Oxford Business Law Blog - May 2024
**[co-author: Iona Gilby]
‘Energy security and net zero are two sides of the same coin.’ This is the opening line of the UK government’s ‘Net Zero Growth Plan’, published in March 2023, and leaves no doubt as to the government’s perception of the interplay between energy security and energy transition. Declining North Sea reserves, energy majors with interests in the UK divesting (in no small part, as a response to the target of net zero by 2050), and geopolitically precipitated disruptions in the global traditional energy supply chains, inter alia, provide an important context to situate the foregoing twin aims. The urgency for an adaptable system is felt and reasonable, but is the framing of the discussion—which will orient the analysis and animate policy prescriptions—correct?
The International Energy Agency (‘IEA’) defines energy security as ‘the uninterrupted availability of energy sources at an affordable price.’ We conceptualise this definition in two limbs: uninterrupted availability as ‘Limb I (Sustainability)’ and affordable prices as ‘Limb II (Affordability)’. However, in many industry and policy conversations about the UK’s energy ecosystem, energy independence is often included too (we call this ‘Limb III (Independence)’). In the UK, there is a clear and conscious decision to marry the concepts of energy security and energy independence. Consequently, the full construct of our conceptual framework for understanding the UK’s approach to energy security includes all three limbs (‘Energy Security’).
The UK needs to recalibrate its approach to Energy Security by (i) deconstructing its limbs, (ii) accepting that its constituent elements can be incompatible, and (iii) creating a coherent but malleable hierarchy that allows for balancing and trade-offs. This post argues, using the grid as a working example, that a refreshed framework for understanding energy security, which prioritises investment in domestic infrastructure and secure international partnerships, and incentivises private investment, will balance the competing aims of Energy Security while streamlining the UK’s approach to energy transition.
Issues with the Grid
The IEA warns that global annual investment in grids needs to double to more than $600bn a year by 2030 to meet national climate targets and support energy security. In the UK, the queue to connect to the transmission grid is clogged (‘TG Congestion’), with over 547GW of generation projects on the Transmission Energy Capacity (‘TEC’) Register as of September 2023. Connection dates for generation are now as late as 2038. However, rather than singularly focusing on building more infrastructure, which (we acknowledge) would increase short-term costs for consumers, National Grid ESO (the energy system operator in England and Wales) also opts for constraint payments—ie payments made to generators as compensation for reducing their output when the network can’t physically transfer the power from one region to another—to minimise price rises and thereby promote Limb II (Affordability). Constraint payments are suboptimal because they deploy funds that could otherwise be used to improve infrastructure, reduce TG Congestion, and expand grid access, which undermines Limb I (Sustainability).
Investment in Domestic Infrastructure
The UK is looking to transnational interconnectors to relieve some of these grid pressures. They help to balance the grid by exporting surplus electricity when demand is low or there is excess generation and can import electricity when the inverse is true. They also diversify the mix of electricity generation by connecting the UK to countries with a different energy balance, such as hydro power in Norway and nuclear power in France. However, the extent to which these interconnectors can reduce costs for end-consumers is contingent on private and public investors being aligned with respect to aims and outcomes.
One such interconnector project, which is real-world and actively ongoing, aims to bring renewable electricity from the African continent to Devon (the ‘A Project’). Its 3,800km underwater high voltage direct current cable is estimated to cost £22 – 24 billion (having already increased from £20 billion) and is reported to be able to generate power at £15 per megawatt hour (£15/MWh) in today’s prices. However, the A Project’s feasibility largely hinges on the cost of transporting electricity from the Sahara. Even if the anticipated cost savings at the point of generation (and transportation) are realised, they may be minimised when we consider that wholesale costs only account for approximatively 35% of end-consumers’ electricity bills. The remaining 65% is made up of VAT, supplier operating costs, government ESG obligations, supplier pre-tax margin, network costs and other direct costs, all of which the government controls but does not fully invoke when considering how best to facilitate interconnectors for the benefit of end consumers.
Secure International Partnerships
If transnational interconnectors are long-term low cost, and for that reason desirable, it is unhelpful to develop policy concerning the same in the context of a framework that is hostile to promoting international partnerships. To achieve any potential cost savings through interconnectors, we must ‘sacrifice’ Limb III (Independence) and thereby undermine Energy Security in pleno (as conceived by the UK government).
To be sure, the current framing of Energy Security, reasonably, highlights weaknesses associated with (over)reliance on third countries. Notwithstanding the foregoing, securing compatible international partnerships as opposed to viewing them with suspicion is the best path forward. In early 2022, France announced that it was developing a seabed warfare strategy, and in February 2023 NATO set up a Critical Undersea Infrastructure Coordination Cell to boost the security of undersea infrastructure. Similarly, following Russia’s invasion of Ukraine in 2022, the UK accelerated the procurement of ships for the Ministry of Defence’s Multi-Role Ocean Surveillance programme. The foregoing demonstrate that the UK and its international partners have a strategy for combatting these physical vulnerabilities, which, through collaboration, bolsters energy security.
Interconnectors, like the global renewable energy supply chain, cannot guarantee electricity supply or reduced prices for end-consumers. At the same time, government policy and investor confidence suggest that the UK needs these countries—whatever politicians say about energy independence.
Incentivising Private Investment
To incentivise private investment and promote Energy Security, the UK government must guard effectively against industry risk.
In July 2023, Vattenfall halted work on the Norfolk Boreas scheme. It blamed surging costs, which made the project unviable given the record low strike price locked in for its electricity in June 2022. One source of these rising costs is steel, which rose 50% over 2020 and 2021, and has increased further due to the war in Ukraine. This trend is set to continue with the introduction of the EU’s Carbon Border Adjustment Mechanism (‘CBAM’), which applies to, inter alia, steel imports.
CBAM equalises the price of carbon between domestic products and imports, which disincentivises importing carbon-intensive products as a replacement for what were previously more expensive, greener, EU-produced alternatives. UK energy and infrastructure projects must comply with CBAM reporting, registration, and verification requirements, particularly if they hope to export electricity to the EU through interconnectors. Additional costs and penalties for incorrect estimates of expected embedded emissions must now be factored into investment decisions for UK projects. Investors must also consider whether the costs of green imports and compliance outweigh the costs of sourcing fewer green alternatives.
In addition to ballooning costs, negative pricing attributable to cannibalisation also stymies investment. Price cannibalisation occurs when increased volumes of renewables with the same generation profile produce at the same time and depress power prices. With marginal pricing, the buyer carries the cannibalisation risk and ‘overpays’ for the generation. As renewables make up an increasing proportion of the UK’s electricity generation capacity, they will set the wholesale price where they are able to satisfy demand for a given period. And, as there is no floor on how low energy prices can go in the UK, negative pricing caused by cannibalisation poses a serious threat to the viability of renewables projects. For example, EPEX SPOT hourly day-ahead market prices reached a record low of -£70/MWh in July 2023.
The UK government’s plans must account for this disincentive. Potential solutions include introducing a floor price for renewably-generated electricity, or incentivising wind-plus-storage and going beyond the announcements in the Spring Budget 2024 to raise barriers to entering and remaining on the TEC Register, by modifying the rules to allow previously approved projects to introduce storage capacity without leaving the queue.
Conclusion
Energy Security, by virtue of its currently confused agenda, hamstrings the UK. A new strategy which prioritises investment in domestic infrastructure and secure international partnerships will make the UK an attractive and reliable prospect for private investment. This new direction will reflect some of the aspects of UK policy that are already succeeding (despite often being incompatible with Energy Security)—increased generation capacity, successful partnerships with European neighbours through interconnectors, and investment in grid networks. It will also enable policy makers to make thoughtful decisions about how best to pursue energy transition in a way that is coherent and that lights the way for private investment, both in the technologies and infrastructure of the future, as well as those we continue to rely on.
**Iona Gilby is a Trainee Solicitor at Vinson & Elkins RLLP.
