Ensuring affordable energy: Key issues for the 2015 Parliament

In the new Parliament the energy sector currently faces a ‘trilemma’ of conflicting pressures:

  • First, consumers want affordable energy. Despite recent falls in wholesale prices, some households have still struggled with energy costs: 10% of households in England were in fuel poverty in 2012 (the latest figures available), and the proportion is not expected to have fallen in 2013 or 2014.
  • Secondly, there is the imperative to ‘keep the lights on’ in the face of a 30% to 100% increase in demand for electricity over the next 35 years.
  • Thirdly, under the Climate Change Act 2008, the Government is committed to reducing its greenhouse gas emissions by at least 80% by 2050.

In the new Parliament, policymakers therefore face the challenge of ensuring affordable energy, sufficient investment in new generation, and an increase in the proportion of supply from low carbon sources.

Affordability and competition

Competition between energy providers, overseen by the regulator Ofgem and endorsed by successive Governments, is seen as the main mechanism for keeping consumer prices in check.

However, there are widespread public concerns about the profitability of large energy firms and the prices they charge, and all the main parties are committed to improving energy affordability.

Chart 1: consumer gas and electricity prices

Consumer prices index, and gas and electricity prices relative to 2009 levels, January 2007 to March 2015

Consumer gas and electricity prices rose faster than prices generally during the last Parliament

Chart showing CPI and gas and electrictity prices relative to 2009 levels between January 2007 and March 2015

Ofgem has referred the operation of the energy sector to the Competition and Markets Authority, which is due to report by the end of 2015.

Its review will need to consider whether the market is operating in a way that prevents consumers from accessing the most competitive energy sources, whether indeed the main energy companies (the ‘Big Six’) have been making excess profits, and whether any further measures are needed to control prices.

The ‘capacity squeeze’

The capacity margin is the difference between expected electricity demand in the winter peak and the supply available from power stations to meet that demand.

The lower the percentage margin, the less flexibility there is to meet unexpected events, such as a power station suddenly becoming unavailable, or a sudden loss of fuel supply due to some unforeseen event. In essence, it is a measure of how close the lights are to ‘going off’.

This margin has tended to fluctuate in the past but it is expected by Ofgem to become lower than it has been. This is mainly due to closures of coal-fired power stations to meet environmental requirements, and the slow response of the industry in the form of investment in new capacity.

There is significant uncertainty and a wide range of expectations about the capacity margin over the next five years; but it is broadly envisaged that it will reach a low point in 2015/16 as further plants are closed, before rising gradually, thanks to new supply and a continuing fall in demand.

In the longer term, capacity will depend on the speed with which the industry responds through new investment, e.g. in nuclear capacity, renewables or gas-fired generation. It will also depend on the degree to which demand responds to programmes and policies to increase energy efficiency in both households and industry.

The previous Government’s solution to the ‘capacity squeeze’ was its Energy Market Reform (EMR) which aimed to provide incentives for investment in low carbon energy infrastructure through two mechanisms:

  • Financial support, to encourage investment in low-carbon electricity generation by providing companies with a guaranteed fixed price for the power they generate through what are known as Contracts for Difference (CfDs).
  • A Capacity Market, to financially support more reliable forms of power to be available when demand for power is high using an auction mechanism. This includes novel measures to pay users to reduce electricity demand at peak times.

The success of the EMR will be determined by the sector’s ability to meet future electricity demand, and the amount of public money it requires to do so.

Investment in renewables – meeting targets or meeting demand?

The UK is currently committed to an EU target for 15% of its final energy use to come from renewable sources. Half of this target is expected to be met through increasing the proportion of electricity generated from renewable sources, mainly offshore and onshore wind and biomass.

The previous Government also supported the more demanding EU-wide renewable energy targets for 2030.

Chart 2: electricity generation from renewables

Electricity generation by source, terawatt hours (projections for 2015 and 2020)

Electricity generation from renewables is projected to increase by two-thirds during the new Parliament

chart showing electricty generation by source (renewables, gas, coal, nuclear and other) in 2010 with projections for 2015 and 2020

Offshore wind is seen as a very significant energy resource for the UK going forward. Though expensive to build now, it is predicted that costs will fall. At the same time, constraints on onshore wind could increase customers’ bills as investment shifts to offshore and other more expensive technologies.

The previous Government set up the Levy Control Framework, which caps total Government funding to support renewable electricity up to 2021.

Contracts for Difference are already resulting in significantly reduced costs as previous subsidy mechanisms such as Feed in Tariffs and the Renewables Obligation are replaced.

There are also policy measures that will indirectly encourage investment in renewables. The regulation of carbon dioxide emissions from power stations, known as an Emissions Performance Standard, means that it will not be possible to build coal-fired power stations without carbon capture and storage.

Meanwhile, the introduction of the Carbon Price Floor has made low-carbon power generation more competitive with fossil fuel power stations.

Failure to invest sufficiently in renewables could affect security of energy supply and jeopardise the UK’s ability to meet domestic and EU targets.

The new Government will face a delicate balancing act between ensuring adequate investment and keeping consumer bills in check.

Party Lines

  • Labour: freeze energy prices until 2017, reform the energy market and create an Energy Security Board to plan and deliver the energy mix needed
  • Conservative: promote competition in the energy market
  • Greens: invest up to £35 billion over the Parliament in renewables
  • Liberal Democrats: back new entrants to the energy market and expansion of renewables
  • UKIP: support a diverse energy market that can be delivered at competitive prices

 

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