TWO CHEERS FOR UK GOVERNMENT’S NET ZERO STRATEGY.

 

Many observers will rightly point to gaps and perceived weaknesses or inadequacies in the the Net Zero strategy. But the general direction is better than we might have expected from a collection of former science deniers, and will need to be defended against sustained attack from groups of Tory backbench reactionaries.

“More joy in heaven over one sinner that repenteth ….”

The transformation of some of our political leaders from positive hostility to the findings of climate science, to at least a grudging acceptance of its realities, or even apparent enthusiasm for a Green future, is remarkable and welcome.

Let’s not forget, though, the past role of such as Nigel Lawson and the Global Warming Policy Foundation, or “think tanks” such as the Institute for Economic Affairs, among many others, in obscuring the issues, and delaying general acceptance and understanding of the truths that have been evident to most scientists and intelligent observers for at least twenty years. This historic guilt can certainly be found in the present Cabinet and there are many unreconstructed MPs in the governing party who cannot be relied upon to support net zero policies when the going gets tough, as it will.

Even our PM’s recruitment to the crusade against greenhouse gas emissions is, he admits, recent. It is not so long since he himself was querying the scientific consensus, dabbling in crackpot theories about sunspots, and disparaging windfarms. The real test will arrive when he has to confront opposition from the climate sceptics within his own party. That will start soon. 

Defeated on the science, the sceptics and fossil fuel lobbyists are now regrouping under the banner of climate action as “too expensive”, and we can expect to hear more from that caucus of MPs – the “net zero scrutiny group” – as the requirements become more apparent.

Two Cheers.

It’s quite clear, and not just from the Net Zero paper itself, that the government does grasp the main priorities for policy, unsurprising since they have the benefit of years of reports from the Committee on Climate Change. Decarbonising the power sector, through some combination of nuclear and renewables, is the crucial first step. The ambition to fully decarbonise by 2035 is welcome.  Then comes the switch from internal combustion (ICE) to electric vehicles (EV). This is now gathering momentum, and not just in the UK.

But the third major building block has to be residential heating. This will be slower, more expensive and more difficult, and will be more contentious while heat pumps remain expensive and largely unproven. Slower progress in this area is the only realistic prognosis, and household fears for the cost and efficacy of low carbon heating are already surfacing. Progress here will necessarily be a marathon not a sprint. This is the area with the most problems to be resolved and where we are most in need of more coherent plans.

Economics and Finance. The Gaps.

The government’s ideological position emphasises the role of the market. Important though this may be, every innovation, from heat pumps to small nuclear reactors, will also depend on government financial commitments. Indeed that commitment is already necessary to ensure sufficient generating capacity of any kind. A solid regulatory framework is also necessary to underpin private investment and provide consumer tariffs that allow consumers to make low carbon choices.

“Public money is essential to kickstart the net zero journey and turn expensive new technology into affordable everyday infrastructure.” (The Guardian) There are signs of tension between the Treasury and other departments over the pace and cost of the government's net zero plans.

The Net Zero Review does not appear to have given too much ammunition to government critics by overstating costs of a net zero transition. The final version of the report, while not presenting a formal cost-benefit analysis, argues that a well-managed net zero transition can deliver net economic benefits to the UK. “Global action to mitigate climate change is essential to long-term UK prosperity," the review states. However this is unlikely to deter the dedicated opponents of any effective action to counter or mitigate climate change.

Political battles ahead

Indeed the “net zero scrutiny” group are already busy inventing their own facts, as I demonstrated in a recent post on infrastructure requirements for EVs, and making extreme claims about the supposed injustices of policies, such as those on EVs, to promote decarbonisation. We should expect a spate of scare stories and misinformation related not just to EVs but to any new technology that moves us away from fossil fuel. These are likely to focus on heat pump plans in particular, where there are some real practical and financial issues, and net zero aspirations are most vulnerable, or may at least take longer to achieve.

Despite whatever reservations there may be as to the sufficiency of the government’s plans, however, the immediate challenge will be to maintain and strengthen the wider public consensus that recognises the gravity of the climate crisis and the need for action.

ELECTRICITY TARIFF REFORM. SHIFTING THE BURDEN FROM ELECTRICITY TO GAS IS A START

 

Plans to shift green surcharges from household electricity bills to gas bills are an overdue and welcome reform. With the necessity to shift consumption away from gas to low carbon power, taxing electricity but not gas has been perverse. In particular it conflicts with policies to shift residential heating to electricity-based systems, especially heat pumps. It was one of several key recommendation of the 2019 report, on network tariffs for a low carbon future, that I prepared for Energy Systems Catapult. So it’s satisfying to see the proposed change.

However this shift is probably not enough on its own to provide a clear incentive for consumers to switch from gas to electric systems, including heat pumps, even if the present surge in gas prices is sustained. A more fundamental recasting of the structure of electricity tariffs will be essential, notably a significant change towards recovering far less of the fixed costs of network infrastructure through the kWh charge. This is a profound change, and may require additional measures to prevent the regressive effects of a larger burden on lower income households. But it can be done in ways that are consistent with equality or levelling up agendas.

The flaw in current tariffs

The incremental costs of supplying energy are the right basis for any price and tariff comparisons that consumers make when choosing a heating system. Costs should ideally include all environmental costs and these may be expressed for example as a carbon price. Energy costs are however only a part of the story for the tariffs faced by consumers. For residential consumers, up to 50% of total costs reside in the fixed costs of the networks, concentrated in the local distribution networks. The marginal cost of accommodating extra throughput is, at least in uncongested networks, very low. But the fixed cost still needs to be recovered. How best to do it poses some difficult questions in terms of reconciling considerations of equity and income distribution, on the one hand, and the efficient allocation of economic resources on the other.

Current UK practice for smaller retail consumers is simply to average most fixed costs over all units of energy sold. This seems fair, and prima facie results in those who consume most (and might broadly also be those with higher incomes) paying the most towards the fixed costs. However it distorts the economic message, that the actual marginal or incremental cost is much lower. This leads to at least two major problems.

1.       It exaggerates the incentive for individual consumers to instal their own forms of power generation, even if these incur high resource or environmental costs, simply in order to avoid network charges. There is no saving in overall fixed cost and, while individual consumers with own generation may benefit, a larger share of fixed public network costs is then picked up by others. Total societal costs increase. Incidentally, this also tends to benefit the wealthier households who are more likely to instal their own generation.

 2.       Policies for a low carbon economy rest on persuading consumers to use large amounts of extra electricity for heating (eg with heat pumps). The high unit kWh rates that result from the current practice of spreading the fixed costs over all kWh then become a very serious obstacle, particularly when the consumer choice is between electricity and gas. This is reinforced by the matter of high per household capital costs for retrofitting heat pumps.

 

For household consumer, a higher fixed charge in the tariff, and a lower unit energy charge, transforms the choice between using the low carbon solution (electric heat pumps) and traditional fossil fuels (gas or oil).  I examined this in my 2019 report, but it is worth recalculating in the light of recent price trends. Assuming 10,000 kWh per annum consumption, a coefficient of performance (COP) of 3 for heat pumps, and 90% efficiency for modern condensing boilers (both slightly optimistic), the message is clear.

 

Economics of Heat Pump vs Gas [Energy Cost Only]	elec tariff p/kwh	Elec useful heat p/kWh	Gas tariff p/kWh	Gas useful heat p/kWh	Heat pump saving £ pa
Current tariffs[1]	14.50	4.83	3.86	4.29	-54
Current tariffs and + 1p/kwh CO2 tax on gas[2]	14.50	4.83	4.86	5.40	57
Reform tariffs + CO2 tax.[3]	7.50	2.50	4.86	5.40	290
Reform tariffs + CO2 tax + permanent high gas price[4]	7.50	2.50	8.00	8.89	638

 

With current tariffs, heat pumps struggle to be competitive with gas even on running costs. A 1p per kWh carbon tax on gas, or its equivalent, helps to shift the balance (to a small advantage for heat pumps). Tariff reform has a much larger impact (2.5 times), and this is of course hugely reinforced if we assume permanently higher gas prices. This takes us at least part of the way to compensating households for the higher capital costs of heat pumps.

Disadvantages to poorer consumers

We noted above that some wealthier consumers benefit from current tariffs through the arguably excessive implicit subsidies to own generation. Other beneficiaries include second home owners with very low annual consumptions. However the regressive impact of a necessary tariff reform cannot be ignored. But there are many different options available.

One is to change the basis for applying standing charges to consumers. One proposal put forward has been to collect contribution to fixed costs through tariffs based on property values, akin to traditional approaches in water based on rateable value, or property tax band.

Another is to limit the application of the lower tariff rate to consumption for heating, but not for other purposes. Modern technology makes separate metering, as well as the detection of any metering fraud, a very plausible option.

………..

The conclusion must be that tariff reform will be an essential component of any national strategy for the decarbonisation of the heat sector.

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[1] Average kWh rate for UK, and recent variable rate British Gas tariff for gas.

[2] Set at 1.0 p/kWh as first approximation to likely impact of transferring environmental cost burden to gas. I used a higher number in the original report

[3] Assumed future average wholesale power cost of 7.5p/kWh

[4] Assumed winter gas price of 170 to 210 p/therm, deduced from recent reports