Cost of Energy Review: Insights from UKERC research

09 Oct 2017

Priorities for the Energy Cost Review

This week, the government’s long awaited Clean Growth Strategy will be published. Like many, we will be looking for details of how UK emissions will continue to be reduced to meet the 4th and 5th carbon budgets. In particular, the Strategy will need to explain how a range of increasingly significant policy gaps will be addressed.

The Strategy is likely to be closely followed by the conclusions of the Review of Energy Costs, led by Professor Dieter Helm. Ahead of the Strategy’s publication, we are publishing a briefing paper that covers four key issues that are central to the terms of reference of the Review of Energy Costs – and to the Clean Growth Strategy itself.

Our starting point is that the primary issue is the cost of energy bills for consumers, rather than only the unit price of energy. It is therefore important to focus on measures that can reduce the quantity of energy required for a given level of service as well as trends that could help to reduce or moderate prices. In line with the terms of reference, our briefing paper focuses on electricity costs since UK electricity prices are higher up the European league table than those for gas.

Energy efficiency

The role that energy efficiency can play in reducing electricity bills needs to be fully addressed. Significant progress in this area remains to be made; savings of up to 10% can be achieved through well designed standards and investment programmes, and a recent UKERC report highlighted that a 25% reduction in household energy demand is possible through cost effective measures.  There is a clear rationale for government intervention, to drive energy efficiency and address the policy gap left behind by the failure of the Green Deal. The case is even clearer when considering the additional economic and social benefits that energy efficiency brings.  

Innovation and technology cost reduction

The creation of new markets help drive technology cost reductions, as does patient government support. Offshore wind is a case in point - achieving much lower than expected prices in the recent Contracts for Difference auctions. If these projects are delivered, this will place offshore wind amongst the cheapest new sources of electricity generation in the UK.

Policy change is required to drive further innovation, yet with investor confidence low, this needs to build on existing policy instruments. A case has been made for moving low carbon technologies into a single competitive auction. However this technology neutral approach favours technologies close to market, failing those which are less developed. Complex technologies such as carbon capture and storage, which have significant potential but high capital expenditure and associated risk, could require a state-led approach to investment, allowing for competition to drive prices down.

A systems approach is required

The review’s terms of reference clearly state that a systems approach is required. The consideration of technologies within this perspective is imperative, as is developing energy policy within this context.  This is particularly relevant for electricity, where a range of mechanisms and markets are used to balance supply and demand in real time.

System flexibility is key to keeping costs down. The cost of integrating renewables into the grid vary widely, with future cost of integrating intermittent power sources, depending upon the availability of cost effective system flexibility. Incentivising flexibility and reforms to the capacity market will be required to facilitate this, and as the proportion of renewables increases, government will need to decide how to account for system costs including those surrounding intermittency.

Research, development and demonstration

Innovation is an important driver for reducing costs and bringing technologies to market. However this non-linear process exists with multiple feedbacks between development, demonstration and deployment. Effectiveness is further dependent on incentives for demonstration and market creation, and UKERC research has shown that innovation in the energy sector tends to take three to four decades from early stage R&D to significant commercial deployment.

Analysis has been undertaken by government to establish this evidence base, yet too often this has focused on discrete technologies, with less attention paid to system innovation. It is this system innovation which will be key to the low carbon transition, alongside effective evaluation, to learn and disseminate lessons.

Eye catching initiatives such as the Faraday Challenge for storage are welcome, as is the UK pledge - as part of Mission Innovation - to double clean energy R&D spending between 2015-2020. Whilst a step in the right direction, when considering the scale of the challenge posed by climate change, many argue that government support for innovation at a greater scale is required.

Download the briefing note to read the full submission to Dieter Helm.