DECARBONISING THE WORLD

A GUIDE TO DECARBONISING THE WORLD

 

John Rhys

                  

Preface. A personal essay. 

The inspiration for this essay has been my exposure, since 2016, to the Oxford Martin School Integrate Programme – full title: “The Integration of Renewable Energy in Power Systems”.  My “tongue in cheek” title reflects the remarkable ambition of that programme, reinforced by the obvious and essential connection of future power systems to decarbonisation of the sectors of transport and heat, and hence its undeniably central role and importance in reducing aggregate CO₂ emissions.

The wider objective that I interpreted for the programme, and which I try to describe and address at least partially in this essay, has been to identify as many key messages as possible for policymakers and stakeholders as they develop strategies for decarbonisation, nationally or globally. I have not tried to tie these to individual research projects within the Integrate programme, although many of those will have contributed directly and indirectly to important general insights. Nor have I tried or been able to do justice to the full richness and detail of the output from that programme, much of which has already been covered by Helen Gavin’s narrative summary.[1]

Not all of these messages are necessarily original thoughts. Some may now be commonplace observations among colleagues and within the energy policy community. Some, like the growing awareness of the importance of direct air capture (DACC) technologies, are rapidly moving towards centre stage. Some are points that I pursued in my blog through the course of the programme. But most of them still deserve emphasis and repetition, as they are not necessarily widely or universally known or accepted. A wider public, even if well-informed, and generally accepting the reality of the climate threat, is often unfamiliar with many of the issues and choices involved. 

Other messages are much less obvious, and some, especially on the role of markets, are still controversial.  Inevitably they reflect some personal judgements over key issues, and, given my “system economics” role within the project, tend to focus on topics with a strong economics and “whole system” connection. Since economics, properly interpreted, enters into just about everything, this is not a particularly serious limitation. But it does imply that I have perhaps focused more on hard-edged engineering, technical and economic questions that I believe to be of the greatest strategic and systemic importance, and rather less on equally important but “soft” issues of public acceptance and implementation.

In trying to cover such a wide canvas, there is an inevitable risk of diversion into lengthy explanations or context description on particular topics, either to explore different perspectives or note the additional complexities of particular issues. To avoid excessive detail and digression, I have made extensive use of endnotes to support some of my assertions and explain side arguments. A good example is the bitcoin issue. I used this, essentially, as just one relatively straightforward example of possible “low hanging fruit” and an “easy win” for CO2 emissions reduction policy. But it is of course a substantial subject in its own right, on which others hold strong views that differ from mine, and may be considered as “easy” only in a narrow technical sense.

It is impossible to cover everything. Agriculture was perhaps the most notable omission from the Integrate programme. Nor was it appropriate to propose detailed plans or optimised systems. We did not try to engage with the intricacies of the international political and diplomatic realities exemplified by the COP summits. But of course, some of our observations may have resonance in all of the above. 

John Rhys

 

Acknowledgements

I had so many helpful interactions with others on the Oxford Martin School during the course of this programme that it’s difficult to remember everyone. However, I should particularly thank three of the programme leaders at different times – Nick Eyre, Malcolm McCulloch and Sarah Darby. I also owe a great deal to Chris Llewelyn Smith who got me involved in, and initiated the team that produced the original programme. A special thanks is also due to Helen Gavin, who encouraged me to pursue this attempt at a personal project narrative within the context of the programme.

Others that I should mention within the programme included Cameron Hepburn, Niall Farrell, Stephi Hirmer, Ted Mose, and Jose Valuenzuela. Beyond the programme itself, I benefited greatly from working with George Day and Phil Lawton from the Energy Technologies Institute, and later Energy Catapult, and with Chris Allsopp at the OIES as my guru on all matters macro-economic and much else. I have also had the pleasure of working at different times with Michael Grubb and Karsten Neuhoff whose book Planetary Economics had a significant influence on my thinking.

I.               INTRODUCTION

An ambitious programme

The scope of the programme, “The Integration of Renewable Energy in Power Systems”, was ambitious and cross-disciplinary. It was intended to include input from several relevant disciplines. The most salient issues included:

·      critical questions of science and technology – for example over the role of batteries and other means of energy storage associated with decarbonising the power sector, rates of progress in reducing the cost of renewables, science and research, the focus of research and the incentives to promote it.

·      power systems engineering. Planning and operating the generation, and transmission and distribution networks of the power system, and managing the utilisation of electricity, are central to the integration of new low carbon sources of energy.

·      governance and markets. The organisation of the power sector, including the legal and regulatory framework, and the market structures within which it sits, are critical to the effective operation of the power system. As a result, they are also critical to achieving and rewarding the required investment in these systems, whether publicly or privately owned. Low carbon generation technologies, whether renewables or nuclear, pose new problems for conventional market structures. Governance questions extend to other sectors, especially heat.

·      system economics. Understanding systemic connections and interactions is an essential to understanding the economics of both the power sector and the wider energy sector; it links planning, investment, finance, operational and market issues, as well as choices related to consumer tariffs and reliability standards.

·      social and behavioural factors. These relate to how people do or might react to the transformational changes implied by a low carbon economy, including the decentralisation associated with some smaller scale generation, demand side management, electric vehicle charging and major retro-fits in the heat sector.

·      policy issues. All of the above come together in policies to promote decarbonisation, and the interplay with national politics and international negotiations.

In other words, the programme aimed, to a greater or lesser degree, to address at least some elements of almost every aspect of the decarbonisation agenda, from innovation and technology choice, the political and policy framework, finance and market arrangements, institutional and regulatory architecture, through to social acceptance, behavioural factors. This included  approaches to finding least cost or satisficing solutions in particular geographies or for particular power systems. The programme gained through the development of a network of participants from outside the immediate programme, as well as a consciously inter-disciplinary approach.

Implicitly, and to a significant degree explicitly, the scope of the programme anticipated issues over all timescales and all geographies. On timescales, the most important division is perhaps between operational questions, associated with managing and operating any specific collection of power sector assets, either current or anticipated future stock, on the one hand, and the more strategic and transformational choices of policy and investment, on the other. On geographies it reflected experiences in very different power systems and very different climates and cultures.

The Three Domains of Policy

This division between the strategic and operational also approximates to a rather useful if imperfect classification proposed by Michael Grubb.[2] This can be described as a trio: the transformational, the operational, and the social or behavioural - a third category that covers everything from the reactions of people with new technology to personal and household behaviour. Equally it corresponds to another method of categorising the relevant policy instruments, as the trio of innovation, markets, and regulation. Innovation means the development, promotion and application of new technologies for energy production, delivery and use. Markets provide economic incentives, mainly through competition, prices, subsidies and taxes. In this context “regulation” should be very broadly defined, and its scope extended to cover not just technical regulation but all the cultural, social and lifestyle choices that have an impact on energy use or energy supply.[i]

I believe this is a helpful categorisation because, as I hope will become apparent, success will depend on policies that are practical and acceptable across all three of the Grubb “domains”. Investments in infrastructure and generation assets have to be chosen and made. The assets created have to be operated reliably and efficiently. And at all stages policies have to be compatible with legal and societal norms and consumer behaviour.

 

Strategic and transformational. Infrastructure is at the centre of all energy and power sectors. It includes power generation assets, transmission and distribution networks, and metering, control and communications systems linking to individual households and businesses. These are all very substantial investments. But the investment need also includes expensive individual and personal capital investments, in electric or hydrogen vehicles, heat pumps and heat networks, renewables and other low carbon, carbon capture and other major infrastructure investment to enable these. This is the domain of innovation, a domain in which policy direction and institutional reform are particularly important. 

The current pace of innovation and discovery provides considerable cause for optimism across the board, but the diverse nature of the energy sector means there is no single magic bullet. Instead, there are dozens of different subsectors, each requiring its own strategy.

Operational and markets. This is Grubb’s “Optimising” domain, in which it is essential to have confidence that the new low carbon assets in the sector can be made to work efficiently. The assumptions and methods of neoclassical economics are a major pillar of policy here. One of several key issues for the power sector is whether market mechanisms designed to produce efficient “least cost” operation of generation assets, balancing supply and demand in real time, are still fit for purpose in a world of low carbon technologies and substantial dependence on storage.

One of the most important but neglected elements in this domain is the design of electricity tariffs. As the key economic message from supply to final user demand, tariffs need to be seen as a fundamental element of the ecology of the sector. They will also be crucial for another question we identify – the relationship between centralised and decentralised parts of the system, and between power, heat and transport.

Social and behavioural. The third domain is that of regulation and lifestyle. Regulation can of course include the mandating of low carbon alternatives within the power sector, and often already includes measures such as appliance labelling and the promotion of low energy lightbulbs. But interpreted more widely this domain should relate to everything in what we usually call the “demand side” of the sector. It encompasses matters such as building standards (insulation), planning of land use (which affects transport and heat demands), and cutting transport fuel consumption through measures to encourage public transport, enforce speed limits and reduce traffic congestion. Even more widely we might include dietary choices, vegetarianism, preferred holiday destinations, and so on. A common feature of many of these items is that, from a consumer perspective, they do not present themselves primarily or exclusively as economic choices around energy.  Much energy use occurs as an expenditure that seems incidental to the primary purpose of a consumer activity and may be a small part of the total cost. This may occur for example in laundry, TV, holiday choice and so on. 

When energy is a purchase that is complementary to the main product or activity, price elasticity tends to be low and the economic incentives to reduce consumption are weaker. But there are many examples where significant reductions in energy consumption can be induced as a by-product or side effect of other policies, or of changes in taste.  Two good examples are in transport, where two of the main drivers of excessive energy use are speed and congestion. In each case the measures to address these can often be easily justified on other grounds. Speed limits improve safety and save lives. Less congestion, for example due to road pricing, saves time, and generates air quality improvement.

Moreover, many of the transformational policies that are implicit in decarbonisation require far more than just a technical feasibility analysis. They require wholehearted acceptance and adoption of the relevant technologies. This will apply, for example, to the use of electric vehicles.[ii]  It also applies to the use of heat pumps and retro-fitting of homes, changes in the definition of utility service offerings, and so on. 

The Grubb domains are closely interconnected. Strategic choices and policies should not be adopted without analysis and resolution of anticipated market and operational issues, and behavioural factors.  

Geography matters 

Rather obviously in relation to climate issues and weather-related renewables, geography matters. Important geographical factors include the huge climatic differences between countries or jurisdictions, expressed as seasonality and either winter or summer peak loads for demand, current levels of dependence on oil, gas or coal, differing natural endowments of wind, solar, geothermal or other renewable resources for supply, differing legacies of other low carbon generation such as hydro and nuclear power, and different opportunities for interconnection and long-term energy storage. 

Integration into power systems implies examination of the interaction with non-renewable sources of power, either because these are part of a legacy of high emissions fossil plant, or nuclear plant. Such systems may continue to have significant nuclear, or fossil with CCS components, while others may become wholly renewable, but only in the long term. The impact of these differences may be particularly acute, potentially, in relation to the need to provide reserve capacity and the management of reliability. 

Less obvious are the many other aspects of human and political geography that matter a great deal. These may include cultural factors and public expectations of the service the power sector provides, but the biggest single geographical factor influencing strategies is the level of economic development. Countries with low levels of energy and electricity use, typically poorer and less developed, face very different choices and problems from those of developed economies. Core issues for the poorest include the approach to rural and urban electrification, achievement of scale, governance, and access to capital at a reasonable cost, issues to which we return in later sections.

Essential features of the power sector

It is impossible to understand the power sector without an appreciation of its essential technical and economic characteristics.

·      The sector itself is not a source of primary energy. It relies on the conversion of primary energy sources, whether thermal, as with fossil fuel or nuclear, or mechanical, as with wind or hydropower.

·      It provides a vector for the delivery of useful energy for consumption of all kinds.

·      To an almost unique extent, it requires substantial elements of real-time command and control. This extends well beyond the real-time balancing of aggregate supply and demand. Larger systems have to be controlled to maintain system stability and provide delivery to consumers at a stable frequency.

·      Assets tend to be very long-lived and are usually at fixed locations, ie non-mobile.

·      It is an industry with a high proportion of fixed costs, ie costs that do not vary directly with output.

·      It has crucial functions throughout modern economies which implies a requirement for very high reliability standards.

·      This essential role also makes it a constant source of political attention and potential sensitivity, in all jurisdictions, particularly in the context of reliability, and prices and tariffs.

Some of these features are amplified by the sector’s role in decarbonisation. Reliability of renewables-based systems has been questioned. So has the potential risk of higher costs and hence higher prices to consumers. But two features that are also of great significance are those of fixed cost and coordination. The future dominance of fixed and capital costs is likely to be even higher, since fuel and running costs will be much lower. The requirement for coordination is also likely to be even stronger in renewables-based systems, and this will be true both in operational “real-time” terms and for investments, in selecting a portfolio of complementary generation and transmission and distribution assets. Inter alia this requires much greater consumer participation.

Other parts of the energy sector

Finally, it is impossible to think about future power systems without thinking about the transformation of road transport and, outside the tropics, the use of energy for heating of buildings. Inclusion of heat and transport comes close to completing the great question, of how to reduce and eliminate, in a global context, the aggregate carbon footprint of our societies and economies, and thereby to counter or mitigate the threats of climate change. Focus on the power sector potentially covers, therefore, a very high percentage of the overall decarbonisation agenda. 

Both transport and heat have profound implications for the power sector, not just in scale but for the types of load they represent, and the type of reliability and security they require. Heat questions are the least well developed in policy terms. They pose perhaps the biggest challenges for both the scale of generation and the scale of storage. Transport and EV battery charging can pose additional challenges for network infrastructure, but also offer partial solutions to storage and reliability issues.[iii]

The most important omission was agriculture, although even that has significant interactions with power in some geographies, for example through competition for water resources, or land use for biomass fuel.

Economics. Externalities and market failures. Cost Benefit Analysis. 

The dominant economic concepts for decarbonisation and policies to mitigate climate change are those of externalities and market failure. The absence, or inadequacy, of any reflection of environmental or climate cost into market prices in the energy sector, leads automatically to a chronic market failure. The root of this fundamental failure is that those who damage others by emitting greenhouse gases generally do not pay. "Climate change is a result of the greatest market failure the world has seen.” (Stern)

This translation into market failure is large and automatic.[iv] There are numerous other policy relevant instances of market failure where economic analysis has something to contribute. This includes failures or imperfections in capital markets, in the links between spot markets and efficient operation for electricity, in the well-known problems of financing infrastructure, and in the management of innovation.

Serious market failure leads on to the requirement for policy intervention, and then on to the requirements to justify corrective action and policy choices through cost benefit analysis (CBA). Relevant techniques can include attempts to value the externalities of not just environmental costs, but also less tangible impacts such as the value of lost load (reliability) or of personal time (relevant to congestion pricing).

There have been reservations about the applicability and validity of conventional cost benefit analysis (CBA) for global and existential issues, and the (no longer in serious dispute) necessity of addressing climate change.[v] However these have centred largely on attempts to measure environmental costs of GHG emissions through so-called integrated assessment models (IAM). In relation to policy choices within a decarbonisation framework, the techniques of CBA remain an important analytical tool.

In summary, economics leads us back to the necessity of attempting to put a value on emissions, as it is a parameter fundamental to the choices we make. Analysis of this issue is one of three major recurring themes in this essay. But economics also has a lot to say on other major policy issues, including incentives and targets, market failures, and energy tariffs. 

Critical Themes and Emerging Lessons and Principles

In order to address these questions the next sections will address the developing policy landscape in terms of the increasing political salience of climate issues and a current energy policy context. This is followed by examination of three themes crucial for our understanding. These can be considered as simple numerical parameters for a power system – the cost of capital, the (social and environmental) cost of carbon, and the value of reliability and security together with the cost of providing it. But each of these also has a profound importance for policy, requires careful interpretation, and each has its own complex hinterland of ideas, and controversy.

This then leads on to a summary of some of the general lessons that I believe we should learn, or the principles we should adopt. This covers topics as diverse as storage matters, energy tariffs, the case for climate finance, and the role of markets.

 

 

II.             A DEVELOPING POLICY LANDSCAPE

 

II.1 Climate Science and Climate Politics

The Increasing Political Salience of Climate Issues

Although climate science has remained entirely consistent and broadly unchanged in its assessment of both actual trends in global temperature and climate, there has, since the inception of the Integrate programme, been a dramatic rise, in most of the world, in appreciation of climate threats identified by the science. This has been driven to a significant degree by severe and consequential climate and weather-related events: droughts, wildfires, floods and extreme heatwaves. Their increasing severity and frequency is entirely consistent with the earlier warnings of climate scientists.[vi]

This means an increasing political salience for climate issues, and less and less political space for outright climate science denial.[vii] The political climate for serious action and investment on climate issues should therefore have improved substantially, even if it remains painfully slow and insufficient.

Historic Responsibility

Unsurprisingly the very real impacts of climate change on some countries have provoked debates over historic responsibility and demands for “climate reparations” have been a major element in COP27. Assigning historic responsibility is not a simple calculation.[viii] Importantly, “reparations” may be unlikely to generate support for climate policies in wealthier countries. Nevertheless, the more persuasive argument, which we shall develop, is that, regardless of any moral imperatives, it is close to self-evident that global climate targets will not be met without substantial financial and technology transfers to enable clean development strategies in poorer countries. To this extent “reparations” become both essential and a matter of self-interest.

Ironically, the importance of cumulative emissions (the stock), rather than annual emissions (the flow) is recognised as fundamental in relation to historic responsibility, but largely ignored in discussion of future targets, which are usually expressed as target annual emissions for a single future year. This is a subject to which we return.

Linked to historic responsibility is a growing awareness of inequality. Recent claims by Oxfam and others suggest that the very wealthiest are currently responsible for a hugely disproportionate percentage of global emissions. Even if the Oxfam metrics may be questionable, there is sufficient substance in the claim, both within and between nations, to make this politically significant.[ix]

More pessimistic outlook from climate science?

At the same time, it is easy to gain the impression that earlier reporting of climate science may have seriously understated the threats.[x] Through fears of being labelled as alarmist, earlier warnings may have been too circumspect and too cautious. There is an increasing recognition, especially, of the numerous potential “tipping points” in the climate system.[xi] These include the dangers of melting icesheets and glaciers, reduced albedo at the Poles, and potential release of methane from the tundra. Some of these are starting to resemble increasingly near term and immediate dangers.

However, despite some of the undoubted advances and achievements of Paris and subsequent COP meetings, progress in limiting the growth in emissions, let alone reducing them, remains painfully slow. This leads to another pessimistic conclusion.[xii] There is an increasing realisation that on current trends the global community is unlikely to achieve sufficient emissions reduction to avoid bad outcomes, warming of more than 1.5^o C or more than 2.0^o C.[3]

One possible and logical deduction, then, might be to pay more attention to the possibilities of direct atmospheric carbon capture (DACC) on a large scale. This was seen as a rather fanciful idea until comparatively recently, but it has been proposed as a necessary and feasible option. Whether there is any realistic possibility of attaining the necessary scale of carbon removal is another matter, but DACC potentially adds another dimension to zero carbon policies, not least if the estimated costs were to provide a clearer basis for pricing emissions. 

The Crisis of Fossil Fuel Costs

Recent events, including the war in Ukraine, have also sparked the resurfacing of fears over oil and gas prices, with the era of cheap gas a fading memory.[xiii] We may dismiss the rather risible claims from residual science denial factions that the crisis is a product of attempts to move away from fossil fuels. [xiv]   There is at least a reasonable probability that recent crises, and the fear of future big spikes in oil and gas prices, could mark a permanent shift in demand and towards less carbon-intensive supply.[xv]

 

 

II.2  Energy Policy Trends

For some time now it has been almost a convention in energy policy discussions to describe the policy landscape in terms of decentralisation, digitalisation and decarbonisation.

Decentralisation

Historically, energy supply, and particularly electricity, has been dominated by large, centralised utilities, reflecting perceived economies of scale and the ability to offer more reliable supply through the diversity of demand in larger interconnected systems. In the UK the power system remains essentially centralised through the continued dominance of the National Grid, and despite the fragmentation of the industry that accompanied privatisation in 1990.

One of the driving forces for the opposing trend towards decentralisation has simply been the relatively small scale of many renewable generation sources, especially solar and to some extent wind power. This has been accompanied by initiatives to create low carbon towns, cities and wider communities.[xvi] Such a grassroots approach has big additional benefits in promoting community engagement with climate issues and climate policy. It also has the potential to integrate a wide range of decisions on local planning and land use with the needs of a low carbon economy. It emphasises the importance of the “social and behavioural” domain.

There is also a much-increased emphasis on the current and potential importance of the interaction between the supply side of the sector (generation and networks) and the choices made by consumers, both household and commercial/ industrial. This emphasis on consumer behaviour is sometimes interpreted as another factor promoting decentralisation, although it is perhaps more important in focusing attention on tariff incentives, as one of the most important instruments of system coordination.

There are other factors and developments, too, that steer towards a much greater role for decentralised decision making. One is that a substantial weight of energy relevant assets and investment is shifting downstream. It is mostly individual consumers who will make substantial investments in electric vehicles (EVs), and in heat pumps. This represents a much greater weight of “energy assets” with the individual than hitherto. The siting of EV charging stations will reflect local preferences, constraints and decisions, and both heat and power distribution (lower voltage) networks are more likely to require more localised operational control. This implies increased asset values that are owned, or at least operated, at local or regional rather than national level. 

The heat sector (heating of buildings, particularly residential) is one of the most challenging and important in the UK. Currently the two main avenues for technical solutions in the heat sector are seen as heat pumps, on the one hand, and heat networks, on the other. Heat networks may depend on CHP, in some geographies on geothermal energy, or stored heat. An additional but untested possibility may be the use of green hydrogen (produced by electrolysis), either for direct distribution to households through an existing gas grid, or as an alternative heat source for heat networks. 

Most of these options pose localised choices, particularly for the establishment of local networks and for retrofitting. Necessarily this implies some communal decisions and choices. Moreover the extra loads will imply the need for more localised control within distribution networks (the medium and low voltage, MV and LV, systems). Positive engagement helps overcome hostility to change.

However none of these trends seem likely, as is sometimes suggested, to eradicate, or even significantly reduce, the continued importance, in most contexts, of centralised decision making, or (in the UK) of the National Grid. There are several reasons. The most important considerations are that:

·      smaller systems have a fundamental need for interconnection, necessary to match supply and demand in real time. This matching is much harder to achieve, efficiently and at low cost, in small systems. Larger systems tend towards a diversification both of consumption profiles and supply.[xvii] Imbalances are accentuated in small systems if they specialise in particular renewables, eg wind or solar, that do not match what is required to balance seasonally with their consumer loads, and by the limited ability to control individual renewable sources in response to demand.

·      in the context of renewables, the available energy resources (eg offshore wind) for power generation will often continue to be remote from the centres of power consumption. Many will also be large scale.

·      Both these considerations will also apply to storage resources, including both pumped hydro and hydrogen. Volume storage naturally tends to enjoy scale economies.

·      a good balance, to achieve both reliability and affordable cost, is required between different renewable resources and, correspondingly, transmission, interconnection and large-scale storage facilities.[xviii] This requires a high degree of coordination, both in terms of investment and operations, which is unlikely to be achieved through simple trades between small, decentralised units.

·      Many of the big technology decisions, for example on hydrogen, the possible future of nuclear power, and national heat policy will be taken at a national or sometimes international level, but all these have major interactions with the power system.

The policy landscape for decarbonisation will therefore continue to include substantial centralised decision making, and one of the continuing challenges will be to reconcile centralised and decentralised systems. Tariffs, which determine the financial incentives for cooperation between central and more local actors, will necessarily play a major part in this.

Digitalisation

Digitalisation is in one sense just a description of one of the dominant, and hugely important, technical and cultural influences on the world in which we live.[xix] The transformation, with digital technology, of communications, measurement, control systems, and complex analysis, has resulted in a set of enabling technologies that have already become fundamental to every aspect of the power sector. It has allowed the development, not just of “smart grids” and better real time management of power flows, but consideration of more complex real time markets, and tariff structures that may help promote not just economic efficiency, but also sustainability and other, wider, social and policy objectives.

The central importance of digitalisation as an enabling technology applies not just within the power sector itself, but also for transformative user technologies like electric vehicles, that are also a major part of the overall energy policy agenda.[xx] It has vastly expanded the range of the possible, including the development of more reliable decentralised systems and improved approaches to retail supply.

But it also presents additional challenges. Seminars within the Integrate project revealed that some measures, designed primarily to promote decarbonisation agendas, raised significant privacy and data security concerns, which must be addressed in each sector.[xxi] Two particular examples are road pricing, which implies recording of the movements of individual drivers, and any form of time-of-day pricing for households.[xxii]

Nor has the revolution been entirely beneficial. It is not energy free and so not carbon free in the short to medium term. It has also enabled cryptocurrency, which creates a large carbon footprint, but offers little or no societal value.[xxiii]

Decarbonisation

Decarbonisation has been the overarching objective of the whole Integrate programme, so, unsurprisingly, deserves its place as overwhelmingly the most important part of the energy policy landscape. CO₂ remains the most significant greenhouse gas, and this drives the urgency of reducing CO₂ emissions across the global economy. Hence decarbonisation frames the policy debate. 

We have already referred to the increasing political saliency of climate issues, and to the coincidental crises in two fossil fuel sectors – oil and gas. But there have also been continuing developments, both in scientific understanding and technology development and, further, in identifying what may be the most important choices that have to be made, either for individual technologies or for more complex pathways for the energy sector.

Innovation

It is in relation to the decarbonisation agenda that the pace and scale of advances in both science and technology continue to surprise. Most important are the continued reductions in cost that accompany technical advances, and the economics of scale production, across sectors as diverse as electric vehicle production, renewable generation resources, carbon capture, and energy storage. But in most instances the innovations on acceptable timescales depend on the introduction and scaling up of proven technologies, not on future scientific breakthroughs

One of the major lessons we should draw with respect to innovation is the absence of a single “silver bullet”, and our dependence on dozens if not hundreds of separate developments, and alternative options in all sectors of all economies.

Nevertheless, there are a few areas which are of particular significance in a systemic sense. Fusion as a source of power generation might fall into this category if it were a more realistic prospect within a useful timescale, but a more cautious appraisal suggests that it is in the area of large scale energy storage that some of the key choices will lie: electrolysis and storage in the form of hydrogen or possibly ammonia.[xxiv]

A second comparatively recent development is of systemic importance and particular relevance to policy and strategy discussions. It is direct air carbon capture (DACC). Once seen as impossibly expensive there are now claims that costs could be brought down to levels that make it a credible technology. Combined with associated methods for the creation of synthetic fuels, this also has the potential to resolve, at least in part, one of the most challenging requirements for a zero-carbon economy, namely sustainable aviation fuel (SAF).

In the past it has been suggested that reliance on DACC was a dangerous suggestion because it appeared to postpone the need for urgent action. Given the increasingly tight targets now required even to stay within the 1.5^o limit, and a reducing probability of attaining them, together with the risk that climate consequences might be worse than central estimates indicate, DACC appears increasingly important.   It should therefore be seen as a useful addition to the set of strategic policy instruments. But it emphatically does not remove the case for urgent action on emissions, and the case for front-ended rather than rear-end loaded reduction strategies.

 

III.           THREE CRUCIAL PARAMETERS AND ASSUMPTIONS FOR POWER SECTOR DEVELOPMENT, AND FOR DECARBONISATION POLICIES.

This chapter addresses three hugely important assumptions that necessarily underpin any analysis of the system economics of decarbonisation, implicitly even if rarely explicitly. Even seen simply as numerical parameters, each of them will necessarily have a huge impact on the shape of future power systems, and indeed on the whole energy sector. They are all recognisably factors of great economic significance, and map across to the familiar “trilemma” objectives[4] of affordability, sustainability and security.[xxv] In spite of this, they often generate surprisingly little attention, analysis or discussion, either in the context of public policy debate or even in much of the technical analysis outside of academia.[xxvi]

Traditional approaches to least cost development of the power sector

The way that power systems are planned and develop, whether through centrally planned or competitive market frameworks, depends on multiple factors including the legacy of inherited assets, technical characteristics of the system, available technology choices, geography, and expectations of consumer loads. These factors were, and are, the starting point. Power sector investments, typically, were then considered, by governments, development agencies and others, in relation to the concept of least cost expansion plans. 

The objective of “least cost expansion planning”, in a central planning environment, or the equivalent to be achieved via market signals, is to get to the most economical generation expansion scheme, with a well-defined level of reliability, based on forecasts of demand over time. Major costs in the power sector include capital investment cost, and variable costs of generation – mainly the costs of fuel input in systems based on fossil generation. The concept of least cost development can be extended to the more general task of decarbonising the energy sector in its entirety.

There are three major assumptions or judgements that necessarily underpin investment choices, and which are also in some sense external. They are outside, or exogenous to, the power system and its starting conditions. But they all have a profound importance in policy and strategic terms. Each of them can, in some circumstances, be reduced to a single, or a very few, numerical parameters. Each of them has major impact on both the scale and choice of investments for an optimised, or efficient and effective, energy sector. Each also reflects to some extent the values of society, in valuing the present versus the future, the value we choose to put on environmental stability, and the way we value energy security and reliability in sources of power.

Three Universal Parameters

The three key assumptions or judgements, and their associated parameters, are:

·      cost of capital; for the capital-intensive power sector, this is critical both to investment choices, balancing capital costs against running costs and against expected asset life, and to affordability. Affordability is a key trilemma objective.

 

·      cost of fuel, which in a decarbonisation context must be re-interpreted to include the value to be placed on reducing carbon emissions. The value of CO₂ reduction, or the cost of CO₂emissions, may be said to be an arithmetic expression of the trilemma objective of sustainability. We must recognise that this is a societal value, and an externality, not a cost usually reflected in the price to an individual business or household.

 

·      the value of reliability, or the cost of unreliability, sometimes expressed as the numerical parameter of value of lost load (VOLL). It dominates decisions on the sufficiency of reserve capacity, and therefore has a major impact on the quantity of generation required and hence the scale of investment. It is therefore closely tied to the trilemma objective of security. In traditional, centrally organised power systems this was treated as a collective or quasi-political decision, since there was little or no scope for differentiation between consumers in the adequacy and quality of supply. In a renewables context, subject to variability in supply, reliability is a particularly important, and sometimes controversial, factor.

We can address each of these in turn. Although under some circumstances each can be reduced to a single numerical parameter, each also raises major policy and strategic issues for a decarbonisation programme. All of them are highly controversial and to different degrees inextricably linked with governance issues. Also, each of them is fundamental to any serious cost benefit analysis (cf the Stern critique). Not dealing with them appropriately through policy is likely to result in market failure or seriously sub-optimal outcomes. But they are rarely discussed directly.

There is a universality to these three parameters in the sense that they all prove to be of profound importance in every jurisdiction, market-based or centrally planned, for all geographies, and for all stages of economic development.

Cost of capital

The assumed cost of capital translates into a discount rate in policy appraisal. It necessarily has a major effect on calculations of net present value (NPV), and hence on financial and economic evaluations, and choice between competing projects or technologies. This will occur for example in options for the generation of electricity or the daily or seasonal storage of energy.[xxvii] This is very obviously important for comparisons of very different profiles of capital and running costs, and will be equally important, in some circumstances, for comparison of alternatives with very different asset lives. A good example, in respect of asset lives, might be a choice of energy storage methods to manage a daily load curve (fluctuations in power demand over the day).[xxviii] This is likely to include choice between batteries (comparatively short lives) and pumped storage hydro schemes, where the main civil engineering asset, eg the dam, is likely to have an indefinite life.[xxix]

The discount rate question needs to be considered both as a societal matter, taking into account all the externalities as one might in a cost benefit analysis of public policy choices (cf Stern), and a practical financial issue, in which it is necessary to look at the financial impact of the actual cost of capital on the main actors and decision takers. For societal values it defines the relative value of present costs and future damages, an inherently ethical and political judgment. For the latter, the burden of actual financing costs falls on government, on regulated utilities or on other players operating in competitive markets. That in turn leads to the passing on of costs to consumers; this will possibly be the biggest single influence on affordability.

The next question then is the appropriate cost of capital to use in policy appraisal, and what will be the actual costs of capital that have to be covered by future energy sector investments. This is a particularly difficult, controversial and confusing subject, but two further sources of confusion deserve particular mention. One is the need to distinguish between nominal and “real” (ie inflation adjusted) rates. The other is the way in which the cost of capital is closely bound up with different concepts of risk.[xxx]

The Stern Review generated a huge amount of academic debate around the appropriate societal value to attach to the discount rate. Stern argued for what was at the time considered an ultra-low discount rate of around 1.0 % per annum.  A 2015 survey of 200 general economists found that most preferred a rate between 1% and 3%.[5]

At the other extreme, notorious climate sceptics such as former UK Chancellor Nigel Lawson argued for figures much closer to those allegedly used by commercial and industrial businesses in appraising major projects, often in the range 10-15 %.

Higher numbers (such as those proposed by Lawson) lead quickly to the discounting of more remote futures (more than ten years ahead, say) as fairly unimportant.[xxxi] The case for using them in policy analysis can be dismissed as the product of confusion between real and nominal rates, failure to understand the nature of risk to return relationships, and the fallacy of using high hurdle rates to discount appraisal optimism.[xxxii] Very low numbers by contrast can be defended as an expression of a “true” social time preference, as a reflection of the actual “risk-free rate” in the dominant CAPM model of investment portfolios.[xxxiii] There is also the evidence of actual real risk-free rates in recent decades.[xxxiv]

The UK consensus, at least, appears to have settled in favour of rates much closer to the Stern position. For example Department of Transport guidance appears to have settled on real rates between 1.5% pa and 3.5% pa, with the lower rate applicable to health, and by implication environmental costs and benefits, for which there is limited or zero market correlation. Our hope and recommendation should be that very low discount rates for policy appraisal become the norm in relation to climate and decarbonisation, and not just in the UK. Unfortunately, it is still common to see cost and investment appraisal analysis routinely conducted in terms of an uncritical adoption of “standard” assumptions of 5% or 10%.

Moreover, the adoption of very low discount rates in policy appraisal, justified though it may be, does not necessarily translate into a low cost of capital for the major actors who have to implement the actual investments that are required for transformative change to a low carbon economy. If there is a divergence, then it should be regarded as a market failure. Investments that we believe are beneficial or essential from a societal perspective may not take place because financial markets necessarily factor in other considerations. Or, if they do take place, much higher interest costs will be passed on to consumers or taxpayers. This is reflected in three particular contexts where the potentially large discrepancy leads on to further policy or strategic interventions.

The first context is that of public utilities, network operators, and investors in low carbon generation. The reality here is a fundamental feature of a great deal of infrastructure investment. Private capital investment in long-lived, immobile, use-specific or customer-specific assets requires certainty. So governance and structure become absolutely critical. This is demonstrated by UK experience. In a largely unplanned way, and against the professed philosophy of the governing party, necessity has forced either government or a central body to become the de facto decision maker on virtually all new investment. This topic was discussed at length in the ETI paper, prepared at the start of the Integrate project, and more recently, but briefly, in a paper by Rhys and Valenzuela.[6] It is also widely recognised through the need to secure low interest costs, and hence affordability, for major projects.

The second is that of government finance. For developing countries, their governments typically do not enjoy the credit ratings available to wealthier nations, sometimes reflecting a perceived risk of default. However investment in clean development is a global necessity.  Its realisation inevitably depends, therefore, not on unfettered capital markets but on the backing either of donor countries or agencies such as the development banks. The divergence in costs of capital mirrors a second cost benefit paradox, in which the benefits of clean development accrues globally but in much smaller measure to individual countries implementing the necessary investments. 

A third context is that of individual consumers, households and small businesses. In the UK, although some mortgage holders have often, at least until recently, been borrowing at 1.5%, many, including those in rented accommodation, do not have access to risk-free rate finance, and will typically pay much higher rates on non-mortgage finance. Their incentive for home insulation or adoption of low carbon technologies is therefore reduced. A relevant and established market intervention in this case is of course subsidy.

 A Macro-Economic Burden?

A related issue is the macro-economic feasibility of the cost of getting to a net zero or low carbon world. It is sometimes claimed that the simple volume of expenditure, whether capital or current, is so high as to be unsustainable.[xxxv]

One of the arguments mounted against effective action on climate is simply that the economic cost is unaffordable. The obvious response is that this has to be compared with the cost of not taking action, the costs of adaptation, and the possibility of existential climate threats on an unimaginable scale. However rather than engage with the occasionally hysterical accusations of alarmism from those in denial on the climate science, it is worth trying to get a sense of the scale of what may be involved in meeting a UK zero carbon target by 2050. Some sense of proportion should start to defuse the issue and calm any fears of national bankruptcy. 

This can be a confusing exercise, not least because estimates (of mitigation costs) tend to be treated quite casually in public debate, and to be used in very different contexts. For example, it is very common for estimates of aggregate costs to be discussed in the broadest terms as a percentage of GDP. This is a useful yardstick and the Stern Review indicated costs of up to 2.0 % of GDP per annum, but some people have argued that this would be a very damaging and unsustainable burden in macro-economic terms.  The Committee on Climate Change currently makes a similar estimate (of 1-2 % of GDP). Others argue that Green investment can actually be used to boost economic growth and domestic employment. There can be at least a partial truth in this argument, even if it can be misrepresented as arguing that the low carbon economy pays for itself. It is not an argument I intend to deploy here. 

Some economists are more concerned with the public expenditure implications, although that issue, too, should be seen much more in terms of more political questions of how we choose to fund transformational change. For example, much of the cost of transition to low carbon will be carried by private consumers, through their utility bills or more expensive motoring choices, but the cost may also include publicly funded infrastructure investment and extensive grants and subsidies.

Macro-economic shocks and UK GDP numbers

2019 GDP (last year before pandemic)                                              £ 2170 billion pa

Estimated permanent loss of annual GDP due to 2008 
financial crisis. The economy is 16%, or £300 billion, smaller 
than it would have been had it followed the pre-crisis trend. [7]   £  300 billion pa

Typical impact of an oil price shock[5] in 1970s, 1980s
and 1990s. This is an order of magnitude estimate, based on
spikes and falls in the oil price of $100/ bbl, UK consumption 
of 100 mn tonnes pa, and scaling up to an equivalent
percentage of 2019 GDP.                                                     £ 100 billion pa                                                                              
Assumption of a 2% of 2019 UK GDP devoted to GHG
reduction and low carbon transition.                                       £ 43 billion pa

None of this suggests that the cost of remedial action is, in macro-economic terms, unaffordable, or that the “shock” to the economy is unprecedented. As an existential threat it should properly be seen as unavoidable and essential expenditure.

Cost of carbon

The Stern Review identified the economic externality of greenhouse gas emissions, causing massive economic, societal and environmental damage on a global scale, as the greatest and most far-reaching market failure of all time. One might therefore expect, as an imperative, attempts to put a value on emissions reduction, and that this value would play an important role in determining the pace and shape of decarbonisation. It would also be an important input to determining the level of any carbon tax.

In traditional least cost expansion plans, assumptions about fuel prices were often key determinants in the choice between oil, coal and gas, and in determining when less efficient plant should be retired; but fuel prices per se will be increasingly irrelevant as power systems transition to low carbon. However, choices in that transition, and for the energy sector as a whole, should continue to be influenced by an appreciation of the costs of emissions and the value of eliminating them. Implicitly, assumptions about the cost of carbon will and should influence the pace of retiring fossil plant and achieving decarbonisation of the power sector itself. The value of emissions reduction should also be included in cost benefit analyses (CBAs) to justify particular policies such as the phasing out of internal combustion (ICE) vehicles in favour of battery-only vehicles (BEVs).[xxxvi]The value that is attached to CO₂ reduction is therefore a vitally important parameter, at least in principle, for justifying decarbonisation measures.

Controversy over the monetary value attaching to CO₂ (emissions reduction) goes back at least as far as the Stern Review. There have been two main quantitative approaches, through attempts to estimate damage directly through integrated assessment models, or through estimates of the marginal cost of abatement. Neither has been entirely satisfactory.

Integrated assessment models (IAMs), in principle, try to measure directly the impact on climate, and have been used in attempts to justify, or dismiss, the case for action to mitigate emissions. This has proved problematic for several reasons. A basic issue is simply that the scale of undertaking is just too big. In principle it demands an ability to forecast, with different assumptions for emissions policy, the outcome for global and all major economies, together with global and regional climate changes and their impacts on output, enhanced risk of conflict and war, and much more, all over an indefinite future, according to different levels of future emissions. 

Such models are also often misused and come “close to assuming directly that the impacts and costs will be modest, and close to excluding the possibility of catastrophic outcomes”, according to Nicholas Stern.[xxxvii]  In other words, they do not deal realistically with existential threats, and largely assume away the problem they are supposed to be analysing.

The second approach, attempting to measure the marginal cost of abatement to meet a defined target, appears prima facie more realistic, assuming the costs of all the possible technologies can be estimated realistically. However, this too makes possibly unrealistic assumptions. One is that we know with confidence the acceptable limits and can determine the right target. Another is that the incremental damage at that limit does actually equate to the marginal cost of abatement.

This may however be the more realistic approach, particularly if we can treat something like the cost of DACC as an ultimate fall-back position. Whatever the limitations of CBA in trying to measure and express in monetary form the catastrophic threats of climate change, putting a DACC base value on CO₂ will be potentially valuable in comparing different decarbonisation policies. 

The Time Value of Carbon

There is one further major issue – the Sinn or Green Paradox. Sinn pointed out that the expectation of a gradually increasing tax, on oil or any fossil fuel, would provide a powerful incentive for the owners of those resources to exploit them as quickly as possible. This is exactly the wrong message if our objective is to limit cumulative emissions. The concept of a gradual future increase in the “cost” of carbon is nevertheless a familiar but flawed position that is rarely questioned even among energy policy specialists.[xxxviii]

Moreover, earlier reductions postpone the date at which specific climate milestones are reached, defined either as parts per million, or as temperature targets, or in relation to climate tipping points. Front end loading of emissions reduction could be equivalent to postponing arrival at a critical milestone by a decade or more.[xxxix] They therefore have a considerable and additional “option value”, in terms of additional time to develop low carbon technologies and to prepare for adaptation.

Current valuations in government appraisals for cost benefit or other purposes

There have been major changes in the valuations placed on emissions in recent years, which have been largely unreported. In the US, the Obama administration paved the way for the first US estimates attributing a social cost to carbon emissions, setting out costs of $36 per tonne of CO₂e for 2015. With the Biden administration reversing the much lower numbers of the notoriously pro-fossil Trump era, this had reached $51 by 2022.

The EU had much earlier introduced a ground-breaking emissions trading scheme for carbon, covering less than 50% of emissions, but by the end of 2020 the carbon price per tonne CO₂ had rarely attained €30. More recently, the highest price reached in 2022 was €98. Some member states had introduced significantly higher taxes on emissions not covered by the ETS.

The 2018 IPCC report hinted at the possibility of significantly larger numbers, of at least $135 in 2030 and $245 in 2050, as required to be consistent with the 1.5 °C limit.[8]

UK numbers have generally been much higher than in the US. Even so my research in 2017 failed to uncover values higher than £65 per tonne (drawn from a single Committee on Climate Change scenario). But in September 2021, possibly reflecting the fact that the UK was hosting the COP 26 summit, the government implemented a huge change to its carbon prices for policy appraisal purposes. The 2022 price was lifted from £27 (traded) and £72 (non-traded) to £248 per tonne for non-traded carbon. More recent reports have suggested much higher numbers.

While it is still possible to take issue with important details such as the time profile, this represents a huge shift towards acknowledgement of the scale of the challenge, and numbers that are at least on a similar scale to estimates of direct carbon capture (DACC). The IEA is quoting current prices of $600 - $1000 per tonne.[9] Others are claiming much lower numbers. Some suggest costs as low as $100 per tonne and others of the order of $250 to $300 by the end of the decade.[10] [11] The lower numbers may well exaggerate the potential but nevertheless the convergence between rising estimates of social and environmental cost and falling estimated future costs of capture suggest there may be “a deal to be done”. 

Failure to monetise the very real global costs represented by these estimates, via carbon taxes, mandatory limits, border tax adjustments, or other means, necessarily has to be viewed as an ongoing market failure. It is a failure that matters in many directions. 

Perhaps the most obvious is the incentive for development of DACC technologies for extraction of CO₂ from the atmosphere, including those that are combined with the production of a synthetic fuel. Sustainable aviation fuels (SAF) are currently estimated to cost about $2 or 160p per litre, while today’s aviation fuel price at London Heathrow or Gatwick is 91p per litre (crude is currently $80 per barrel). A carbon credit of £250 per tonne is worth about 61p per litre, which already comes very close to closing the price gap. Airlines are already taking a keen interest in SAF, as they are faced with the prospect of progressively tighter demands to reduce emissions. These numbers make SAF development a much more credible option, but monetising the carbon value will probably be essential to incentivise development of SAF technologies.

A second is simply the evaluation of public policies with a carbon emission impact. This will matter for many policy and investment choices in both high and middle/lower income countries, but one simple illustration might be the choice between alternative routes for a new road, one of which is through an established forest. Forests are a major carbon store, and based on one recent appraisal, the “carbon cost” of clearance, for certain types of forest, could be set at £450,000 per hectare.[xl]  This sort of valuation would typically inhibit the construction of new roads, or even overhead high voltage transmission lines, where these cannot be shown to be low impact or carbon neutral. 

A third illustration is the economics of carbon capture from an existing coal, oil or gas power plant. This is usually assumed to be less than 100% successful, so the cost attaching to CO2 leakage, eg the cost of any subsequent DACC, should automatically be part of the investment appraisal for the project.

Finally, a fourth is simply the way that power systems are run in the interim period before they can be made fully fossil-fuel free. The reason this matters so much was exemplified by the case, a few years ago, when power producers were prevented by the competition authorities from agreeing to restrict their coal consumption in favour of gas. Partly due to an inadequate market price for carbon, this was held to be a cartel arrangement that penalised customers.[xli]  

 

Reliability 

In traditional power sector planning in developed economies, and to a lesser extent developing economies too, one of the key issues has always been the appropriate level of security for which to plan, and the resulting amount of reserve capacity then required to provide a desired quality of service. Necessarily the choices made have a large impact on capital requirements.

This was most easily discussed in relation to the adequacy of generation capacity, mostly expressed as ability to meet peak demands.[xlii] Since it was usually assumed that system failures and blackouts would affect all consumers to a very similar degree, the level of reliability was a societal or collective choice determining the standard to which suppliers of electricity could be held.

That choice could be expressed numerically as a single parameter, the value of lost load (VOLL). In a centrally planned system, the VOLL, together with an estimated loss of load probability (LOLP) for different levels of capacity, could be used to calculate the expected social cost of supply interruptions for different levels of capacity. 

Multiple attempts have been made over the years to infer a social, economic or consumer-based estimate for VOLL, with methods ranging from willingness-to-pay surveys to simplistic GDP per kWh calculations. A 2018 CEPA report described a range of estimates across the EU of between £2 and £22 euros per kWh, with the higher estimates tending to be in the more affluent countries with a history of reliable supply.[12]

In market systems, such as the UK in 1990 or the Texas system more recently, VOLL could then be used to set administered prices to which market participants would be obliged to respond. Alternatively, regulators should be prepared to allow periods of extreme price surges, as a necessary basis for funding peak capacity

Markets have not done particularly well. Viewed as independent countries California and Texas would both rank among the ten largest economies in the world. One Democrat and the other Republican, the feature they now have in common is as examples of failure to prevent extensive and disruptive interruptions to power supply – California in 2001 and Texas in February 2021. In both states near-catastrophic failures raised questions as to the viability of highly market-driven fragmented power systems, which contrasted with the stability of the more integrated models of the East Coast of the US, and internationally. The answers matter, not just for Texas, but for developed and developing economies everywhere.

The whole question of designing systems for reliability standards is however  transformed both by the particular issues of low carbon generation, and by digital technologies for measuring, communication and control.

First, the advent of a high percentage of renewables, where output is variable and weather-related, necessarily leads to dependence on high volumes of storage, to guard against long periods of low wind or solar output. This means that peak capacity, measured in as kW of power, is no longer the main measure determining reliability. Storage of energy, or kWh, becomes just as important. Moreover the character of an energy shortage is quite different, since it can amount to shortages or rationing over prolonged periods of weeks or months rather than brief periods of inconvenience due to insufficient capacity.

Second, the advent of digital technologies makes it possible for the level of reliability to be driven much more by individual choice. An Ofgem partner made the radical suggestion that consumers might wish to pay for higher or lower reliability standards for their own supply.[xliii] This implies a much more market-based approach in which consumers can choose their own standard of reliability, and indeed are likely to choose different standards for different parts of their load. Reliable power for lighting or IT uses, for example is generally more important than guaranteed power for EV charging. A digital world enables those choices and differentiated levels of reliability. All this implies a redefinition of the services that utilities provide.

The natural route to provision of this degree of choice to consumers is through tariffs, which of course will then need to be reflective of the costs of reliability provision, both through reserves of generating peak capacity and reserves of storage. 

Overall, we should expect a transformative impact on what we mean by reliability and how we define it. This flows from the low carbon future envisaged and the combined impact of renewables together with more opportunity for digitally enabled consumer preferences. How we define it and set standards will necessarily much more complex. Old-style reliance on a single parameter such as VOLL, or kWh of lost load per annum will no longer be useful.

We shall instead need to resort to a much more broadly based concept of system resilience across the energy sector as an entirety. The risk for example may be much less that of a short-term “needle peak” concept of insufficient generating capacity. It may be more akin to that of an overall energy shortage, possibly due to sustained weather conditions and insufficient energy storage, not generating capacity per se.

Moreover, it may be sensible to see such crises as more similar to situations such as those experienced in the UK in the 1956 Suez crisis, the three-day week of the 1970s, or the recent pandemic, ie as “whole economy” crises – serious but capable of being managed without economic and social collapse. From a whole economy perspective, for example, stocks of finished product are as much part of a resilience margin as additional capacity in the energy sector, and a possibly cheaper and more effective approach to reliability.

These are the opportunities that a differentiated approach to reliability provides.

 

 

 

IV.          THE MOST IMPORTANT LESSONS

This chapter aims to pick up the three “parameter” themes above, together with the general issues of coordination and governance, and to develop some principles that will be important for a progression to a low carbon world.

Network Issues for a Low or Zero Carbon Energy Sector.[xliv]

There are some general policy requirements that can be drawn from the programme and linked pieces of research and analysis. 

The first is that, in all but the smallest power systems, there is typically a clear need for whole system coordination, over and above what can be delivered by markets alone. Even if we focus purely on the power sector, there is no visible mechanism by which uncoordinated responses to market signals can be guaranteed to provide a credible approximation to the right seasonal balance of renewables, notably wind and solar. Nor is this deliverable through collaboration between localised, decentralised systems. Similar considerations apply to getting the right amount of conversion capacity to ensure an economic and reliable infrastructure for storage – including both the stores themselves and the conversion capacity for inputs to store, electrolysis, and outputs as eventual use of the stored energy. This coordination is essential both at the investment stage and in system operation. 

The fundamental need for whole system coordination applies a fortiori as decarbonisation extends to the electrification of both transport and heat. A second policy conclusion therefore is that the fundamental decisions on power sector investment and infrastructure need to be closely coordinated with decisions for the heat and transport sectors. Reliance on heat pumps for example will substantially increase the seasonal imbalances and introduce weather related volatility on the demand as well as on the supply side. Similar considerations will apply to planning the network infrastructures appropriate for electric vehicles, although the latter can be used to assist operational management of power systems. 

A third is that we need to re-examine and discuss the treatment of reliability and risk in power sector policy and planning. A disturbing message from multi-decadal meteorological data is that we do need to consider the possibility of very occasional crises, even if perhaps only one every few decades, when there is an extreme and sustained shortfall in energy provision. Such crises are of course not confined to renewables systems. The UK experienced the 3-day week of the 1970s, induced by industrial unrest, and the petrol rationing of the 1956 Suez crisis, and France or other countries could experience, for example, type fault issues with nuclear power. The issue is how we plan against extreme events. The answer is not necessarily massive and unaffordable investment in spare capacity. Defining capacity adequacy will be important; but there can also be a degree of acceptance that from time to time we can face major crises which are disruptive but can be managed without societal collapse. The recent pandemic provides interesting parallels.

None of the above implies the abolition of markets, or creation of totally centralised planning and control systems. It does imply less reliance solely on markets, and the need for a system architecture that can cope with multiple coordination issues and, sometimes, the market failures that stem from either the externalities of CO2 emissions or the nature of network industries.

The decline of “reliance on market” solutions.

The liberalised market paradigm for the organisation of competition in the power sector has dominated discussion of institutional and governance issues since the early 1990s, much of which has related to the design of specific markets. It was also promoted as an aspirational goal by supra-national bodies such as the European Commission and the World Bank. It does however appear increasingly inappropriate.[xlv]  There are several factors:

·      technical characteristics of low carbon technologies, including renewables and nuclear; these break the link between spot market prices and efficient operation.

·      markets have generally provided inadequate signals for investment, largely but not wholly due to the lack of carbon pricing.

·      increasing awareness of the need for coordinated investment and operations.

·      perceived failures in jurisdictions, such as that in Texas, which relied on scarcity prices.

The World Bank has become much more sceptical of the virtues of privatisation, unbundling of integrated power sectors, and reliance on markets.[13] It notes some of the issues above, as well as problems more specific to developing economies. As an example of the latter, adoption of the liberalised market approach has not resolved one of the most important issues for many developing country power sectors, that of adequate tariffs and cost recovery. ESMAP also identified the absence of an overarching least cost expansion plan as leading to significant problems, including associations with inappropriate, ad hoc and opportunistic generation investment.[xlvi]

In a UK context this has been leading to a reversal of some of the reforms and structures that accompanied the 1990s privatisations, many of which have in any case have lost their original function and purpose.[xlvii]

All these issues point to the need for a wide rethink of institutional architecture, a subject that has been dominated in recent decades by the predominance of purist market ideologies.

Institutional architecture and redefining the role of markets (cost of capital as a significant factor)

Institutional architecture and governance matter a great deal for the energy sector.[xlviii] In the context of decarbonisation policies, policy, market and regulatory frameworks for network infrastructures need to bring forward the right investment at a reasonable cost of capital (the ‘investment phase’), enable efficient operation of networks (the ‘operational phase’), and support retail markets that empower consumer choice and involvement (including efficient tariff structures). 

Good governance, especially, is essential to removing the investment risks with which private investment cannot cope, notably so-called regulatory risk or policy risk, where governments can arbitrarily change the rules of the game after substantial investments have been made, and the costs sunk. These are the risks that are outside the control of the investor, and, unsurprisingly, major infrastructure investments often require government guarantee.

The ETI paper was prepared early in the Integrate programme and addressed a range of network governance issues across all the current and potential future energy networks, including existing gas and transport fuel distribution networks.[xlix] It focused on the UK and was commissioned to cover a particular set of energy scenarios which envisaged, inter alia, a substantial role for heat networks. In that context, it made several proposals. These included: 

·       formalising the recent trend towards central strategic direction of the UK energy mix, with a technically competent central procurement agency (CPA) for electricity capacity. The CPA would be required to procure a sufficient, balanced portfolio of generating capacity, consistent with zero carbon objectives for the sector.

·       The CPA would enter into long term power purchase agreements (thereby securing a lower cost of capital) and would resolve investment co-ordination between capacity and power procurement, system operation and transmission functions. This would obviate the need for a separate capacity market instrument, since long term contracts could be structured to reward capacity and availability. 

·       Enable more effective competition in the supply market, allowing electricity suppliers to act more innovatively as demand-side aggregators, with radically different service offerings for customers that will also help shape consumer loads. 

·       a new Heat Networks Authority to facilitate early roll out of heat networks, identify promising candidate locations for early adoption of district heating, and promote best practice. It might also anticipate and resolve coordination and other issues with the power and other sectors in areas (possibly a majority) not covered by heat networks. 

·       Encourage heat network deployment by government support for and underwriting of early “model” projects, while reviewing regulation of decentralised heat monopolies.

This is not to ignore the vital role of markets in both innovation and the allocation of resources. The incentives to innovate in generation technology all remain in what will remain essentially a global and highly diverse international market. But in other areas the role of competitive markets needs a radical reappraisal. During the programme, several points have become apparent which run counter to conventional wisdom:

·      the spot market concept, based on replacing traditional centralised merit order dispatch with marginal cost bidding or related mechanisms, is largely obsolete in the world of low carbon generation.

·      competition in retail supply has not delivered higher consumer satisfaction, and, in a UK context, probably held back the development of smart metering by several decades.

·      competitive procurement is important but the overwhelming importance of coordination in system design means that the concept of technology neutral procurement is likely to remain an unrealistic aspiration. 

Values and costs attaching to carbon, capital and reliability

Progressing from these important structural and institutional questions, it is possible to develop further some of the ideas that flow from our three “parameter” themes, the costs of carbon, capital and reliability. 

We can start with the cost of carbon issue. A serious but frequently repeated fallacy is the assumption that the cost we should attach to carbon emissions, and hence the value of emissions reduction, rises with time. As argued earlier, the cumulative nature of CO₂ implies that the opposite is true.[l] Early reductions postpone climate milestones (dates when concentrations reach or exceed target or critical levels) and create additional “option value” in the scope for both mitigation measures and adaptation.

Cumulative emissions are the real target. Premium on early action. (a cost of carbon issue)

It is paradoxical that the significance of cumulative emissions is fully recognised in discussion of national historic responsibilities but has far less traction in relation to future emissions targets, other than in occasional presentations that discuss remaining “carbon budgets” compatible with particular temperature targets.[li] This is inconsistent and potentially dangerous.  The urgency of action on climate has been disputed for far too long but is no longer in serious doubt. Distant single year targets (such as net zero by 2050) risk encouraging the postponement of necessary but politically difficult measures; they prioritise promises over action.

On the other hand early action produces cumulative gains. This is not only an intrinsic benefit in cost-benefit terms. Globally it postpones climate milestones (eg any given level of ppm concentration), and hence provides additional option value for future mitigation and adaptation.

The headline-grabbing simplicity of single year targets is an obvious advantage, and may be a necessary simplification in many contexts, but it would be good to see much more emphasis on cumulative performance, at COP negotiations and more widely.

Low Hanging Fruit

A rather obvious corollary is that there is a substantial gain to widespread implementation of measures that are not necessarily transformational, are relatively cheap, do not require major infrastructure investment, and are broadly independent of major structural choices, but also deliver relatively quick reductions. Many are in what we referred to earlier as the regulatory domain and relate to behaviours that are positive from an environmental perspective but are insufficiently encouraged through current economic and market incentives.

Insulation campaigns and subsidies are a familiar example.[lii] In cost benefit terms the return is potentially high, and the incentives (at least in Western Europe) are enhanced by the recent surge in gas prices.

But other comparatively easy options are rarely discussed, or, if discussed, not followed through. A non-exhaustive list includes the following.

·      Crypto currencies are not just the latest speculative bubble.  Bitcoin (and others) may be virtual commodities, but they have big real-world impacts, and are a threat to our attempts to contain climate change. Stopping their contribution to CO₂ intensive emissions should be one of the simplest of credibility tests for international agreement in international climate negotiations.[liii]

·      More controversially most of the arguments against carbon intensive mining of crypto currencies will often apply with similar force to the mining of gold. Stopping mining can be described as “easy” only in the sense that it does not require significant investment, lifestyle transformation or new technology. Political and financial implications are substantial.

·      Another relatively simple measure would be reduction in motorway speed limits. This is not a new idea. The USA really did introduce 55 mph speed limits in 1974, in response to the 1973 fuel crisis.

·      More attention to the many aspects of carbon pricing and carbon taxation, including border tax adjustments to prevent distortions to international trade.

·      Notably, taxation of aviation fuel should be more in line with road fuel. This has long been mooted.  It can be seen as an easy win in not requiring major structural change, although the requirements for international agreement are difficult. 

·      Inter alia tax on aviation fuel would bear down particularly heavily on private jet use. Given recent awareness and concern with climate and emissions inequality, this would impact most on the wealthiest 1% who account for a disproportionate share of emissions. This would improve the saleability of less popular policies with a wider public impact.  

·      Other tariff reforms are discussed in more depth below. These include, but for the power sector, should not be confined to the reflection of the carbon externality into current tariff rates.

Most of the above are now familiar ideas, and they share the characteristics of relatively modest requirements for investment and structural change. Greater emphasis on early action, consistent with the premium on early emissions reduction ought to be a signal for a higher profile.

Failure to grasp these relatively easy options arguably emphasises the importance of “soft” issues of public acceptance and lifestyle choice, together with willingness to make politically controversial choices that may upset particular interest groups.

Development Issues

The Integrate programme, through some of the projects with which participants were engaged, also offered some insights into the problems of low carbon and power sector development in poorer countries and the developing world. Once again one can observe the crucial importance of the three major themes of the previous chapter: cost of capital, valuation of emissions, and reliability. There are also parallel issues of governance and market failure. The issues are often even more starkly defined and cannot be separated from general issues of governance and economic development. 

One source of CO₂ emissions that sits almost under the radar is the very widespread use of firewood and charcoal for domestic cooking, by hundreds of millions of households in Africa, Asia and South America. Barely visible in much of official or commercial energy statistics, it is, globally, on a comparable scale of emissions to the aviation sector, and often has further negative impacts through deforestation, and for human health. In principle this could be addressed through electrification, either through grid extensions or, in rural areas, local mini-grids, and the global benefit from reducing or eliminating this source of CO₂ would be huge.

We can add the even larger potential for emissions reduction through the electrification of transport. If the expected expansion of road transport could be diverted to carbon-free sources, whether through all battery vehicles or a hydrogen (for freight) route, the benefit would be huge. This also assists resolution of one of the major problems with electrification, that of scale.

One of the biggest obstacles to rural and peri-urban electrification in poorer countries is the scale of initial demand. High fixed costs, mainly and especially network costs rather than generation costs, need to be covered by consumers in low-income communities. But the tariff levels required to finance this suppressed demand are often not affordable in those communities.[liv] This indicates the need for more business and smaller scale industry electrical loads associated with wealth and income generating potential. This can create a virtuous circle that both reduces the kWh unit cost with a higher volume, and provides local communities with the higher incomes that make access affordable. 

Unfortunately, in many instances the problems are compounded by poor governance, and poor reliability performance which makes businesses less willing to rely on a public supply. Poor governance combined with a chronic shortage of finance results in a vicious circle of underfunding, inadequate tariffs, poor reliability and low business growth, all of which feed on one another. Governance solutions also have to resolve some of the added complexities that result from donor finance, divided responsibilities and the political management of different interests, such as urban or peri-urban and rural.

Consideration of low carbon policies for developing economies arguably emphasises even more strongly the importance of the three themes of cost of capital, valuing CO₂, and reliability. The connections between cost of capital and improved governance have long been recognised as major issues, and a major feature of reforms promoted by donor agencies and banks. Equally or more important in the cost benefit equation for national decision makers is that the very high “global value” of emissions reduction does not translate into national benefits for poor consumers and producers. Reliability, itself partly due to inadequate finance and poor governance, also remains a widespread issue that inhibits quick solutions. 

Prescriptions of liberalised markets and privatisation have not delivered on their promises, as noted earlier, but the global necessity for clean development is clear. It is the basis for an overwhelming case for financial transfers and financial support. Collectively this is no longer a matter of moral obligation but one of shared self-interest.

Storage. (a matter of reliability)

Approaches to reliability are certain to dominate future discussion of storage, although the future will see much less attention devoted to single parameters such as VOLL, for the reasons set out earlier.

In the past reliability provision has been defined in most systems by the ability to meet “needle peaks”, to have sufficient kW capacity to meet extreme conditions perhaps experienced in only one half-hour of the year.  Adequate reserves of energy (kWh) were hitherto provided very effectively and cheaply by stored coal, oil or gas. In the future reliability will depend much more on use of a kWh energy reserve without use of fossil fuel. But this also means that the reliability focus will shift towards the adequacy of new forms of storage provision.

A precondition for understanding the economics of storage is to appreciate the significance of both the frequency of the expected charge/discharge cycle and the scale of kWh storage involved. It is often widely assumed by journalists and the public that solutions are simply a matter of advancing battery technology, thus reducing the cost per kWh stored of battery capacity, or battery efficiency, perhaps together with more pumped hydro storage facilities. Batteries, plus pumped hydro and a few other technologies for short term storage at similar cost, together with measures to persuade consumers to spread their loads, may indeed be sufficient to managing short term balancing and the average within the day mismatches between consumer demand and variability in renewable supply.

For batteries, there are some interesting economic issues related to the appropriate design of power sector tariffs. For example one important question is whether it makes sense for battery storage, to meet daily or very short term imbalances, to be owned and operated by individual households or small consumers, or by local network companies and the national grid. This issue is sometimes described as whether batteries should be behind or in front of the meter. The argument for batteries to be network owned and “in front of the meter” is that this allows greater economies of scale, and higher utilisation factors for a capital-intensive item, exploiting system diversity. However poorly defined tariff messages can lead to the opposite outcome, implying significant waste of resources.[lv]

But batteries alone are in any case not nearly adequate for a renewables based system of the nature currently envisaged for the UK. One reason is the frequency or infrequency of the charging/ energy release cycles. It is relatively easy to justify £ 75-100 per kWh of storage capacity for a battery, or a similar capital investment in pumped storage, when there is a daily or more frequent charging cycle and the fixed costs of the capital investment are therefore spread over 365 cycles a year or more.[lvi] This does not work for seasonal storage, or, for provision against extreme weather events. With annual or even less frequent cycles for a single cycle of charge and discharge, such a high capital cost is unaffordable. 

The other factor is scale. The scale of summer/winter compared to daily imbalances is an order of magnitude greater, perhaps 500 times greater than daily imbalances, although for the UK this can be substantially reduced with the right mix of wind (winter) and solar (summer) renewables. (Royal Society report.)  The bigger issue is weather variability. This goes well beyond daily volatility and includes both “wind droughts” that can last a couple of weeks (during very cold weather) and very substantial variations between years, with runs of years above or below average.

This scale necessitates storage solutions with much lower capital costs, even if the “round trip” energy conversions are less energy efficient than batteries. On current knowledge this implies some form of chemical, thermal or large-scale compressed air storage (ACAES).  “Green” hydrogen produced by electrolysis is currently seen as the leading option, and a working hypothesis in a recently published study prepared for the Royal Society.[lvii]

Renewables generation in the UK is currently based mainly around wind and solar, and their weather dependent nature largely defines storage requirements.  Most significant are “extreme” weather events, such as an extended “wind drought”, when the wind is not blowing anywhere in Northern Europe, and big variations driven by the North Atlantic Oscillation in annual renewables output – sequences of years with less sun or less wind. 

This highlights the importance of meteorological data. Substantial variations in annual output, and sustained deviations from average, mean that looking at just a few years of data may not reveal the scale of the problem. Llewellyn Smith uses “middle of the road” projections for consumer load, and “real weather” meteorological data over 37 years for his assessments, though expert meteorological opinion is that even this may not be enough to capture extreme sequences of years. This is an important observation, and one that is compounded by uncertainties over the future impact of climate change on UK weather.  

 

Importance of the right mix of renewables

A first, and surprising, result is that, for the UK, and at least with projections based or assumed around current load patterns, the need for storage is dominated by weather volatility not (as often asserted) by seasonality per se. In other words what matters is extreme weather or unusual weather patterns, eg two or three weeks of no wind or whole years with poor renewables output.

Typical or “average” seasonal storage requirements could be largely managed by having the right mix of wind and solar, with an 80/20 wind solar split as one feasible option on the basis of the particular assumptions in the study.

However one of the findings of the study is that even the seasonal imbalances between summer and winter can vary substantially from year to year, reinforcing both the need for much more concentration on weather volatility, and the conclusions on the need for substantial long term storage provision.

Exactly how much storage is required will also be an economic choice based inter alia on the relative costs of storage and renewables capacity, and on conversion capital costs and efficiencies, but initial indications suggest numbers as high as 130- 200 TWh, serviced by 80-120 GW of electrolysers. The TWh of energy storage is very substantially higher than simply seasonal balancing needs, and represents over half total current annual consumption, while the electrolyser capacity in GW comfortably exceeds current peak power demand.[lviii] 

The result demonstrates the system importance of managing the mix of weather dependent renewables. Bringing baseload nuclear power and fossil generation with carbon capture into the choice of technologies also offers further options, but at least for a system with substantial renewables content, the analysis has essentially similar characteristics with respect to storage investment choices.

Most analysis has ignored capacity required for both input to, and extraction from, storage.

An obvious but hitherto mostly neglected element in the calculation is the capital investment in the energy conversion capacity required for putting kWh of energy into storage and taking it out for final use. Both require significant high capital cost capacity – electrolysis for the production of hydrogen as input to store (when renewables output exceeds demand), and then use of that hydrogen to generate useful energy, as electricity or heat, when demand is high. Both these types of conversion capacity will also have to operate at relatively low load factors, and the scale of electrolysis capacity will likely need to match that of current generation capacity. The loss of energy in this “round trip” – 41% efficiency for hydrogen - is often discussed, but not the amount or cost of capacity required to charge or discharge from store. This should be sufficient capacity to match either surpluses or shortfalls in renewables output, but there will be a trade-off between the extra costs implied by “wasting” or spilling renewables  output, the size of storage requirement, and spending more on electrolysis capacity. Identifying this gap in the analysis is another important result from the Llewelyn Smith findings.

 Consumer and other Tariffs

The importance of energy tariffs, in a sector dominated by public or private utilities, ought to be obvious. They provide the primary economic connection between the costs of supply and the choices made by consumers, including households, businesses and industry. They are therefore a fundamental part of the ecology of the energy and power sectors. Moreover their importance is hugely enhanced by the increasing recognition that the future operation of low carbon and renewables base systems will depend on much greater interaction with consumer behaviour.

Tariffs design is also required to perform multiple functions, sometimes with competing or conflicting objectives. A primary function for utilities is simply that of sufficient recovery of revenue. But economic and technical efficiency also demands that signals to consumers need to include both short term signalling – when the marginal cost of electricity supply may be either zero or very high for a relatively short period (a price spike), and also signals of the long term incremental costs of supply.[lix] Neither, but particularly the zero short run marginal costs associated with renewable systems, necessarily equates with revenue recovery.

A second issue is the recovery of the fixed network costs. These are typically averaged over all kWh sold, largely to reflect another objective of tariff policy, namely the most equitable allocation of the network costs which can often be up to 50% of the cost of supplying smaller consumers and households. But this can have some damaging effects, for example through an excessive incentive to install batteries “behind the meter”, and on efforts to persuade households to shift from gas to heat pumps.[lx]

These issues are now becoming much more serious, first with the increasing proportion of low carbon generation, and second with the efforts to electrify the transport and heating sectors.

Our three “parameter” themes are once again of fundamental significance for tariffs. The cost of capital is the largest single element of cost in a capital intensive sector. Pricing to reflect the social cost of carbon is likely to be essential to promote the voluntary switching from fossil fuels to electricity for heating. Finally, as indicated earlier, we should be making a transition to a much more sophisticated approach to reliability planning, which pays far more attention to consumer engagement.

 

 

V.            CONCLUSIONS X

This essay began with a discussion of key instruments and areas of policy, including the Grubb “domains”, and the conventional “three D’s” of decentralisation, digitalisation and decarbonisation. This provided a context to focus on the three key parameters of what was historically a quite narrow technical exercise, that of least cost expansion plans for the power sector, and extending the concept to decarbonisation questions for the energy sector, both for production and consumption. 

A number of messages emerged from this process, many from within the Integrate programme itself.

·      One is a reminder of the almost unique dependence of the power sector on real time coordination. Strong elements of command and control are embedded, implicitly and explicitly, in even the most fragmented and market-oriented of power systems. The nature of much or most low or zero carbon generation, and the additional constraints it imposes on system management, reinforce this dependence.   

·      It is technical and economic considerations that drive the necessity of close coordination over both operational (market) and strategic or transformational (investment) timescales. This reality is also constantly reinforced in the context of major sector issues such as energy storage, and the penetration of electricity into heat and transport sectors.

·      This in turn emphasises the importance of reconciling the role of markets, and also the increasing importance of decentralised operations and ownership, with significant degrees of central coordination. This is increasingly recognised, de facto, in UK government decision making and control over major investment, and by the World Bank (eg ESMAP) in policy making for developing economies.

Each of the three parameters - cost of capital, cost of CO₂ emissions, and cost or value attaching to reliability, represents important societal and political choices. Simplistically these might be described as the value of the present versus the future, the value we attach to environment and climate, and the extent of our dependence on reliability in power and energy supplies. All are linked to other significant messages.

·      Cost of capital is an important determinant of investment choices and of total costs, but, despite substantial discussion in the Stern Review, gets limited attention in much of climate policy. We observed that low real rates, eg 1-3 %, are appropriate for policy purposes, and are attainable.

·      Good governance, and the reduction of regulatory risk, are essential to minimising the cost of capital and hence to enabling investment in decarbonisation. This includes the need to develop institutional architectures compatible with a balance between coordination and markets.

·      Cost of capital issues, and elements of market failure in capital markets, are one of the two major factors necessitating financial support to developing economies. This is essential to the encouragement of clean, ie low carbon, development. 

·      A related issue is the claim that the policies necessary to mitigate climate change are in some sense “unaffordable” even in developed economies, due to their macro-economic scale. A realistic approach to cost of capital, and comparison with other economic shocks and choices, makes this claim demonstrably absurd.

Turning to the social and environmental cost of carbon, we observed hopeful signs that more realistic levels of carbon price are being considered for the appraisal of public policy choices. In the UK this has recently been raised to £250 per tonne CO₂e. We also noted the Sinn Paradox, and the reality that the true cost of CO₂ emissions is higher for current than for future emissions, due both to the cumulative nature of CO2 and the additional “options value”.

·      A high cost of carbon, and the premium on early emissions reduction, ought to drive, inter alia, a strong incentive to pursue relatively easy carbon reduction measures as “low hanging fruit”, comparatively inexpensive measures not requiring major transformative investments.

·      Assumption of a high cost of carbon, if monetised, transforms the economics of a whole range of potential innovative technologies, including direct air carbon capture (DACC) and sustainable aviation fuels (SAF)

·      There is however no single “silver bullet” available in the future; the urgency of action implied by a high carbon price, together with increasingly tight targets to achieve a 1.5^o or 2.0^o C limit, means we are largely dependent on existing and proven technology, not on possible futures such as nuclear fusion.

·      We identified several relatively easy targets for early reductions, including crypto currencies, congestion pricing, and the familiar home insulation. Their technical and economic feasibility, and the absence of substantial progress or agreement on them, emphasises the importance of the social and political dimensions of climate policy.

·      The “cost of carbon” is a second factor driving the importance of clean development finance. In cost benefit terms, the huge benefits are global, but the costs are local.

·      In an international context, we noted the growing focus on the concept of historic responsibility. This is likely to continue, and concern over differing approaches to pricing or taxing carbon, with much higher carbon prices, is likely to intensify the importance of the subject in the context of international trade.

·      We should also note the importance of reflecting a value of CO₂ emissions into energy tariffs. This will be especially important if, for example, we want households to switch voluntarily from gas or oil heating to the use of electric heat pumps.

Our third parameter was reliability. In our analysis we linked this to the impact of digitalisation, and to the transformative impact of digitalisation on metering, communication and control systems. This connects with a key issue of particular significance for systems with a high percentage of renewables, namely energy storage. Some of the implications are profound. 

·      Definitions of reliability will need to change, away from generation capacity adequacy in terms of reserve kW to cover short term, typically half-hourly, demand peaks. The change will be towards measures of sufficient provision of energy, kWh, across much longer time periods, perhaps of several weeks.

·      Different types and levels of reliability are required for different applications of electricity, for example as between instantaneous satisfaction of requirement as for lighting or IT use, on the one hand, and EV charging, at the other extreme, where time-flexible consumption may be in part supplier managed.

·      Consumers should be able, as with other services, to choose their own levels of reliability, and time-flexibility, even differentiating between their different usages.

·      The old concept of trying to assign a single value to lost load (VOLL) is essentially obsolete.

·      An important corollary is that power sector reliability needs to be considered and planned in the context of a much broader context of society’s resilience against extreme but sometimes quite rare events.

·      Enabling consumer choice on reliability introduces an additional dimension into the design of consumer tariffs, and expands the role of smart metering.  

We need to rediscover the importance of tariffs in the context of managing power and energy systems. As the primary economic link between production and consumer behaviour, they are fundamental to the ecology of the sector, and this will be even more important in a low carbon world, while much more sophisticated tariffs are made possible through digital technologies. Tariffs, however, have to meet multiple conflicting criteria: providing the right economic signals on both short term and long term incremental costs of generation, distributing equitably the fixed costs associated with network provision, and avoiding the introduction of perverse incentives to consumers (eg through either excessive or insufficient incentives for their own private investments in energy use)

A final observation from the programme was a growing realisation of the fundamental importance of energy storage in future low carbon systems, where that storage is no longer provided by stores of coal, oil or gas held at generation sites, refineries or in gas fields and networks. The recent (September 2023) Royal Society report explored this issue for the UK.[lxi]  As well as dealing with some of the issues around choice of storage medium (most likely a chemical store via hydrogen or ammonia), it revealed:

·      the large scale of storage required in systems with a high proportion of weather-dependent renewables, to cover both inter-seasonal and large scale year on year annual variations.

·      the consequent requirement for many decades of meteorological data to form good estimates of storage requirements.

·      the need to take into account the production capacity required for the input into storage, for example electrolysis to produce hydrogen, and also the capacity to release from store when needed. Little attention had hitherto been paid to this topic.

·      the reality that grid-scale batteries have an important role, but currently there is little prospect of capital costs falling to levels necessary for long term storage

There are of course many more topics to consider. This essay has perhaps indicated a few questions and a few answers but many policy choices remain to be made. The most open in relation to the UK are perhaps those relating to the heat sector, and, once again, analysis should remind us of the importance of geography.

 

 

 

 

 

ENDNOTES

---

[1] Synthesis Report published by Oxford Martin Programme on Integrating Renewable Energy. Helen Gavin, Oxford Martin School. December 2020

[2] Planetary Economics: Energy, Climate Change and the Three Domains of Sustainable Development. Michael Grubb, Jean Charles Hourcade and Karsten Neuhoff, Routledge (2014)

 

[3] Emissions Gap Report. 2022.United Nations Environment Programme. https://www.unep.org/resources/emissions-gap-report-2022

[4] Energy and Climate: The Dilemma, Trilemma, and Quadrilemma. Dr Tedd Moya Mose, Oxford Martin Fellow at Oxford University’s Martin Programme on Integrating Renewable Energy ICPAC, November 2020, https://icpac.medium.com/energy-and-climate-the-dilemma-trilemma-and-quadrilemma-839a8d657369

 

[5] Discounting disentangled: an expert survey on the determinants of the long-term social discount rate.  Moritz Drupp, Mark Freeman, Ben Groom and Frikk Nesje, May 2015, Centre for Climate Change Economics and Policy Working Paper No. 195. Grantham Research Institute on Climate Change and the Environment. Working Paper No. 172.http://piketty.pse.ens.fr/files/DruppFreeman2015.pdf.

 

[6] In plain sight: The rise of state coordination and fall of liberalised markets in the United Kingdom power sector, Jose Maria Valenzuela and John Rhys, Energy Research and Social Science, 94, (2022)

 

[7] 10 years on - have we recovered from the financial crisis? Paul Johnson and Jonathan Cribb. Institute for Fiscal Studies report. (2018)

[8]  IPCC (2022). "Summary for Policymakers". Climate Change 2022: Mitigation of Climate Change. Contribution of Working Group III to the Sixth Assessment Report of the Intergovernmental Panel on Climate Change

[9] Direct Air capture. Tracking Report. September 2022. International Energy Agency (IEA). Link: https://www.iea.org/reports/direct-air-capture

[10] Cost of capturing CO2 from air to drop to $250-$300/mtCO2e end-decade: Climeworks, SP Global. Commodity Insights.

[11] Sustainable Aviation Fuels: What Does Real Leadership Look Like? The International Council on Clean Transportation. August, 2022. https://theicct.org/us-eu-saf-leadership-aug22/

 

[12] Study On The Estimation Of The Value Of Lost Load Of Electricity Supply In Europe. Agency For the Cooperation of Energy Regulators. July 2018. ACER/OP/DIR/08/2013/LOT 2/RFS 10.  Link to CEPA study on VOLL

 

[13] Rethinking Power Sector Reform in the Developing World, ESMAP Background Paper, September 2019. https://www.esmap.org/rethinking_power_sector_reform

---

[i] Since energy use is bound up with virtually every aspect of life, the economy and society, this is not a particularly restricted category, and could be interpreted to cover just about anything and everything.

 

[ii] One piece of the Integrate programme research, for example, dealt with the issues around the siting of EV charging points, while another investigated the subtleties of road pricing.

[iii] Electricity Tariffs.This is a potentially major feature of future energy systems and its importance is now widely recognised. It is discussed in a little more depth in a paper prepared under the auspices of the Integrate programme for Energy Catapult, the main subject of that paper being tariffs. Inter alia that paper characterises transport as a premium use of electricity (eg for charging electric vehicles, EVs), but a premium use that paradoxically may requires a lower standard of reliability (at least in terms of generation capacity adequacy) than many “traditional” uses such as lighting.  

“Cost Reflective Pricing in Energy Networks. The nature of future tariffs, and implications for households and their technology choices.” Available to download from Catapult. This paper is referenced several times in this essay.

[iv] Market failure and the second best. This deserves a brief digression into the theory of the second best. Essentially the theory tells us that a major breach of one of the conditions for markets to promote welfare has potentially open-ended consequences for policies across a wide range of issues. The most significant condition, in the context of climate and energy, is the requirement to reflect the externalities of social and environmental costs into prices. If such a condition is not satisfied, then policies that could normally be claimed to promote economic efficiency and welfare may have a negative impact on welfare. 

 

This extends, for example, to competition policy and regulatory policy aimed at reducing consumer prices. If these result in extra consumption, then the ultimate effect on welfare may be negative. More generally the theory illustrates some of the complexities of policy making to correct market failures. Some of these complexities will often be illustrated in a cost benefit analysis (CBA) of particular policies.

 

[v] Cost benefit issues. The limitations of cost benefit analysis (CBA) deserve discussion, although this is more relevant to the now largely settled debate on the overarching question of whether action to mitigate climate change is required or not to most of the questions in this essay. (cf the Stern Review). These limitations have rather less significance in the context of the much more sector specific measures with which this essay has been mainly concerned.

In the wider context, some of the weaknesses are of a technical, conceptual or even philosophical nature. In dealing with risk and uncertainty, there is little or no empirical basis for assessing probability distributions. Non-linearities and non-market effects present technical challenges. The often path-dependent policy choices are a long way away from the world of marginal analysis in which CBA is typically more comfortable. Distributional and inter-generational inequalities bring in philosophical and ethical questions, and economics still lacks a philosophically sound and universally accepted basis for time discounting. 

An even bigger issue perhaps has been the inability of conventional macro-economics to capture the complexities, or indeed the potential scale, of major disruptions caused by climate (or, arguably, other non-marginal or disruptive changes such as Brexit).  So-called integrated assessment models (IAMs) purport to capture complex feedbacks between climate impacts and economic output, but the judgment from academics on IAMs has been damning.  

One author, Robert Pindyck, is particularly scathing. 

A plethora of integrated assessment models (IAMs) have been constructed and used to estimate the social cost of carbon (SCC) and evaluate alternative abatement policies. These models have crucial flaws that make them close to useless as tools for policy analysis: certain inputs (e.g., the discount rate) are arbitrary, but have huge effects on the SCC estimates the models produce; the models' descriptions of the impact of climate change are completely ad hoc, with no theoretical or empirical foundation; and the models can tell us nothing about the most important driver of the SCC, the possibility of a catastrophic climate outcome. IAM-based analyses of climate policy create a perception of knowledge and precision, but that perception is illusory and misleading. ["Climate Change Policy: What Do the Models Tell Us?" Pindyck, Robert S. 2013. Journal of Economic Literature, 51(3): 860-72.]

 

Such models come “close to assuming directly that the impacts and costs will be modest, and close to excluding the possibility of catastrophic outcomes”, according to Nicholas Stern.   In other words, they largely assume away the problem they are supposed to be analysing. It is for these reasons that CBA arguments have become the new line of defence for climate sceptics whose refusal to accept the fundamental findings of climate science has clearly become untenable. It is claimed instead that the cost of action is “unaffordable”. [The Structure of Economic Modelling of the Potential Impacts of Climate change: Grafting Gross Underestimation of Risk onto Already Narrow Science Models. Nicholas Stern. Journal of Economic Literature, Vol. 51, N° 3, pp. 838-859, September 2013.]

This subject is also discussed at greater length in my blog, Can cost benefit analysis grasp the climate change nettle? And can we justify ambitious targets. Oxford Martin school blog. February 2019

 

[vi] None, individually, validate the warnings, but taken together they refute any claim that nothing of significance is happening. Temperature data alone should of course continue to be sufficiently compelling evidence of the truth of the basic thesis – the link between human induced GHG concentrations and a warming planet.

 

[vii] The clearest possible demonstration of this was the attendance at COP27 of the then Prime Minister of the UK, despite a history of climate science scepticism within his party.

 

[viii] Historic responsibility. Defining historic responsibility for carbon emissions is not straightforward, and defining current responsibility is not necessarily much easier. In a world of international trade, does responsibility lie with the country where the fossil resource was extracted, where it was refined or converted, or where the final products were consumed. In other words is it producers or consumers who are responsible? What is the appropriate starting date? Historic development is responsible for most of the positive features of the modern world as well as its problems. And what responsibility do we assign for population growth, a prime cause for a substantial part of growth over recent decades?

 
A much more fruitful, and politically more saleable, avenue for the justification of financial transfers from rich to poor should be simple self interest. Promoting clean development will almost certainly be much cheaper than having to pay for direct air carbon capture (DACC), the ultimate fall-back if or when climate change, and emissions in excess of carbon budgets, are fully recognised as existential threats. This is a theme to which this essay returns.

 

[ix] Oxfam and inequality. Oxfam arrive at their numbers by attributing the emissions of fossil fuel industries, and other carbon-intensive industries, to wealthy billionaire investors through their individual shareholdings. In other words, while these individuals may indeed also use private jets and operate luxury yachts with high resulting emissions, the attribution extends well beyond their personal behaviours and consumption choices.

 

So this is arguably a rather misleading set of statistics. If the shareholdings in energy and other carbon-intensive companies were widely and equally distributed across the whole population, ie this component of inequality actually reduced or eliminated, it is not clear why emissions would fall. This is not to deny the very substantial inequalities in respect of carbon footprint, or their significance, but exaggerated claims or misleading statistics can undermine the argument.

 

[x] Pessimistic science. This may be a rather subjective assessment, but in my view it is borne out by the reading of successive IPCC reports, and by increasing concern on specific threats of tipping points such as polar ice sheets.

 

[xi] There may of course still be many modelling uncertainties around key issues, including the speed of stabilisation if net zero is achieved, and the dangers of irreversibility for certain components of the climate system. None of these can currently be taken as encouraging undue optimism.

 

[xii] There is “no credible pathway to 1.5C in place”, the UN’s environment agency has said, and the failure to reduce carbon emissions means the only way to limit the worst impacts of the climate crisis is a “rapid transformation of societies”. (Guardian. 27.10.2022)

 

[xiii] Cheap gas. In the UK the era of cheap gas is largely associated with the move from coal to gas generation in the 1990s. The US is a separate case, and for many years there was a disconnect in prices between Europe and Asia. The increasingly interconnected nature of the gas market has been one of the factors behind heightened competition for gas supplies, but the big “spike” in gas prices dates to mid 2021.

 

[xiv] “This winter, European governments are facing a growing public backlash as the combined effect of Net Zero plans and disastrous green energy policies will hit tens of millions of low-income and ordinary households” according to Net Zero Watch, a campaign group launched by the Global Warming Policy Foundation. (September 2021 press release).

 

[xv] Fracking. The emphasis on energy self-sufficiency and the supposed threat of climate choices is reminiscent of the debate on fracking. Howard Rogers in a 2013 OIES paper noted that “... the sobering conclusion is that UK shale gas, given its timing and perhaps modest scale in terms of production level, in no way changes the critical and pressing nature of UK policy challenges and decisions needed between now and the end of the decade.” [UK Shale Gas – Hype, Reality and Difficult Questions, Oxford Energy Comment, July 2013, Oxford Institute Energy Studies]

 

[xvi] LEO. A particular example associated with the Integrate project is Local Energy Oxfordshire (LEO). The project has been running trials in Oxfordshire, with the declared objective of building a broad range of reliable evidence of the technological, market and social conditions needed for a greener, more flexible, and fair electricity system. Project LEO is a collaborative project crossing business, academia, social enterprises, and local authorities. It is part funded through the Industrial Strategy Challenge fund to support the global move to renewable energy: Prospering From the Energy Revolution (PFER).

 

[xvii] Diversity, or diversification, in this context, as in investment portfolios, is merely the feature that confers the positive benefit of the law of large numbers in reducing volatility. It is relevant in other power system contexts, too, and provides one of the reasons why tariffs for residential consumers are rarely framed to reflect installed capacity in households or to limit maximum instantaneous consumption. 

 

[xviii] Balance requires, for example, the right mix of solar and wind resources to reduce seasonal imbalances. Different locations will have comparative advantage in different renewable technologies. Moreover, reliability will benefit from diversity of wind locations, which does not necessarily equate to the lowest construction cost or highest wind output sites.

 

[xix] Digitisation is the conversion of information to digital form. Digitalisation describes the impact on the processes with which we are concerned.

 

[xx] For example, digital technology may enable EV drivers to identify the nearest available charging points, or to reserve charging slots quickly and easily. There is also an important potential function for future interactions with the power system through consumer tariffs. Inter alia this may provide a valuable energy or capacity reserve when there is an energy shortage or other stress on the power network.

 

[xxi] Privacy issues. A personal view is that these concerns can be exaggerated, given willing public acceptance of risks from similar privacy and security breaches in modern life. Carrying and using a mobile phone can reveal your location, while owning and using a store card reveals your purchasing habits. And use of the internet or social media may reveal even more material to be fed into marketing algorithms, or potentially for more sinister purposes. The conclusion should be that these are serious issues to be addressed through regulation and specific protections, rather than major roadblocks that prevent progress.

 

[xxii] Road transport measures. This is an important measure because two of the “easy wins” in reducing energy consumption for transport come from reducing excessive speed and reducing congestion.

 

[xxiii] Crypto issues. Scepticism about cryptos as elaborate Ponzi schemes is now a well established issue. But they also have a real world CO₂ impact on a scale similar to aviation. 

 

[xxiv] Large Scale Electricity Storage. September 2023. The Royal Society. This very comprehensive report explores both alternative means of storage and the potential scale of requirement under well-defined scenarios, primarily in the context of expectations that future systems may be largely renewables based. Link to Royal Society report.

 

[xxv] The Energy Trilemma is defined as the need to find balance between energy reliability, affordability, and sustainability.  The term was coined by the World Energy Council as a succinct summary of the most pressing international problems that involve energy and climate change There are several variants in the definition of the trilemma, but all address three fundamental challenges: those of economics (affordability), politics (energy security or security of energy supply), and the environment (including climate change and sustainability). Recently, energy access has been added to cover the situation of developing countries. A recent article by Dr Tedd Mose, also associated with the Integrate programme, covers this subject:

Energy and Climate: The Dilemma, Trilemma, and Quadrilemma.

 

[xxvi] Social cost of carbon. One example is the decision in September 2021 by the UK’s HM Treasury to raise the valuation of the social and environmental damage of GHG emissions; this went largely unremarked. Similarly the practice of routinely using discount rates with alternative values of 5% or 10% has been commonplace for years. It is rarely challenged, even though, in other contexts, economists will debate much lower rates for policy purposes. And in the context of supposedly competitive markets in retail supply, little or no attention is paid to reliability standards.

 

[xxvii] Storage. An incidental insight is that the storage issue should be seen as mainly about minimising capital cost of storage capacity, as opposed to seeking minor improvements in technical efficiency. This is particularly the case for seasonal or inter-year storage options.

 

[xxviii] In system economics terms, the full range of choices will of course include demand side management options, and also choices in generation, transmission and interconnection.

 

[xxix] Asset life. One should be careful to distinguish between physical life and economic life of an asset. We generally assume that demand for power will persist into the indefinite future, but this will not necessarily be the case in all circumstances.

 

[xxx] Cost of capital. There is a vast literature on this subject, which nevertheless falls short of providing definitive answers. I summarised some of these issues for an Integrate seminar. Slides of Bluffers Guide to Cost of Capital can accessed via my blog. It surfaced as a major issue in the aftermath of the Stern report, Stern having argued for the adoption of very low rates for the purposes of policy appraisal, a position which I support.

 

[xxxi] The attempt to promote use of high discount rates is of course entirely consistent with Lawson and GWPF efforts to dismiss the climate change issue.

 

[xxxii] The fallacy is to confuse project specific risks with the time value of money.

 

[xxxiii] It is worth commenting on the sense in which these investments might be justifiably regarded as risk-free. Within the paradigm of the CAPM model, risk has a particular meaning, specifically the correlation with stock market movements in the market as a whole, or, more loosely, the business cycle.  Project specific risk is ignored in this context, as it is assumed that in notional portfolios investors can diversify away from project specific risks. Since the threat of climate change is totally independent of stock market movements or the business cycle, the value of investments 

 

[xxxiv] UK mortgage holders have borrowed at 1.5% or less, below the rate of inflation and negative in real, ie inflation adjusted, terms.

 

 

[xxxv] Macro issues. Notably a 2021 report by the lobby group Fair Fuel claimed that the infrastructure cost for EVs would “bankrupt UK plc”. This claim is dissected in another comment posted as an Oxford Martin school blog: Costing an electric vehicle. Ignore the alarmists.

 

[xxxvi] A recent example of application of such a valuation of carbon can be found in a recent CEBR report. I have been critical of the findings of that report for other reasons, but it does represent an attempt to take into incorporate a realistic valuation of emissions. A fuller critique of the CEBR cost benefit approach to EV policy can be found in my blog: The case for electric vehicles is strong enough to survive the ICE lobbyists.

 

[xxxvii] Limits of cost benefit. This subject is covered in more depth in an Oxford Martin School blog: Can cost benefit analysis grasp the climate change nettle? And can we justify ambitious targets? February 2019. OMS website link: CBA and targets.

 

[xxxviii] Sinn paradox. This subject is covered in much more depth in my OIES paper (see the next endnote for the reference). Recognising that the true cost of current emissions actually exceeds the cost of future emissions resolves the Sinn Paradox, at least in principle. The paper illustrates the issue using the following hypothetical question as an example.

Question. Suppose I have a large store containing thousands of tonnes of CO₂, held under pressure in large corroding metal vessels.  Technical experts have advised me that there is no means of permanently sealing the vessels, other than at prohibitive cost, but that I can with only modest expense treat the seals of the vessels in a way that will prolong their expected life from 6 months to 20 or 30 years, at which point there will be a slow leakage into the atmosphere, perhaps over a 10 year period.  What should I do, given an objective of minimising adverse climate impact?

Answer.  Working from a price signal – such as a rising carbon price – that suggests later emissions are significantly more damaging, the answer seems obvious. We should be prepared to spend money not on reinforcing the vessels, but on breaking them open immediately, since the social cost will be significantly higher in five years and even more so in 30 years. Moreover, immediate release would additionally make it easier to meet annual emissions targets for future years. 

This is clearly absurd if limiting the CO₂ stock is the real target, and if CO₂ emissions are essentially cumulative. Immediate release, according to some IAM estimates should be considered some 20–30 per cent more damaging. Moreover we should not ignore the possibility that a novel low-cost technical solution will be developed for the problem of sealing the corroding tank. There is therefore an additional option value which attaches to not releasing the CO₂, a value not captured in a simple social cost of carbon analysis.

 

[xxxix] An illustration of this simple arithmetical truth is provided in the OIES Working Paper. Cumulative Carbon Emissions and Climate Change: Has the Economics of Climate Policies Lost Contact with the Physics? OIES Working Paper, July 2011. Available at Oxford University Research Archive. Link to paper in archive.

 

 

[xl] Forest carbon. A first observation is that this externality will also apply to any forest clearance for the purpose of power lines – ie at least a 10m corridor, perhaps more. Power lines through a forest will also incur significantly higher maintenance cost – frequent trimming to prevent outages due to tree growth.

One hectare of forest can contain a carbon store of 250-500 tC. [Some sources put the figure as high as 700-800 tC.]   Multiply the first range by 3.6 to get c 900-1800 tco2e.  This, even at the lower assumed value of $200/tonne, is $ 180,000 – 360,000. [even the conservative “political” estimate of the Biden administration is for a CO2 value of $50]

With CO2 at $ 100-200 this would put the “capital cost” of forest destruction in the range of $ 90,000 – 360,000 per km, depending on the type of forest. [I hectare = 10000 m2. A 20m road means 2 hectares per km. 10 m road means 1 hectare per km.]

Other literature concentrates on alternative uses of the forest and its ongoing future role in absorbing carbon. This will assign a different positive or negative value to the different management options in NPV terms. Most of this literature is older and relies on very conservative estimates of the value of carbon storage. Even with very low CO2 value assumptions, the authors report that the value of carbon storage is dominant in any cost benefit analysis of alternative forest usage. 

There is an extensive literature. One of the many possible references is:

Quantifying Carbon Fluxes in the World’s Forests | World Resources Institute (wri.org)

 

[xli]  Problems in EU climate policy.  One example was the 2017 objection on competition policy grounds to proposed closure of five coal power plants in the Netherlands, as part of a national agreement to move towards cleaner energy. Since this was to be done on the basis of an agreement between producers, it hit problems of competition law. The companies pleaded a “public interest” defence, namely reduction in CO2 emissions. However the Dutch competition authority concluded that the agreement was in violation of the cartel prohibition, arguing that the proposal would not reduce CO2 emissions, as claimed by the producers, since the redundant emission rights would be sold on the open market and would therefore only be relocated. In other words the “waterbed myth” was used to obstruct an “overlapping” policy that would have resulted in a real and immediate emissions reduction. The case is discussed in more detail in my co2economics blog with the following link: Another clash between EU competition law and climate policy

 

Inter alia this shows that the impact of policy failures can go beyond simple failure to achieve expectations, and can act as a barrier to other effective initiatives. Many will be aware of my opposition to the UK’s exit from the EU, but the EU ETS has not proved to be a good example of successful EU policy. It may still be sensible for the UK to participate post Brexit, in the hope of its ultimate reform, but the UK will clearly need to continue its own policy initiatives, as it has to date. This subject was covered at much greater length in another Oxford Martin School blog. EU emissions trading scheme and Europe's climate policy. A flagship floundering.

 

[xlii] Reliability. Of course it is in principle of equal importance to achieve high standards in transmission (high voltage) and distribution (medium and low voltage) networks, but it would be very unusual in most cases to achieve uniform standards across the network. Different parts of the network are inevitably more or less reliable, from a consumer perspective, depending on their distance from sources of power, whether power lines are overhead or underground, different weather conditions, and so on. The emphasis on generation is therefore the simpler topic; in the context of renewable energy, it is also the more relevant, as transmission and distribution standards will depend less on the precise mix of generation.

 

[xliii] This was discussed in an Oxford Martin School blog, A Two Tier Energy Market for the 21^st Century, 22 December 2016. 

 

“The FT recently reported that Andrew Wright, a senior partner at OFGEM, had argued that Britain could be moving towards a two-tier power market in which some households pay for reliability while their neighbours “sit in the dark”. Ignoring for the moment the selective reporting of a complex discussion, and a mildly hysterical tabloid reaction to this proposition, we need to recognise that the world is changing. Different tiers of reliability, in which customers can choose their own combinations of price and quality/availability, are now both technically feasible and advantageous to consumers. There are deficiencies in current retail markets, so new formats for the “consumer offering” are both necessary and desirable. They will give us better control over our power systems and can even help with thorny problems such as those of fuel poverty.”

 

[xliv] Network issues, markets and governance. The arguments behind this section are covered much more fully in a paper prepared for the Energy Technologies Institute (ETI), the predecessor of Energy Systems Catapult, at the outset of the Integrate programme. Policy and regulatory frameworks to enable network infrastructure investment for a low carbon future. It can currently be found at this link, inter alia.

[xlv] One of the publications deriving from interactions in the Integrate programme discusses the comparatively recent phenomenon. In plain sight: The rise of state coordination and fall of liberalised markets in the United Kingdom power sector
Jose Maria Valenzuela, John Rhys,  Energy Research & Social Science

 

[xlvi] This is often bound up with general governance issues, including accommodating the preferences of national aid agencies, and local vested interests and pressure groups.

 

[xlvii] This is also described in the Rhys/Valenzuela paper referenced in xliii above.

 

[xlviii] Institutional architecture is a relatively recent term. It is intended to describe the whole body of law, organisation and market arrangements that pertain to the energy sector. It therefore includes questions of ownership, whether public or private, the objectives and responsibilities of all the institutions engaged in the sector, their licence conditions where appropriate, the objectives and powers of any regulatory bodies, the market arrangements within the sector, and the body of law governing the sector, including competition law.

 

[xlix] The context in this instance included the prospect, for some fuels, of managed decline, and the recovery of fixed costs over a declining customer base.

 

[l] Cumulative CO₂. Carbon dioxide (CO₂) emissions are essentially cumulative.  The thesis of this paper is that much economic analysis and policy making in relation to the mitigation of CO₂ emissions has failed to reflect fully this essential element of the science.  The cumulative and irreversible nature of CO₂ implies that a significantly heavier weight should attach to current as opposed to future emissions.  This is in major contrast to current application of market-based approaches to limiting carbon emissions.  Application of a progressive tightening of “carbon caps” – limits on total CO₂ emissions -  has in practice tended to deliver a very different message on the relative importance of present and future emissions, with the price of current emissions being very low but with a prospect of rapid rises in the future.  

This inconsistency in time profiles, between a focus on costs or externalities _– the social cost of carbon (SCC), and the market price outcome from an emissions cap approach, has the potential to create major distortions in policy and is likely to be seriously sub-optimal.  It is possible for example that strategic choices with front end loading, but which reach net zero after 2050 may be better than delayed actions which meet that particular target.  Similar criticisms could be levelled at policies or climate negotiations which tend to focus on individual year targets rather than cumulative emissions.  Policy making needs to redress this imbalance.  Recognition of the cumulative nature of CO₂ should strengthen the case for urgency and also lead to more recognition of the option value of early action on emissions.

 

[li] A partial exception to this criticism is the concept of carbon budgets, often used in explaining the climate issue, but rarely reported in international negotiating contexts.

 

[lii] Insulation. Cost of capital anomalies can be an important market failure issue here and a justification for policy intervention.

[liii] Bitcoin. Alarm over the carbon footprint of bitcoin is the latest illustration of the convergence of climate change issues with a widening range of social and economic issues. We are witnessing a collision between two of the most disruptive themes in today’s global economy - sustainability and the cryptocurrency explosion.

Cryptocurrencies were already a controversial subject, promoted by libertarians as an alternative to national currencies, a currency that would be outside the control of governments or “inflation promoting” central banks, and a means to improve on existing payments systems. They are however also seen as potentially damaging innovations, whose main application may prove to be, at best, facilitation of criminal activity, tax evasion and money laundering, and whose main product has no real function or value other than as a vehicle for speculative investment. At worst they may simply be an elaborate Ponzi scheme.

What is bitcoin, and could it replace other currencies?

The Judge Business School has provided some useful descriptive material and information on estimated network power demand of up to 32 GW of power demand https://cbeci.org/ . Moreover this is a demand growing at an increasing (potentially exponential) rate

“Bitcoin is a software protocol and peer-to-peer (P2P) network that enables the digital transfer of value across borders without relying on trusted intermediaries. … an open and permissionless system: anyone can participate in the network, as well as send, store, and receive payments. Bitcoin has its own cryptocurrency called bitcoin (BTC), as the universal unit of value within the network. New bitcoins are issued … through a process called mining.“ It is a virtual currency, and the Bitcoin protocol specifies that a maximum of 21 million bitcoins will ever be created. Of this 21 million, it is estimated 17 million have been create to date, of which some 4 million have simply been “lost”. It is intrinsic to this virtual currency that, once lost, they can never be found. [Judge Business School]

Bitcoin is a virtual currency whose proponents believe it could represent the future for payments systems of all kinds – the future of money. The three main functions of money are to act as a unit of account, a medium of exchange and a store of value. Bitcoin’s price volatility militates against its future either as a unit of account – the unit in which most transactions are priced and value is measured, or as a medium of exchange. As a store of value it has been compared to gold, in having a limited supply, with the potential to become more and more valuable as bitcoin use increases. This third function is, at least theoretically, a more credible possibility. After all gold has a price that is disconnected from its use in jewellery and its value in industrial applications. 

We could with equal force raise similar objections to the continued mining of gold, which also has substantial environmental problems, and with which cryptos are often compared as an alternative to so-called fiat currencies.

[liv] Tariffs in Africa. It is noteworthy that Africa has electricity tariff levels that are among the highest in the world. While there are many factors involved, the primary reason is almost certainly the low level of demand from low income communities, requiring cost recovery for fixed and network costs over a much smaller number of kWh. This implies a vicious circle of poverty, high prices and unaffordability.

 

[lv] Tariffs. Explored in more detail in the tariffs paper referenced earlier  If tariffs allow too much of the cost to be spread over the kWh consumed or provide excessively generous incentives for avoiding network, this will make customer owned batteries more attractive but will lead to a net loss in terms of overall economic consequences.

 

[lvi] Storage costs. Current costs of EV or other lithium batteries are easily found online, and may be compared with the historic cost of the Dinorwig pumped storage scheme, to take just one example.

 

[lvii] Sir Christopher Llewelyn Smith led this study, and this essay largely reflects its findings. Analytical results used in this report are based primarily on the modelling work reported by Llewelyn Smith.

 

[lviii] Electrolysers. Note that this does not represent an additional demand on capacity for the power network. This is electrolyser capacity that is making use of surplus power spilled by renewables or nuclear generation that is already in place, but whose output is surplus to immediate requirements. 

 

[lix] Basic concepts of marginal cost. “Marginal cost is an engineering estimate of the effect upon the future time stream of outlays of a postulated change in the future time stream of output. There are as many marginal costs as there are conceivable postulated changes.” ¹ (Ralph Turvey, one of the pioneers, with Boiteux, of LRMC theory in electricity.)

This quote forms the conceptual basis for practical application of LRMC principles to electricity tariffs. If we are talking about the LRMC calculation most applicable to domestic (household) load then the “postulated change” may take several forms. It may simply mean more households with the same consumption pattern, in which case the deemed LRMC of supplying that increment of load over an indefinite future will equate to the deemed LRMC of the existing load.

However some of the new loads with which we are concerned will have very different characteristics from existing load and from each other, as is discussed in some depth in the Catapult report, and one of the key concepts is load factor, another term which needs an explicit explanation.

Load factor (over a year) can be defined simply as the ratio of average consumption to annual peak period consumption.  The most relevant period for the calculation may be 30 minutes (to capture “instantaneous” peak) or it may be measured in terms of daily or monthly consumptions. The last case is instanced in this report as “seasonal load factor”, the ratio of average to peak month requirements. In the context of particular loads (eg the past history of night storage heating) and overall system characteristics at any given time, the most relevant measure of load factor is consumption in relation to its contribution to the system peak, In other words it is the impact on the economics of the system that matters most, rather than the consumption/peak ratio for the individual category of load.

The importance for the incremental cost of meeting a particular type of load such as heat pumps for domestic heating, is that the most important element in that cost is the cost of additional capacity required to service the additional load. If the load factor is low then that capacity cost has to be recovered from a much smaller number of units (kWh), and will therefore be higher. The converse is the case for a high load factor. For any particular application, such as heat pumps, the higher the load factor, the lower will be the incremental per kWh cost of providing heat through the power system

Tariffs will, and should, on occasions be used to influence load factor. Night storage heaters were developed, with appropriate tariffs, because they make no contribution to peak and carry none of the associated capital cost. They improve the overall load factor of the system, and the much lower tariff price benefited consumers wanting to use this form of electric heating.

The load factor of an individual consumer is not normally a particularly relevant figure in tariff design. It is the categorisation and aggregation of loads that provides a useful basis for tariffs. Currently that essentially treats all residential consumer load as if it were the same. It is the clear differences that exist for some of the major new loads that provides one of the major themes addressed in this report.

1.    What are marginal costs and how to estimate them? Professor Ralph Turvey, University of Bath, 2000.

 

[lx] Once again this issue, the economics of heat pumps and their competitiveness,, is explored in much more detail in the tariffs paper prepared for Energy Catapult. Much higher gas prices, and attribution of a much higher cost/value to CO2 emissions, make the tariff issue even more relevant.

 

[lxi] Storage. As indicated earlier this essay relies primarily on material and ideas first presented at the 2022 Oxford Energy Day, and later in the Royal Society report.