Uncertainty over UK energy mix

The focus on ensuring a secure and stable energy supply presents challenges while there is uncertainty over the future direction of UK government policy

The UK energy sector has seen support for renewables and nuclear, as well as an increasing focus on shale gas, which the government says is “good for jobs, good for growth and good for energy security”.

The challenge is meeting the sometimes conflicting ambitions between security, growth and decarbonisation along with an historic lack of investment in the UK energy market which is now undergoing significant change.

“The future energy mix should be consistent with a journey to 80 per cent decarbonisation by 2050, at minimum cost to consumers,” says Ian Mays, group chief executive of renewable energy company RES. This target is enshrined within the UK’s Climate Change Act, which will effectively require the full decarbonisation of the electricity sector.

Transitioning the UK’s electricity supply to accommodate lower-carbon emissions is going to have a significant impact on its future generation mix – a greater use of renewables, increased use of gas for generation and carbon capture for existing coal-fired stations are all possibilities. The issue is identifying the best route to achieving this goal.

UK energy demand

Ian Maclean, UK managing director, energy and industry, at WSP Parsons Brinckerhoff, says: “The UK energy market is dominated directly and indirectly by large players. Managing vested interests to deliver the transition at reasonable cost to consumers and the UK economy is a major challenge.”

As Phil Grant, a partner at Baringa, says the last 30 years have seen market dominance of large fossil-fuel plants with power transported by networks. “We are now in an interesting transition period where there is a vision of an integrated energy market across power, transport and heating, with individual control of production and consumption,” he says. What seems lacking is an integrated vision of how to achieve such systemic change.

In electricity alone, the arguments are rife. Renewable energy provides a secure fuel supply at low marginal cost, but can be intermittent and energy storage technologies remain fairly immature at a large scale. Natural gas is far cleaner than coal and could, if UK shale becomes fully developed, be a secure domestic fuel. But focusing on natural gas could lock us into a carbon trajectory that is significantly higher than is compatible with the UK’s carbon reduction commitments over the next 20 years. And while nuclear is low carbon, its capital costs are comparatively high, making a push for large-scale expansion unlikely.

The future of the UK energy mix is largely dependent on clarity about the direction of policy

Further, as Harald Heubaum at the School of Oriental and African Studies, University of London, highlights: “Nuclear is currently an inflexible energy technology in that it doesn’t respond very well to supply variations. This may be fine for the time being, but will be increasingly problematic as renewables grow to the point where they make up most of the power generation mix.”

The one thing most experts agree upon is the need to phase out polluting coal and roughly 2 gigawatts is due to come offline in the next couple of years. Yet when the issue of fuel poverty arises, domestically or internationally, the cheapness and availability of coal increases in importance. A recent UBS report described solar as the default energy technology of the future, but if an intermittent technology will be providing the majority of energy and electricity, then the question of flexible back-up power becomes important. Nuclear cannot provide that degree of flexibility, while coal and gas can.

The UK has attempted to address this issue with the development of capacity markets. As Aldersgate Group executive director Nick Molho points out, these were developed to ensure back-up supply. To date they have mainly been used to support gas generation plant, but “we also need to support other technologies that can guarantee system security in a low-carbon and efficient way, such as through storage or demand-side response”, he says. The capacity markets were intended to derisk investment, and address the missing money for investors and owners of thermal plant. However, there appears to be a significant risk of unintended consequences caused by the current design.

Part of the challenge, as Tomas Freyman, a partner in valuations at BDO, points out is that economic policy and energy policy are not always aligned, and there is a lot of flip-flopping on priorities when it comes to infrastructure. “Investors loathe nothing more than uncertainty,” he says. Mr Molho agrees, arguing that the private sector needs to understand a consistent minimum of planned activity in order to plan for future priorities.

Mr Grant adds: “We have the paradox of long-term investment frameworks necessary for investors, but a short-term five-year political cycle.” This can increase the perception of risk for investors. This is only exacerbated by volatility in the wider energy environment. Steve McCabe at Birmingham City University’s Business School says: “An unfortunate side effect of the fall in the price of oil may be that alternatives become relatively more expensive in the short-term and make the quest for alternatives less urgent.”

Then again, as Dr Heubaum points out, lower oil and gas prices are also an opportunity for governments to further reduce fossil-fuel subsidies and potentially increase surcharges on fuel supplies. Such levies could then be used to “speed up and expand the low-carbon transition into the heating and transportation sectors, for example through further investments in electro-mobility”, he adds. The future of the UK energy mix is largely dependent on clarity about the direction of policy.

What is needed is to avoid the short-termism that characterises British thinking

There are other trends which may also have an impact on the future UK energy mix. Dr Mays says: “Challenges include the commercial and technical transition from centralised generation to more decentralised generation, and the time required to roll out storage and demand-side management infrastructure.” And Ian Thomas, managing director at Turquoise, a leading cleantech investor, points out: “There is a societal change where people increasingly want to control their energy usage, whether due to disillusionment with quasi-monopolistic utilities or simply a desire to have more choice. There is a growing interest in distributed generation of all kinds.”

Demand management is going to play an increasingly important role. Open Energi  has forecast that by 2020 demand response could save  the UK £1.12 billion, by reducing investment in new transmission and generation infrastructure, avoiding peaking power costs.

“There is a powerful economic case for demand response to distribute demand more efficiently, regardless of the future generation mix – the capital cost of building a new peaking power station can be up to £5 million per megawatt of power,” says David Hill, business development director at Open Energi. This is opposed to current costs of aggregating a megawatt of power at around £200,000. What will matter is a coherent and consistent policy environment to support its development. As Dr McCabe says: “What is needed is to avoid the short-termism that characterises British thinking.”

Given the lack of clarity about efficiency, demand-side management and an integrated policy approach to all forms of energy, the future of the UK’s energy generation mix looks unclear and may stay that way for some time to come.