The Gordian Knot of UK energy policy
Gas is fundamental to UK energy markets. It comprised 42% of primary energy consumption in 2020, principally for power generation, industrial processing and domestic heating. It has largely replaced coal (3%) as a fuel source, something that was 30% of the mix as recently as 1990. It has made a major contribution to reducing the UK’s greenhouse gas emissions, and to cleaner air. Oil at 31% remains the second most important fuel, most notably for transport, with the rest made up of nuclear and renewables (12%), bioenergy and waste (11%). The UK also still produces around a third of the gas we need domestically, almost all of it from offshore drilling under the North Sea with most of the rest coming from pipelines.
Commodity price rises are a short-term issue, wholesale forward delivery contracts have almost doubled since February, the more volatile day ahead prices have spiked by a factor of nine from an historic trough last May. The last time this happened was 2013, when the UK-Belgian interconnector briefly shut down, a fault echoed today with a fire in the French electricity interconnector. There have also been relative reductions in wind power on last year, caused principally by there being fewer major storms. Some have blamed Russia for the spike, but their exports are not usually a major cause of concern for the UK. We import most of our gas from Norway and much of the rest from the EU, Qatar, the US and other global providers. Russian antics will have regional price impacts at the margins but not to this degree.
The more immediate concern is the entirely predictable rise in energy demand following the pandemic slump. Gas consumption in the UK was 8% lower in Q1 2021 than a year earlier. This was mostly the result of industrial shutdowns caused by lockdown. Domestic gas consumption by comparison actually increased in 2020 with more people working from home. As we head into winter, with industry attempting to return to normal, demand will rocket. Things that were turned off, are being turned on again. We should expect demand pressures to continue.
In a functioning market, this is a self-correcting problem. Prices rise, new or reserve resources come on stream, prices then fall. But the problem is clearly that the market is not functioning, firms that would otherwise adjust their prices, cannot. There has been a price cap on unit prices for consumers since 2019, and this has eliminated any capacity in the firms to save for a rainy day, leading to several going bust. This ‘Marxist’ policy is the result of successive Governments buying into a baseless narrative that energy companies are greedy profiteers price gouging huge profits from captive consumers who are being ripped off. But retail margins have always been small (<5%), with some 40-50 suppliers and switching is so easy you can now pay companies to do it for you without ever visiting an energy company website.
And that is just the most visible sign of a problem. The layered complexity of multiple regulations, taxes and targets makes the UK energy market almost impossible to understand. This problem is self-sustaining. Politicians fight a never-ending intervention race where the latest proposal is designed to correct the bad headlines attached to the last one, while creating new and unintended consequences, and repeat. Calls for a bad bank for failing energy companies for example is a daft idea designed to address the problem that the energy price cap kills energy companies. The solution to that is obvious, but would require politicians to change their minds. Something they appear curiously incapable of doing, despite the evidence of harm.
The UK otherwise has several serious options to cope with a security-of-supply crisis: accelerate new sources of domestic gas production and new generation, more imports from European interconnectors or global LNG supplies, and finally, using storage reserves. In all cases UK policy has been counter-productive. We have prioritised an acceleration of the low carbon transition, treated affordability as something that can be mandated, and undermined security of supply by blocking domestic production.
Domestic gas for example means either offshore in the North Sea or onshore fracking. North Sea output is now a third of what it was in 1999 and falling. We could turn this around with substantial simplification of the offshore regime and equalising taxes with those of normal businesses, but there has never been any will to do so, only add more layers of complexity. Fracking was effectively banned in 2019, having already been smothered in red tape at birth, restricting the activity disproportionately relative to other, similar industrial processes. The Committee on Climate Change is still calling for that moratorium to continue to meet climate goals.
However, there are no sensible alternatives to gas at the current time. Not for generation and not for heating. Renewable plant at scale takes 3-7 years and generally means offshore wind. Onshore wind is unpopular and attracts planning protests nearly as much as fracking proposals. Tidal is uneconomic, solar is becoming economic but remains trivial and land-intensive, while there is little scope for new hydropower. Large new nuclear reactors are uneconomic, and, in any case, take up to ten years to build. Small nuclear remains at least ten years away from commercialisation and fusion power at least 15 years away. If the latter happens, it kills the rest. Which is a serious problem for all of us if the rest still have 35-year contracts committing the taxpayer to subsidise them.
One of the problems of trying to accelerate the low carbon transition beyond the pace that markets will bear is that you end up buying a lot of the wrong technology at too high a price. You simultaneously cripple funding to do so by undermining competitive and tax-generating activities with artificially expensive energy, that causes offshoring, in turn increasing your consumption emissions through imports.
Energy efficiency and the thermal efficiency measures will help, but these rely on hundreds of technology changes every year in thousands of markets. You cannot plan for it, nor predict which of them will be adopted. Coal power, even supported by scrubbing and carbon capture and storage, is a non-starter. It is either too expensive or too polluting, or both, relative to gas. Oil is even worse and has not been a serious option for years, albeit still used in some legacy plant. Gas today is the least bad option.
It can come back in two ways. Recommissioning mothballed gas plants is one option, particularly with a capacity mechanism encouraging it. But the plants that are mothballed tend to be the older, less efficient, more polluting models that are in every respect inferior to building new gas capacity. Something that can be done in just a year on the simpler projects. The capacity market further is designed for limited use, hedging against renewables intermittency, not a major expansion of baseload. Nor is expansion guaranteed. Energy intensive industries with interruptible processes (which are not many) can bid to provide the capacity market with ‘negawatts’: payments for shutting down. It is not hard to see why that would be a problem at scale, particularly in the midst of an isolated supply crunch on CO2 from fertiliser manufacture causing problems in food supply.
Imports are no panacea either. Interconnectors are important, particularly the Langeled pipeline to Norway which can account for 20% of the UK supply, but these are expensive capital projects, limited in scope to geographical neighbours. LNG is important and can come from anywhere, but it is just not as efficient to ship gas in pressurised containers across oceans. Neither option can do much about price rises from a global supply crunch other than ensure more efficient distribution across wider geographies. Storage has never been a serious option for the UK, beyond a winter reserve They have not been needed, the North Sea has always been the reserve. They can be extremely expensive to run, and are locally unpopular, given the small but not zero risk of explosions. Again this is no substitute to allowing domestic production to expand.
The main argument against this is the chilling effect Government policy has had on investment. A policy to ban gas boilers by 2025 for example is a signal that no investment in this technology is wise. That means the last boilers will be more inefficient and polluting than they would have been had the market been allowed to evolve and die from natural causes. It means investors in gas supply will factor a substantial risk premium into any investment about future demand. Which in turn means supply will continue to lag demand.
The UK proposition to the market is that we are substantially reliant on gas, but gas has no future. You would be a brave investor to put capital behind that pitch.
A more rational approach to decarbonisation would be more technology neutral-and less interventionist. The Government should eliminate the price cap immediately, end the moratorium on fracking, and put every aspect of the UK’s energy policy into a fundamental review immediately after the theatre of COP26 has passed. This is a Gordian knot problem, you canot fix it by pulling at the threads. Further, it is only six weeks since Business Secretary Kwasi Kwarteng vowed to “put a free market approach at the heart of the post-Covid recovery”. This is his first test, and the headline he’s generated instead is “Gas price crisis: Government poised to step in”, with promises of bribes for the largest energy companies. Not an encouraging sign.