The energy crisis, heat decarbonisation and policy implications

In this post I’ll consider what is going on in the global energy market, local implications and how it may affect plans for heat decarbonisation. It’s UK focussed but will be applicable to other countries with a heavy gas reliance. TLDR: Go as fast as you can on energy efficiency and renewables.

The context

The current energy crisis is fundamentally a gas supply crunch. Gas prices are affected by a number of factors, primarily extraction costs but levels of demand and supply constraints have a big impact too.

Following a reduction in global gas demand in 2020, the world woke up from the covid lock-downs and has seen the demand for gas increase above 2019 levels in 2021. Around half of the EU’s gas imports come from Russia with some also ending up in the UK via this route. Concerns have also been raised that Russia may be playing power politics with supplies to the EU, increasing scarcity and therefore also further driving up costs.

The scale of these international gas cost increases is shocking, maybe scary is a better word. In Asia, liquefied gas prices are up five times on the previous year. Even in the US, a net exporter of fossil gas, has seen prices double on the year before.

For countries which are heavily reliant on imports, the impacts can be most significant as international marginal prices end up setting local prices. Below is UK National Balancing Point (read UK wholesale market) prices for the past 5 years. You can see why some are predicting UK energy bills may double.

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Enter the new experts

It’s been interesting and quite depressing, to watch some of the UK’s commentators and politicians suddenly proclaiming their energy market expertise, despite never showing any interest in energy before and indeed not having any expertise. The most disingenuous claim of course is that UK bills are being pushed up by climate change and renewable energy policies. The reality is than any subsidy costs now pale into insignificance compared to wholesale prices (see above graph).

There is another line. According to some, shale gas, could have and could still save us. Yet even in 2013, the boss of Quadrilla admitted, the quantities of shale gas needed to affect prices would need to be gigantic.  Something that is just not going to happen, certainly any time soon and almost definitely not before the 2 degrees global warming target is breached. Short version: the UK is not the USA.

Blue hydrogen never lived

One positive outcome of the price rises is that the idea of blue hydrogen, i.e. that produced from gas with CCS, is basically dead. Even before the gas price rises, analysts were predicting that green hydrogen (from renewable electricity) would be outcompeting blue nearly everywhere by 2030. Clearly the gas price rise will have hurried that along, to a point where investment decisions being made today on blue hydrogen would be taking a humongous risk.

Hindsight is a wonderful thing; but don’t let them tell you this has anything to do with hindsight

That Europe’s two heaviest gas users for heat, The UK and the Netherlands, were to become increasingly reliant on imports and that gas would likely become more expensive as production became more marginal has been obvious for many years. Although very few people have been saying this, and indeed the Government’s own expert review by Dieter Helm suggested that idea of rising global gas prices was a ‘doubtful assumption’.

The best way to shield yourself from these not necessarily predictable, but very possible, gas supply events is to use less gas. When you live in a country with some of the least efficient housing stock in the continent and you already know that there is still loads of energy efficiency work which is cost-effective (before these price rises) you’d think getting on and doing the energy efficiency would be a fairly obvious strategy.

Yet with the recent heat and buildings strategy, there is still a chasm of policy and political will that could do with a whole lot of rock-wool filling. And still energy efficiency is rarely mentioned by anyone in power. Please don’t tell me energy efficiency isn’t sexy. I don’t care….it just needs to get done.   

Cost paradox

Yes, it (energy efficiency and getting off gas) will cost something in terms of capital investment. But the real cluster-f*** here is that while over the past decade there was loads of cash washing around with equity funds literally begging for places to squirrel away their trillions, the UK, and countries in a similar position are now going to have to spend a fortune. This is not just on the expensive gas itself but also on the associated impacts be that suppliers going bust, business bailouts and because it will likely lead to both inflation, higher government spending and a lower tax take. As Energy UK CEO Emma Pinchbeck pointed out, these prices represent a ‘systemic economic risk’.

WHO KNEW that going harder and earlier on renewables and energy efficiency would be a good idea!

And so now, we’re in a place where clearly the long-term answer is to deploy energy efficiency literally as quickly as possible because SO MUCH MORE is now cost effective (relatively). And on the supply side renewables look EVEN MORE cost-effective.

Taking a look back to the macro-economic level, analysis by Cambridge Econometrics for Greenpeace showed that decarbonising heating is far from a cost but actually a money maker because we spend so much on energy imports and decarbonisation would reduce imports and create all sorts of positive economic feedbacks (multipliers). And that was before these gas price increases. Increasingly, decarbonising heating looks financially very positive, and that’s not even considering issues of health and comfort which it would also deliver.

At a household level the picture is also good. Taking a house from an EPC E to a B (as I have done), which includes insulation, a heat pump, a smart tariff and solar panels, bases on todays rates, takes the heating bill from £1600 per annum, to £375.

I’ll say it again, yes this costs something to do. But the return is excellent and the benefits last….. in perpetuity.

Room for optimism?

An economist might tell you that high gas prices are good for decarbonisation because, as pointed out already, renewables and energy efficiency suddenly look even more cost effective. However, energy markets form part of a political economy and as such are heavily shaped by policy and politics. And, humans are not economically rational actors. For example even though energy efficiency (and now solar panels) are cost effective, doesn’t mean they will happen.

So in the longer term, the government needs to reshape the energy market, while making sure households are supported to act. And the scale of the support and intervention needed is huge, even though it is cost effective.

But clearly in the shorter term something is needed to protect people from the expected huge price rises which will, terribly, likely, very sadly, lead to suffering and deaths. As many have recognised, cash will be key here because it can be arranged quickly and will solve the short term problems. Many options are on the table here from tax cuts to new grants and moving policy costs into government debt.

The longer-term strategy

One way to provide cash, or at least reduce bills would be to move the quite significant levies currently on electricity into general taxation. Of course whatever is done, someone pays eventually. And the removal of levies alone may not be enough for most households. However, such a strategy would have the added benefit of further shifting energy system economics towards electrification.

Before the crisis, there were also been calls for a carbon tax on fossil fuels. But with the current price of gas, such a financial move would currently be unnecessary and would lead to further short term cost issues. It’s possible that in the longer term, gas prices fall although will what happen is extremely uncertain. If prices were to fall, perhaps something akin to a minimum effective carbon price could be introduced to reduce the risk of electrification gains being lost. The introduction of an emissions trading scheme on heating, as has been proposed in the EU, could also be a sensible backstop.

I’m not an economist, but the risks of generic windfall taxes are quite clear, even though they may be politically and socially popular. Electricity market reforms have also been suggested to ensure that the lowest cost forms of electricity get built, and also that consumers receive those low costs, rather than allowing gas to set the system price, much of the time. There are very good arguments for maintaining marginal pricing models, but, perhaps the risk and operational profile of electricity systems with very high proportions of renewables means other models need consideration.

Of course finance will also be needed to support households and businesses fit energy efficiency measures, add solar panels and install low carbon heat pump based heating systems etc. There are multiple routes to deliver this finance with funding coming from general taxation seen to be more popular and fairer than private finance alone. But cheap loans, such as those currently offered by Germany’s KFW development bank (which are now self funding) have been recently suggested by the UK Climate Change Committee as something which would offer clear value.

Will the stars align?

The current energy pricing crisis could, in theory, support a more rapid transition to a sustainable energy system. The cost-effective pathway to zero carbon, based around renewables which have themselves seen rapid price reductions, is even more cost-effective. For the UK, such a pathway, likely to be based around offshore wind generation, would also reduce exposure to future energy price shocks as energy imports would be reduced.

But even with the shifting economics, the transition will still need to be enabled. In addition to the finance requirements already mentioned, regulation of suppliers and networks needs to be updated, as do building and energy regulations more broadly. Of course the winding-down of certain sectors will need to be carefully managed too.

But there is now no risk on going as fast and hard on energy efficiency and renewables as possible. The biggest risk is if our policy makers fail to see the medium and long-term outlook and get blinded by short term politics, fossil fuel industry lobbying and other distractions. I’m always a hopeful person – so let’s hope history isn’t anything to go by.

N.B. These are my personal thoughts and this blog was written in my own time. The cover photo is from the coast path in Falmouth looking towards St Anthony’s lighthouse on a recent rare dry dog walk.

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