Readers may be interested
in two pieces of evidence recently submitted to the House of Lords Select
Committee on Economic Affairs Inquiry on the Economics of UK Energy Policy and published on 12 October 2016. The
main authors are both lead investigators within the Oxford Martin School Programme
on the Integration of Renewable Energy – Dr John Rhys who is attached to the Environmental
Change Institute, and Professor Cameron Hepburn of the Institute for New
Economic Thinking (INET), with co-authors Jacquelyn Pless and Alex Teytelboym.
The theme of the inquiry is market failure in energy markets and the
submissions address this issue from different but complementary perspectives. The
INET team focus on two of the biggest sources of market failure – spelling out
issues stemming from the absence of adequate carbon pricing, and the need to
ramp up research and development expenditure on low carbon alternatives. They
also remind the Inquiry of the carbon budget issue. The low carbon targets
implied if we are to meet 2oC, let alone 1.5oC, mean that
no new fossil generating plant should be built without a clear plan for
early closure or required retrofitting of CCS.
John Rhys, in addition to addressing a number of specific questions
posed by the Committee, also concentrates on some specific UK market failures,
the core theme of the Inquiry, and argues that the combination of large scale
infrastructure investment and the very different nature of low carbon
technology present major challenges for the “system architecture” of the UK energy
sector. He notes that most current market structures, wholesale and retail,
were built around managing the particular technical characteristics of large
scale fossil generation plant. They are intrinsically and increasingly unable
to accommodate the technical and economic characteristics of low carbon
generation, significant degrees of decentralisation in the power sector, and
major changes in the “demand side”, the ways that consumers will need and want to
purchase and use electricity in the future.
Taken together the submissions make a powerful case for policies to
resolve these market failures, and therefore promote more effective action on
decarbonisation. They indicate some important priorities.
Carbon pricing
The INET submission highlights some of the consequences of failure to
deal adequately with the issue of carbon pricing. These include inconsistencies
in policy and perverse incentives, both in a UK and a broader international
(EU) context, that can both lead to higher current emissions and inhibit
investment in development of new low carbon generation. Resolving these issues
is a high priority.
Encouragement of Innovation
It has been shown that R&D tax incentives and support schemes have
significant effects on innovation outcomes (such as patenting) as well as firm
R&D spending. The submissions also draw attention to areas where innovation
will be of fundamental importance to the achievement and efficient functioning
of a low carbon economy. These include solutions (at acceptable cost) to the
problem of seasonal storage, a role which batteries and hydro storage currently
seem unlikely to fulfil. The most promising route may be chemical storage of
energy, eg conversion of electrical power to hydrogen, or further conversion to
liquid fuel or synthesised natural gas. This would resolve many of the real
time balancing, seasonal and security problems, including the intermittency
problem (for renewables), and make energy conform more closely to the model of
conventional commodity markets.
Infrastructure investment
The fundamental challenge for the energy sector is the scale of the transformative
changes needed to meet low carbon objectives. This is true across different
subsectors, including multiple issues in power, transport and heat. This requires a range of policies across the
sector, and very substantial investment requirements. The scale and dominance
of capital requirements make the cost of capital extremely important in making
the necessary transition affordable. One key economic challenge is therefore
creating the market, regulatory and institutional arrangements that provide
confidence to infrastructure investors, as a necessary condition for adequate
levels of investment from the private sector, and an affordable cost of capital.
The central role of climate and energy policies implies key roles for
government and regulation in this process.
Role of Government in Decision Making for the Power Sector
This leads to a continuing important role for government, and it will
almost inevitably continue to get drawn into questions of technology choice and
support for major investments. Capacity markets in the UK have the government
acting as a de facto central purchaser, a role already implicit in its support
for renewables and nuclear investment. This, taken with the INET criticisms of recent
capacity auctions, suggests that a central buyer model is a necessity driven by
technical and market fundamentals of the power sector. This should be a central
purchasing agency at arms length from government, with a high degree of
technical and commercial expertise. This could be given a formal remit
embodying environmental objectives, ensuring at least some degree of insulation
from political interventions and interest group lobbying.
System Architecture
“System architecture” is becoming an increasingly familiar term in
examination of future energy policies. In summary it means the totality of
technical, commercial, market and regulatory arrangements for all aspects of
the energy sector, including production, wholesale markets, transmission and
distribution, metering and final use by consumers, the role of competition, regulation
and, where appropriate, policy interventions.
Particular issues highlighted in the submissions are the investment
requirement discussed above, implications of central purchasing, the operation
of wholesale markets, decentralisation and the demand side. The technical
characteristics of low carbon generation force a re-evaluation of the current
role of wholesale markets. Decentralisation undermines the conventional
business model of network utilities (in distribution), and metering and control
technologies enable a range of new approaches to the way consumers buy and use
electricity. But the questions cannot be answered in isolation, as the answers
will be highly interdependent.
In essence the overarching challenge is to find the right combination of
regulated monopoly or public guarantee (to achieve a lower “utility” cost of
capital), competitive markets and incentives (to promote efficiency and
innovation), policy intervention (to meet climate or other social and political
objectives), and technically competent institutions (to manage complex
interdependencies). Implicitly this also includes a number of appropriate and
consistent technical choices throughout the system.
The OMS Programme
The Oxford Martin School Programme on the Integration of Renewable
Energy will be returning to these and other questions, not just for the UK but
in a wider international context.
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