Market News

By Eamon Akil Farhat

(Bloomberg) -- The UK government risks baking in higher energy costs for consumers as it pushes to meet a challenging — and upgraded — target to decarbonize the country’s power supply by 2030.

After bringing forward a deadline to deliver a clean power system — defined as one that relies on gas for less than 5% of supply — to 2030 from 2035, ministers may lock consumers into higher prices, according to energy analysts at Cornwall Insight, Carbon Tracker and Aurora Energy Research Ltd. That’s because the cost of raw materials and borrowing have increased, making it expensive to build new wind farms. Approving a wave of projects in a rush to meet the target could also kill off competition that drives down costs.

“Assuming renewables keep reducing in cost as manufacturing and installation costs fall, then installing more in the short-term could result in locking in higher costs, compared to installing the same capacity later when costs have fallen,” Cornwall’s principal modeler, Tom Edwards, said. He added that the more ambitious target risks reducing competition for new renewable projects, adding further to the price burden on consumers.

A delicate balance is needed to keep costs under control and there’s a risk attached to accelerating the UK’s clean energy drive under the assumption that renewable energy is cheaper.

Prime Minister Keir Starmer and Energy Secretary Ed Miliband pledged during this year’s election campaign that their plan to slash greenhouse gases would reduce annual energy bills for consumers by as much £300 ($381) a year. Starmer’s spokesman, Tom Wells, said last week that ministers “stand by independent modeling based on pre-election prices which said that the savings could be £300 based on clean power by 2030.”

Inflation across the economy has hit households hard in the past few years and although prices have been increasing at a slower pace in recent months, the headline rate jumped to an eight-month high in November. This means a less chance of interest rate cuts, which contribute to the higher spending on renewable projects due to financing costs.

A push to reach net zero emissions in the power sector by 2030 would cost £11.4 billion more over the next 11 years than sticking to the 2035 deadline, according to Aurora Energy Research analysis from earlier this year. The government’s fiscal advisor, the Office for Budget Responsibility, has increased its forecast for UK expenditure on environmental levies through 2029 by £8.8 billion in total.

The government laid out plans last week to reform rules on planning and grid connection in a bid to spur the £240 billion of investment it says is needed by 2030 to transform the energy system and meet its decarbonization goal. The plan envisaged as much as 50 gigawatts of offshore wind power capacity by 2030, more than triple today’s level.

Most new wind farms are supported by government-backed contracts that fix prices for 15 years. The costs of building offshore wind has increased in recent years due to higher costs for financing and raw material costs as well as weather delays that have plagued projects. That means the UK will have to lock in new projects at a particularly expensive time. 

To reach the targets quickly, “we will need to select some projects which are less economical and have higher costs,” said Lorenzo Sani, a power analyst at energy research firm Carbon Tracker.

Power prices are calculated by the most expensive megawatt of generation needed to meet demand. When gas is needed, it will push the price to a much higher level than on days when it’s windy or sunny. Under one scenario envisaged by the UK’s National Energy System Operator, gas would be setting the power price almost half of the time, exposing consumers to international commodity markets.

Gas plants “will contribute significantly to the overall cost of power as they will be setting the price during periods of scarcity,” said Cornwall’s Edwards.

Building a large amount of wind capacity in Scotland doesn’t fix everything. So far this year, the UK has spent more than £1 billion in congestion costs to turn off plants when it’s too windy because of grid constraints, and to switch on others. As more renewables come online, and storage solutions fail to keep pace, that wasted energy is set to quadruple under both scenarios set out by NESO.

To help cut wasted power, the UK aims to speed up grid expansion to better move green electricity from the windiest, often remote regions, to population centers in England. NESO identified 68 projects that could be delivered by 2030, and said that delaying even one of those could add an extra £500 million per year in constraint payments.

The grid operator’s report found the UK could decarbonize power by the end of the decade without increasing costs overall. But that scenario is based on assumptions that may be unrealistic, including natural gas prices remaining at historically high levels and quadrupling of the UK’s carbon price. 

“If the carbon price doesn’t rise to that level and the gas price isn’t as high, then that idea that the clean energy system will cost the same isn’t correct,” said Tara Singh, managing director of public policy at Burson and a former lobbyist for Shell Plc.

The government could yet fudge delivery of cheaper domestic energy by shifting some components of power and gas to general taxation. Currently, wholesale costs contribute to just over 40% of total consumer bills, with the remainder including network costs, policy levies and operating costs. 

Regardless of what Labour does, any hope of a return to the prices consumers paid before the energy crisis is slim: Pranav Menon, a research associate at Aurora Energy Research, said he expects prices to remain “consistently higher” than the levels enjoyed from 2014 to 2019. 

Beyond the burden on consumers, higher power prices put the speed of the energy transition at risk as EVs, heat pumps and other parts of the economy set to be electrified battle with higher costs.

“High electricity prices are currently the greatest barrier to electrification of heat and transport and clean power 2030 threatens to worsen this.” Sani said. “The most important action is for government to stop this siloed approach and recognize that the real mission is the “Clean Economy” not Clean Power.”

--With assistance from William Mathis.

(Adds line on inflation release in paragraph 6.)