The Bill wisely offers a phased approach to dealing with technology uncertainty. But the details must be filled in soon if business is to stay the course. Viewpoint from James Smith, Chairman, Carbon Trust
Electricity technologies and electricity markets are enormously complex. Yet these technologies and markets must change significantly and quickly, becoming even more complex in the process. Sadly, there is no simple option either in technology or market mechanism. Low carbon electricity technologies face many unknowns, especially about their true costs. And the electricity markets that have mostly worked alright for 20 years, mainly because of low cost UK North Sea gas, do not have the mechanisms necessary to promote about £110 billion of essential investment in new, low carbon capacity.
Government published a draft Energy Bill in May that will be brought to parliament in the autumn. The Bill has attracted plenty of criticism. The Energy Select Committee described some of the proposals as unworkable. But the Committee also acknowledged there isn't time to start again. In my opinion we should get behind the Energy Bill. The underlying reality is so complex that any approach will have its voluble critics. In truth there is not much room for manoeuvre.
Among the critics are those who strongly support some of the low carbon technologies and strongly condemn others. Yet with no consensus, it is worrying that all options have a strong body of opposition. We'd better accept that no technology is clean and cheap and always on. None is perfect but several can do the job. My plea is that people suspend judgement until we can get clear evidence on cost and reliability. The key technologies, offshore wind, nuclear and carbon capture and storage (CCS), need to be built at scale so their costs and performance can be properly discovered. A crucial feature of the Energy Bill is that it is designed to enable this. Competitive market forces, driven by dispassionate cost engineering and not emotional preference, should dictate the low carbon electricity technology mix.
It should be accepted that immature technologies need some level of subsidy if they are going to be developed rapidly. Such 'launch aid' is an established feature of modern market economies and serves to stimulate economic growth. Launch aid can come in a variety of forms. It already exists for offshore wind and in a competition for bringing forward CCS projects.
Yet launch aid must never become an open ended subsidy. Open ended subsidies destroy innovation and create a high cost legacy that is unfair to consumers. So the launch aid for low carbon electricity technologies has to be limited in time and money. The so called 'levy cap' in the Energy Bill creates such limits. The Treasury is being criticised for this levy cap and there are suggestions of divisions in government about it. But such controls are vital if public confidence is to be retained and if innovation is to flourish. The procedures around operation of the levy cap need improved but I know from my time at Shell that engineers working to tight budgets and tight timeframes are the most innovative.
A central feature of the Energy Bill is 'contracts for difference' (CfDs). In mature markets these can dampen price volatility. However over the coming years they will be used to provide launch aid subsidies for low carbon electricity. This will necessarily be done in different ways because the risk profiles of the technologies differ significantly. That's normal business.
CfDs are the most controversial aspect of the Energy Bill. Some of the criticism is justified. In particular, as currently designed, they may not be acceptable collateral for lenders to multi billion pound electric power investment projects. This has to be sorted out and the Government has already acknowledged it.
But much of the criticism of CfDs would be answered if there was confidence that they are a transitional mechanism, albeit over the next ten years or so, and their costs to the consumer will be contained. Once the relative costs of the key technologies have been confirmed, the need for CfDs is much diminished. Based on mature technologies, the unseen hand of the market can be relied on to make the most cost effective choices based only on the market price for electricity and the cost of emitting carbon dioxide.
The Energy Bill describes a phased approach where subsidy and stimulus are used only initially to get technologies properly tested and demonstrated. I believe it would help the acceptability of the Bill if this was better highlighted.
This is not to say the Energy Bill has it right in all respects. There is an ill-defined 'capacity market' proposal that is serving to frighten investors and undermine the energy security it is aimed to support. And the carbon price floor will only move, at our expense, carbon emissions from the UK to Europe. Better to tackle the root of the problem and make the European carbon market effective by withdrawing surplus emissions credits and giving strong signals for the post 2020 carbon market. These matters have to be dealt with when the Energy Bill comes to Parliament.
So this looks to me like a sensible Energy Bill, mainly because it provides the means of finding out which low carbon technologies operate at lowest cost - and then leaving it to the market. We need to appreciate that the huge engineering scale means that this transition will take ten to twenty years.
But there is a crucial point that government dare not take for granted. Long business cycles, big money and big risk are axiomatic to energy. This is not a business sector like fashion and consumer electronics. Energy company strategies cannot turn on a sixpence. Prudent companies cannot afford to compound their own irreducible technology risk with unnecessary external market policy risk. Companies are sceptical of political staying power and cannot afford to take material commercial risks where politics and market fundamentals might be at odds. If industry is to stay the course there needs to be confidence in the regulatory framework. Given the recent ministerial changes at DECC, coming at such a crucial time, delivery of the Energy Bill will be an acid test for political staying power.
Sustaining the confidence of industry is why the problems with the Energy Bill as presently drafted need resolved and the details need filled in - soon. It is also why Government's promised strategy document is so vital in creating a believable context for how the UK will get its low carbon electricity. If Government thinks it can fill in the blanks on strategy and policy as it goes along on electricity markets, business will lose confidence and close down product and project development pipelines - permanently. The consequences will be risks to energy security, much higher cost eventually and lost opportunity for economic development. Tackling climate change will also be undermined.