The UK energy confusion: Good policies, shame about the politics

To outside observers, UK energy policy must seem to be hopelessly confused and the energy sector in a mess. Actually, the problem is not so much the policies, writes Stephen Tindale, associate fellow at the Centre for European Reform. They make a lot of sense and may lead the country to a secure and low-carbon energy future. The problem is the politics – populist proposals create confusion and may undo the good work that is being done.

Earlier this week RWE pulled out of developing a 1.2 gigawatt, £4 billion offshore wind farm, the Atlantic Array, which was going to be built in the Bristol Channel. Another of the ‘big 6’ UK energy companies, SSE, has warned that capacity margins are so low that the lights may go out. Labour leader Ed Miliband has promised to freeze energy bills if he wins the 2015 general election. Prime minister David Cameron has allegedly said in response that the solution is to “cut the green crap”.  (His press office will not confirm the words, but do not deny that this is Cameron’s sentiment.)

The UK has sensible energy policies. The problem is the politics. Chancellor of the exchequer George Osborne can – and must – put this right when he makes his autumn financial statement to parliament on 4 December.

Almost a fifth of the UK’s existing generating capacity will close by 2020. Most of the existing nuclear power stations will reach the end of their design life. Some coal stations will close due to EU directives. At the same time, the government expects electricity consumption to double by 2050, driven mainly by the electrification of heating and transport.

So the UK needs enormous investment in new generating capacity – £110 billion by 2020, according to the government. To meet climate policy objectives, most of this will have to be low-carbon generation  These climate objectives are not a matter of party-political divide. The Conservative, Liberal Democrat and Labour parties all supported the Climate Change Act, which requires reductions of annual greenhouse gas emissions of 80% (from 1990 levels) by 2050. To deliver this, they all support energy efficiency and a mix of generation technologies: renewables, carbon capture and storage (CCS) and nuclear.  They all accept that gas will be needed for back up and baseload generation, and call for a gas CCS demonstration – although the Conservatives, in particular Osborne, are more pro-gas than the other parties, and promote fracking as a response to the decline of North Sea gas.

Nuclear power used to be a party-political issue, but is not any more. The Conservatives have always been pro-nuclear.  Labour became pro-nuclear in its third term, 2005-10. The Liberal Democrats were anti-nuclear until they entered government. The coalition agreement they signed with the Conservatives stated that new nuclear power stations would be supported – but without public subsidy. What counts as a subsidy? Ed Miliband, while Energy and Climate Secretary from 2008 to 2010, said correctly “you can have cheap energy, or you can have clean energy. You can’t yet have cheap clean energy”. Without  financial support, there would be very few renewables, no CCS and no nuclear.  The coalition’s first Energy and Climate Secretary, Chris Huhne, acknowledged this. He said that there would be “no specific subsidy” for nuclear power. Instead, the government will offer financial support for all low-carbon energy options. So there will be subsidies for nuclear.

Nuclear power used to be a party-political issue, but is not any more

Energy bill

To get investment in low-carbon energy production going – the government has put together an energy bill, which is still wending its way through the houses of parliament but which the government hopes will become law before the end of the year. This  will provide ‘Contracts for Difference’ for renewables, CCS and nuclear. Under these contracts, companies will receive payments up to a certain level (“strike price”) to cover the difference between the cost of the technology being used and the average market price for electricity.  In future, the government argues, these contracts will be awarded by auction, so will be technology neutral. But this won’t happen until the end of this decade at the earliest.

To begin with, the government will set different strike prices for different technologies. The proposed levels are:

• £305 per MWh for wave and tidal
• £155 per MWh for offshore wind, declining to £135 by 2018
• £145 per MWh for anaerobic digestion
• £125 per MWh for large solar, declining to £110 between 2016 and 2019
• £125 per MWh for geothermal
• £100 per MWh for onshore wind, declining to £95  from 2017
• £120 per MWh for biomass
• £90 per MWh for energy from waste
• £65 per MWh for landfill gas

The s strike price for nuclear power, announced in October after lengthy negotiations between the government and EDF Energy, is £92.50 for the first station, in Somerset, falling to £89.50 if EDF builds a second new reactor in Suffolk. This enabled EDF Energy to argue that nuclear will be cheaper than most renewables. However, the contracts for renewables will be for 15 years. Those for nuclear will be for 35 years. So whether nuclear or renewables are less expensive depends on the discount rate used in the calculation. The appropriate discount rate is subject to much dispute, as the reaction to the Stern Review on the economics of climate change has demonstrated.

The Contracts for Difference will increase consumer bills – though the Department for Energy and Climate Change argues that a do-nothing policy would increase bills by even more, due to the need to import more fossil fuel from global markets. This counterfactual is plausible, but impossible to prove or disprove, so leaves plenty of scope for political argument. The contracts will be an addition to several other levies on consumers’ bills which aim to improve energy efficiency and boost low-carbon energy supply.

Green levies

In response to opposition leader Miliband’s much-talked about September speech, in which he called for a freeze of energy bills, the government launched a review of these green levies in October.  Cameron says that in total they currently  increase the average domestic energy bill by £112 – around 8% of the total. Government figures say that if left unchanged this will rise to £194 in 2020 – 14 %.  Over half of the money goes to an energy efficiency scheme, the Energy Company Obligation or ECO.  This does have some carbon objectives. But it is primarily a health policy, to stop those on low incomes in hard-to-heat homes dying of hypothermia. There were 31,000 excess winter deaths in 2012/13 in England and Wales. Most of the UK’s building stock is extremely wasteful of energy.

The contracts for renewables will be for 15 years. Those for nuclear will be for 35 years

House of Commons research indicates that changes in global gas prices are the main cause of rising UK energy bills, though soaring profit margins by the Big Six are another. Profits they have made per household have, according to the regulator Ofgem, risen from £30 per household in 2011 to £105 this year. But the only Conservative politician who has yet suggested action on company profits is former prime minister John Major, who called for a windfall tax. Conservatives in the current government focus instead on what they call ‘unnecessary’ measures to support renewables. Many of them oppose onshore wind farms, as they have rural constituencies and the most vocal of their voters dislike turbines in their back yard. And some Conservative MPs deny any link between human activity and climate change.

The Liberal Democrats remain committed to climate action. And Lib Dem energy secretary Davey has focussed on the right question. On 5 November he reassured the renewables trade association, RenewableUK, that “the current review is not about changing investment incentives for renewables…These are essential for investor confidence in the renewables sector and our commitments to a low-carbon economy. But we do need to make sure that support is paid for in a way that is fair to consumers. And that is what the current review is about, not the level of support – that has already been agreed – but how it is paid for.” Osborne should confirm, in his autumn statement, that the question is how we pay, not whether we pay. And Labour should say the same. That would remove some of the political uncertainty.

How should we pay?

So how should we pay?  There are innumerable ways in which  governments could raise the money, but they can be divided into three: general taxation; green levies on domestic energy use; other green taxes.

General taxation would be progressive. But this would make the low-carbon transition and energy efficiency part of the annual battle for public spending, so would not provide any  certainty. And it would be a reduction in the proportion of revenue raised through green taxes, which Cameron has said that he aims to increase.

Levies on domestic energy are a green tax, but not a good tax, at least in the UK. They are regressive, and have little impact on behaviour.

The most sensible way forward would therefore be for the government to remove the green levies from domestic energy and increase other green taxes. The revenue from these should be allocated to energy efficiency work and support for low-carbon generation.

Taxes on domestic energy have been politically toxic in Britain since the early 1990s.  VAT on fuel was introduced in 1993 by Major’s Conservative Government, at a rate of 8% with the intention to increase this to the then standard VAT rate of 17.5 per cent.  The Conservatives got the 8% passed, but Labour and the Lib Dems, then together in opposition, defeated the increase. Labour promised to reduce the rate to five per cent, which it did after it won office in 1997. (It would have reduced the rate to zero, but EU rules do not permit this.) I believe that for health and social policy reasons, the Conservative/Lib Dem government should abolish all levies on domestic energy.

Increasing the Air Passenger Duty and using some of the money for energy efficiency programmes  would be a very progressive package. Poor people do not fly often, if at all

Which green taxes should be increased then to recoup the money and show that the government is not retreating from green taxes? The best option would be to double the Air Passenger Duty (APD). This kind of demand management through taxation may remove the need for a new runway in South East England, which voters under the existing flight paths, and their MPs (many of them Conservative) oppose.  So doubling APD would be good politics. The threat of a new runway will be a strong enough issue to swing votes in a marginal constituency; the APD level will not.  There is no evidence that the APD damages British competitiveness, despite airlines’ constant claims that it does. Increasing  APD and using some of the money for energy efficiency programmes  would be a very progressive package. Poor people do not fly often, if at all.  Energy efficiency spending should be targeted at the poor.

Another way to raise money is for the government to allocate the revenue from the UK’s auctioning of Emissions Trading System (ETS) permits to energy efficiency, rather than simply counting the revenue as general taxation receipts.  The British government has introduced an ETS  price floor, starting at £15.70 per tonne of carbon dioxide in 2013. This will increase each year, reaching £30 in 2020 and £70 in 2030.  This is one example of the UK being ahead of the rest of Europe on climate policy – which Osborne has said we should not be. Indeed ,it’s perfectly possible that he will abolish the price floor next week.

A better approach would be to push actively for an EU-wide price floor. The new German government might be persuaded to support this. The SPD in Germany, the new coalition partner of Merkel’s Christian-Democrats, is traditionally close to the coal industry, but may be more willing to support a strengthened ETS than the free market FDP would have been. Berlin needs a lot of public money to pay for the Energiewende. The French would almost certainly support it, given their low-carbon fuel mix.

Will Osborne do any of this? It is not likely: he is a Eurosceptic who is not very interested in climate change. But nor is it impossible.  The Liberal Democrats are strongly committed to climate action, and a complete retreat on the green agenda could even threaten the coalition’s survival. And the Conservative party well remembers the political unpopularity of VAT on fuel, not least because David Cameron was the then Chancellor’s political adviser when it happened.