The UK is on target to meet the Second Carbon Budget – but at what consumer cost and security of supply?

Whilst there is a clear ambition, both in terms of committed policy measures and in political ambition, to deliver a low carbon future, the continued impact of economic conditions coupled with the continued uncertainty as to how to achieve carbon reduction continues to be a major risk for UK energy consumers. Beond believes that the continued development of a low carbon generation market, and policy measures to incentivise consumers to adopt a low carbon business model poses a significant financial risk and should be understood, measured and considered by all energy consuming organisations.

This document looks to elaborate further on the pace of carbon reduction and further identify evident risks based on the issues faced by the UK energy sector in delivering reform whilst ensuring the market remains functional.

 

Emissions reductions towards the Second Commitment Period (2013-2020)

Under the second commitment period the EU has a collective target to reduce its emissions by 20 percent relative to base year levels over the period. The UK’s allocated emissions level for this period of the Kyoto Protocol is set in line with its 2020 target under the Effort Sharing Decision. Whilst not yet ratified details are being finalised. The UK met its emissions reductions target under the first commitment period of the protocol (2008-2012) – with the UK undertaking to reduce greenhouse gas emissions by 8% against 1990 levels and achieving 12.5%.

This is a clear sign that achieving emissions reductions is a key part of on-going energy policy as the perception of energy policy supporting security of supply has been changed to the pursuit of low carbon energy development – albeit recent statements around security of supply are being introduced given the fear over long term supply security.

The UK is on target to meet the Second Carbon Budget – but at what consumer cost and security of supply?

In 2014, UK emissions of the basket of seven greenhouse gases covered by the protocol were estimated to be 514.4MtCO2e – this was 7.7% lower than the 2013 figure of 557.3MtCO2e. Of this reduction the largest decrease (13.6%) was due to a decrease in the use of coal for electricity generation.

Energy supply (at generation source) remains the largest emitter of greenhouse gas emissions and whilst significant reductions have occurred since 1990, it is clear that future policies to reach the 2020 targets and the forthcoming agreement from COP21 on the period post 2020 will ensure that energy supply remains significantly influenced by low carbon policy – with the future of coal and gas uncertain and undesirable.

Government commitment to security of supply alongside the development of low carbon generation

Amber Rudd (Energy & Climate Change Secretary) made a clear statement on Tuesday (1st March 2016) that “Ensuring our families and businesses have secure energy supplies they can rely on is not negotiable and I’ll take no risks with this. I’m taking further action to tackle the legacy of under-investment and ensure our country’s long-term energy security”.

This statement has come at a time when security of supply has been pushed back to the fore as both industry fears and the wider media once again prompt fears over security of supply issues as we move into 2017 and beyond. The UK market has been supported by the decline of energy consumption as a consequence of the economic downturn and the relatively mild winters we’ve been experiencing but longer term it is clear that the removal of coal and gas as a baseload generation fuel does pose significant risks to the security of UK supply given that the majority of low carbon generation sources are intermittent.

The Government’s intention to phase out unabated coal by 2025 whilst cancelling the planned £1bn investment in carbon capture and storage has further raised fears over the long term viability of secure energy sources with SSE announcing the closure of Fiddlers Ferry and Engie announcing it will shut its Rugeley coal plant.

Mechanisms for minimising the risks of blackouts are in place

Whilst a pessimist may see the fears over security of supply as similar to those widely stated in the media over the past 14 years, there is a clear risk to future security due to the decisions on the closure of unabated coal and the removal of funding to invest in new clean coal technology. In addition to this, the financial return of building new gas fired plants is not as attractive as in previous years because of the growth of low carbon generation and the concern over gas playing a marginal role in power dispatch.

However, the UK Government have introduced a number of schemes to support demand reduction and management (which does not include the support mechanisms for incentivising the build of low carbon technologies under RO, FiT & CfD and the recently introduced RO & FiT compensation scheme for energy intensive consumers) which in effect provides price signals to generators and consumers:

  • DSBR, STOR, Triad, DUoS avoidance and Frequency response; which all offer large energy consumers a financial return for managing load in periods of tight supply.
  • The Capacity Market (CM); which is aimed at securing future grid capacity during winter peak periods from generation which may not necessarily run within the current market conditions.

More recently we have seen clear signals that the CM review will bring forward auctions to secure capacity, having already run auctions for delivery in 2018/19 and 2019/2020, to secure capacity for 2017/18. There is likely also to be higher penalties for non-delivery (largely due to the Fiddlers Ferry closure given its future contracted output) and stricter rules for participation.

As we enter a new future which clearly has to address the fears over security of supply alongside continuing to achieve low carbon development in support of emissions reductions targets, it is inevitable that energy policy will continue to react and adapt to changing conditions. This uncertainty poses a significant risk to energy consumers, as the cost of maintaining policy measures, supporting low carbon generation and delivering security of supply will no doubt lead to higher costs.

Consumer Risk & Beond Approach

The topic of non-commodity costs (those charges included in an electricity bill which are not the wholesale market) has been a widely publicised topic over the past 5 years, as the percentage of a delivered energy bill these charges account for has continued to increase (circa 52% in 2016). (Our previously published insight into the 5-year commodity / non-commodity outlook can be obtained upon request).

Our latest view predicts that these will continue to form a greater part of the overall bill as we move towards 2020 – therefore changing the nature of how energy contracts are purchased and managed and further reinforcing the need for demand management and energy efficiency to be at the core of future strategy.

Assuming that the markets will offer price signals to remove the risk of blackouts and security of supply issues there are evident risks to consumer bills over the next 4 years:

  • If the capacity market is brought forward to 2017-2018, this is likely to increase the cost to consumers. Any consumers who have agreed contracts for the period post October 2017 should pay particular attention to any risk of additional pass-through charges. This further increases the risk of rising non-commodity levies and taxes on a consumer bill.
  • The recently introduced RO & FiT compensation scheme (further information can be found on our website) will increase the cost of these charges for those consumers who are not eligible (who are not deemed to be energy intensive) – posing further upside financial risk. Whilst actual figures for the additional cost of supporting the compensation scheme is yet to be confirmed, this is anticipated by Beond’s analysts at around a 6% increase to the future cost of the RO & FiT.
  • Demand management schemes will look to consumers who can demand manage and offer further financial benefit for those who can react – posing a missed opportunity to those who are yet to consider this.
  • Network and infrastructure charges will continue to increase to support the growth of low-carbon generation and further increase the cost of environmental levies and taxes.

With rising taxes, levies and market based costs levied on consumers, Beond is working with our clients to explore the entire spectrum of energy cost and consumption – looking to identify not only the long term risk specific to each client but also the opportunities available to reduce cost, mitigate future risk and identify best practice solutions.

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