Summary
The Government has committed in law to achieve net zero by 2050. It has stated that its target is to decarbonise the power system by 2035. This report examines some of the steps needed to meet these targets, particularly how the Government can mobilise the capital needed to ensure the transition is orderly and that energy supply is affordable and reliable. It also briefly sets out measures to mitigate the energy affordability crisis which started in 2021 and was then exacerbated in February 2022 when Russia invaded Ukraine.
Private investment is required to achieve net zero. However, there is a gap between the Government’s ambitions and the practical policy that is needed to provide confidence and clear market signals to investors. The Government has set capacity targets for sources of low carbon power generation without explaining what balance of public and private investment is needed. The Government should set this out in broad terms and provide an assessment of relevant costs and savings.
The consequences of the Ukraine crisis have made the task of achieving net zero, while ensuring energy security and affordability, more complex. To help avoid a disorderly transition and to provide clarity to investors, the Government should publish a net zero delivery plan which takes account of energy security, making clear what decisions and operational actions are needed, and by when. Any such plan will need to incorporate the flexibility required by a three-decade, economy-wide transition.
The Russian invasion of Ukraine has created global energy supply and price issues. We recommend several measures which could make a significant difference to energy security and affordability over the next three to five years:
- High energy bills mean households may focus on energy usage and the Government should harness this public concern to speed up the pace of home insulation and other measures to improve energy efficiency. The Government should publish an energy demand reduction strategy and it should redouble its work with the financial sector to identify financing options for energy efficiency measures.
- Accelerating and increasing the deployment of renewable sources of energy can reduce the UK’s dependency on volatile gas markets. While we acknowledge some local opposition, onshore wind is one of the cheapest and fastest ways to increase renewable energy generation. The Government should re-examine its ambitions for onshore wind and consider possibilities for promoting local acceptability where local communities can benefit from the additional energy generated.
- We support the Government in seeking to maintain existing energy generation in the short term, including coal-fired power stations where necessary, to reduce dependency on expensive gas imports.
- There is no agreement in place between the UK and its European partners to manage energy supply emergencies. The Government should urgently seek an agreement with its European partners on energy cooperation.
Most of the investment required for an orderly transition to net zero by 2050 is expected to be delivered by the private sector. We were told that there is a large amount of private capital available for investment once policy and financial uncertainties are resolved. The Government can increase investor confidence by designing market models for low carbon technologies that make energy pricing more predictable. We recommend the Government:
- Set out a cost analysis for its target of 24GW of nuclear capacity compared to alternative options of providing similar baseload capacity. While we have heard that the Regulated Asset Base model could unlock private sector investment for nuclear, questions remain about the cost impact on consumers. The Government should ensure that plans for new nuclear power stations are as robust as possible, and credible in terms of costs and timing, and set out how it will protect energy bill payers in the event of cost overruns and construction delays.
- Provide more detail on the capacity, timeframes and expected costs of long-duration energy storage and develop an appropriate market model. We heard that a cap and floor model would be most effective.
- Outline market structures and mechanisms for blue and green hydrogen as soon as feasible, recognising that different applications of hydrogen might suit different market models.
- Design market models for carbon capture and storage so that investors are given greater confidence that there will be a long-term market.
While many low carbon technologies are low cost, many other technologies required for the energy transition are at an early stage in their development and not yet commercially viable. Some public financing will be needed to leverage private investment. The UK Infrastructure Bank should focus on financing innovative and potentially riskier projects with the aim of signalling to private investors that these projects are viable and have the potential to scale up in line with Government plans. We note, however, that the UK Infrastructure Bank has limited risk capital. It should focus on using its investments to manage, share and reduce risk to enable the private sector to invest where otherwise it would be difficult.
In the short term, Europe needs alternative sources of oil and gas to replace supply from Russia; and the UK will continue to require gas during the transition. Enabling more investment in North Sea production can help address this, although it will not provide a significant reduction in energy prices. Over the medium term the use of oil and gas needs to fall to align with the strategies on climate change. Any extension of oil and gas exploration or investment should focus on projects with short lead times and payback periods to limit the risk of stranded assets.
The UK may benefit from additional gas storage capacity which can also be made suitable for hydrogen storage. We welcome the Government and Centrica examining the case for reopening the Rough storage facility.
Given the urgency of the transition and the dangers of delay, we recommend the National Planning Policy Framework be revised. We recommend that energy security objectives be included along with the existing climate change objectives.
The planning process for nuclear reactors that are sited on locations of former nuclear reactors should be expedited. The Government should also encourage schemes to compensate residents for energy projects built in their areas.
We support proposals by Ofgem to increase anticipatory investment in grid capacity to unlock additional investment in renewables and to increase the UK’s energy supply at greater speed, provided that the impact on consumer bills can be contained. One way to enable anticipatory investment is the Government and Ofgem’s plan for a Future Systems Operator, which will have responsibilities across electricity and gas networks. The Future Systems Operator should be set up in a way that is operationally independent from Government. It is unclear about what role the appointments of Energy Networks Commissioner and the industry champions will have in relation to the Future Systems Operator.
The Government has introduced an Energy Profits Levy to help pay for financial support to domestic energy consumers. The Government should explain what effect the levy is expected to have on investment decisions in the North Sea and when it says that the levy could end when oil and gas prices are at “normal” levels, it should quantify what “normal” means. The Government’s decision to announce a possible extension of the levy to electricity generators, before having assessed whether it is justified, may risk affecting investor confidence in renewables. The Government should set out whether it intends to move forward with a levy on electricity generators as soon as possible, to avoid damaging investor confidence further.
Extending carbon pricing could be an effective way to disincentivise holding carbon intensive assets and encourage investment in low carbon alternatives. The UK has some carbon pricing already through its Emissions Trading Scheme and taxes on fuel. The Government should set out whether it plans to extend carbon pricing to other greenhouse gas emitting activities and provide detail on pricing levels and timescales. This could provide more clarity to investors.
Since March 2021, the Bank of England has been required to consider the Government’s commitment to decarbonisation when making policy. In April 2022 the Government asked the Bank and financial regulators to have regard to energy security as well. To provide clarity to the financial sector, the Financial Policy Committee, the Prudential Regulation Committee, and the Financial Conduct Authority should set out high-level principles on how they are interpreting the Chancellor’s instruction on energy security as soon as possible.
Understanding climate risk and managing the transition to a low-carbon economy requires data and appropriate analytic approaches. The UK’s largest companies, including financial institutions, are required to publish disclosures on their impact on the climate. HM Treasury and financial regulators will need to support businesses to make disclosures consistently and help them to gather quantitative data on their climate impact. This applies particularly to scope 3 emissions, which are indirect emissions that occur in the value chain of a reporting company, such as emissions from suppliers and customers and are especially difficult for companies to assess.
The Bank of England has conducted green stress tests to ascertain the level of exposure that financial institutions have to climate change risks. This did not result in changes to capital requirements to manage these risks. However, the quality of data and analytic approaches for assessing exposure is currently insufficient for regulators to reach reliable judgements on the appropriateness of capital requirements. This problem is exacerbated by a lack of clarity from the Government on energy needs during the transition and how sectors will be expected to adapt.
Green taxonomies can help define which infrastructure and technologies are “green”, which helps investors to judge the effect of their decisions on the environment. However, they can also be seriously misleading by giving the impression that projects are either green or brown. If poorly designed, green taxonomies risk driving capital to a narrow subset of existing options, which may stifle innovation and they can fail to take account of the process of transition towards new sets of activities. The Government should be mindful of this risk by avoiding a narrow interpretation of the taxonomy and ensure that guidance to investors reflects the fact that the transition to net zero may involve complex interlinkages between renewables and fossil fuels. The Government should also work with other jurisdictions’ authorities to ensure that the principles underpinning a UK taxonomy are consistent with taxonomies in other countries and regions.
The Government wishes to unlock more capital for net zero-aligned investment by reforming the Solvency II regulatory regime for insurance companies. The insurance industry has said such changes would release substantial capital, but insurers do not have an obligation to use any capital that is released for such purposes. The Government should explain how it can encourage capital to support the energy transition.
The EU has started to create the foundations for a Common Purchase Platform so that it can leverage its collective weight in negotiations with gas and hydrogen producers. While these plans are at an early stage, if the EU’s ambitions are realised, they may affect the UK’s energy supply. The Government should engage with the EU to increase the chance that the UK can benefit from working with the Platform if there is some advantage in doing so.
Increasing the UK’s reliance on renewable energy sources will create new dependencies on foreign countries, particularly in terms of manufacturing renewable technologies and accessing critical minerals which are used in the production of those technologies. The Government should work with allies to ensure that the UK does not become reliant on strategic competitors, notably China, for critical minerals needed for low-carbon technology, and identify what investment is needed to achieve this, similarly for key supply elements such as solar panels.
The Government’s critical minerals strategy, which is due to be published later in 2022, should examine supply chain vulnerabilities and policies to mitigate them. Ahead of its publication, the Government should engage with the financial and industrial sectors to assess the viability of preferential supply chains, the timeframes in which they could be created and how they might affect the cost of capital over time for developing renewable technologies.