Security, affordability, the environment: Britain has an energy trilemmaby Michael Grubb / January 22, 2015 / Leave a comment
What does the tumbling oil price imply for Britain and its energy policy? Energy bills in the United Kingdom have been going up for years, and newspapers have been warning of the threat of blackouts. North Sea oil and gas output is declining, and political volatility in the Middle East and the Ukrainian crisis have heightened fears about Britain’s growing dependence on unstable international energy sources. The end of the year brought news that 2014 was the warmest year on record, also bringing back to the fore concerns about the consequences of fossil fuel emissions.
What will the present collapse in oil prices—to almost half the level only six months ago—do to policy?
The energy “trilemma,” the need to deliver security, affordability and on the environment—defines the central challenge. All three must be reconciled for an efficient and long-term energy supply.
But energy policy must also reckon with the extraordinary volatility and uncertainty surrounding fossil fuel markets. What will the present collapse in oil prices—to almost half the level only six months ago—do to policy?
The price rollercoaster
Do not be fooled. Only 15 years ago, oil cost close to $10 per barrel, and the Economist predicted it could go still lower and “would be unlikely to rebound.” Just nine years later it hit an all-time high of $147 per barrel, before settling back to near $100 per barrel, a level that markets came to regard as being the “new normal.”
The danger is that when prices are low, consumers get careless, governments traditionally draw back, and companies get leery of making new investments. Use of energy goes up—but exploration of new sources goes down. The low energy prices of the 1990s led to precisely these circumstances, as the rising demand for energy outpaced discoveries of new reserves. So, during the 2000s, the oil price rose spectacularly. In turn, this caused consumers to use less energy, governments to toughen up policies on efficiency and new energy sources, and oil companies to drill in tougher environments, such as in deep waters, the arctic and in shale fields. The net effect of a decade of high prices was to increase global supply capacity to a level that is now no longer needed.
The ensuing price collapse was inevitable. We have entered the downward swing of the fossil fuel rollercoaster and barring major geopolitical shocks, fossil fuel prices could remain low for some years. But this is an unstable basis for policy.
Putin’s invasion of Crimea and rising instability in the Middle East meant security dominated energy debates of 2014. The year before, more homes lost their power supply than in years—but this was caused by flooding early in the year, not a shortage of supply. Yet the public and political imagination is fired by the idea of the UK running out of power, with some blaming wind and solar, which fluctuate in output.
In reality, the biggest threats are from a decade of limited investment and the loss of several nuclear and coal plants due to age and environmental deadlines set in the 1990s.
What is needed to compensate for this loss of capacity is a new, smarter system, drawing on advances in efficiency and on shale (fracking).
The success of energy efficiency policies has compensated for this. Demand in Britain actually stopped rising at around the turn of the millennium. Demand for electricity and for energy overall has been falling since about 2005; both are now lower than they were 15 years ago, changes driven by government programmes. A smarter system could draw on improved energy management, industrial back-up generation, and refurbishment of retired plants, for example. Complemented where necessary with modest gas investment, this would allow the next government to guarantee a steady energy supply.
As for affordability, following years of rising bills driven by rising oil and gas prices, the cost of energy caused a political frenzy in 2013. Ed Miliband’s promise to freeze energy prices was one of his most popular moves. George Osborne reacted by halting plans for a gradually-rising charge, that would be paid by companies reponsible for CO2 emissions. Election manifestos may well carry promises of more changes. But this kind of political meddling would be a mistake. Reserves of cheap conventional oil are dwindling. The “new normal” of low oil prices is no more inherently stable than any previous one. Indeed, members of Opec (Organisation of the Petroleum Exporting Countries) can maximise their revenues through periodic cycles of high prices, which generate massive income, and low prices to kill off emergent, higher-price competitors. Affordability should be a sustained goal, based on long-term investment designed to withstand both the vagaries of fossil fuels markets and their environmental costs.
A little-known metric called the Bashmakov-Newbery constant suggests that—given time for adjustment and effective policy responses—national energy efficiency rises in line with prices, meaning that the overall costs of energy remain constant. This is born out by the observation that, in the course of the last 100 years, most countries have spent typically 8-12 per cent of Gross Domestic Product on energy despite huge fluctuations in energy prices. The reason is that low prices amplify complacency, waste and dependence. The Soviet Union subsidised energy and ended up with the world’s most profligate energy consumption and high bills. Conversely, high prices have led consumers, markets and governments to improve efficiency and develop alternatives.
The conventional wisdom is that when, as now, the price of oil is falling, it becomes more costly to maintain programmes that promote energy efficiency and to encourage the development of alternative energy sources. The struggle of this government was to fund these efforts on top of rising bills. The challenge for the next government is to maintain such policies even as bills come down.
If 2013 headlines about bills slowly gave way to 2014 concerns about security, 2015 looks like the year that will reassert the third part of the energy trilemma—environment. The CO2 concentration in the atmosphere is at a level not seen in 5m years. For the last half century, the average global temperature in each decade has been 0.2 degrees Celsius hotter than the last—2014 has turned out to be the hottest recorded year in history.
The European Union increased its goal for a reduction in emissions to 40 per cent below 1990s levels by 2030. In a joint US-China announcement, the US set reductions and China agreed to cap its emissions by 2030 or earlier. This orchestrated push by the major powers encourages all countries to set goals during 2015 in the run-up to a global summit in Paris next December. Decarbonisation is back on the agenda.
Faced with concerns about costs, the conventional environmentalist’s response was that clean energy would pay for itself, because fossil fuels would become more and more expensive “as the oil runs out.” Cheap oil makes that look like wishful thinking.
Yet history is salutary. In the oil shocks of the 1970s, projections of ever-rising oil prices prompted the British government to support £100bn of capital investment that helped to launch the UK offshore oil industry. The same is possible for new energy systems, but this would require investment on a scale comparable to the North Sea investments of the 1970s. Yet it could yield comparable long-term benefits.
Any credible policy requires accepting that energy is different. Unlike most products it is used by all people, all of the time, and yet is largely invisible and incidental. Only rarely do consumers deliberate on their energy needs and choices, and the whole system is based on massive long lived assets.
The price of energy—be it oil or electricity—is thus hopeless as a prime determining factor for making investments in large scale energy infrastructure projects, the consequences of which can span years. The knock-on effects for the environment and security are also felt in the very long-term, meaning that perhaps more than any other sector, energy is characterised by a disjuncture between the myopia of markets and the timescales and consequences of investment.
The essential challenge is to accept these realities while avoiding the politicisation of energy policy. For politicisation along partisan lines implies instability, which will hamper the investment that is essential to any strategy.
Also crucial for a rational policy is to understand innovation, which is vital in helping to deliver affordability, security and decarbonisation. Failure to grasp that innovation comes from investment and deployment, not R&D alone, lay at the heart of the decade-old belief in ever-rising fossil fuel prices. It also led to the notion that what the environmental cause really needed was a good oil price shock. We got one, but the oil industry did not turn away from fossil fuels as a result. Rather, the incumbent companies got substantially richer, and chose to spend that revenue on furthering their core business—developing new ways to get at more fossil fuels to sell.
Almost all of the impressive advances in clean energy have ultimately been funded by government incentives. No individual company can capture the full value of such innovation, and only governments can consciously steer the industry in a cleaner direction.
The present government’s energy legacy will be that it introduced the most radical reform for a generation: the Energy Market Reform Act, which took most of this parliament to put in place. Despite all the criticisms, warts and rough edges, it embodies the most essential need: it uses competitive forces as tools aligned to the strategic needs of the sector.
Politically, the success of these reforms has maintained the UK’s most valuable single asset to date: national consensus. Cameron resisted internal clamour and refused to be known as the prime minister who broke legally-binding commitments, specifically the UK’s EU target to get 15 per cent of its energy from renewable sources by 2020, on which hinge billions of pounds of investment. Labour too resisted the temptation to team up with the rebels who objected to the introduction of the reforms. All this has kept the target for renewable electricity within reach.
A future government will have no shortage of other challenges. In a market economy, paying for pollution is necessary, but rarely popular. Chancellor George Osborne deserves credit for introducing the rising floor price for carbon emissions, and some sympathy for freezing it in the face of a political firestorm and a widening gulf with the EU carbon price. But industry must be convinced that the cost of emitting CO2 is only going up. Restoring the escalator—and ideally helping the EU to reform its carbon pricing system—will slowly increase the cost to companies of emitting CO2, will accelerate the move from coal to gas and reduce the cost of subsidies to renewables, as well as raising revenue. In turn though, that will require a new approach to energy intensive industries.
With the collapse in fossil fuel prices and the completion of Britain’s market reforms, a new government will inherit a new world of energy. The acid test will be whether it seizes that as an opportunity to move forward, or as an excuse to go backwards.