3.3 The Coming of Age of Climate Change Concern
So far the impact of climate change policies on electricity prices and the
operation of electricity markets has been modest in the UK. Even by 2012 – the
end of the current trading period of the European Emissions Trading System – the
likely impact on electricity prices in the UK will be 10-15% on the basis of a continuation
of existing policies.9 The impact on the operation of the wholesale power
market is also likely to be modest: all new large power stations will be CCGT
with no nuclear, clean coal or carbon capture and storage (CCS) enabled plants
likely to be on line by then. Wind generation is currently being built at a modest
rate. Even though the requirements under the Renewables Obligation Certificate
(ROC) Scheme are that around 12% of electricity be produced from renewables
by 2012, it seems very unlikely that this target can be met. In 2007 less wind capacity
was added in the UK than in 2006 and this figure was less than 1% of total
installed capacity on the system.10
However climate change concern is increasing. The influential Stern Review,
published in 2006, has contributed to a strengthening of government policy
and government attitudes in the UK.11 The Stern Review carefully discussed the
value of doing something about climate change and reached the clear conclusion
that significant expenditure of the order of 1% of GDP was justified by the economic
value of avoiding the risk of significant climate change.12 This expenditure
should be spent to achieve a CO2 emissions reduction of at least 60% on 1990
levels by 2050. 1% of GDP in the case of the UK is of the order of £13bn in 2007.
The electricity sector is capable of reducing its emissions by 80% by 2050 (Elders
et al., 2006). Assuming other sectors collectively were to keep their emissions
constant at no extra cost (which would be a good baseline performance) an 80%
de-carbonization of the electricity sector would reduce total emissions by 20% by
2050. This suggests that extra expenditure in the electricity supply industry of say
£4bn p.a. (i.e. one third of the total extra expenditure) might be justified to meet
climate change emissions reduction targets by 2050. Currently the actual amount
of expenditure might be of the order of £1bn13 (extra spending on renewables and
networks), thus giving room for a significant increase.14
The Stern Review has informed the Climate Change Bill (2007) which
establishes the Office of Climate Change. This Office is charged with setting
5-year greenhouse gas emissions targets for the UK (–20% by 2020 and –60%
by 2050) and ensuring that these are achieved. A raft of policies have been announced:
including the phasing out of filament light bulbs by 2011, the requirement
for all new homes to be zero emission by 2016 and the tendering process for
a large scale demonstration CCS power plant and the commencement of a design
approval process for a new generation of nuclear power plants. In addition the government
is looking at a proposal to create a tidal barrage across the Severn Estuary,
which would generate 5% of total electricity demand.15 Meanwhile the European
Union has announced a 20% reduction in CO2 and a target of 20% of all energy
coming from renewable sources (this could imply 35% for electricity), though the
targets vary across countries.16 The second trading period of the EU ETS began on
1 January 2008 with much lower quotas than in the first period and significantly
higher prices for CO2 permits. At the municipal level, some local authorities have
announced their own CO2 reduction targets. In some cases these have been more
ambitious than national targets. For instance the former Mayor of London had announced
a commitment to 60% reduction in CO2 from London by 2025.17
The cumulative impact of these policies on the electricity market looks
likely to be significant. There is likely to be pressure to build significantly more renewable
generation capacity than in the past and for this to run on the system to save
CO2. The impact of this on the operation of the wholesale market is potentially very
significant. Large amounts of high fixed capital cost – low running cost plant creates
price volatility in the balancing market and exposes un-hedged players to significant
risks. This is in contrast to the benign effect of the entry of combined cycle
gas turbine (CCGT) plants into the wholesale power market in the 1990s. CCGTs
could be built quickly in response to market conditions, they were straightforward
to finance and could be invested in on a merchant basis. One could argue that it was
CCGT technology which facilitated the emergence of a competitive market in the
1990s. Systems where hydro power was the price setting plant often had to accommodate
wholesale price volatility (which they did in Norway and in New Zealand)
or to employ a system of cost-based bidding in the power pool which they did in
Chile. However such instability in hydro systems is seasonal rather than intra-day.
It is possible that a deregulated market can accommodate the volatility introduced
by renewables into pricing but it will require much more flexibility in demand side
management (such as residential smart metering to control domestic loads).
The new low carbon electricity market envisaged by policy makers is
still some way off. In the UK 9.2 GW of wind capacity (more than 3 times the
current installed capacity) is in the planning process, awaiting approval from local
planning authorities.18 Such wind capacity will also require significant upgrading
of the national transmission grid (which also requires local planning permission).
Approval of the design of new nuclear power plants is only the start of the process
of actually building a new nuclear power plant. It seems unlikely that a new
plant will open for 10 years (5 years for approval, followed by 5 years to build).
Carbon capture and storage is progressing with a demonstration plant competition
underway in the UK and may yet prove to be highly significant, especially as
a medium term solution.19 However its true costs (particularly per tonne of CO2
actually captured) remain to be established in a real power station and its public
acceptability (as a technological fix) is largely unknown, due to ignorance of how it
works (see Reiner, 2008). Much is made of the scope for demand side reductions in
energy use, with low energy light bulbs and smart metering clearly being targeted
by government policy. However the significant behavioral change required will
test public commitment to climate change policy. Zero carbon new homes will be
a significant driver of change in terms proving of new technologies but the market
for retrofitting existing homes with micro-generation sources or connection to district
heating networks (which would significantly save on emissions from heating
and electricity) has yet to established, but the theoretical potential is significant.20
The UK, like many other countries, has been through a period of significant
uncertainty with respect to climate change policy. However there are now a
number of significant commitments making progress into law. In particular, there
is a commitment to firm CO2 reduction targets and carbon budgeting, to be overseen
by the Office of Climate Change21. This is the context that will shape much
of the investment that will go into the electricity sector in the years to 2020 and
beyond. Much uncertainty about the detailed content of policy remains but the
general direction seems clear. It is also clear that the climate change related component
of prices for energy will have to rise significantly.22
Of course it is still possible that we will see a retreat from these policy
commitments, but that seems increasingly unlikely, especially in the context of
EU wide agreements. This is because the reality of actual climate change and its
effects on both the UK and on other countries seems likely only to intensify political
pressure for action in the domestic electricity sector. It is possible that some
relief will come from the ability to purchase carbon emission reductions from
other developing countries (via Clean Development Mechanisms (CDMs) or Joint
Implementation Agreements (JIAs)). There is also the possibility that the absence
of any action to reduce emissions in the US or in the major developing countries –
particularly China and India – will lead to a retreat from action in Europe. The EU
already has a commitment to a deeper cut in CO2 of 30% by 2020 (against 20%)
if other countries agree significant action.
I think it is not going too far to suggest that the three points above constitute
a strong case for saying that we need a substantial reexamination of the
model of electricity regulation that has been so successful in the UK from 1991 to
2007. Climate change concern and its associated policy implications are so major
that it would irresponsible not to ask whether our current regulatory model is fit
for policy. This is because the current model existed in a world where the focus
was on exploiting the efficiency gains that could be had from introducing competition,
primarily facilitated by natural gas fired power stations in generation, and
where independent regulators could deliver high values of X within price reviews
from inefficient monopoly network owners via incentive regulation. Indeed Helm
(2005) argues that the years since 1990 represent an unusual period of withdrawal
of active political interest in the energy sector and that renewed political oversight
and interference is now likely. Climate change will necessitate substantial institutional
change in order to deliver a significant change in the carbon dioxide produced
by the electricity sector. Of course it is not just regulation that is potentially
at stake but also the ownership of electricity assets and the nature of how markets
are organized in the electricity sector.
So far the impact of climate change policies on electricity prices and the
operation of electricity markets has been modest in the UK. Even by 2012 – theend of the current trading period of the European Emissions Trading System – the
likely impact on electricity prices in the UK will be 10-15% on the basis of a continuation
of existing policies.9 The impact on the operation of the wholesale power
market is also likely to be modest: all new large power stations will be CCGT
with no nuclear, clean coal or carbon capture and storage (CCS) enabled plants
likely to be on line by then. Wind generation is currently being built at a modest
rate. Even though the requirements under the Renewables Obligation Certificate
(ROC) Scheme are that around 12% of electricity be produced from renewables
by 2012, it seems very unlikely that this target can be met. In 2007 less wind capacity
was added in the UK than in 2006 and this figure was less than 1% of total
installed capacity on the system.10
However climate change concern is increasing. The influential Stern Review,
published in 2006, has contributed to a strengthening of government policy
and government attitudes in the UK.11 The Stern Review carefully discussed the
value of doing something about climate change and reached the clear conclusion
that significant expenditure of the order of 1% of GDP was justified by the economic
value of avoiding the risk of significant climate change.12 This expenditure
should be spent to achieve a CO2 emissions reduction of at least 60% on 1990
levels by 2050. 1% of GDP in the case of the UK is of the order of £13bn in 2007.
The electricity sector is capable of reducing its emissions by 80% by 2050 (Elders
et al., 2006). Assuming other sectors collectively were to keep their emissions
constant at no extra cost (which would be a good baseline performance) an 80%
de-carbonization of the electricity sector would reduce total emissions by 20% by
2050. This suggests that extra expenditure in the electricity supply industry of say
£4bn p.a. (i.e. one third of the total extra expenditure) might be justified to meet
climate change emissions reduction targets by 2050. Currently the actual amount
of expenditure might be of the order of £1bn13 (extra spending on renewables and
networks), thus giving room for a significant increase.14
The Stern Review has informed the Climate Change Bill (2007) which
establishes the Office of Climate Change. This Office is charged with setting
5-year greenhouse gas emissions targets for the UK (–20% by 2020 and –60%
by 2050) and ensuring that these are achieved. A raft of policies have been announced:
including the phasing out of filament light bulbs by 2011, the requirement
for all new homes to be zero emission by 2016 and the tendering process for
a large scale demonstration CCS power plant and the commencement of a design
approval process for a new generation of nuclear power plants. In addition the government
is looking at a proposal to create a tidal barrage across the Severn Estuary,
which would generate 5% of total electricity demand.15 Meanwhile the European
Union has announced a 20% reduction in CO2 and a target of 20% of all energy
coming from renewable sources (this could imply 35% for electricity), though the
targets vary across countries.16 The second trading period of the EU ETS began on
1 January 2008 with much lower quotas than in the first period and significantly
higher prices for CO2 permits. At the municipal level, some local authorities have
announced their own CO2 reduction targets. In some cases these have been more
ambitious than national targets. For instance the former Mayor of London had announced
a commitment to 60% reduction in CO2 from London by 2025.17
The cumulative impact of these policies on the electricity market looks
likely to be significant. There is likely to be pressure to build significantly more renewable
generation capacity than in the past and for this to run on the system to save
CO2. The impact of this on the operation of the wholesale market is potentially very
significant. Large amounts of high fixed capital cost – low running cost plant creates
price volatility in the balancing market and exposes un-hedged players to significant
risks. This is in contrast to the benign effect of the entry of combined cycle
gas turbine (CCGT) plants into the wholesale power market in the 1990s. CCGTs
could be built quickly in response to market conditions, they were straightforward
to finance and could be invested in on a merchant basis. One could argue that it was
CCGT technology which facilitated the emergence of a competitive market in the
1990s. Systems where hydro power was the price setting plant often had to accommodate
wholesale price volatility (which they did in Norway and in New Zealand)
or to employ a system of cost-based bidding in the power pool which they did in
Chile. However such instability in hydro systems is seasonal rather than intra-day.
It is possible that a deregulated market can accommodate the volatility introduced
by renewables into pricing but it will require much more flexibility in demand side
management (such as residential smart metering to control domestic loads).
The new low carbon electricity market envisaged by policy makers is
still some way off. In the UK 9.2 GW of wind capacity (more than 3 times the
current installed capacity) is in the planning process, awaiting approval from local
planning authorities.18 Such wind capacity will also require significant upgrading
of the national transmission grid (which also requires local planning permission).
Approval of the design of new nuclear power plants is only the start of the process
of actually building a new nuclear power plant. It seems unlikely that a new
plant will open for 10 years (5 years for approval, followed by 5 years to build).
Carbon capture and storage is progressing with a demonstration plant competition
underway in the UK and may yet prove to be highly significant, especially as
a medium term solution.19 However its true costs (particularly per tonne of CO2
actually captured) remain to be established in a real power station and its public
acceptability (as a technological fix) is largely unknown, due to ignorance of how it
works (see Reiner, 2008). Much is made of the scope for demand side reductions in
energy use, with low energy light bulbs and smart metering clearly being targeted
by government policy. However the significant behavioral change required will
test public commitment to climate change policy. Zero carbon new homes will be
a significant driver of change in terms proving of new technologies but the market
for retrofitting existing homes with micro-generation sources or connection to district
heating networks (which would significantly save on emissions from heating
and electricity) has yet to established, but the theoretical potential is significant.20
The UK, like many other countries, has been through a period of significant
uncertainty with respect to climate change policy. However there are now a
number of significant commitments making progress into law. In particular, there
is a commitment to firm CO2 reduction targets and carbon budgeting, to be overseen
by the Office of Climate Change21. This is the context that will shape much
of the investment that will go into the electricity sector in the years to 2020 and
beyond. Much uncertainty about the detailed content of policy remains but the
general direction seems clear. It is also clear that the climate change related component
of prices for energy will have to rise significantly.22
Of course it is still possible that we will see a retreat from these policy
commitments, but that seems increasingly unlikely, especially in the context of
EU wide agreements. This is because the reality of actual climate change and its
effects on both the UK and on other countries seems likely only to intensify political
pressure for action in the domestic electricity sector. It is possible that some
relief will come from the ability to purchase carbon emission reductions from
other developing countries (via Clean Development Mechanisms (CDMs) or Joint
Implementation Agreements (JIAs)). There is also the possibility that the absence
of any action to reduce emissions in the US or in the major developing countries –
particularly China and India – will lead to a retreat from action in Europe. The EU
already has a commitment to a deeper cut in CO2 of 30% by 2020 (against 20%)
if other countries agree significant action.
I think it is not going too far to suggest that the three points above constitute
a strong case for saying that we need a substantial reexamination of the
model of electricity regulation that has been so successful in the UK from 1991 to
2007. Climate change concern and its associated policy implications are so major
that it would irresponsible not to ask whether our current regulatory model is fit
for policy. This is because the current model existed in a world where the focus
was on exploiting the efficiency gains that could be had from introducing competition,
primarily facilitated by natural gas fired power stations in generation, and
where independent regulators could deliver high values of X within price reviews
from inefficient monopoly network owners via incentive regulation. Indeed Helm
(2005) argues that the years since 1990 represent an unusual period of withdrawal
of active political interest in the energy sector and that renewed political oversight
and interference is now likely. Climate change will necessitate substantial institutional
change in order to deliver a significant change in the carbon dioxide produced
by the electricity sector. Of course it is not just regulation that is potentially
at stake but also the ownership of electricity assets and the nature of how markets
are organized in the electricity sector.
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