Some key issues for reviews of the costs of low-carbon electricity generation in the UK
The energy policies of recent UK governments have aimed to balance the three main contributors to the ‘trilemma’ of energy security, affordability and sustainability. However, the current Government has placed a greater emphasis on affordability for consumers than on the other two dimensions.
Ongoing concerns about the best policies to achieve affordability have led to three reviews: of energy costs, of the Levy Control Framework, and of carbon pricing. This paper draws on research findings and empirical evidence to identify key principles and issues that should be taken into account by the Government in relation to these separate but related reviews.
The UK Government should:
- Seek to optimise the balance between carbon pricing applied to fossil fuels and direct subsidies for low-carbon alternatives, to ensure that market failures and distortions are addressed while meeting emissions reduction targets as efficiently as possible. This should be an explicit goal of its Clean Growth Strategy, and reinforced by other policies.
- Reform the currently overlapping carbon pricing policies in order to create a consistent carbon price, not only across the power sector, but also across all firms and fuels in the economy. The Climate Change Levy or the Carbon Price Support Rate could be modified to become an effective economy-wide carbon tax.
- Consider how the electricity market should develop in order to take into account the fact that renewables potentially have low, if any, marginal costs, and that fossil fuel plants enjoy a hedge against price risk. In the current electricity market marginal costs of the marginal plant are usually related to the operating costs of fossil fuels, i.e. the cost of fossil fuels for the marginal plants can be passed through into electricity prices.
- Focus on bills, not prices, in order to realise its ambition of having the lowest energy costs in the EU for household and business consumers.
- Focus on measures to improve energy efficiency for households and businesses, such as minimum energy-efficiency standards, increasing information available to consumers (for example, appliance labelling or household energy-use certificates), financial support for consumers seeking to undertake energy efficiency improvements, or direct financing.
- Consider funding subsidies for new low-carbon power sources through measures that are less regressive than increases to consumers’ electricity bills.
- Allow competitive auctions to drive down prices rather than applying a cap on overall expenditure on subsidies through the Levy Control Framework, which risks undermining reductions in greenhouse gas emissions from the power sector.
- Explore the possible introduction of ‘subsidy-free’ Contracts for Difference for mature renewables technologies, such as onshore wind, to reduce the risk for developers and thus lower the cost of financing.
- Not accept the recommendation by the Cost of Energy Review to merge the Contracts for Difference and capacity auctions, as this would be less efficient and would create additional barriers to new renewable power generators attempting to enter the market.
- Explore better ways of promoting energy efficiency for businesses, as recommended by its Clean Growth Strategy.
- Assess the overall welfare cost to household consumers, taxpayers and businesses, and not just the direct cost to consumers, when assessing the cost-effectiveness of policies to reduce greenhouse gas emissions.
This policy insight has been produced jointly with Energy Futures Lab and the Grantham Institute – Climate Change and the Environment at Imperial College London.