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Investing in energy: price, security, and the transition to net zero Contents

Summary of conclusions and recommendations

Introduction

1.Decarbonising the UK’s energy system while ensuring that the UK’s energy supply is affordable and reliable is a highly complex challenge. Russia’s invasion of Ukraine has made the task more complex. No government can be expected to predict the future with accuracy, nor should a government seek to plan for every eventuality. Instead, the Government should address issues that undermine investor confidence and increase resilience in the energy system. The Government will need to:

2.One challenge for the Government is to ensure that short-term measures to maintain security of supply are consistent with the Government’s net zero plans, and that this objective is well communicated to industry. While the Government should continue to address the impact of the immediate supply crisis, it should also act to encourage long-term investment to facilitate the transition to net zero, which should help to ensure more sustainable energy security and greater long-term price stability. In this report, we set out what needs to be done now to increase investment that will assist in carbon reduction and improve energy resilience. (Paragraph 20)

Investment and action in the short term

3.High energy prices mean households are concerned about energy prices and may therefore focus more on energy usage. The Government can harness this public concern to speed up the pace of home insulation and other measures to improve home energy efficiency. Increasing the supply of installations should be driven by clear, long-term signals from the Government, and a commitment to working with the private sector. These measures require significant investment in both the near and longer-term. The Government’s British Energy Security Strategy does not sufficiently explain how such investment will be released. (Paragraph 30)

4.We recommend that the Government publishes an energy demand reduction strategy. To strengthen public confidence, the Government should work with the financial sector to provide financing options and increase incentives for investment in energy efficiency measures. In addition, the Government needs to set clear signals so supply capacity can be increased along with steps to support the development of resilient supply chains and workforce skills. It should have a clear, practical delivery plan which learns from the failings of previous initiatives. The strategy should be published as soon as possible. (Paragraph 31)

5.The British Energy Security Strategy sets out several ambitions for increasing the deployment of renewable energy, which we support. While we acknowledge some local opposition, onshore wind is one of the cheapest and fastest ways to increase renewable energy generation. We recommend the Government re-examines its ambitions for onshore wind when it publishes its consultation on creating local partnerships with communities living near energy infrastructure, later in 2022. (Paragraph 39)

6.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. We welcome the Government’s continuing commitment to renewable energy in the longer term. Extending the life of nuclear power stations over coal power stations where possible, and cost effective, would result in lower carbon emissions. (Paragraph 44)

7.While we welcome statements from ministers on UK–EU cooperation on energy security, we note reports of Government contingency planning for scenarios in which either the UK or EU cuts gas exports to the other party if there is a severe shortage. As one of the few countries in Europe with significant ability to import LNG and transport natural gas, the UK is playing an important role in supporting security of supply in Europe. In return, some EU countries have gas storage capacity from which the UK could benefit this winter. The Government should urgently seek an agreement with the EU and, if necessary, Norway on energy cooperation to manage possible shortages. (Paragraph 54)

Increasing investment in the transition

8.While we welcome the Government’s clear and ambitious targets for many renewable technologies, it should set out now the policy detail on how these targets will be met. The Government should provide more detail on the capacity, timeframes and expected costs of long-duration energy storage. It should also quickly develop a market model for long-duration energy storage. The view among witnesses was that a cap and floor model would be most effective. (Paragraph 74)

9.We welcome the Government’s ambition to increase hydrogen production. We support developing both green and blue hydrogen; the evidence suggests this builds on the UK’s industrial and geological strengths in offshore wind and gas reservoirs. We recommend that the Government outlines market structures and mechanisms for hydrogen as soon as feasible. (Paragraph 87)

10.Carbon capture and storage is expected to play a small, but valuable, long-term role in the transition to net zero. The limited scale means that there is likely to be little appetite for the private sector to invest in it without a stable and enduring commitment from Government to support it. The Government should therefore play a role in setting up clusters and in designing market models as soon as feasible so that investors are given greater confidence that there will be a long-term market for carbon capture and storage. (Paragraph 94)

11.There have been conflicting statements from ministers about whether the Government intends to start the construction process for one nuclear reactor each year so that up to eight are in development at the same time or intends a different sequencing. This is especially important if a RAB model of financing is used because of the costs that would fall on consumer bills, including those of the poorest, during construction. The Government should set out its delivery plan and construction timetable for nuclear reactors. It should also clarify what impact delivering multiple projects simultaneously could have on consumer bills. (Paragraph 104)

12.The Government should explain why it is aiming for a target of 24GW to be supplied by nuclear by 2050 when this is over double the capacity assumed by the Climate Change Committee. The Government should set out its cost analysis of 24GW of nuclear capacity compared to alternative options of providing baseload capacity. (Paragraph 105)

13.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 cost and timing, and the Government should set out how it will protect energy bill payers in the event of cost overruns and construction delays. (Paragraph 106)

14.As there is evidence of substantial private sector-interest in investing in sustainable projects, the UK Infrastructure Bank should ensure that it adds value by focusing investment on innovative and potentially riskier projects with the aim of attracting and enabling additional private-sector funding. 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. We note, however, that the UKIB has limited risk capital. (Paragraph 113)

15.In the short term, Europe needs alternative sources of oil and gas to replace supply from Russia. Moreover, 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 next few winters. 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. There is uncertainty over how the risk of creating stranded assets will be managed. The Climate Compatibility Checkpoint should ensure that additional investment in oil and gas is focused on production that reflects the UK’s diminishing but continued demand for gas during the transition and not enable substantial levels of long-term production that conflicts with net zero objectives. (Paragraph 127)

16.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. Additional storage could provide more resilience against supply bottlenecks and would provide more security were agreements to import energy from mainland Europe to break down. The Government should examine the case for opening other storage sites which could be adapted for hydrogen. (Paragraph 134)

17.Balancing national policy with local preferences is challenging but the planning process takes too long for renewables, nuclear and the transmission network. (Paragraph 144)

18.We recommend that the Government encourages schemes to compensate residents for energy projects built in their areas. This already happens for certain onshore wind projects but should be extended to other forms of low-carbon generation, or grid infrastructure. (Paragraph 145)

19.We recommend that energy security objectives be included in the National Planning Policy Framework alongside the existing climate change objectives. (Paragraph 146)

20.We also recommend that the planning process be expedited for nuclear reactors that are sited on locations of former nuclear reactors, while maintaining high health and safety standards. (Paragraph 147)

21.Insufficient investment in the transmission network, is delaying the deployment of renewable projects. We support proposals by Ofgem to improve anticipatory investment and deliver sufficient 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. (Paragraph 153)

22.The Future Systems Operator will have a key role in encouraging anticipatory investment to remove barriers in the grid transmission network and to enable a growing capacity of renewables to connect to the grid. We recommend that the Future Systems Operator be set up in a way that is operationally independent from Government. It should be set up promptly since decisions are needed in the short term to ensure that the grid is capable of transmitting the increased electricity supply needed for the net zero energy transition. (Paragraph 160)

23.The Government should set out clearly what the Future Systems Operator’s relationship will be with BEIS, Treasury, Ofgem and the recently appointed Electricity Networks Commissioner. It is unclear what role the new Energy Networks Commissioner and industry champions will have in relation to the Future Systems Operator, especially since the Future Systems Operator is intended by the Government to take a ‘whole system approach’. Although the Future Systems Operator should be operationally independent, the Government should be responsible for setting its overall policy remit. (Paragraph 161)

24.The Government has introduced an Energy Profits Levy to help pay for financial support to domestic energy consumers. It 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. (Paragraph 167)

25.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. (Paragraph 168)

26.The Government should set out whether it plans to extend carbon pricing and provide detail on pricing levels and timescales. This could give more clarity to investors and could provide incentives to fund projects necessary for the transition. (Paragraph 171)

Financial regulation

27.We note the Chancellor’s decision to balance the Bank of England’s remit to support the transition to net zero with a requirement to have regard to its policies on energy security. Net zero and energy security are compatible objectives and well-designed supervisory policy can support their alignment. We recommend that the Financial Policy Committee, the Prudential Regulation Committee and the Financial Conduct Authority set out, at the earliest opportunity, high-level principles on how they are interpreting the Chancellor’s instruction on energy security. (Paragraph 179)

28.Understanding climate risk and managing the transition to a lower-carbon economy requires data and appropriate analytic approaches, which disclosures will help to accumulate. HM Treasury and financial regulators will need to support businesses to make disclosures consistently. Businesses will need support on how to identify quantitative data on their climate impact, particularly in relation to scope 3 emissions which are especially difficult for companies to assess. (Paragraph 188)

29.The quality of data and analytic approaches for assessing climate risks, especially transition risks, are insufficient for regulators to reach judgements on increasing capital requirements on the financial sector. The weakness of the data is exacerbated by a lack of clarity from the Government on energy needs during the transition and how sectors will be expected to adapt. (Paragraph 198)

30.Green taxonomies can help to provide investors with greater confidence to invest in sustainable projects, but they can also be seriously misleading by implying that projects and technology are either green or brown. If poorly designed, they risk driving capital to a narrow subset of existing options, which may stifle innovation and investment 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 trade-offs and interlinkages between renewables and fossil fuels. The Government should work with other jurisdictions’ authorities to ensure that the principles underpinning a UK taxonomy are consistent with other taxonomies: fragmentation causes confusion which can undermine investor confidence. (Paragraph 208)

31.The Solvency II legislation is designed to protect policy holders and provide financial stability, but it also limits investment levels by major asset holders in the insurance sector. Reform of Solvency II will be the first significant change to the UK’s financial regulatory architecture following the UK’s exit from the EU. We agree with the Government that there is a significant opportunity to allow insurers to provide long-term capital to support investment consistent with the transition to net zero. The insurance industry has said such changes would release substantial capital, but we note that insurers do not have an obligation to use released capital for such investments. When it publishes the outcome of its consultation the Government needs to set out how it can encourage unlocked capital to support the energy transition. (Paragraph 217)

International cooperation

32.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 UK could benefit from buying energy with the EU, but more detail is needed on how trade would operate in practice. It is important that the Government engages with the EU to increase the chance that the UK can benefit from working with the Common Purchase Platform in the event that there is some advantage in doing so. The Government should explain its assessment of the EU’s plans, what role it foresees for the UK, and how UK policymakers and the private sector could contribute to policy decisions. (Paragraph 221)

33.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 UK could benefit from buying energy with the EU, but more detail is needed on how trade would operate in practice. It is important that the Government engages with the EU to increase the chance that the UK can benefit from working with the Common Purchase Platform in the event that there is some advantage in doing so. The Government should explain its assessment of the EU’s plans, what role it foresees for the UK, and how UK policymakers and the private sector could contribute to policy decisions. (Paragraph 221)

34.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 and components which are used in the production of those technologies. This could create new risks in supply chains. To mitigate this, the Government should work with allies to ensure that the UK does not become reliant on strategic competitors, notably China, for critical minerals and components, and identify what investment is needed to achieve this. The Government will need to ensure that its foreign and trade policies (on both critical minerals and oil and gas) and its policy on net zero are aligned. (Paragraph 235)

35.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 and components which are used in the production of those technologies. This could create new risks in supply chains. To mitigate this, the Government should work with allies to ensure that the UK does not become reliant on strategic competitors, notably China, for critical minerals and components needed for low-carbon technology, and identify what investment is needed to achieve this. The Government will need to ensure that its foreign and trade policies (on both critical minerals and oil and gas) and its policy on net zero are aligned. (Paragraph 235)

36.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. It should publish its conclusions in the upcoming strategy. (Paragraph 236)

An energy strategy for the future

37.Given all the issues raised in this report, we conclude that a detailed and comprehensive plan is needed from Government which so far is missing. The gaps between the Government’s ambitions and practical policy are significant. The Government has set targets for low carbon power generation, without explaining what the transition will cost, what combination of public and private investment it expects, and what choices will be required. The Government should set this out in broad terms and provide an assessment of relevant costs and savings. (Paragraph 237)

38.The Russian invasion of Ukraine has created global energy supply issues and has highlighted the vulnerabilities of the UK energy supply. To help avoid a disorderly transition, the Government should set out a net zero delivery plan which takes account of energy security and foreign policy considerations. It should make clear what decisions will need to be made and by when. Any such plan will need to incorporate the flexibility required in a three-decade, economy-wide transition. Nevertheless, such a plan would help to provide additional confidence to the public, businesses, and investors. The present uncertainty and lack of direction in policy and strategy is hampering consumers, businesses, and investors from responding on the scale and with the urgency required. (Paragraph 238)



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