28.The Climate Change Act 2008 requires the Government to publish policy proposals setting out how the Government plans to meet the UK’s carbon budgets and the long-term goal for 2050 ‘as soon as is reasonably practicable’ after legislating for a carbon budget. After a prolonged delay and fifteen months after legislating for the fifth carbon budget, the Government set out its proposed policy framework in its Clean Growth Strategy published in October 2017. The Strategy covers the work of multiple Departments with policies on energy, housing and transport. It set out five key policies, including an £18million heat recovery programme, continued Energy Company Obligation funding for energy efficiency improvements and an increase in the Renewable Transport Fuels Obligation. However, during our inquiry we focused specifically on the proposals it set out relating to green finance.
29.The Strategy said the Government would ‘accelerate clean growth by developing world leading Green Finance capabilities’ by:
30.In the Autumn 2017 Budget, a few weeks after the Clean Growth Strategy was published, the Chancellor announced a moratorium on financial support mechanisms for new low-carbon energy projects. The new Control for Low Carbon Levies will monitor the total cost of the Contracts for Difference, Feed-in-Tariffs and the Renewables Obligation and will not allow any further subsidies to be introduced until the total cost of such levies is falling. The Treasury has forecast this will not happen until 2025. The Control applies only to new levies, and specifically excludes existing money committed under the Contracts for Difference (CfD) auctions, Renewables Obligation, Feed-in Tariffs and £557 million allocated for future CfD auctions. The only other case where the Treasury will make an exception to its control on new levies for low carbon electricity projects is ‘where they have a net reduction effect on bills and are consistent with the government’s energy strategy.’
31.Many of the submissions we received praised the Government for the overall vision of the Clean Growth Strategy and its cross-departmental breadth. We heard positive feedback about the establishment of the Green Finance Taskforce and the Government’s plans to work on green finance standards, which we discuss in Chapter 4. The Government’s endorsement of the TCFD was also broadly welcomed and there was much discussion during the inquiry of how best the Government could implement its recommendations. We will address this issue in our next report on greening finance.
32.Despite praising the Strategy’s aspirations, much of the evidence we received was critical of its lack of detailed proposals. Alex White from the Aldersgate Group said:
It sets great ambition and the narrative should not be underplayed in how important that is for investors, particularly international investors looking to invest in the UK. On top of that, it does seem to have good cross-Whitehall buy-in.[…] that gives greater confidence that there will be stability going forward.
However, she went on:
… we would look for greater detail in some of the policies. For example, they have said there is an aspiration for all homes to be EPC band C by 2035. We would say that that should, first of all, be a target and, secondly, what levers are you going to use to get there? They have set that end goal with no explanation of how they see that happening.
33.In its submission, the Green Alliance also criticised the Strategy’s reliance on aspirational targets, which ‘do not drive investment’. It argued that:
… the only major investments made in low carbon technologies have been through the Renewables Obligation (RO), Feed In Tariffs (FITs) and Contracts for Difference (CfDs). The RO had a clear target that licenced electricity suppliers had to meet with regards to renewable sources and both CfDs and FiTs provided a clear way for investment to be put into low carbon technologies. By contrast, the Clean Growth Strategy allocates £557m for Pot 2 CfD auctions, but is otherwise vague on how its aspirations will be achieved.’
34.Similarly, the Principles for Responsible Investment (PRI) network criticised the Strategy’s failure to set out a timetable for regular auctions of low-carbon power contracts. It argued that if the March 2019 Contracts for Difference auction ‘was split into two or three well-spaced auctions it would provide investors in the UK wind sector with some much-needed certainty in the medium term’. The Overseas Development Institute said in its evidence that the UK’s Clean Growth Strategy is undermined and contradicted by continued public finance to fossil fuels through UK Export Finance. It said that its research had found that UK Export Finance provided £551 million for fossil fuel production on average per year in between 2014 and 2016.
35.During the course of our inquiry, the Committee on Climate Change (CCC) warned that urgent action is needed to flesh out the plan to meet our carbon budgets between 2023–2032. It praised the Government for placing ‘the low-carbon economy at the heart of the UK’s industrial strategy’, but pointed out that even if existing and new policies were ‘interpreted generously’ and delivered in full, the UK will miss the fourth (2023–27) and fifth carbon budgets by 10–65 MtCO2e. The CCC said that the UK’s first three carbon budgets had turned out to be easier to meet than expected for a range of reasons—including economic weakness during and following the financial crisis. It warned the Government that this surplus should not be relied upon to meet the fourth and fifth budgets.
36.The CCC highlighted a particular risk of missing the fourth budget, given that it begins in only five years and project lead times can be lengthy. It noted the announcement of innovation funding could have a positive long-term impact, but would contribute little to existing carbon budgets. It argued the Government will need to be prepared to provide deployment support to existing technologies and should include cost-competitive technologies, such as onshore wind and solar PV, when procuring low-carbon energy. It called on the Government to set out by the end of 2018 how it intended to close the remaining gap to meeting the budgets.
37.We put the Committee on Climate Change’s criticisms to the Minister, who defended the strategy:
Claire Perry: …I think what they [the CCC] commented on were the policies and proposals in the Clean Growth Strategy for which estimates have been created, and only 30% of the 50 policies and proposals are at a developed enough state to put emissions reductions against them. Even with those estimates—and using the updated emissions estimates from January—we are on track to meet 97% of the fourth carbon budget and 95% of the fifth carbon budget, and those are budgets that end in 10 or 15 years’ time.
38.In March, as we were preparing this report, the Green Finance Taskforce established by the Clean Growth Strategy published its recommendations to Government on accelerating green finance. It called on the Government to set up a Local Development Finance Fund and issue a Sovereign Green Bond as part of a National Capital Raising Plan tied to the delivery of the Clean Growth Strategy and 25 Year Environment Plan.
39.We are encouraged by the cross-Departmental ambition of the Government’s Clean Growth Strategy. However, in many areas the detail is lacking. Aspirations alone are not enough to redirect investment away from high carbon to lower carbon alternatives. Indeed, the Government’s independent advisers, the Committee on Climate Change, have warned of a policy gap that will lead to a shortfall in the fourth (2023–2027) and fifth (2028–2032) carbon budgets even if the Strategy’s policies are ‘interpreted generously’ and delivered in full.
40.Given that these budgets are only a few years away, Ministers must urgently plug this policy gap and publish a delivery plan to secure the investment needed to meet the fourth and fifth carbon budgets—without relying on carrying over a surplus from previous budgets. It is imperative that the Government responds to the Green Finance Taskforce’s recommendations promptly and produces a delivery plan in time for the 2018 Budget to show how it intends to deliver the Clean Growth Strategy. Ensuring that we are on track to meet our current carbon budgets is even more important now that the Government has asked the Committee on Climate Change to explore how to strengthen the UK’s greenhouse gas targets in the light of the 2015 Paris Agreement aspiration to limit temperature rises to 1.5 degrees.
41.Several submissions to our inquiry argued that capital was already available to deliver green investment and the Clean Growth Strategy, but highlighted that the key is ensuring that the right policies are in place to reduce risks and bring forward a pipeline of projects for investors. The Institute for Sustainable Resources at University College London explained that ‘the challenge is to ensure a pipeline of bankable projects offering returns that are attractive to investors and respond to their risk management needs’.
42.This can be done in two main ways, according to the Institute for Sustainable Resources. Direct support instruments, such as renewable energy subsidies or de-risking measures like fixed long-term contracts, are effective policy mechanisms for reducing risk and increasing investment in low carbon energy projects. More broadly, carbon pricing mechanisms such as a carbon tax or emissions cap-and-trade schemes can be used to alter the balance of value and risk between low-carbon investments and their high-carbon equivalents. We heard a variety of evidence about these two methods of redirecting investment from high to low carbon projects, which we will consider here.
43.Low carbon electricity generation tends to benefit from lower operating costs, but often requires high up-front capital investments. As a result, its economics are strongly influenced by the cost of capital and the required rate of return—which is reflected in how risky an investment is considered to be. In Lord Turner’s view, the most effective way the Government could provide certainty, reduce risk and deliver investment in renewable energy was through fixed-price contracts. He believed these could soon be subsidy free:
The crucial thing there is not to redesign anything in the financial system. The finance is there, as long as there is the ability to invest with the certainty of selling the electricity at a defined price in advance. Until now, we have written those CFDs with an expectation that on average, over time, they will cost something. Relative to the reference price of what we think the wholesale price will be, we have paid a higher price. I think that there should be a developing vision that we move towards more CFDs at a lower and lower premium over the expected wholesale price, and I suspect that within three or four years we will write contracts that have no expectation of subsidy, but which still require the Government or the systems operator to make a fixed price commitment.
44.NextEnergy Capital, which manages $1 billion of solar investment equity, said it would soon be possible for them to deliver subsidy free solar power installations, but that fixed price contracts in the form of Power Purchase Agreements should replace CfDs. It argued that:
CfDs favour large business operators due to the cost, time and resource demand of bidding for a CfD. As such, the CfD model is a bottleneck to investment–in particular, a bottleneck to investment in small scale, low carbon generation. Investors require pipeline depth and viability ahead of mandating an investment strategy. There is an inherent illiquidity associated with the small number of large scale opportunities offered via CfDs.
45.The PRI also argued for the use of Power Purchase Agreements for ‘subsidy free renewables’, which would guarantee an inflation linked price at a level below the wholesale rate. Recent research has indeed indicated that certain mature technologies, such as onshore wind, could be brought forward in the UK without the need for any direct subsidy as long as fixed-price contracts are used to reduce risk.
46.WWF said that the Treasury’s move to constrain the money available for low carbon levies until 2025, ‘will not bolster investor confidence’. It also said the Strategy was ‘silent on future support for, or direction of policy in relation to, onshore wind or solar power, generating further uncertainty for future investment in these technologies.’
47.Given the disruption and policy uncertainty of the last three years, the Treasury must ensure that its attempts to keep costs down for consumers do not exacerbate the current dip in clean energy investment. The Government should launch a consultation before the next round of CfD auctions in 2019 to explore how it can continue to encourage new low-carbon generation with fixed-price contracts in the early 2020s, while keeping costs down for consumers.
48.The UK’s Carbon Price Support policy and Carbon Price Floor has been one of the most effective examples of carbon pricing in the world, according to the Institute for Sustainable Resources, becoming the ‘primary policy mechanism for shifting the energy mix from coal to less carbon intensive gas.’ Carbon Price Support is a tax on every tonne of CO2e emitted by electricity generators. We also heard that a higher carbon price could, in the long run, be an effective and technology neutral way to drive investment and innovation in emissions-reducing technologies across the rest of the economy. Lord Turner argued that, while direct support for low-carbon technologies through fixed price contracts was necessary to deliver deployment of renewables and other low-carbon electricity, a rising carbon price would be necessary to decarbonise other areas of the economy as we progress towards our 2050 target:
Where the carbon price will be absolutely crucially dependent is in driving the decarbonisation of industrial sectors. When you get to, “How are we going to take the carbon out of plastics production, chemicals, ammonia, steel and cement?”, in those areas you cannot possibly define centrally a small number of things that you need to do—“Build this much nuclear and that many windmills and you’ve got there.” You have to have a very complicated, private sector, competitively driven search process for the best solutions. […]
As we move beyond the challenge of decarbonising the power sector and start to look at some of the other sectors of the economy, the carbon price could be more important than it has been. Generating an expectation of a gradually rising carbon price is hugely important.
49.When the UK’s Carbon Price Floor was introduced, it was due to rise every year until 2020 (to a price of £30/tCO2). In the 2014 Budget, the Government capped it at a maximum of £18/tCO2 from 2016 to 2020 to limit the competitive disadvantage faced by business and reduce energy bills. This price freeze was extended to 2021 in Budget 2016. NextEnergy Capital argued that for carbon pricing to be truly effective, the Government needed to set a clear, stable and steeper upward trajectory. It suggested this could be mapped out over a 30 year period with the carbon price increasing every five years.
50.As a member of the European Union, the UK participates in the EU’s Emissions Trading Scheme (EU ETS), which sets a price on carbon for the power sector, and energy intensive industries. The EU ETS covers approximately one third of UK carbon emissions, and Carbon Price Support only applies to electricity generators. The remaining two thirds of the economy is covered by no carbon pricing policy. Although the Government have said it is their intention to negotiate to remain in the EU ETS, the ETS is a single market mechanism, and there is no guarantee that the UK will be able to participate after Brexit if the UK leaves the single market.
51.At the Autumn Budget 2017, the Treasury announced that the UK’s Carbon Price Support would remain in effect until “unabated coal is no longer used”. This means the Carbon Price Support policy will cease to be in force after 2025, which is when the Government has committed to phase out unabated coal.
52.The future of both of the UK’s carbon pricing policies are at risk, on the one hand from Brexit and on the other from the lack of Government commitment to use carbon pricing to drive decarbonisation in the power sector after unabated coal is phased out. Carbon pricing has been extremely effective at driving investment away from carbon-intensive forms of generating electricity. We heard evidence that a carbon price would be an effective way to drive decarbonisation in other sectors of the economy. Long-term clarity about the future level of that price would allow businesses and investors to plan for the transition to a low-carbon economy.
53.Ministers should set out a trajectory to gradually increase the carbon price—starting after the current freeze on Carbon Price Support comes to an end in 2021—to continue driving investment away from fossil fuel based electricity generation. The Government should also carry out an assessment to consider how extending carbon pricing to cover the whole economy could help us meet our climate change targets.
44 Committee on Climate Change, An Independent Assessment of the UK’s Clean Growth Strategy (January 2018); Climate Change Act 2008 ss12–13
45 Department for Business Energy and Industrial Strategy, (October 2017)
46 Committee on Climate Change, (January 2018)
47 Department for Business Energy and Industrial Strategy, (October 2017)
48 HM Treasury, (November 2017)
49 HM Treasury, (November 2017)
50 HM Treasury, (November 2017)
51 Aviva (GFI0024)
53 Green Alliance (GFI0011)
54 Principles for Responsible Investment (GFI0029)
55 Overseas Development Institute (GFI0018)
56 Committee on Climate Change, (January 2018)
57 Committee on Climate Change, (January 2018)
58 Committee on Climate Change, (January 2018)
60 Green Finance Taskforce, (March 2018)
61 Institute for Sustainable Resources, University College London (GFI0020)
62 Institute for Sustainable Resources, University College London (GFI0020)
63 Institute for Sustainable Resources, University College London (GFI0020)
64 Grantham Institute, (November 2017)
67 NextEnergy Capital (GFI0031)
69 Principles for Responsible Investment (GFI0029)
70 Arup, (July 2017)
71 WWF (GFI0022)
72 WWF (GFI0022)
73 Institute for Sustainable Resources, University College London (GFI0020)
75 House of Commons Library Briefing, (January 2018)
76 NextEnergy Capital (GFI0031)
77 House of Commons Library briefing, (January 2018)
78 This is based on an analysis of figures from the Annual Statement of Emissions 2015, which states that total UK territorial emissions were 495MtCO2e in 2015, and that UK operators of ETS installations surrendered 171MtCO2e. This shows that emissions from ETS installations accounted for 34% of total UK emissions in 2015.
79 HM Treasury, Autumn Budget 2017, paragraph 3.45.
Published: 16 May 2018