By Paul Gleaves, Head of Trading & Risk
Energy regulator Ofgem has launched its ‘Decarbonisation Action Plan’, outlining the key actions that they intend to take over the next 18 months as the UK moves towards achieving its target of net zero emissions by 2050. The launch came with some fanfare, coinciding as it did with new Ofgem Chief Executive Jonathan Brearley’s first day in office. Speaking at the launch, Brearley praised the UK’s efforts to date in tackling the decarbonisation of the economy but stated that they “must go further, particularly on heat and transport.”
It is perhaps unsurprising that the policy landscape is shifting away from power generation and towards surface transport and heating. Indeed the UK power sector has cut emissions by two-thirds since 1990, whilst 2019 saw the first 12-month period that electricity generated from low-carbon sources outstripped fossil fuels in Great Britain. The transformation of the UK’s energy generation stack has been driven by government subsidy schemes such as the Renewables Obligation, Contracts-for-Difference and Feed-in-Tariff which have enabled rapid growth in the renewables sector, whilst gas has largely replaced coal as the flexible supply source of choice.
The Action Plan
Ofgem’s nine-point action plan for a net-zero future, incorporates the following:
- Ensuring that energy networks are designed to facilitate net zero carbon, whilst keeping costs as low as possible;
- Setting up of a strategic Innovation fund focussed on decarbonisation;
- Co-ordinating the adaptation of the transmission network to facilitate greater offshore wind generation;
- Ensure that the transition away from gas heating is done fairly, with the cost burden spread between current and future consumers;
- Ensuring that the role and responsibilities of system operators are fit for purpose in order to achieve net zero carbon;
- Ensuring that the future electricity system rewards flexibility in consumption by end-users;
- The creation of a regulatory framework that will enable the roll out of electric vehicles whilst keeping costs as low as possible;
- Review and reform of retail markets to drive innovation and consumer confidence, whilst tackling issues such as “greenwashing”;
- The setting up of a Net Zero Advisory Group within Ofgem to drive decision-making.
The points outlined above offer a blueprint to Ofgem’s vision of a pathway to net zero future for the UK energy system. Although the document doesn’t go heavily into specifics it does offer some interesting insights into what energy supply will look like in the future and its impacts on consumers. The following sections will assess a number of the key issues raised.
Energy costs will likely increase in the short-term
Solving the “energy trilemma” (a term coined by the World Energy Council) of decarbonising the economy, maintaining security of supply and keeping prices affordable has been the eternal challenge facing the UK’s energy policymakers. As the energy regulator, Ofgem are well aware of their role in keeping costs as low as possible and have long stated their desire to ensure that the costs associated with decarbonisation are implemented as fairly as possible and without overburdening vulnerable consumers.
Ofgem do expect that there will be cost increases in the short term, although they do state that “investing in the short term will save money in the medium and long-term.” Increases in costs appear to be inevitable given that renewables growth will need to be strongly underpinned by an increase in off-shore wind generation, which will require significant investment in the transmission network. Meanwhile, the regulator will also need to invest in long-term low carbon replacements to peaking plant and flexible supply, which has traditionally been provided by fossil fuels (due to the speed with which these forms of generation can be brought on and offline). To further aid system balancing, the action plan also stresses a commitment to incentivising end-users to consume flexibly. This is interesting, and somewhat contradictory, given that the ongoing Targeted Charging Review (also being led by Ofgem) is set to remove much of the current benefit to consumers who can drop load during peak times.
When (and how) cost recovery will start to hit consumers bills is not yet known, although the Government have potentially backed themselves into a corner having previously pledged that there would be no new subsidies or carbon taxes until there is a clear downward price trend in existing schemes within the Levy Control Framework. This may mean that any cost shortfall would have to be recovered via network costs or the balancing mechanism, although it is perhaps more likely that the government will simply enhance existing programmes.
Greater clarity will be known on potential cost increases by the end of 2020, when Ofgem publishes its latest round of price controls for distribution and transmission networks, known as the RIIO-2 framework. The latest round of price controls have already proven to be controversial, after the regulator found that only one the network operator’s initial proposals had been “genuinely proactive in shaping the path to net zero.”
Greater clarity on Green Electricity Contracts
Buried in amongst the 37-pages of text there is an interesting passage where Ofgem acknowledges “growing concerns about ‘greenwashing’, where the environmental impact of a particular tariff or supplier is overstated.” The concept of ‘greenwashing’ has become a hot topic in energy circles, referring to the practice whereby suppliers may sell a 100% green electricity contract, regardless of where the energy was originally sourced from. This is done simply by purchasing (very cheaply) the equivalent volume of REGOs (Renewable Energy Guarantees of Origin) to the energy being supplied, which – like some sort of electrical alchemy – turns a brown energy contract into a green one. Although this practice is perfectly legal, there are some market participants that believe that green energy contracts are opaque and don’t differentiate as to whether or not the supplier are truly investing in renewables, either via self-generation or buying directly from renewable generators.
It will be interesting to see how Ofgem will look to tackle this issue. One potential way to achieve this would be to ban the unbundling of REGOs, this would prevent the de-coupling of REGO certificates from the original unit of renewable power put into the grid, meaning all REGO-backed electricity contracts would be 100% green (rather than 100% “green”). Another method would be to introduce different levels of green energy supply contracts, for example, a recent article by Which? Magazine suggested that the range of green energy tariffs in the marketplace could be better described as ‘Dark Green’, ‘Mid Green’ or ‘Pale Green’.
Electric Vehicles and heat decarbonisation are definitely going to happen
The timing and uptake of electric vehicles and the decarbonisation of heat has long been a significant driver in the economics of the energy industry, given that these factors are a key driver of long-term gas and electricity demand forecasts. Although, these factors have long been talked about, the truth is that such discussions have often been marinated in a degree of scepticism, perhaps as the result of a suspicion that other more cost effective technologies may emerge, but also doubts have often been raised about the UK governments true commitment to fully decarbonising the economy. Indeed, it’s worth bearing in mind that in only two out of four of National Grid’s Future Energy Scenarios, is Net Zero achieved by 2050.
The enshrining into law of the UK’s commitment to reach net zero carbon emissions by 2050, has certainly changed the energy landscape and Ofgem’s Action Plan is clear in its focus on developing a regulatory framework to facilitate this. The changes (and costs) associated with this will be hugely significant given the scale of the challenge. Currently, only 5% of the energy used to heat homes and commercial buildings is derived from low carbon sources, whilst the number of electric vehicles on the road must increase by 45 million by 2050.
According to the Committee on Climate Change, 3,500 rapid and ultra-rapid chargers will be needed in the vicinity of motorways whilst 210,000 public chargers will be needed, meaning a huge upturn in grid to vehicle technology. The upheaval will be equally felt in the heating of buildings, where the same committee states that 100% of non-residential buildings should be heated by low carbon sources. Quite how this is to be achieved is far less clear, although replacing natural gas with hydrogen and the use of electric heat pumps will likely play a key role.