28/03/17 – Updated assessment of the impact of carbon budgets on energy prices

Speaker: Mike Hemsley, Power Sector Analyst at Committee on Climate Change

28 March 2017 – meeting notes

Updated assessment of the impact of carbon budgets on energy prices

Chair: Lord Palmer

Lord Palmer opened the meeting:

Good evening, everybody. I’d like to extend a warm welcome to you all to this, the 34th meeting of the All-Party Parliamentary Group on Energy Costs.

I am Lord Palmer, co-Chair of this Group and an elected hereditary crossbench peer.

As you know, this meeting was originally scheduled for last Wednesday but had to be postponed because of the dreadful events that took place here.

Unfortunately attendance is a little light today as many of us could not come tonight on such short notice. However we thought it right to carry on with our work with as little disruption as possible so thanks to you all who have been able to attend.

And special thanks to Mike Hemsley from the Committee on Climate Change to speak to us about their new report, which includes new research and analysis and which considers the impact of UK carbon budgets on household, commercial and industrial sector energy bills.

The press release that accompanied the report was headlined: ‘UK climate action has reduced emissions without increases in household energy bills’.

Lord Deben, CCC Chairman and a vice-Chair of this Group, is quoted as saying: “Action to deliver a cleaner, more efficient energy system is already delivering benefits for households and businesses. UK emissions are falling – down 38% from 1990 to 2015 – while GDP has risen by almost 65% in the same period. Meanwhile, the typical household energy bill has fallen in real terms since 2012. The UK’s progress to reduce emissions, and its comparative advantage in important areas such as the automotive sector, offer opportunities for future growth and employment while delivering vital action to tackle climate change.”

Mike Hemsley, Power Sector Analyst at Committee on Climate Change

In our first report on the impact of low-carbon policies on energy bills in 2010, we suggested that bill savings from energy efficiency would more than offset the increase in low-carbon policy costs on consumer bills. Our latest report, released last week, confirms this.

The CCC were established under the 2008 Climate Change Act as an independent advisor to both Government and Parliament, so it’s a pleasure to be here today. We provide objective advice on long-term targets in the UK, and assess the Government’s progress in achieving these targets.

I’m the analyst at the CCC responsible for this report, and this is the second energy prices and bills report I’ve worked on. After six months of crunching numbers and analysing data, it’s good to be here today presenting what I think are quite striking conclusions.

I’m going to talk through the results of our analysis today, including both the change in energy bills since 2004 to the present day, and the projected impact on energy bills of meeting our scenarios for the 5th Carbon Budget, which sets a limit on the cumulative emissions that the UK can produce between 2028-2032. I’ll do this in four parts:

  • Why and how we did the analysis
  • Household bills
  • Energy efficiency savings
  • Business energy costs and competitiveness, opportunities and the low-carbon economy

So first a few words on why and how we did the analysis:

So why do we do these reports? The CCC has a duty under the 2008 Climate Change Act to consider the implications of low-carbon policies on competitiveness and the fuel poor, and we set out the impacts of these in our reports.

We aim to calculate an all-inclusive cost on bills of meeting carbon budgets. So we include obvious things like support costs for renewables, energy efficiency (ECO) and the carbon price, but also things like:

  • Strengthening of the grid to accommodate not just the low-carbon power, but also theEVs and heat pumps in our scenarios
  • The costs of managing the more intermittent resources, primarily costs of building more back-up capacity
  • We even add the extra contributions per unit that gas users will have to make to maintain the gas grid when there is less gas being used overall (i.e. through energy efficiency)

We want to cover all energy that is used, so we use the mean energy consumption per household, rather than the median. That results in bills (and low-carbon impacts) that are around 10% higher than if you use the more  common median estimates, but it reflects a strong principle that we always want to be conservative.

For example, we estimate average energy efficiency savings for households, noting that for many households there will opportunities for even deeper reductions in energy consumption. For businesses, we assume they face the full impact of future price increases, though there will be opportunities for businesses to offset these costs through energy efficiency.

We are interested in the low-carbon component of policy, so while we report things like the Warm Homes discount we don’t count it as low-carbon policy since it is not there to reduce emissions.

We assume that costs keep being recovered in the same way as at present, i.e. electricity costs from electricity bills.

We are fairly cautious in our cost assumptions e.g. we assume that the next round of offshore wind auctions bring projects costing £100/MWh (the reserve price), whereas many commentators are expecting bids a fair bit lower.

So next a few key numbers for households, and what we get for this spending:

For the 85% of UK households that are dual-fuel (i.e. using gas for heating and hot water and electricity for lights and appliances) the average annual energy bill was around £1,160 in 2016. Bills have fallen by around £115 in real terms since the Climate Change Act was passed in 2008, having risen around £370 from 2004 to 2008 as international gas prices rose.

The majority of the bill reflects wholesale and network costs unrelated to climate policy. Around £105 (9%) of the 2016 bill resulted from the shift towards a UK-based low-carbon electricity supply and support for energy efficiency improvements in homes. This has been offset by lower energy consumption since 2008, which saves households around £300 per year, whereas emissions have reduced by 23% over this period. The £105 is around 17% of an electricity bill, and can be broken down as follows:

  • £55 goes to supporting low-carbon electricity generation, which now (not counting existing nuclear power) makes up 25% of the UK’s electricity generation. This £55 includes everything from payments to households who install solar panels on their roofs, to the giant offshore wind farms that are being built in the North Sea. This also includes the additional costs that intermittent renewables impose on the electricity system, such as additional transmission and distribution infrastructure, and backup generation. Some of these costs are offset by the ‘merit order effect’ whereby renewables reduce the wholesale price of electricity.
  • On top of this, £30 is added to the bill due to fossil fuel power stations paying a carbon price on their emissions, and passing the costs through to consumers. This also raises revenue for the exchequer of around £2bn pounds.
  • £15 goes to supporting energy efficiency in households for low-carbon reasons; we separate this out from energy efficiency for fuel poor households, which adds a similar amount.

We expect this £105 to rise to around £200 by 2030:

  • £35 from the carbon price: less carbon but paying a higher price, similar revenue to the Exchequer, around £2bn. That is more than enough revenue to cover the renewable heat programme and the support paid to energy-intensive users.
  • £110 from low-carbon support which is enough to support a portfolio of low-carbon technologies reaching 75% share of generation by 2030, including support for 2 or 3 CCS clusters, offshore wind and some nuclear.
  • £20 to cover the intermittency costs of the renewables, which for example at today’s capacity prices would be enough to support over 50GW of back-up capacity.
  • £15 for energy efficiency, which would cover the uptake of insulation in our 5th carbon budget scenarios.

As a package that is enough to keep on track to the carbon budgets and to

prepare for the 2050 target. It should position bills to then fall after 2030 as low-carbon contracts start to expire and as new capacity can be added at lower costs. It will also bring major benefits for air quality and health and position the UK to take advantage of the growing global markets for low-carbon goods and services.

So I’ve talked about significant energy savings: gas and electricity use have been cut by 23% and 17% respectively since 2008 and (37% and 18% respectively since 2004), saving the average household £290 a year since 2008 (or £490 a year since 2004). Where have these come from?

The majority of these savings have come from improved appliance, lighting and boiler efficiency driven through minimum standards at both the UK and EU level. These have substantially reduced energy consumption without significant up-front costs. For example since boiler regulations came in in 2005, condensing boilers now make up 60% of the stock.

Similarly, energy efficient lights have gone from 10% of the stock in 2008 to over 50% today, and fridges rated A or better have gone from less than 10% in 2004 to 70% in 2015. Furthermore, across the EU since 2004 the average price of new fridges, freezers and washing machines has decreased between 12-25% in real terms, whilst their energy consumption has decreased 25% and their capacity has increased.

And there is potential to keep getting better: our work envisages households saving a further £150 per year by 2030 a slowdown on past savings, but progress nonetheless.

  • 30-40% of boilers are still non-condensing
  • Only 1% of lightbulbs are LED
  • The growth in efficient fridges has been from A banded fridges, and recently A+, but there is still scope for further improvement
  • Of course UK houses are still drastically inefficient, averaging D on their energy performance certificates

The majority (80%) of the savings in our scenarios simply come from households upgrading their appliances to the latest versions.

So now onto business energy costs, competitiveness and opportunities for the low-carbon economy:

First, it’s important to be clear that when we look across the economy for the vast majority of businesses, energy costs are relatively marginal, and within these the low-carbon proportion of energy costs is even smaller: we estimate that low-carbon energy costs make up less than 1% of operating costs for the majority of businesses, and that this will double to 2030. If businesses passed all of these costs onto UK consumers, then it would add around 3p to a £10 basket of goods and services across the economy in 2016, and 6p to the same basket of goods by 2030. Though of course businesses will have opportunities to offset these costs through energy efficiency.

We see this message reflected in historical trends: Indeed industrial emissions have halved since 1990, whilst the value of manufacturing output remained relatively constant, with a small increase.

But of course for specific sectors with high energy use costs could be affected much more. It’s right that the Government have introduced compensations and exemptions and the Committee think these are at about the right level. These can reduce low-carbon policy costs on electricity by up to 80%. For these firms low-carbon policy adds less than 10% to the electricity price, which adds less than 2% to operating costs in the case of steel. They could have been brought in more quickly however, and the Committee have recommended that now that they are in place they should be predictable and reliable into the future. Furthermore, these businesses often face higher costs than their international competitors, but these higher costs are not due to the low-carbon policies they are compensated for, but due to network and wholesale costs.

So, avoiding competitiveness risks in these areas isn’t about doing less, it is about getting the policy right.

Moreover, acting to tackle emissions has meant that the low-carbon economy is growing rapidly. It is already as big as the energy-intensive sectors and is due to grow multiple times to 2030 and again to 2050.

The UK is particularly well-placed to take advantage of growing global markets, with skills in several emerging sectors. For example:

  • Through the visible low-carbon manufacturing already taking place: Nissan’s factory in Sunderland producing electric vehicles. Siemen’s wind blade factory in Hull. Vestas’s wind turbine facility on the Isle of Wight.
  • Separately, through other things that are behind the scenes: such as research into bioengineering and fuel cells, financial services and consulting linked to low-carbon services, sustainable architecture and building design.

The Committee were careful to point out that this is more than an opportunity, it is an imperative. The world is increasingly carbon-constrained and a successful UK economy must be one that is positioning itself as a low-carbon economy.

So just to conclude, if I may:

  • Firstly, we’ve found that energy efficiency savings are offsetting the increase in energy bills due to low-carbon policies for households.
  • Secondly, risks to competitiveness of low-carbon policies have been limited to date, and provided the compensation and exemption schemes the Government has introduced are maintained and well-managed, there will be limited impact in future.
  • Thirdly, the low-carbon economy in the UK is now roughly the same size as the high carbon economy, and as the world reduces emissions in line with the Paris Agreement, there will be significant opportunities for UK business.

Question from Lord Palmer: Why is it that modern fridges, in contrast with older models, don’t seem to last very long?

Response: I’m not sure, but our research assumes that households replace their white goods every 15-25 years in line with current trends.

Hugh Lee – Ebico: This all seems wonderful but the Government does seem to be dragging their feet: they don’t say much and there seems to be no emphasis on this at all.

MH: The UK is an international leader with a long term view. We will reduce emissions more quickly than the rest of the EU: about 50% of our electricity is low-carbon now and that should be 75% by 2030. That said, there is still work to be done in other areas, e.g. transport – and what are we going to do about heating – can we decarbonise gas or use heat pumps? That, and other things, is for the Government to decide, and their plans to address a lot of the policy gaps are imminent.

Rebecca Newsom, Greenpeace Energy Desk: has CCC in their modelling looked at the cost of nuclear power vs renewables and done any further forward projections on both? We’re seeing a dramatic drop in prices for renewables so have has the cost-effectiveness of both been looked at? The next offshore wind auction is likely to come in below the contract price for Hinckley, for example.

MH: We are technology-agnostic and we do look across the prices for all low-carbon technologies. For this analysis we used BEIS’s latest cost report which does have some renewables cheaper than nuclear in the 2020s, and some not. We used their figures rather than trying to predict the outcome of auctions. For the fifth carbon budget we produced around seven scenarios, and of those I’ll mention three: one with a high deployment of carbon capture and storage; one with a high deployment of nuclear power; one with a high deployment of renewables. For this analysis we costed the high renewables scenario and looked at the impact of that on bills, because if you look at what’s happening elsewhere, that one looked more likely. That said, we were conservative on the cost of renewables as well. We’ve assumed that Hinckley will come online in the 2020s but if that doesn’t happen, we’ll be looking at something else low-carbon to replace it, at a similar or lower price than has been struck for Hinckley.

Lord Palmer: Do you think Hinckley will go ahead?

MH: I don’t have a view but (when pressed by LP) yes.

Andrew Bainbridge, Major Energy Users’ Council: Have you read Peter Lilley’s report? Even if fossil fuel prices make a strong recovery between 2021 and 2030, the overall cost of the climate change act is likely to remain above £300bn, and lower prices could see the cost rise to almost £350bn.

Government no longer carries out assessments of policy costs that have been made in previous years, and this means that policies are shielded from the scrutiny they deserve.

The CCC says that energy costs to businesses are relatively marginal, but large industrial users (Rolls Royce, B&Q, Tesco, etc.) do not take that view. The bills are painful and they keep rising. Britain is responsible for a tiny proportion of emissions and yet we seem to be taking the world on to set an example, and I don’t understand why. The pain of carbon emissions of British business is huge. Please can the staff at the CCC be disavowed of the idea that these are marginal costs: they are huge costs.

MH: We agree on the scale of costs, and that’s part of the reason that we looked in-depth at the impact of competitiveness.  Our targets are in line with the Paris agreement, and we expect other countries to adopt similar targets as well. The UK has been an early leader in this. That’s part of the reason for compensations and exemptions, as well, although it’s not the committee’s job to say which businesses should have them. We do recommend that the Government looks at how businesses are impacted by low carbon policies, and make sure that the compensations are targeted to ensure that these businesses don’t go somewhere else but stay in the UK.

I don’t recognise the £300-£350bn figure immediately. Our report looked at bills for households, and separately for businesses. For most UK businesses, low carbon policy costs are a very small proportion of their operating costs: but that’s not saying they’re not important.

In other reports, such as the fifth carbon budget, we do set out the overall impact of our scenarios on the UK economy, and consistently we’ve said it’s around 1% of UK GDP.

This is our fourth energy pricing bills report, and we did set out a range that we considered for low carbon policy costs between all those reports looking to 2030, and the numbers that we have in this report are within the same range as we previously had: between £150 and £230 pa per household.

Ashutosh Shastri, EnerStrat Consulting: All efficiencies are seen in the UK – would Brexit lead to a loss of all these efficiency gains? Will this be an additional aspect that will reduce competitiveness?

MH: We looked internationally for the business costs, especially in specific sectors of that the UK has (steel, cement, etc.) The UK’s electricity prices are relatively high compared with key European countries (France, Belgium, Germany, etc.), as well as US states and China (although the UK has lower gas prices than a lot of these).  The reason they were identified as being high wasn’t low carbon policy costs but more set-up and network costs, and there was some ambiguity as to why costs were higher than elsewhere. In some countries, some large users get discounts (not just on low carbon policy costs but on network costs as well) which can make a big difference. We see our role as doing the analysis and then handing over to the Government to look more deeply.

We haven’t done a full assessment of Brexit yet so we don’t really know what the implications would be, but as soon as we have more information we will do one. We did do an initial report last year, highlighting the areas that are driven by EU policy, and that’s about 50% of emissions reduction in the UK so those standards will need to be replaced.

Ashutosh Shastri, EnerStrat Consulting: In the analysis it was said that the cost of low-carbon policy includes a subsidy for CCS. If there will be no coal by 2025, why has an allocation for CCS been included?

MH: We have assumed that coal will be phased out of the system by 2025 in line with stated policy. We treat CCS separately, with a combination of gas CCS and coal CCS, so post-2025 the CCS will go over to gas. There is a potential for coal CCS if it’s cheaper, but in this scenario any coal plants would be new ones with CCS added: studies done in the UK have suggested that existing coal plants should not have CCS retrofitted. This would only happen if coal CCS is cheaper though.

The meeting closed at 1850.