Is net zero and environmental policy responsible for rising energy bills?

Is net zero and environmental policy responsible for the energy crisis we’re currently going through?

It’s one of those charged questions being asked not just in households across the country but in Whitehall too, with Conservatives arguing that the current spike in costs is proof that the UK needs to concentrate more on extracting fossil fuels than pursuing its goal of eliminating greenhouse gas emissions by 2050.

And like most questions in this deeply complex arena there’s no simple answer and no easy answers – contrary to what some people might like to imply.

So let’s take this step by step.

Why the UK remains reliant on natural gas

First off, let’s go back to basics and remind ourselves where we get most of our electricity these days.

A few decades ago the main fuel we used to power the grid was coal, but these days coal accounts for barely a fraction of our power.

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This is a non-trivial switch, given that natural gas – while still a fossil fuel – emits 44% less carbon than coal.

Here in the UK a bigger and bigger proportion of our power is coming from onshore and (even more so) offshore wind.

Indeed, in recent weeks there have been days when more than half of all our electricity came from wind power.

Yet because the wind isn’t always blowing hard, there have also been days in the past few weeks where wind contributed only about a tenth of our power and the majority came instead from gas.

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That wind power (or for that matter solar power) are inherently intermittent is not going to stop this country from eliminating greenhouse gas emissions in the coming years.

In the longer run the plan is to have forms of energy storage which can adjust for this: when the wind is blowing hard electricity can be stored up in batteries or hydrogen which can then be spent on calmer days.

But such technologies are in their infancy, so in the meantime the best backup we have is natural gas.

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That means that the UK will remain reliant, one way or another, on natural gas for some time. Which means in turn that it will have to pay international prices for that gas as and when we need it.

That we also use a lot of gas for our central heating only compounds this reliance.

I say “international” prices to underline that even if the UK were producing more natural gas domestically, we would still have to pay those prices – unless we’re intent on disconnecting our economy off from the rest of the world.

Anyway, having established that we still need gas for quite some time, let’s tackle the first big question: are those international gas prices influenced to some extent by environmental policy?

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Teasing out the root causes of movements in international assets is never all that easy, especially when there’s a lot going on, and when it comes to global energy markets there’s certainly a lot going on.

The world has just lurched down and up on the biggest economic rollercoaster in memory.

Energy markets have been affected by all sorts of unusual factors: low levels of hydroelectricity in China, low wind speeds last summer in Europe.

And that’s before one considers the Russia factor: how much of what we’re seeing in gas prices is a reflection of concerns over what might happen in Ukraine?

The short answer is that no one knows for sure but most people assume these are contributing to higher gas prices.

But something else is happening too.

China increasing its use of natural gas

Over the past decade or so we’ve seen a gradual and then not-so-gradual shift in the fuels being used for power in Asia.

One way of looking at it is by considering Chinese fuel imports over recent years.

Back in 2012 China imported $25 billion worth of coal and just over $10bn of natural gas in its liquefied form. But by 2019, just before the pandemic, those numbers had reversed: $29bn liquefied natural gas imports and $19bn coal imports.

You see what’s happening here: China is sucking in ever more gas as it quietly shifts over from coal.

Don’t discount how big a deal this is: gas is 44% less carbon intensive than coal, and were China to shift all its coal power stations onto gas tomorrow we’d instantly be on track to keep global warming below 2C.

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But the upshot is to push up demand for gas which, in the absence of more supply, will also push up prices.

And given it’s not altogether clear supply is rising as fast as demand (certainly in the past year or two, due in part to the difficulty of building more LNG projects during the pandemic), then it’s hard not to conclude that higher Asian demand for gas (which is itself in part driven by environmental concerns) is at least a part of the explanation for higher global gas prices.

Then there’s the direct impact on households.

As you might have noticed when scanning your energy bills, on top of the wholesale costs and operational costs of the typical bill is something else – “policy costs”.

This includes “environmental and social costs” and while not enormous (about 8% of the average bill as of the new price cap levels) it is not trivial either.

Clearly this represents extra financial pressure for households.

But here’s the thing: this slice of our bills is actually a legacy of the past.

To see why you need to look at the lifetime costs of different energy sources.

The lifetime costs of different energy sources

As of 2009, the cost per megawatt/hour of gas was $83 while the MWh cost of wind was $135 and solar was $359.

As of 2021 those costs had completely reversed: wind and solar were $36 per MWh versus $60 for gas.

Now, those costs don’t take into account the intermittency issues we’ve covered above, but they nonetheless underline that new subsidy-free renewable power is actually cheaper than fossil fuels.

But there are two problems: as I say, due to the way the government financed early investments in renewable, we paid quite a lot of money at those higher costs – costs which are still being recouped via that “policy costs” slice of our bills.

The second is that even though renewables are cheap over their lifetime, they are still pretty expensive to build (the point being that unlike coal and gas you don’t need to keep feeding them with fuel).

They are also considerably less power dense than their fossil fuel counterparts.

Consider the up-front costs alone. If you are a company or country desperate for extra power capacity here’s how much you have to pay for a given power source for a MWh of power a year: gas: $29, wind: $840, solar: $1,007.

You see where we’re heading here.

Governments aren’t spending that much on green energy projects

If we’re serious about replacing fossil fuels with renewables we will have to build an awful lot of them and while the eventual lifetime cost could be lower than fossil fuels, the short-term cost per MWh is way, way higher.

So if we’re serious about net zero you’d expect our governments and companies to be spending extraordinary amounts on new primary power projects right now.

But glance at the statistics and it turns out we’re not.

On the contrary, investment in primary energy – those plans and solar panels and wind turbines we need to give us power – has flatlined since 2015.

Some of this might be down to falling prices but, frankly, not all of it.

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In other words, the real concern might not be about the current energy crisis.

The real concern is that countries around the world are under-investing in their energy supply.

The real concern is that this under-supply means we face not just a few months of higher energy prices but many years of it.

Of course, teasing out whether this is the case is tricky. It’s a hypothesis more than a prediction.

But the point is that the data as it currently stands is just as consistent with the theory that we are facing a long-term energy shortage as it is with the theory that this is simply a short-term bump, caused by COVID and tensions over Ukraine.

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