A LOW CARBON FUTURE. MAKING IT HAPPEN.

ETI PUBLISHES INDUSTRY PERSPECTIVES ON HOW TO DELIVER EFFICIENT NETWORKS FOR A LOW CARBON FUTURE ENERGY SYSTEM.

The Energy Technologies Institute (ETI) has just published a number of perspectives on the issues that can be anticipated in moving the UK to a future low carbon energy system. The authors are Robert Hull of KPMG and formerly OFGEM, Keith Maclean Chair of UKERC, Co-Chair of the Energy Research Partnership and formerly Policy Director of SSE, Jorge Vasconcelos, Chair of New Energy Solutions, formerly Chair of the Portuguese energy regulator and founder and Chair of the Council of European Energy Regulators, and myself.

This stemmed from an ETI project to build understanding of options for reforming governance, market and regulatory arrangements to enable efficient investment in low carbon energy network infrastructures. The perspectives were all, in broad terms at least, built around the ETI’s projections of how, in terms of the technically possible, the UK might meet its ambitious targets for reducing carbon emissions. The intention was to identify the non-technological issues faced in transforming the energy sector from long established fossil fuel dependency to a complex mix of interrelated low carbon technologies.

The complex choices are discussed both in the ETI scenarios and in the perspectives. Inter alia they include the multiple links between:

·         A power sector struggling to accommodate its own mix of low carbon technologies – nuclear, renewables and carbon capture.

·         A heat sector looking to the development of district heating networks.

·         A transport sector looking at a future of electric vehicles or possibly hydrogen.

·         Possible options for energy storage, in electro-chemical form, as heat, or in other forms of chemical storage.

·         A combination of centralised and decentralised production, storage and decision making and markets

This formidable challenge is not just about trying to find workable combinations of the above. It is about creating the environment that can make it happen, in terms of market structures, regulation and the wider institutional arrangements that govern the conduct of the energy sector and the application of energy policy. In the widest sense this is something that we can describe as the institutional architecture. Ultimately this determines how decisions are made at all levels.

Particular questions that need to be addressed include:

·         Finding structures that make the necessary investments financeable at a reasonable cost.

·         Dealing with the very different technical characteristics of low carbon generation.

·         Implications of major changes in the heat sector for matters of consumer choice.

·         Finding the right balance between markets, as instruments for decentralised decision making, and policy interventions.

The ETI perspective make an interesting first shot at different aspects of this key task.

HINKLEY POINT. A FURTHER RECOGNITION THAT INFRASTRUCTURE DECISIONS BELONG WITH GOVERNMENT.

GOVERNMENTS CAN NO MORE STAND BACK FROM SYSTEMIC FAILURES IN THE ENERGY SECTOR THAN THEY CAN IN MONEY, BANKING AND FINANCE.

Recognition of the limitations of the market in the energy sector is rapidly becoming universal. The Comment in today’s FT by Martin Wolf, possibly the most widely respected economic commentator in the UK, hammers this point home. The immediate focus of Wolf’s article is the Hinkley decision, but his arguments have a much wider resonance. For the energy sector, and the power sector in particular, the problems (and the market failures) run even deeper than those for infrastructure projects in other sectors. And governments can no more stand back from systemic failures in the energy sector than they can in money, banking and finance.

……….

“This decision had to be taken by government. No competitive market process would have reached such a decision or even been allowed to reach such a decision. ….  But if government or its agencies are to take such decisions, they must also take them well. …  Regulatory regimes must be designed to address the complex attributes of sectors with significant externalities. Decisions in such sectors are often very lumpy and politically difficult. They cannot — and will not — be left to decentralised market processes.” [Martin Wolf. FT. 16^th September 2016]

This is an excellent summary of what I have argued at greater length in the page on low carbon power. The essential feature of infrastructure, from the perspective of any private or institutional investor, is that the asset is immobile, has few or no alternative uses, and depends on revenue streams over a long period. Moreover infrastructure usually relates to essential services whose management and conduct is subject to various forms of policy and regulatory intervention. It is no accident that the historical development of public utilities has been strongly associated with regulated monopoly, which protects the utility as much as the consumer, with vertical integration, and with long term contracts and government guarantees. These all offer the investor some protection against political or regulatory opportunism, and the temptations to expropriate the investment once the costs have been sunk.

In addition the power sector has some particular market failures of its own. The case for and value of almost all low carbon investment stems from its contribution to reducing emissions and hence limiting the damage of climate change. In the continuing absence of effective and reliable means of pricing CO2 at levels consistent with the policy imperatives of mitigating climate change, there is no way that any private investor can capture this value from any of the existing market processes.

Supply security might in principle be susceptible to a “market” solution, but the NETA reforms in 2000 effectively removed the previous mechanisms that had been designed to incentivise new capacity. Energy only wholesale markets, essentially the lynchpin of current market structures, cannot reward capacity properly, and their weakness is reinforced by the increasing proportion of plant on the system at zero marginal cost. Capacity markets may be part of the solution, but these have to be implemented by some party, the government or its agent, who can specify how much is required and then monitor, control and pay for its delivery.

Existing markets were largely designed by and for fossil fuel fuel generators, the CEGB and its successor companies. They depend on the particular technical and economic features of fossil generation – flexibility, and fuel driven marginal costs – to replicate the merit order in a market driven optimisation of plant scheduling and dispatch. The conditions for this to work successfully cease to apply in situations with more complex technical constraints, such as plant inflexibilities (nuclear) and intermittency (solar or wind).

And of course there are also the many questions linked to the operation of complex transmission and distribution networks, to the influence of external sources such as interconnection, to the use of storage technologies and to the much closer engagement of consumers within future systems. We should also add the strong possibility that technical factors, especially around renewable technologies and storage, will lead to a power sector with much more decentralised operations and decision taking, alongside a continuing need for large scale transmission and interconnection.

Identifying the need for some central and strategic decision making is just the first step. Improving the quality of those decisions, and their execution, is vital. There is a strong case for an agency at arms length from government, and hence more removed from political pressures. It is also easier to build the essential technical and commercial expertise within such a body than within a government department.

The wisdom of the Hinkley decision itself is a more controversial question. Entities such as the Committee on Climate Change or the Energy Technologies Institute, charged with examining approaches the UK’s low carbon targets, tend to positions that assume significant components of nuclear or carbon capture.  There may have been serious questions for EdF around the choice of Hinkley technology, and for the UK government around the negotiation of the price, but, assuming delivery, there is no hard evidence that this is a bad deal. The frequent comparison with current wholesale prices is largely irrelevant since it is quite clear that these are unsustainable as the basis for rewarding investment in a future low carbon power system. The government process may not have been impressive, and it may be quite seriously sub-optimal, but it has at least now made a pressing decision, and we should hope that the Hinkley venture is as successful as the French nuclear programme of the 1980s.

The wider questions, looking beyond Hinkley, are around what institutional changes may be required, in order to exploit rapidly changing technology options, implement the policy imperatives of sustainability and security, and make effective use of markets. All this is calling for a new “system architecture”, a comprehensive re-think of the way the sector is regulated, new market designs, and how networks are managed at local, national and trans-national levels. Expect to hear a lot more about system architecture!

POLICIES FOR DECARBONISING HEAT

A round table discussion last week on decarbonisation of the heat sector was a reminder of just how large and complex a question the future of UK domestic heating is set to become. A paradox of the sector is combination of major technology choices at one end of the chain, with all the potential concerns of parish pump politics (not intended as a disparaging term) at the other. Sourcing the heat in the first place has multiple competing options and poses huge strategic decisions across the power and gas industries; these include modular nuclear, heat and other storage technologies and linkages to carbon capture. But there are also distribution issues including the demand heat pumps can place on local power networks. And downstream distribution of heat in district heating schemes is dominated mainly by the relatively low tech problems of digging up streets, laying pipes, retrofitting homes, persuading or compelling householders, and a myriad of particular local issues and considerations which historically at least are associated firmly with local authorities and their skills and expertise. Our round table focused on the latter and on district heating in particular.

The Big Picture

Most scenarios for a low carbon future, and, post Paris, especially a zero carbon future, expect domestic heat needs to be met predominantly from innovations such as heat pumps installed for individual households, or through communal systems involving the sourcing of heat from combined heat power production, involving various thermal generation technologies. These include modular nuclear and fossil plant with carbon capture, combustion of waste products, and some geothermal and other sources. A fuller discussion of the heat sector from this perspective is given on the [DECARBONISING HEAT] page (button at the top of this page).

The future of heat delivery, in terms of these “big picture” options,  is very obviously bound up with the future of the power sector, but it also has a local scale at which the major transformation has to be implemented, potentially affecting every household in the country. Key points that emerged both from what was discussed at the round table, and what was not discussed, were several.

Immense scale of what is involved, compared to UK experience to date.

DECC evidence suggests there are at present some 1750 district heating networks in the UK, with two thirds of these classified as small (less than 100 households), with an average of 35 households per scheme. There are only some 75 “large” networks with more than 500 households, and the total number of households connected to a network is around 220,000, or less than 1% of all households. So the UK does have some experience in developing and maintaining these networks, but the scale is tiny compared to our expectations for the future.  Even defining “large” as 500 households is revealing in this context. In Denmark the CTR scheme for central Copenhagen serves 275,000 households.

To put this in perspective there are some 27 million households in the UK, so the full decarbonisation of the heat sector by 2050 is likely to require installation or retrofitting  of low carbon solutions (heat network or individual property solution) to around 20,000 households a week over about 25 years, assuming a starting at some point in the 2020s.  In other words this implies an entirely different scale of operation from anything of which the UK has any past experience.

A future district heating industry will develop a very different culture.

The dominant culture in the management of heat networks reflects (mainly) a history of post World War II local authority reconstruction schemes, together with some opportunistic exploitation of specific sources of waste heat from power station or other industrial schemes. The positive benefits of utilising “waste” heat combine with some of the social objectives associated with local authority schemes, including keeping the costs to householders as low as possible. One of the benefits of “waste” heat is that it has frequently been provided at very low or no cost to the scheme.

The low carbon objectives which will underpin the future of district heating will create some very different economic conditions. The supply of waste heat per se is really very limited, although the future will most likely include purpose built installations built specifically with the dual purpose of providing city-wide heating and power to the national system. But schemes will have to fund significantly higher heat costs, as well as infrastructure, and the cost of heat is likely to be significantly higher than it is for today’s householders who enjoy a gas supply.

The economics of large schemes depend on scale. Getting to a reasonable average cost will depend on achieving near universal penetration in high density urban populations. This will accentuate the problems of collective choice for heating and may introduce elements of compulsion.  

Taken together with the sheer scale of the district heat undertaking, the challenges for traditional management structures and assumptions in the heat sector will be immense.

Cost of capital again a critical issue.

Once again, and as in the power sector, the capital requirement will be very large. I have emphasised on many occasions the fact that infrastructure projects “ought” to be considered as low risk, low cost of capital investments. But this requires careful attention to the structuring of the funding arrangements and may require substantial public sector guarantees and significant local government borrowings, another major cultural shift. This is increasingly accepted but it is a necessary condition for the transformation of the sector at a reasonable and affordable cost.

Roll out in conjunction with energy efficiency

One of the most fundamental obstacles to introducing large scale district heating is the physical disruption to the householder. The same issues promote inertia in introducing household level measures for energy efficiency. Given that energy efficiency is a necessary part of overall heat strategy anyway, in order to bring heat loads down to manageable levels, then coordinating and integrating the rollout of low carbon district heat with energy efficiency measures makes a lot of sense.

Regulation

Finally we can foresee some new and challenging questions for energy regulation, and a considerable political overlay.

First, this is another sector dominated by fixed infrastructure, ie network, costs. There is considerable scope for alternative approaches to how those are recovered from consumers, eg a fixed charge per household or an averaging over all kWh of energy consumption. This will include the question of whether heat metering is feasible and desirable.

Second there will almost certainly be a huge variation in actual costs between different schemes and geographies. This may provoke political demands to “even” out the costs to householders, avoiding the “postcode lottery”.

Third, initial concentration on high density urban housing will ensure that social policy issues come rapidly to the fore. Will this lead to new approaches to fuel poverty questions?

RATIFICATION OF THE PARIS AGREEMENT. A MAJOR LANDMARK

The BBC reports today that both the US and China - together responsible for 40% of the world's carbon emissions - have now ratified the Paris global climate agreement.  Members of China's National People's Congress Standing Committee adopted "the proposal to review and ratify the Paris Agreement" on Saturday morning at the end of a week-long session.

The US has long been regarded as in thrall to the fossil fuel industry lobbyists, and Trump and the Republican party platform aim to “forbid” the regulation of carbon pollution and “reject” global efforts to tackle climate change. Trump wants to “scrap” environmental regulations and “cancel” the Paris Agreement.[1] And Republicans may well mount further legal challenges to ratification. However this climate denial is now clearly at odds with public opinion in the swing states that will decide the outcome of the election. In Colorado, North Carolina, Florida, Virginia, and Pennsylvania, at least 75 percent of surveyed adults support regulating carbon dioxide as a pollutant. Over 60 percent of respondents in those same states said that global warming will harm future generations. The marked increased incidence of “once in 500 years” events has also played its part. The New York Times noted the Baton Rouge flood was the eighth once-in-500-year event to occur since May 2015.  To quote a landmark  report of the 214 National Climate Assessment: “Climate change, once considered an issue for a distant future, has moved firmly into the present.”  All this suggests that, despite some of the wilder aspects of the Presidential campaign, a major reversal of US policy, while still a risk, is a less likely outcome.

So what might we conclude from these momentous events?

First, it is increasingly improbable that other countries enjoying or aspiring to global significance or standing will be able to hold back from ratification. The agreement comes into force legally after it is ratified by at least 55 countries, which must also account for 55% of global carbon emissions. With the US and China alone accounting for 40%, and the third largest economy in the world, that of the EU, having been a prime mover in demanding action on climate, the Paris ratification conditions will, one assumes, be met easily and soon.  However the US and Chinese announcements will also put pressure on G20 nations to move faster with ratification and, inter alia, with pledges to phase out subsidies to fossil fuels. In UK domestic politics it no longer credible to argue that UK emissions reduction will have no effect “because the biggest emitters are doing nothing”.

Second, this may be an event that finally marks the end of an era of damaging and irrelevant debate and denial over the fundamental validity of the underpinning science. The science has been very clear for a long time that persistence with high levels of CO₂ and other GHG emissions is an unacceptable risk to the future of humanity. But we are now seeing, perhaps, the collapse of continuing political resistance to these inconvenient realities. That is not to say that further understanding of our climate systems may not throw up some further nasty surprises, or more positively hitherto undetected effects that go some way to mitigating the worst outcomes. But the basic features of the climate risks we are running are now an established, and essential, part of any serious policy debate. And the upward statistical trend lines on global temperature are starting to look remarkably stable. Despite a weakening el Nino, July 2016 set a new record for the highest global temperatures on record.

Third, the challenge of actually meeting the ambitions of Paris remain huge, both in the context of individual national economies and in terms of reaching binding international agreements. At some point we can expect a resumption of debates about historic responsibilities, collective or national, and more hard bargaining over who is going to meet the costs either of mitigation or of adaptation to a warming world.

Finally, and turning to some of the specific issues for the UK, it seems unlikely that that the UK’s commitment to emissions reductions will be reduced by its prospective exit from the EU.  There will be some interesting questions to address, including how the UK motor industry seeks to influence patterns of regulation and technology choice for a low carbon road transport sector in the EU. There will also be the question of continuing membership of the emissions trading scheme, and indeed the future of that scheme within the remaining EU. But some of the more important impacts may well be felt through changes in the tone of domestic economic policy within the UK. The abandonment of austerity targets is likely to change the political and economic climate for infrastructure development, with more willingness to engage in lower cost of capital public borrowing to support investment, and policies that are more friendly towards the UK’s industrial heartlands and the “left behind” voters and regions who swung the vote towards Leave. Exactly how all this will play out remains uncertain, but there is no doubt that energy policy is now being framed against some very different policy priorities, both economically and politically.

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[2] according to Think Progress