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Balancing visibility and flexibility through a power sector decarbonisation target

Analysis by the Committee and others has repeatedly shown that the roll-out of low-carbon power generation to 2030 is a key part of the cost-effective path towards the UK’s statutory 2050 target.  Power is directly responsible for around a quarter of UK emissions, multiple low-carbon options are available (e.g. onshore and offshore wind, nuclear and solar technologies), and low-carbon electricity offers a route to reducing emissions in other sectors of the economy (e.g. via heat pumps and electric vehicles).

In line with advice from the Committee, the Government has introduced long-term contracts and price discovery through competitive auctions for low-carbon power. These are the best way to keep costs down for capital-intensive projects, and results of the first auction were encouraging in this regard. However, success will only continue if projects seeking contracts continue to come forward – competition requires competitors.

There is a risk that a continuing stream of low-carbon projects (or indeed investment further up the supply chain) may not be forthcoming given the limited visibility currently available and the political risk this implies for investors:

  • To 2020, there are many indications that contracts will be available – £7.6 billion of annual funding has been committed under the Levy Control Framework, the EU Renewable Energy Directive requires that the share of generation from renewables increases from 20% in 2014 to around 35% in 2020, and the Government’s Electricity Market Reform Delivery Plan includes scenarios indicating potential roll-out of individual technologies.
  • However, beyond 2020, there are limited market and regulatory signals. There is currently no renewables target under the 2030 EU package and no commitment in the UK of funding for new projects post-2020. Indeed one of the scenarios in the Government’s Delivery Plan envisages no growth in low-carbon capacity from 2020 to 2030. Lack of visibility through the 2020s implies significant risk for developers of new projects and the supply chain.

Policy risk is hard (and costly) for investors to bear. That is particularly problematic as many low-carbon technologies have high development costs and long lead-times (e.g. large, far-from-shore offshore wind farms may need five to seven years and up to around £60 million before they are ready to bid for a contract, nuclear power stations and carbon capture and storage plants may need more). Investments in the supply chain (including in R&D) are also important in driving down costs and are made based on an assessment of future demand.

If the world resembled a classic economics “textbook”, this uncertainty could be dealt with through a clear long-term trajectory of carbon prices. Firms would be able to forecast (with reasonable accuracy, as with other commodities) the future price of carbon, and the associated cost of high-carbon alternative generation options. They would develop investment plans, taking account of the uncertainty around price forecasts, confident that there would be a market for their product provided they can deliver the right quality at an appropriate price.

In reality this is unlikely to be forthcoming for some time. Internationally, the price in the EU ETS has been low, recently only around 7 euros per tonne, because the EU ETS is a work in progress. It has proved hard for the UK to commit unilaterally to a carbon price: within a year of its introduction it was announced that the UK’s carbon price support would be frozen.

Parliament has therefore recognised the need for an alternative way to signal its intentions. It included a power in the Energy Act to set a target range for decarbonisation of the UK power sector in 2030. Set at the right level, it is one way to provide a clear indication of direction, whilst maintaining the flexibility about how to achieve the target – we can see which technologies are able to deliver at lowest cost.

It would be a signal to all, but a promise to none.

Such a target can substitute for a long-term credible trajectory for the carbon price. It would provide a commitment from the Government to offer contracts as if there was a carbon price sufficient to drive low-carbon investment (e.g. as in line with the Government’s published carbon values, reaching a central estimate of £76/tonne in 2030). Choices over the best technology to bring forward would remain largely with the market. Consumers would only be exposed to costs on contracted generation (whilst a rising carbon price would affect all generation), and firms facing genuine competitiveness risks could be exempted.

There are alternative ways of providing visibility – for example by extending the funding envelope beyond 2020 – though this is likely to be more credible when backed by a clear legislative commitment.

Alongside our advice on the fifth carbon budget (to be published by the end of the year), we will update our scenarios for cost-effective investment in the power sector, and advise on the suitable level for the target range. Our most recent assessment is that a range of the order of 50-100 gCO2/kWh would be suitable. This would imply that most new generation through the 2020s would be low-carbon and allow for a portfolio of options, which is appropriate given the many uncertainties over cost and deliverability.

We welcome evidence on this issue. We have, separately, issued a Call for Evidence about a range of issues related to our advice on the fifth carbon budget. We would appreciate views on the summary of current thinking set out above.