Covid challenge is a ‘skirmish’ compared to battle for net zero

The dual challenges of coronavirus and climate change should trigger an urgent rethink of the way low-carbon infrastructure investment is incentivised and rewarded, said industry experts at a Utility Week debate hosted in association with National Grid.

Key points from the debate:

• There is no time to waste in enabling the inevitable infrastructure investments needed to deliver the legally binding net zero target
• The costs of prevarication will be higher to society and the environment than the costs of investing ahead of need
• The post-coronavirus economic crisis will exacerbate challenges around the distribution of energy transition costs, but should not be allowed to cause progress to stall
• Triggering a wave of low-carbon investment will bring economic as well as environmental benefits by providing revenue certainty to supply chains and creating jobs
• Net-zero infrastructure investment must be taken with whole system decarbonisation front of mind
• Whitehall is unlikely to have the capacity to undertake systems thinking and understand whole system needs – leading to the need for a new independent energy system planning agency

The acute threat posed by the outbreak of Covid-19 has prompted unprecedented interventions by governments around the world to try and minimise loss of life, either as a direct or indirect result of the virus.

In line with this, industries and associated institutional bodies have responded with a war-like mentality, fast tracking the implementation of measures which can contribute to the fight against coronavirus. From reconfiguring manufacturing plants to producing all important personal protective and medical equipment, to pushing through code changes, flexing regulatory structures and altering working arrangements so that essential supplies of energy and water continue to flow – especially to critical sites – the pragmatic mobilisation of talent, ingenuity and resources has been inspirational.

Stand back from this good news story for a moment though, and consider the equivalent action to tackle what remains the biggest single threat to life as we know it on planet Earth – climate change.

The comparison is not a flattering one, as participants at a recent virtual round table debate hosted by Utility Week, in association with National Grid, agreed. One participant, a regulatory expert, observed: “Covid-19 is just a skirmish compared to the much more formidable crisis that is climate change!  It’s pretty thought-provoking to compare our societal responses to the two crises when put side by side.”

The event, which involved influential and experienced figures from the worlds of investment, regulation and policy as well as energy distribution and transmission, was tasked with considering the ways in which traditional energy system investment approaches may need to alter in order to deliver the UK’s legally binding net-zero target for 2050.

Resoundingly, the group agreed that the sense of urgency and pragmatism generated by the pandemic must now be captured to unleash a wave of investment in low-carbon infrastructure and facilitate the decarbonisation of key energy vectors, including heat and transport.

Doing so will not only head off catastrophic environmental damage but also provide a road to recovery from the devastating economic fallout of coronavirus, they said.

Furthermore, the group unanimously warned that prevarication on triggering investment is very likely to end up incurring higher and hard to bear costs to consumers and society – both in terms of the energy transition bill and continued environmental damage – than taking immediate low regrets action, even if we are not certain today of the exact shape and nature of a future zero -carbon energy transition.

As one event participant – an experienced thinker on policy and disruptive change – put it, “Yes, this transition is going to be messy. But we can’t hang around waiting for a perfect answer. We need to get on with it.”

Paying for the energy transition

This will for decisive and rapid action was not expressed without due appreciation of the complex challenges and uncertainties which must be addressed in order to unlock investment in some of the big ticket infrastructure upgrades and alterations which net zero – and especially the decarbonisation of heat and transport – will require.

Perhaps most notably, the group was acutely aware that an already contentious debate over consumer willingness to foot the bill for the energy transition – whether through costs on bills or in taxation –  has been exacerbated by the financial hardship and economic meltdown incurred by coronavirus.

“We must ensure that the costs of meeting our energy needs are balanced fairly across society and between current and future consumers” Read commentary on this debate from National Grid’s Darren Pettifer

A senior representative of a major consumer advocacy organisation shared figures to highlight the scale of the Covid impact on the financial wellbeing of consumers and households across the nation.

“Four in ten households have reported lost income as a result of Covid and one in ten households have lost more than 80 per cent of their income,” they said. The upshot, is that there are now “around 13 million households across the UK who have expressed concerns about being able to pay incoming bills as a result of the crisis”.

Notwithstanding this economic backdrop however, event participants emphasized that a “staggering amount of investment” will need to be delivered – much of it within the current decade – if the UK is to stay on track for net zero.

It is critical, they agreed, that an acute crisis in consumer financial hardship today should not postpone important decisions about how to fairly distribute the costs of energy transition. Indeed, the current crisis makes such decisions all the more urgent.

One senior representative from a major energy infrastructure provider commented: “We have to be really careful during the Covid recovery about willingness to pay. But at some point this investment is going to be needed if we are going to deliver net zero…and it is inevitable that costs are going to go up [for consumers]. The question is where those costs are going to come and how they will be covered.

“We need, therefore, to be confident we are investing in the right spaces. But we also need not to be too cautious. I think too much caution is not our friend in this space because the cost of getting this wrong is greater than the cost of taking steps slightly early.”

Rethinking risk and reward

This thinking prompted lively debate over traditional approaches to risk allocation and regulatory pricing of risk in relation to infrastructure investment. And a strong feeling emerged that longstanding approaches in this area may no longer be fit for purpose.

For example, in the context of “truly worrying” budget deficits across many European countries, one experienced infrastructure investment expert suggested investors will become increasingly “thoughtful” about how much regulatory and political risk they can accommodate within revenue constructs.

“What we need is more certainty for longer periods of time so that people can lower their costs of capital. And to my mind, for a while there has been an under-pricing of regulatory risk in the utilities market – both in the public market and in the private market. I think there is a good case for a shift in regulatory practice.”

While there was no indication from regulatory experts involved in the discussion that Ofgem’s position on cost of capital for upcoming transmission and distribution price controls might be reopened for debate, there was some potentially significant discussion of other possible ways of treating investment risk which could facilitate large scale low carbon investments ahead of need.

For instance, one influential regulatory thinker mulled the potential for a new incentive within the networks regulatory regime which could reward companies for taking long term low carbon bets and compensate them for the loss of cost sharing benefits – which tend to arise from minimising capital expenditure – in the meantime.

They asked: “Do you need some kind of low carbon incentive which says to the networks, if you achieve a particular outcome over a longer period of time you will get remunerated for it and compensated for the fact that you will have had to spend more and therefore benefited less from any interim cost sharing incentives?”

Other suggestions for mechanisms which might provide enough certainty for investors to back important low-carbon technology and infrastructure projects centred around revisiting and adapting the EMR toolset and using much sharper carbon pricing.

One area which attracted some significant debate, for example, was the potential to build on EMR in order to create a “more ambitious” auctioning system for capacity or flexibility which can “correctly price” low carbon investment risk.

Using an auctioning approach could provide a “powerful system for getting investment signalling right” reflected one regulatory authority. They added that while it might be “complicated” to auction network capacity, “it is not impossible, and has been done with interconnectors.”

Another suggestion was that a new equivalent to the Renewables Obligation could be created to spur investment in infrastructure for low carbon heat. And simultaneously, several members of the group mourned the “tragic” demise of the non-domestic RHI as a sever blow to the decarbonisation of heat agenda.

The systems thinking imperative

On which note, it should be recorded that all participants in this debate repeatedly and passionately argued that whatever mechanisms and policy frameworks are brought forward to support net-zero investment, it is critical they are designed with whole system decarbonisation in mind.

Without this foundation in systems thinking, it was feared that suboptimal investments will be incentivised, pushing the UK off course from delivering its carbon budgets. But furthermore, that without systems thinking, there will be no way of bringing forward investments in complimentary gas and electricity system infrastructure which can head off rising renewables curtailment costs.

These costs are “frightening” said one influential energy policy advisor and will soon become “publicly unacceptable”. Other participants agreed and said that the prospect of a curtailment costs scandal should be used as a driver for investment in hydrogen infrastructure, since “hydrogen is clearly a vector which can absorb that excess renewable generation”.

Having made the case for systems thinking as a key component to creating market confidence in emerging low carbon technology areas however, it was also agreed by most contributors in this debate that government currently has “no bandwidth” to develop it due to the combined major distractions of Brexit and coronavirus.

Consequently, there was strong backing for the idea of creating a new, independent energy planning authority which could make strong and meaningful recommendations to government, and regulators, on the priority levers which should be pulled to deliver whole system decarbonisation, at pace and within the bounds of affordability.

A suggestion was made that this authority might be the National Infrastructure Commission, which subsequent to this debate published a report recommending a new framework for ensuring infrastructure resilience in the future. The report stressed that legacy approaches to considering risk and resilience will not serve in the face of future challenges, in part due to increased interdependency between different infrastructure systems.

However, this suggestion was countered by one seasoned energy policy shaper, who said instead that Transport for London provided a “better analogy” for what is need in the energy system.

“TFL does the systems thinking about transport across different modes for London,” they said. “It is politically accountable, at the end of the day, for its performance. But it does provide an integrated set of solutions for the transport network in London which thinks about the interplay between cycling, the tube, buses and so on.

“I think it is a good analogy when you think about the kind of system thinking we need in energy because I think the next phases of this – we’ve talked a lot about power as ever – is much less about power and much more about the integration of power, heat, transport and industry.”

Representatives from the world of policy and regulation claimed to be “open minded” about this call for change in the institutional architecture governing energy system investment and acknowledged the need for it – though one participant also called the new institutional architecture imagine by Dieter Helm in his 2017 Cost of Energy Review “far-fetched”.

Build Back Better

Even with the kind of emergency mentality embodied by the Covid response however, most participants accepted that major changes to the institutional architecture of the energy system are unlikely to emerge in the very near term.

In the meantime therefore, it falls to existing actors in the energy system to ensure that investment plans which can offer “optionality” for future low carbon pathways are fast tracked where possible, our group said. It was also emphasized that demonstration projects which will create an evidence base for understanding the economics around promising low carbon solutions – such as hydrogen, are progressed at scale.

There was therefore a strong message to the regulator, especially from infrastructure owners around the virtual table, that it should consider its ability to use the RIIO2 price control processes as a lever for triggering a spate of both incremental and big ticket infrastructure investments for net zero. Importantly, this should cause the regulator to revisit the way it currently incentivises networks to minimise in-period expenditure.

Unlocking investment ahead of need in “no regrets” low carbon infrastructure is critical to ensure the UK makes good on its promise to tackle climate change. But our group also emphasized the redoubled importance of sparking capital programmes in the wake of coronavirus give the “enormous” potential of this activity to create jobs, encourage liquidity in supply chains and contribute the UK’s economic recovery from coronavirus.

Now, more than ever before, our group concluded, it is essential that government and regulators use their powers incentivise investment to tackle the dual crises of coronavirus and climate change. They must use all options available, including the regulated price controls, to contribute to a burgeoning national determination the “Build Back Better” for the long term.

Participant quotes:

“Covid-19 is just a skirmish compared to the much more formidable crisis that is climate change!  It’s pretty thought-provoking to compare our societal responses to the two crises when put side by side.”

“For a while there has been an under-pricing of regulatory risk in the utilities market – bot in the public market and in the private market. There is a good case for a shift in regulatory practice.”

“We need to make space on the energy bill  to fund the investment that is going to be inevitable over the next 10-15 years for net zero and that means bearing down as hard as we can on the running costs of a lot of these  businesses and on the cost of capital. I think by making sure that risk allocation is efficient.”

“The ESO’s curtailment costs are going to go through the roof. That is going to be a story in itself as consumers end up paying twice for the same power – and it’s not a good story…We need systems thinking to understand how are we going to harness the excess renewable generation. Hydrogen is clearly a vector that can do that.”

“If we want the tax system to not only be progressive but also to support net zero, surely we want to be taxing the things we are trying to discourage – like carbon  – and keeping taxes down on things we want to encourage – like labour. So we need to get the debate going about the future of green taxes in a way I see no evidence of at all at the moment.”

“Do you need some kind of low-carbon incentive which says to the networks, if you achieve a particular outcome over a longer period of time you will get remunerated for it and compensated for the fact that you will have had to spend more and therefore benefited less from any interim cost sharing incentives?”

“A lot of this investment is going to move us towards a world which is a capital intensive world, with low marginal costs and high fixed costs. How those fixed costs are distributed across the population, certainly in the short term as we come out of Covid and also in the longer term, are hugely important policy questions.”