, to protect us all from what they thought would be ever more exposure to ever more expensive fossil fuels. It would be win (carbon), win (security) and win (competitiveness). Except it turned out to be lose, lose and lose.

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The renewables lobby has been keen to emphasis the extent to which these technologies were converging on “grid parity”. The argument is that these “winning” technologies need time to mature, and that subsidies are a temporary means to achieving the big cost reductions that they keep promising. Putting aside for a moment that grid pariry ought to mean on a full cost basis, (and hence as firm power, and not only their own intermittent costs), it is reasonable to say that after a couple of decades of practice a wind turbine ought to be mature. So what is the problem with taking the subsidy away, now onshore wind has matured? The answer must be that it isn’t really competitive.

A similar story can be told about solar, but it is at least more convincing. The rooftop solar companies have had the largest subsidy-driven experiment in the world, carried out on their behalf in Germany. If deployment is required to reduce costs, then Germany has done the job for us. It cannot be that the instructions are in German and not English. Costs for solar have indeed fallen substantially, and this was reflected in the recent solar FiT auctions. Solar should be able to wash its face in the market after such an enormous subsidy programme, and Amber Rudd has done the right thing here too.

On the Green Investment Bank, this was Ed Davey’s colleague Vince Cable’s pet project and legacy. But nobody ever came up with a convincing reason as to why renewables and energy efficiency needed their own bank. Banks identify markets for loans, and they can specialise in particular areas, building teams and investment portfolios. We don’t have a special agricultural bank, or a pub and restaurant bank, or a car bank. What is special about this area? Could it be that the real motivation was to take extra risk, and to be ultimately supported by the taxpayer? It is no accident that at the election Labour and the Liberal Democrats wanted to pump in more public money. But if the economy is to decarbonise, then it should be mainstreamed. Britain isn’t short of banks and financial institutions. Might it instead be that it is short of NPV positive projects and that the politicians’ “winners” might not be what they seem? Government, after all,

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On the taxation front, renewables are no longer to be exempt from the Climate Change Levy. Part of the muddle here is that by selecting some technologies as taxable and others not, there is no incentive to bear upon the marginal cost of carbon. It is simply a further crude exemption for current selected renewables, and as such has little justification. Having extended the tax, the question left open is what should be the proper price – and mechanism for pricing – carbon. This is another piece of very unfinished business. Currently we have energy taxes (including on petrol and diesel), the EUETS, the carbon floor price and the Climate Change Levy – all developed separately in an ad hoc fashion. It is not hard to think that more could be charged for less here – less measures and less cost.

That leaves the changes to planning and the planning process. Here the first 100 days has seen some rather obvious inconsistencies. When it comes to onshore wind, the government wants local communities to have a greater say. But when it comes to fracking, it wants to time limit the local input, which it sees as an obstacle to the progress it wants to see.

Planning needs consistency and it needs a proper balance between national direction and local decisions. For the Coalition government – and Labour before 2010 – the direction of travel was towards centralisation. The National Infrastructure Plan would identify projects of national importance, and there were sectorial plans, which would identify such projects of national importance that local planning authorities would be effectively obliged to accept them. Labour wants a national Infrastructure Planning Commission.

Whatever the right balance, at least the direction of travel was clear. But the wind decision looks like a reversal, and it is not surprising that Amber Rudd has come under fire for this, when she has also appears to favour a more national

5 Energy Futures Network Paper No. 13 approach to fracking. Planning needs to be sorted out - this should be on her “to do” list.

Thus, with the exception of planning, these early decisions are mostly sensible – the MHD framework was based upon the wrong assumption – indeed an assumption about fossil fuel prices which should not be made as the basis of any energy policy. The question is what now to do positively, having made the initial largely negative moves.

Sorting out a coherent carbon policy

A coherent carbon policy would focus on two things: finding the cheapest ways to reduce emissions in the short term; and finding new technologies which can actually make a difference to climate change in the medium and long run. In The Carbon Crunch, the answers provided are: for the former, to switch from coal to gas; and for the latter, to focus subsidies on the next generation of renewables, and especially solar.

Coal is terrible stuff. Coal mines emit methane, they pollute the water table, they impair the health of anyone who goes in a mine, Coal is heavy to transport, and when it is burned it emits a cocktail of pollutants, water is needed for cooling, and then there is the waste to get rid of. It makes fracking gas look benign. There are therefore multiple environmental reasons for getting out of coal as a first priority.

This can be done at low cost – by replacing coal with gas. Carbon emissions would fall by roughly half. CCGTs are cheap to build, and can pay back in less than a decade – by which time credible alternatives might start to appear. Gas is secure – the world is awash with gas, and LNG as well as interconnected pipelines offer a high level of portfolio diversity. It is a no-brainer.

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Yet remarkably under MHD, the opposite has been pursued. The coal burn has increased, at the expense of gas. It is even worse in Germany, where several new coal stations have been built, lignite mining has been expanded, and coal has replaced both nuclear and gas. If the government is not prepared to have a proper carbon price (which it should), then closing coal has to be achieved through Emission Performance Standards (EPS). This is the Obama approach in the US, and it should be extended beyond requiring CCS for new coal to bear down on pollution from existing plants.

Switching from coal to gas is the immediate imperative. But Amber Rudd needs a credible medium to longer-term strategy for decarbonisation. Wind, (and especially offshore wind), and current generation solar are low-density energy sources. There simply are not enough shallow seas and rooftops to generate the level of electricity needed – even before transport is electrified and adds substantially to electricity demand. David Mackay’s brilliant book Sustainable Energy2 – explains this. Whilst each has a contribution to make, neither can solve the problem.

What could possibly solve the climate change problem is the next generation of renewables technologies. Solar is the obvious candidate. The light spectrum could be opened up, and new materials in the context of solar film might be applied not just rooftops but whole buildings, and even cars and clothes too. Britain excels at R&D, despite being starved of monies. These R&D projects are, by definition, genuinely immature – unlike wind turbines and current rooftop solar PV panels. Britain invented 3D Printing (Bath), graphene (Manchester) and has substantive robotic research. It has the capacity to take solar forward. Instead of spending tens of billions on North Sea offshore wind farms which cannot solve the problem, the government could redirect some of these billions to targeted energy research – directed towards places like the Northern Powerhouse energy nexus, and more generally. The remarkable thing about R&D

2 MacKay, D. (2008), Sustainable Energy - Without the Hot Air, Cambridge, UIT Cambridge.

7 Energy Futures Network Paper No. 13 is that it is cheap. One billion goes a very long way. The remarkable thing about offshore wind is that it is expensive. Amber Rudd could cut the total subsidies and make the rest much more effective in tackling climate change. This is a case of more-for-less.

Getting out of picking winners – using auctions

The challenge for Amber Rudd is to steer herself through the minefields of current intervention. MHD left a central buyer model with the state determining virtually all investment decisions. Worse still, it now does this through a set of FiTs, one for each technology, and five different capacity auctions. This is picking winners on a massive scale, and takes the electricity industry right back to the days of the CEGB.

In its last year the Coalition started to move away from this, probably horrified by the consequences of the legislation it had pushed through. Amber Rudd clearly wants to be more radical. But how can she escape from the morass of treacle she is stuck in? How can she avoid creating ever more interventions, as each interventions has unintended consequences which sucks her in ever deeper?

Though it is seductive to think that there can be a gradual and piecemeal withdrawal of specific interventions, it is unlikely to work out well. In any case she has already dealt with the easy ones. What is needed is a reset. This requires utter clarity on the objectives, and what the government has to do – and about what the market will fail to achieve left to its own devices.

There are just three overriding interventions that are needed – fixing carbon, fixing the security of supply margin, and funding R&D. In a perfect world, the first would be achieved by setting a carbon price which would go to whatever level

8 Energy Futures Network Paper No. 13 necessary to achieve the carbon budgets and hence the overriding carbon targets (leaving aside the question of why these targets should be unilateral). This carbon price would be complimented by a target security of supply margin – since the market will not of its own volition deliberately create the excess supply necessary for as long as electricity is not generally storable.

In such a world, new capacity would be determined by a single unified auction. Bidders would be required to quote for firm power, so that intermittent generators would have to sub-contract for back-up when the wind does not blow (and in the process, create a secondary market in back-up generation). The contracts would be awarded on a rolling basis, with the System Operator in charge of doing this, contracting within the ambit of an overall target excess margin. Since there are many exogenous variables in play (like GDP), it is hopeless to try to predict the exact requirement, and since excess demand is asymmetrically worse than excess supply, a crude target is all that is required, and the best that can be achieved.

To give a measure of the way the market is currently failing, despite the credit crash and the great recession having knocked British GDP back over 20% below the expected trend from just before the crushes in 2006/07, it is extraordinary that in such circumstances the capacity margin could be as tight as 2%. Indeed, it is extraordinary that the Competition and Markets Authority (CMA) chose to ignore this is giving the wholesale market a clean bill of health. A rough number like 10% would be a great improvement on where we are now.

A single auction – combining FiTs and the current multiple capacity contracts – would be simple, and economically efficient. The bidders would target a payment for availability above their estimate of wholesale market revenues. But it would need a proper carbon price and it would be very rash to assume this is going happen anytime soon. Thus the complexity of picking winners creeps back in. But a more complex auction still need not discriminate between low carbon technologies. Rather, the auction could be made a two-stage process. In stage one,

9 Energy Futures Network Paper No. 13 anyone can bid anything. The SO then looks at the bids, which reveal a great deal of information, and compares them against the carbon budgets. If there is not enough carbon reductions coming from the winning bids, then a second stage, constrained auction can be held.

Reflect for a moment on how different this is from the current mess of interventions. Now Amber Rudd’s responsibilities are radically simplified. All she and DECC have to do is set the security margin and leave it to the Climate Change Committee (CCC) to determine the carbon budgets, subject to Parliamentary approval. The SO does the rest. In practice, there would need to be quite a lot of engagement with the SO, but this is a world away from the detailed analysis, modelling and time involved in trying to pick winners.

The 2-stage auction would be terrible news for the lobbyists like Renewables UK. It would no longer be able to lobby for each technology its members would like to have subsidised. The specific carbon “pork-barrels” would have gone. It would no longer be able to try to persuade ministers as to the desired subsidies. There would be little room for the sort of PR about each new wind farm generating enough electricity for so many thousand homes – now they would have to bid firm power and thus add the rider “when the wind blows”. Markets and competition have a habit of revealing the true costs – and not those the PR merchants would have us believe.

R&D

The final bit is the R&D – the bit that really could make a difference. Unlike broader energy and climate policy design, this is very difficult to get right. Most R&D projects fail – that is why they are R&D. There are a small number of winners, and because it is R&D it is very hard to predict which will work. General tax credits and economy-wide incentives are very much scatter gun approaches, and in any event they do not address public research.

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An R&D policy needs to concentrate resources without trying to prejudge the winners. In The Carbon Crunch, the case is made for focussing on a small number of areas, and then using the research councils and other mainstream mechanisms for awarding research monies.

When it comes to energy there are several exciting prospects already. For electricity generation, low carbon options include: next generation solar; nuclear; geothermal; and gravity (such as hydro). Given that nuclear is being pursued are a global level and Britain has largely opted out of the involvement of British firms in this area, and given the scale of resources required, this is probably less attractive than solar, where Britain has many opportunities. Geothermal and gravity have similar global dimensions, and again it is not clear that these are areas of comparative advantage for Britain. CCS has an obvious British context – there are lots of empty gas fields in shallow water with pipes already attached, and coal power stations on the east cost. If there is anywhere in the world to try out CCS, it is in the North Sea.

Next comes storage, batteries and transmission technologies. Electric cars are not a question of if, but rather when, and car batteries will be a major storage device for the electricity system – as petrol tanks are now for the oil industry. Research on batteries is following a bewildering number of different vectors. Electric car research is global, but with Britain having a potential role. Other forms of energy storage are also promising.

The third bit of the energy chain is on the system management and the demand side, and here the application of information technology creates a whole series of “smart” opportunities – smart meters, smart appliances, smart grids, and smart cities.

The primary task for Amber Rudd is to create a clear R&D budget – preferably transferring some money from current subsidised renewables like offshore wind

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– and a clear framework for the allocation of R&D funds, at arms’ length from DECC.

Setting out the framework

These three elements – carbon, security and R&D – make up the main areas of policy intervention. Markets reveal the information, and they kill off the plague of lobbyists.

If this is the direction of travel, then Amber Rudd needs to spell it out as the basis of her energy policies – and what the next four years are supposed to achieve. Otherwise she is vulnerable to, at best, the charge of being ad hoc, and at worst of not really taking climate change seriously.

There have been two main turning points in the last three decades. Nigel Lawson set out his Market for Energy3 in a speech in 1982. His vision lasted for over two decades. Then came Ed Milliband’s – the Fall and Rise of the Department for Energy – speech in 20084, which laid the basis for the central buyer and the subsequent policies of Chris Huhne and Ed Davey. Amber Rudd should add her contribution, getting onto the front foot with a positive and efficient policy framework, based on markets and championing research and the new industries on which Britain may come to rely. Graphene, solar, robotics, 3D printing, smart technologies and the electrification of almost everything should be the key words – with rather less on yesterday’s onshore wind and related pet technologies of the lobby groups.

3 Lawson, N. (1982), Speech given at the Fourth Annual International Conference, International Association of Energy Economists, Churchill College, Cambridge, 28th June. Reproduced in The Market for Energy, eds D. Helm, J. Kay, and D. Thompson (1989), Oxford, Clarendon Press. 4 Miliband, E. (2008), “The rise and fall and rise again of a Department of Energy”, lecture by Miliband, Imperial College London, 9 December (accessed at www3.imperial.ac.uk/pls/portallive/docs/1/54221696.pdf, 19th August 2015).

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